Accounting for material, labour and overheads: formula sheet

Key formulas

Total cost identity

Opening inventory + Purchases = Cost of issues + Closing inventory

Use this to check your answer. If it does not balance, you made an error.

FIFO issue rule

Issue from the oldest batch first, then the next oldest

Closing inventory is made up of the newest batches.

LIFO issue rule

Issue from the newest batch on hand first, then the next newest

Closing inventory is made up of the oldest batches. In a perpetual record, 'newest' means newest at the date of the issue.

Weighted average cost (periodic)

AVCO per unit = Total cost of opening inventory and purchases ÷ Total units of opening inventory and purchases

Use one average for the whole period when the question asks for it.

Weighted average cost (perpetual)

New AVCO per unit = Cost of inventory on hand after receipt ÷ Units on hand after receipt

Recalculate after every receipt. Issues do not change the average per unit.

Value of an issue

Cost of issue = Units issued × Price of the units issued

Under FIFO and LIFO the issue may use more than one price.

Economic order quantity

EOQ = √(2 × Co × D ÷ Ch)

Co = cost per order, D = annual demand in units, Ch = holding cost per unit per year. Use consistent time periods.

Reorder level

Reorder level = maximum usage × maximum lead time

This is the usual ACCA definition. If a question gives only average usage and lead time, it may use those instead, so read the wording.

Buffer stock

Buffer stock = reorder level − (average usage × average lead time)

The extra stock held to cover usage or lead time above average.

Minimum stock level

Minimum level = reorder level − (average usage × average lead time)

Same calculation as the buffer stock formula above.

Maximum stock level

Maximum level = reorder level + reorder quantity − (minimum usage × minimum lead time)

The highest stock should reach if usage and lead time are at their lowest.

Average stock

Average stock = EOQ ÷ 2 (with no buffer stock); EOQ ÷ 2 + buffer stock (with buffer)

Used to find total annual holding cost.

Total annual inventory cost

Total cost = purchases + ordering costs + holding costs = (D × price) + (D ÷ Q × Co) + (average stock × Ch)

Q = order quantity. Use this to compare bulk discount options.

Time-rate gross pay

Gross pay = hours paid × rate per hour

Hours paid include idle time, since idle workers are still paid.

Piecework gross pay

Gross pay = units produced × rate per unit

Use good units only if the question says rejects are not paid.

Guaranteed minimum wage

Pay = higher of (piecework earnings, guaranteed wage)

The guarantee is a floor, not an addition.

Overtime pay

Overtime pay = overtime hours × basic rate × (1 + premium %)

Premium only = overtime hours × basic rate × premium %.

Overtime premium

Premium = overtime hours × (overtime rate − basic rate)

Normally an overhead, unless caused by a specific job.

Idle time cost

Idle time cost = idle hours × basic rate

Treated as overhead. Idle hours = hours paid − hours worked.

Direct labour cost

Direct cost = hours worked on production × basic rate

Excludes overtime premium and idle time in normal cases.

Labour turnover rate

Labour turnover rate = (number of replacements ÷ average number of employees) × 100

Some questions use the number of leavers instead. Use what the question states. Use replacements if given, and note that leavers and replacements may differ.

Efficiency ratio

Efficiency = (standard hours for actual output ÷ actual hours worked) × 100

Above 100% means output was produced faster than standard.

Capacity ratio

Capacity = (actual hours worked ÷ budgeted hours) × 100

Shows how much of planned labour time was actually used.

Activity ratio

Activity = (standard hours for actual output ÷ budgeted hours) × 100

Shows actual output compared with budgeted output, measured in standard hours.

Link between the ratios

Efficiency % × Capacity % = Activity % (as decimals, multiply and convert back)

Useful as a check, or to find a missing ratio.

Standard hours for actual output

Standard hours = actual units produced × standard hours per unit

Always work this out first. It is the 'earned' hours.

Predetermined OAR

OAR = budgeted overheads ÷ budgeted activity level

Use budgeted figures for the production centre. The activity is labour hours, machine hours or units.

Overhead absorbed

Overhead absorbed = OAR × actual activity

Use actual hours or units for the period, not the budget.

Reciprocal method equations

S1 = own costs + x% of S2; S2 = own costs + y% of S1

Solve for S1 and S2, then share each total to all other centres by the stated percentages.

Allocation versus apportionment

Allocate whole cost to one centre; apportion shared cost across centres

Apportionment needs a fair basis, such as floor area or headcount.

Absorption rate per unit

Overhead per unit = OAR × hours per unit

Use this to build the overhead part of a unit cost.

Predetermined absorption rate

Rate = Budgeted overhead ÷ Budgeted activity level

Activity can be labour hours, machine hours or units. Use the base the question gives.

