8. Overhead Apportionment and Flexible Budgeting Heron Ltd has two Production Departments I and 2 and two ancillary Service Departments X and Y - Leaving Cert Accounting - Question 8 - 2012

To transfer the service department costs:

1. Determine the total service department costs that need to be apportioned based on existing machine hours.
2. Calculate the percentage of total machine hours that each production department utilizes relative to the total machine hours. 3.6,000 machine hours for both departments relative to the service department's hours, let's assume:

• If Dept 1 uses 60% of total hours and Dept 2 uses 40%, apportion the total service costs based on this ratio. Thus, this will allow for a fair distribution of service costs to the production departments.

To calculate the machine hour overhead absorption rates:

1. Dept 1:

   • Total Overheads assigned to Dept 1 divided by machine hours of Dept 1.

   • If total overheads are €36,060 (as per prior calculation) and machine hours are 4,000, then:

   • Absorption Rate = ( \frac{36,060}{4,000} = 9.015 \text{ per machine hour} )

2. Dept 2:

   • If total overheads assigned to Dept 2 is €24,540 and machine hours are 2,000, then:
   • Absorption Rate = ( \frac{24,540}{2,000} = 12.27 \text{ per machine hour} )

Transferring service department costs to production departments is necessary as these costs contribute to the overall production process. The reasons include:

• Accurate Costing: Understanding the full cost of production requires including all relevant costs, including those from service departments.
• Decision Making: Management decisions about pricing and profitability depend on accurate cost accounting. Without including service costs, decisions may lead to underestimating the true costs.
• Budgeting: Effective budgeting and forecasting require a comprehensive view of all costs associated with producing goods, thus including service department costs ensures all variable and fixed costs are accounted for.
• Performance Evaluation: Properly allocating overhead allows for more accurate performance measurement of departments, showing how well each is utilizing resources.

To separate production overheads into fixed and variable elements:

• Fixed Costs: These remain constant regardless of production levels and include:

  • Depreciation of equipment and factory buildings
  • Administration expenses

• Variable Costs: These change with production volume, including:

  • Direct materials
  • Direct labor
  • Production overheads (calculated previously based on volume, e.g., €5.70 per unit)

All variable costs are computed based on the number of units produced, while fixed costs remain unchanged within a specified range of production.

Creating a Flexible Budget using Marginal Costing involves the following steps:

1. Calculate Total Sales: At 95% activity level of sales.
2. Identify Variable Costs: Sum up all variable costs at this level.
3. Calculate Contribution Margin: Subtract total variable costs from total sales.
4. Deduct Fixed Costs: Establish the total fixed costs from production overheads and other expenses.
5. Establish Profit: Calculate the overall profit by subtracting fixed costs from contribution margin.

By depicting each of these components visually, you can create an understanding of how costs behave at various activity levels.

Controllable costs are those expenses that can be regulated or influenced by the actions of a manager. For example:

• Direct Labor Costs: A production manager can choose to hire more workers or manage current workforce hours.
• Direct Materials: Management can negotiate prices with suppliers affecting input costs.

Uncontrollable costs, on the other hand, are those that cannot be changed by the manager within a certain time. For instance:

• Rent or Property Leases: Typically a fixed expense that cannot be altered in the short-term.
• Depreciation: While managers can decide on the level of investment, once the asset is acquired, the depreciation expense is fixed based on the acquisition cost and policy. Thus, understanding the difference between these costs assists managers in effective budgeting and financial decision-making.