Question

Stylish Chairs has a production budget of 600 chairs for the current year and for allocating the manufacturing overhead (i.e., indirect cost pool) Stylish Chairs uses the direct labour-hours (i.e., cost-allocation base). AnniFrid and Benny are not sure whether the production budget will be met and some of its consequences.

Required

a) If the quantity produced in the current year reaches the budgeted amount of 600 chairs whereas in the past year the production was 500 chairs, Björn says the unit product cost in the current year will decrease when compared to the previous year because the production has increased. Is Björn right or wrong in his statement and why? (Chapter 2, 10 marks)

b) Considering Stylish Chairs uses budgeted indirect costs during the year, if the quantity produced in the current year is only 500 chairs whereas the production budget for the current year is 600 chairs, Björn says there will be an overallocation of indirect costs. Is Björn right or wrong in his statement and why? (Budgeted indirect costs and end-of-period adjustments, Chapter 3, 10 marks)

Answer 1

a) Björn is right by saying that the unit product cost in the current year will decrease when compared to the previous year because the production has increased. Since, the indirect cost pool will be allocated over more units (100 units more in current year), this will lead to reduction in unit cost compared to previous year.

b)No, Björn is wrong by saying production of 500 units will lead to overallocation of indirect costs. Since, the indirect cost was allocated on budgeted unit hours of 600 chairs. So under production will lead to underallocation of indirect cost.