Costs of conversion and allocation of production overheads

Learning objectives

• Identify the costs of conversion: costs directly related to the units of production (direct labour) and a systematic allocation of fixed and variable production overheads.L2
• Calculate the fixed overheads allocated on the basis of normal capacity, the unallocated portion recognised as an expense and the reduction of the amount allocated to each unit when production is abnormally high.L2, L3
• Allocate the costs of joint production between products on a rational and consistent basis, and treat an immaterial by-product at its net realisable value deducted from the cost of the main product.L3, L4
• Recognise the inclusion of production costs in inventories and the expense arising from under-activity.L2, L3

Normative references

• IAS 2 §12The costs of conversion include costs directly related to the units of production (such as direct labour) and a systematic allocation of fixed and variable production overheads. Fixed overheads remain relatively constant regardless of the volume of production (depreciation and maintenance of factory buildings, equipment and right-of-use assets used in production, and the cost of factory management and administration); variable overheads vary directly, or nearly directly, with the volume of production (indirect materials and indirect labour).
• IAS 2 §13Fixed production overheads are allocated on the basis of normal capacity, that is the production expected to be achieved on average over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance; the actual level of production may be used if it approximates normal capacity. In periods of low or abnormally low production, the amount of fixed overhead allocated to each unit is not increased and unallocated overheads are recognised as an expense in the period in which they are incurred; in periods of abnormally high production, the amount allocated to each unit is decreased so that inventories are not measured above cost. Variable overheads are allocated on the basis of the actual use of the production facilities.
• IAS 2 §14When a production process results in more than one product being produced simultaneously (joint products, or a main product and a by-product) and the costs of conversion are not separately identifiable, they are allocated between the products on a rational and consistent basis, for example the relative sales value at the split-off point or on completion. By-products, which are generally immaterial, are often measured at net realisable value, and this amount is deducted from the cost of the main product, so that the carrying amount of the main product is not materially different from its cost.

Original summaries of the paragraphs (reference register), never a quotation of the standard.

16 questions

• At Harlan, depreciation of the factory machinery is a fixed production overhead, which forms part of the costs of conversion of the inventories produced.L2
• Iseran produced significantly less than its normal capacity this year. It must increase the amount of fixed production overhead allocated to each unit so that all of these overheads are included in its inventories.L2
• Which of the following costs of Jouvence's factory is a variable production overhead?L2
• Kalimba, a manufacturer of seasonal toys, documents its method of allocating production overheads. Which statements comply with IAS 2?L3
• Fermine manufactures wooden pallets. Its fixed production overheads for the year amount to {fixed_overheads}. Its normal capacity, estimated by management from the average production expected over several years, is {normal_capacity} pallets. Following a drop in orders, it produced only {actual_production} pallets, an abnormally low level of production. Compute the fixed overheads included in the cost of the pallets produced and the unallocated fixed overheads.L2
• The foundry Gravelin produces castings. For each casting, materials cost {materials_per_unit} and direct labour {direct_labour_per_unit}. Variable production overheads for the period amount to {variable_overheads} and fixed overheads to {fixed_overheads}. The normal capacity used by Gravelin is {normal_capacity} castings; a prolonged shutdown of a furnace limited actual production to {actual_production} castings, a level considered abnormally low. Compute the unit production cost of the castings and the amount of unallocated fixed overheads.L3
• The brickworks Hautmont incurs {fixed_overheads} of fixed production overheads for the year. Its normal capacity is {normal_capacity} pallets of bricks. An exceptional order for a major construction project raised production to {actual_production} pallets, an abnormally high level. All pallets produced are in inventory at the reporting date. Compute the fixed overhead to be allocated to each pallet.L3
• The bottle manufacturer Ivrelle worked overtime all year to meet exceptional demand. It produced {actual_production} cases, whereas its normal capacity is {normal_capacity} cases, a level management considers abnormally high. Per case, materials cost {materials_per_unit}, direct labour {direct_labour_per_unit} and variable overheads, allocated on the actual use of the facilities, {variable_overhead_per_unit}. Fixed production overheads for the year amount to {fixed_overheads}. Compute the fixed overhead per case and the unit production cost.L3
• Jorvane records its costs by nature in a production costs account. This month, it recorded there {direct_costs} of direct costs (materials and direct labour), {variable_overheads} of variable production overheads and {fixed_overheads} of fixed overheads. Its monthly normal capacity is {normal_capacity} units; a breakdown limited production to {actual_production} units, a level considered abnormally low, all in inventory at the end of the month. Record the entry capitalising the production costs in inventories, showing the unallocated fixed overheads separately.L2
• The electric bicycle manufacturer Kervel keeps its accounts by nature. For the quarter, its production cost accounts show {direct_costs} of materials and direct labour, {variable_overheads} of variable overheads and {fixed_overheads} of fixed overheads (depreciation of the lines, factory supervision). A battery shortage reduced production, to a level considered abnormally low, to {actual_production} bicycles, whereas the quarterly normal capacity, based on the average of previous quarters, is {normal_capacity} bicycles. No bicycle has been sold yet. Record the quarter-end entry transferring the production costs to inventories.L3
• Lavéra processes an ore from which a single process simultaneously extracts two joint products, Alpha and Beta; the costs of conversion of each product are not separately identifiable. The joint costs up to the split-off point amount to 600,000. At the split-off point, Lavéra obtains 4,000 tonnes of Alpha, saleable at 150 per tonne, and 6,000 tonnes of Beta, saleable at 50 per tonne. Its accounting policy, applied consistently, allocates the joint costs on the basis of the relative sales value at the split-off point. What cost is allocated to the Alpha inventory?L3
• The cheese maker Mirandol produces {main_units} cheese wheels, its main product; the same process generates whey, an immaterial by-product. The process costs for the period amount to {process_costs}, of which {abnormal_loss} relates to milk lost following a refrigeration failure, a loss considered abnormal. Mirandol measures the whey at its net realisable value, estimated at {byproduct_nrv}, and deducts that amount from the cost of the main product. Compute the total cost of the cheese wheels and their unit cost.L4
• Noirmont incurs 400,000 of fixed production overheads. Its normal capacity is 80,000 units, but a prolonged shutdown of a line due to a breakdown limited production to 50,000 units, an abnormally low level. The management controller included all fixed overheads in the cost of the units produced, at 8 per unit. What is the error?L3
• Sorbier manufactures cosmetics. Which of the following costs must be recognised as expenses in the period rather than included in the cost of its inventories?L2
• Rivaldi manufactures, for a particular hotel, a set of furniture designed specifically for it; the order is in progress at the reporting date. Costs incurred: materials used 40,000; direct labour 25,000; production overheads allocated 15,000; design of the furniture for this hotel 6,000; wood wasted through a faulty setting, a loss considered abnormal, 3,000; commercial presentation to other hoteliers 2,000; storage of finished pieces not necessary for the rest of the manufacturing 1,000. Rivaldi considers that these design costs help bring the order to its present condition. What is the cost of the inventory at the reporting date?L2
• Sorlan incurs two administrative costs: 90,000 for the management and administration team of its factory, and 140,000 for the group finance department, which plays no part in production. How should these costs be treated in measuring inventories?L2