Explain the difference between the cost classification Production prime costs and indirect production overheads. And discuss the traditional absorption costing system application of the differences. Could anyone help.
Prime cost is the combination of a manufactured product's costs of direct materials and direct labor. In other words, prime cost refers to the direct production costs.
Indirect production OHDs refer to those costs that can not be directly atributable to production. Examples: HR Dpt costs, Finance Dpt costs, Heating cost for the premises etc.
Whereas the direct production costs can be directly allocated to the product cost, the OHDs need to be allocated using some allocation keys. The simplest key is production volume. You can use the Direct Labour Headcount, direct labour etc. or some very complex ABC costing allocations.
A company produces 100 units of product A and 150 of products B. The direct material costs are 1000 for product A and 800 for product B. Direct Labour costs are 500 for product A and 800 for product B. In order to produce the 250 units, the company incurred a cost of 600 in Production OHDs for the period.
A: 1000+500 = 1500
B: 800+800 = 1600
Indirect costs allocation:
A: 600 x 100/(100+150) = 240
B: 600 x 150/(100+150) = 360
A = 1500+240 = 1740=> unit cost: 1740/100 = 17.4/unit
B = 1600+360 = 1960=> unit cost 1960/150 = 13.07/unit