To expand a bit more on Alex’s helpful answer about the difference between absorption and variable costing:

 

Absorption costing involves allocating fixed overhead costs across all units produced for that period. On the other hand, variable costing lumps together all fixed overhead costs and reports the expense as a one line item. 

 

Variable costing doesn’t establish a per unit cost for fixed overhead, whereas absorption costing does. 

 

Absorption costing will have two categories of fixed overhead costs: 1) cost of goods sold 2) inventory. Whereas, variable costing will produce a one lump sum expense for fixed overhead costs when calculating net income.

Hi Oliver, sorry for the late reply to your question! In preparation for the final, I think that some extra help with your question can help you prepare! My group mates did an exceptional job with the technical explanation but here is some theoretical explanations to help refresh some concepts. 

Chapter 17: 

Transferred costs are one of three costs that need to be kept track of in process costing schedule (the other two costs being direct materials and conversion costs).

A transferred cost is a cost that is incurred in one department of production that is attributed to the product's total cost, and this cost will be carried with the unit throughout production cycle. Because the unit moves from one department to the next, the costs incurred will also move with them at 100%. 
In process costing, as previously mentioned, transferred costs are one of the costs we keep track of to calculate the equivalent units of production, cost per equivalent unit which will help us solve the cost of ending work-in-progress and the cost of units transferred. 

Chapter 18: 

Spoilage is waste or non-
processable materials that are a result of the production process.

Normal spoilage is the standard amount of waste that is caused by production, which is difficult to avoid. For example, not using the zest from an orange at an orange juice factory.

Abnormal spoilage exceeds the expected rate of spoilage. For example, melted ice cream cannot be served to a customer.

Rework is the correction of a product that did not meet a minimum quality standard. The rework allows the product to then be sold, creating revenue from a product that would otherwise have been scrapped.

When transferring products/services at market prices, this generally leads to optimal decisions when 3 conditions are met:

A perfectly competitive market exists when there is a homogeneous product with equal building and selling prices and no buyers or sellers can affect those prices by their own actions. In perfectly competitive markets, the minimum price the seller is willing to accept from the buyer is the market price, b/c the seller can always sell its output in the external market at that price. The maximum price the buyer is willing to pay is the market price, b/c the buyer can always buy it input in the market at that price.

For example: 

Assume that there is a perfectly competitive market for crude oil and that the market price is $85/barrel. 

As a result, each division (transportation and refining) can buy or sell as much crude oil as each wants at $85/barrel. However, suppose the company would like its managers to buy or sell internally. What decisions would the company’s division managers make if each had the option to sell or buy oil externally?

If the transfer price between the two divisions is set below $85, the manager of the transportation division will want to sell all production to outside buyers @ $85/barrel.

If the transfer price is set above $85, the manager of the refining division will want to purchase all its crude oil requirements from outside suppliers.

A current market value transfer price of $85 could motivate both divisions to buy and sell internally

At the end of the year, an over applied (Sum of MOH Control < Sum MOH Applied to all products made) or under applied  (SUM of MOH Control > MOH Applied to all products made) will occur. The reason is MOH applied account was used to estimate how much OH costs are contributed to the product cost. It is an estimation due to the use of normal or activity based costing where we use the following formula:
(Budget MFGOH Costs / Budget Q of input) x actual Q of input used

The MOH Control account on the other hand is based on the actual MFGOH costs that was Incurred in which we don't have enough idea on how much it contributed to the product cost. So at the end of the year, we would reconcile the difference and either allocate it fully to COGS or prorate it to COGS & WIP & FG. 

Oliver, if you still don’t understand what I am trying to say to you, please review chapter 4 again and please do question 4-27 in the text book. My other team members can also help expand on this idea if you still don't understand.

Question 2:

Normal Costing: 

The concept of the single predetermined OH rate used in jor order costing system is used in a MFG Operation where there is no customization of products and more than one product is manufactured in the same plant.

The Formula to find the allocation rate = Budget MFGOH Costs / Budget Q of input. When we applied the OH onto the job, the formula = The allocation rate x Actual Q of input used. For example, if we use Direct labour hour to allocate OH, regardless of other activities that might play a role in the OH cost of the product, we disregard them.

Activity Based costing:

The assumption is that products consume the activities that are incurred in the production process. Not all output consume the same amount of Overhead as each products are differentiated from one another. Also, each activities have an associated Cost driver. An Example of company that uses ABC would be Nike. Let assume Nike made 3 shoes: Red, Black, and White.  Let assume they have multiple of activities that are part of OH Costs such as inspection, scheduling order, product support. The cost driver for Inspection , Scheduling order, and Product support would be # of shoes inspected, Number of Orders, and Number of engineers respectively

For the first activity, Inspection, to allocate OH, we use the following formula:

(The budget total cost of Inspetions/Budgeted Total number of shoes inspected ) x # or Red/Black/White shoes inspected.

The same process would go also to activities concerning scheduling order and product support and their associated and respective cost drivers of Number of orders and number of engineers . dy.com,I��;i}�

First method market-based pricing is when the transfer price is obtained from the going rate on the open market, so the buying division will pay the same rate whether they buy internally or from external sources.

Second method cost-based pricing is when the transfer price is obtained by calculating the cost of the intermediate product, each subsequent division will add their costs to the product before transferring to the next division. The costs can be calculated in a variety of ways from; variable costs, fixed costs, and even contain markup.

Third method negotiated pricing is when the transfer price is obtained through a negotiation between the selling and buying division. The managers of each division are free to make decisions of whether to buy and sell internally or externally.

 

Transferred-in costs are the costs accumulated from previous departments, so they are always 100% when calculating the cost of units. Whether the unit is in beginning inventory or ending inventory the degree of completion is 100% for transferred-in costs since it is not part of the current department's process. 

 

Using this information we don't have to account for partially complete transferred-in costs when calculating equivalent units or costs. 

 

For example 

Given transferred-in cost per equivalent unit of $200 and ending WIP of 50 units. To calculate the transferred-in cost in ending WIP, always account for all the units. So this results in $10,000 (200 x 50) for transferred-in costs to ending WIP. 

Beginning inventory is the recorded cost of inventory in a company’s accounting records at the start of an accounting period. Whereas, transferred in costs (which is also known as previous department costs) are costs that have been incurred in a previous department that are carried FORWARD as part of the product’s cost as it moves to a following department for processing. And so, as the physical units move from one department to the next, their costs move with them.

I’ve also listed some common mistakes with transferred in costs that will hopefully help us avoid making them:

Hope this helps! :)