Economic Order Quantity (EOQ): Practical Problems and Solutions

Problem 1 The John Equipment Company estimates its carrying cost at 15% and its ordering cost at $9 per order. The estimated annual requirement is 48,000 units at a price of $4 per unit. Required: What is the most economical number of units to order? How many orders should be placed in a year? How often should an order be placed? Solution 1. What is the most economical number of units to order? An…

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Calculating the Machine Hour Rate

What Is Machine Hour Rate? A machine hour rate is the hourly cost in terms of factory overheads to operate a particular machine. It is obtained by dividing the factory expenses associated with the machine for a given period by the number of hours worked by the machine during that period. In Thothadri, Nafeesa, and Jalalutheen’s seminal 2019 book entitled Cost Accounting, the machine hour rate is d…

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Blanket Absorption Rate and Departmental Absorption Rate

Blanket Absorption Rate Blanket absorption rate is used in relation to the recovery or absorption of overheads. For ease and simplicity, a common absorption rate for overheads may be used across a factory for all jobs and units of production, irrespective of the department in which they were produced. This is known as the blanket absorption rate. A common absorption rate is not appropriate when a…

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Methods of Factory Overhead Absorption

These methods apply to absorbing the factory overhead: (1) Units of Output Method Absorption of the factory overhead occurs based on the number of units manufactured. Dividing the overhead expenses by the number of units of output obtains the overhead rate. Formula Overhead rate = factory overhead of the department / number of units of output. Example If the factory overhead for department ‘A’ for…

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Actual Overhead Rate and Pre-Determined Overhead Rate

Overhead rates that are established for the absorption of overheads may be divided into two parts: Actual Overhead Rate Pre-Determined Overhead Rate 1. Actual Overhead Rate The actual overhead rate is based on the actual amount of overhead to be absorbed and the actual quantum or value of the base selected (e.g., direct wages, cost of materials, machine hours, direct labor hours, etc.). The actual…

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Under-absorption and Over-absorption of Overheads

What is Under-absorption and Over-absorption of Overheads? Where the absorption of overheads is made using a rate based on actual data, the overhead absorbed must be equal to the actual overhead incurred. But where a pre-determined rate is used, there is generally a difference between the overhead absorbed and the overhead incurred. If the absorbed amount is less than the actual overhead, there is…

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Memorandum Reconciliation Account

What Is a Memorandum Reconciliation Account? The reconciliation of cost and financial accounts can also be presented in the form of an account prepared on a memorandum basis. Such an account is known as a memorandum reconciliation account. The amount of profit as per cost accounts is shown on the credit side of this account. Also, the various items to be added to the profit as per cost accounts ar…

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Reconciliation of Cost Accounts and Financial Accounts

Introduction Cost accounts are maintained independently of financial accounts because the two accounts have different aims, namely: Financial accounts record expenses in a subjective form according to their nature Cost accounts maintain an objective form according to their purpose The results of these accounts also differ, meaning that contrasting profits and results may arise. Such differences re…

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Normal and Abnormal Wastage

Normal Wastage (Loss) This term refers to the natural percentage of unavoidable wastage in a process or operation. Such wastage is not avoidable as it occurs in the operation’s natural course. The resulting normal wastage and loss should be charged to the good units arising out of the process. In this way, the cost of spoiled and lost units is absorbed as an additional post of the goods produced b…

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Batch Costing

Batch Costing: Definition Batch costing is nothing but a modified form of job costing in which the cost of each batch of production is calculated. This method of costing is suitable for manufacturing units in which items are manufactured in definite batches. The batch costing method is also known as lot costing because products are produced in lots of, for example, 500, 1,000, or any other number….

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