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CA Foundation · Accounting · Inventories

Under AS 2, fixed production overheads are allocated to the cost of conversion on the basis of the normal capacity of the production facilities. Which of the following correctly describes the treatment when actual production in a period is much lower than normal capacity?

When production is below normal capacity, fixed overhead per unit is not increased, and the unallocated fixed overheads are charged as an expense of the period. AS 2 bases allocation on normal capacity so that inventory is not valued above cost.

  1. AOverhead per unit is increased so that all fixed overheads are absorbed into inventory
  2. BOverhead per unit is not increased; the unallocated overheads are recognised as an expense in the periodCorrect
  3. COverhead is allocated on the basis of actual production and carried forward as an asset
  4. DUnallocated overheads are added to the cost of the closing finished goods only

Explanation

AS 2 requires allocation based on normal capacity. When production is abnormally low, the amount of fixed overhead per unit is not increased, and the unallocated overhead is expensed in the period. Raising the per-unit amount would value inventory above cost.

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