Overhead absorbed

Absorbed = Actual activity × Predetermined rate

Always use actual activity, not budgeted activity.

Under- or over-absorption

Absorbed − Actual overhead incurred

Positive result = over-absorbed. Negative result = under-absorbed.

Effect on profit

Under-absorbed: reduce profit. Over-absorbed: increase profit.

Applies when profit has been calculated using absorbed overhead.

Ledger entries for absorption

Dr Work in progress, Cr Overhead control (absorbed). Dr Overhead control, Cr Bank/payables (incurred).

The balance on the overhead control account is the under- or over-absorption.

Profit difference

Absorption profit − Marginal profit = (Closing inventory units − Opening inventory units) × Fixed overhead absorption rate per unit

Use the rate per unit actually used in absorption costing. A negative result means absorption profit is lower.

Fixed overhead absorbed per unit

Budgeted fixed production overhead ÷ Budgeted activity level

Activity is usually units or labour/machine hours. If hours are used, convert to a rate per unit.

Marginal costing inventory value

Variable production cost per unit × units in inventory

Includes direct materials, direct labour and variable production overhead only.

Absorption costing inventory value

(Variable production cost + Fixed overhead per unit) × units in inventory

Valued at full production cost.

Reconciliation rule

Inventory increases: absorption profit > marginal profit. Inventory decreases: absorption profit < marginal profit. No change: profits equal.

Assumes the same fixed overhead absorption rate is used in both periods.

Quick revision

• FIFO issues oldest cost first, so closing inventory is at the latest prices.
• LIFO issues latest cost first, so closing inventory is at the oldest prices.
• AVCO uses a weighted average cost, recalculated after each receipt.
• EOQ = √(2 × Co × D ÷ Ch), where Co is cost per order, D is annual demand and Ch is holding cost per unit per year.
• At EOQ, annual ordering cost equals annual holding cost.
• Labour turnover rate = leavers in the period ÷ average number of employees × 100.
• Allocate whole costs to one cost centre; apportion shared costs using a fair basis.
• Absorption rate = budgeted overhead ÷ budgeted activity level.
• Overhead absorbed = actual activity × absorption rate.
• Under-absorption: absorbed is less than actual overhead, so profit is reduced.
• Over-absorption: absorbed is more than actual overhead, so profit is increased.
• Profit difference = change in inventory units × fixed overhead absorption rate per unit.

Common mistakes

• Averaging the unit prices instead of weighting them Fix: Divide total cost by total units. Batches of different sizes carry different weight.
• Mixing up which batch is left in closing inventory Fix: Under FIFO the closing inventory is the newest cost. Under LIFO it is the oldest cost. Write the remaining batches down.
• Using monthly demand with an annual holding cost Fix: Convert everything to a year before using the formula.
• Forgetting purchase cost in bulk discount comparisons Fix: When price changes with order size, include D × price in every total cost.
• Charging the whole overtime payment to the job as direct cost. Fix: Only the basic rate part is direct. The premium is overhead unless the overtime was requested for a specific job.
• Adding the guaranteed wage to piecework earnings. Fix: Pay the higher of the two. The guarantee is a minimum, not a bonus.
• Using the wrong numerator in the efficiency ratio, such as budgeted hours. Fix: Efficiency never uses budgeted hours. It compares standard hours for actual output with actual hours.
• Using standard hours for budgeted output instead of for actual output. Fix: Multiply actual units produced by the standard hours per unit. Only the budgeted hours figure comes from the budget.
• Using actual hours or actual overheads to calculate the OAR. Fix: The rate is always budgeted overheads ÷ budgeted activity. Actual activity is used only when you absorb.
• Confusing allocation with apportionment. Fix: Ask whether the cost belongs wholly to one centre. If yes, allocate. If shared, apportion.

Exam tips

• Write a small stores record with date, units and value columns. Do not do it in your head. Most marks are lost through slips in the middle.
• Read whether the question uses periodic or perpetual valuation. Periodic uses one average for the period. Perpetual recalculates after each receipt.
• In multiple-response questions on profit effects, check the price trend first. Rising prices: FIFO gives the highest profit. Falling prices: LIFO gives the highest profit.
• For number entry, check the rounding instruction. Keep unit prices unrounded in your workings and round only the final answer.
• Use the total-cost check on every question. It catches most errors quickly.
• Number entry questions often need rounding. Check whether the answer should be to the nearest whole unit or dollar.
• Read whether holding cost is given per unit per year or as a percentage of price. Convert before using the formula.
• In bulk discount questions, always compute the EOQ first. If it is already at or above a discount threshold, that discount applies and no comparison is needed for lower prices.