Question 2

A.

1. ‘Direct costs are always variable relative to the level of output, indirect costs are always fixed.’ Comment on this statement, providing examples to illustrate your points.

2. Research evidence shows that the direct-labour-hour basis of overhead absorption by cost units (products) is the most popular basis used in practice. Is it a logical basis? Explain your answer.

B. You have been asked to suggest a method of deducing the full cost of various production orders of Patel Ltd. This method will be used as a basis for setting prices. The production orders vary greatly in size and nature from one to the next.

The following information has been taken from the budget for the forthcoming financial year:

The business is not departmentalised for accounting purposes.

All direct labour is paid the same hourly rate.

Required:

(a) Calculate the two following overhead rates for the year; the Direct labour hour (DLH) rate of overhead recovery and Machine hour (MH) rate of overhead recovery.

(b) Prepare full costings for Order No 101 using each of the rates calculated in (a) (that is, two separate costings).

The cost sheet for Order No 101 shows the following:

Raw materials                                         £5,000

Direct labour hours                         4,000 hours

Machine hours                                 1,900 hours.

(c) State briefly which of the two bases of overheads you prefer and why. How might you improve on the two possible costs that you derived in (b) by taking a slightly different approach?