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Allocating overhead costs to products
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Evaluating the allocation alternatives
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Issues in estimating overhead rates
Using a plantwide overhead rate:
1.
1.Identify the overhead cost driverIdentify the overhead cost driver
2.
2.Calculate the overhead rate per unit of cost driverCalculate the overhead rate per unit of cost driver
3.
3.Apply the manufacturing overhead cost to the products Apply the manufacturing overhead cost to the products based on the predetermined overhead rate and the based on the predetermined overhead rate and the product’s consumption of the cost driverproduct’s consumption of the cost driver
Allocating Overhead Costs to Products (cont.)
Allocating Overhead Costs to Products (cont.)
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•Using departmental overhead ratesUsing departmental overhead rates
-TwoTwo–stage cost allocation process to allocate stage cost allocation process to allocate overhead costs to products via department overhead costs to products via department overhead ratesoverhead rates
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•Stage one: overhead costs are assigned to Stage one: overhead costs are assigned to production departmentsproduction departments
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•Stage two: overhead costs are applied to Stage two: overhead costs are applied to productsproducts
Developing Departmental Overhead Rates
Developing Departmental Overhead Rates Using TwoUsing Two–Stage AllocationStage Allocation
Evaluating the Alternatives for Allocating Overheads
Evaluating the Alternatives for Allocating Overheads
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•Plantwide and departmental overhead Plantwide and departmental overhead costing systemscosting systems
-Overcost highOvercost high–volume relatively simple products volume relatively simple products and undercost lowand undercost low–volume complex productsvolume complex products
-Less costly to establish and operateLess costly to establish and operate
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•ActivityActivity–based costingbased costing
-Multiple cost drivers and overhead ratesMultiple cost drivers and overhead rates
-More complicated and costly to operateMore complicated and costly to operate
Issues in Estimating Overhead Rates
Issues in Estimating Overhead Rates
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•Identifying overhead cost drivers: three Identifying overhead cost drivers: three questionsquestions
1.
1.What is the major factor that causes What is the major factor that causes manufacturing overhead to be incurred?manufacturing overhead to be incurred?
2.
2.To what extent does the overhead cost vary in To what extent does the overhead cost vary in proportion with the cost driver?proportion with the cost driver?
3.
3.How easy is it to measure the cost driver?How easy is it to measure the cost driver?
Volume
Volume–based Cost Driversbased Cost Drivers
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•Volume based cost drivers are a measure Volume based cost drivers are a measure (proxy for) of volume of production(proxy for) of volume of production
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•Assume that overhead costs vary Assume that overhead costs vary proportionally with production volumeproportionally with production volume
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•For plantwide rates, select a cost driver that is For plantwide rates, select a cost driver that is common to all productscommon to all products
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•Cost drivers that are measured in dollars Cost drivers that are measured in dollars should not be used as cost drivers as they should not be used as cost drivers as they are subject to price level changesare subject to price level changes
Non
Non–VolumeVolume–based Cost Driversbased Cost Drivers
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•Not all manufacturing overhead costs vary Not all manufacturing overhead costs vary with production volumewith production volume
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•ActivityActivity–based costing uses both volumebased costing uses both volume–based and nonbased and non–volumevolume–based cost driversbased cost drivers
Distinguishing Between Fixed and Variable Overhead
Distinguishing Between Fixed and Variable Overhead CostsCosts
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•Dual overhead ratesDual overhead rates
-Separate rates for variable and fixed overheads Separate rates for variable and fixed overheads may be calculatedmay be calculated
-Fixed costs have no “accurate” cost driverFixed costs have no “accurate” cost driver
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•Variable (Marginal) Variable (Marginal) product costing systemproduct costing system
-Only variable costs are included in product costsOnly variable costs are included in product costs
-Cannot be used for external purposesCannot be used for external purposes
Budgeted Versus Actual Overhead Rates
Budgeted Versus Actual Overhead Rates
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•Budgeted costs and amounts of cost drivers Budgeted costs and amounts of cost drivers are used to calculate overhead ratesare used to calculate overhead rates
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•TradeTrade–off between timeliness and accuracyoff between timeliness and accuracy
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•Actual costing versus normal costingActual costing versus normal costing
Period Covering Overhead Rates
Period Covering Overhead Rates
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•Over what period should overhead rates be Over what period should overhead rates be set?set?
-Yearly rates are generally usedYearly rates are generally used
-Monthly rates are not recommended as they Monthly rates are not recommended as they fluctuate due to price changes and seasonal factorsfluctuate due to price changes and seasonal factors
-A normalised overhead rate is an overhead rate A normalised overhead rate is an overhead rate calculated over a relatively long periodcalculated over a relatively long period
The Effects of Capacity
The Effects of Capacity
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•Estimating the amount of a cost driverEstimating the amount of a cost driver
-Denominator volume: an estimate of the quantity of Denominator volume: an estimate of the quantity of the cost driver used or supplied, to determine the cost driver used or supplied, to determine overhead ratesoverhead rates
-Expected use of cost driver, based on the budgeted Expected use of cost driver, based on the budgeted volume or normal volumevolume or normal volume
-Expected supply of cost driver, based on theoretical Expected supply of cost driver, based on theoretical capacity or practical capacitycapacity or practical capacity
Allocating Indirect Costs to Responsibility Centres
Allocating Indirect Costs to Responsibility Centres
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•Helps managers understand the economic Helps managers understand the economic effects of their decisionseffects of their decisions
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•Encourages a particular pattern of resource Encourages a particular pattern of resource usage/behaviourusage/behaviour
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•Supports the product costing systemSupports the product costing system
Allocating Indirect Costs to Responsibility Centres
Allocating Indirect Costs to Responsibility Centres (cont.)(cont.)
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•Allocation bases should be cost drivers, where Allocation bases should be cost drivers, where there is a clear and direct relationship between there is a clear and direct relationship between the amount of cost driver and the level of costthe amount of cost driver and the level of cost
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•Other criteria that can be usedOther criteria that can be used
-Benefits receivedBenefits received
-Ability to bear additional costsAbility to bear additional costs
Allocating Indirect Costs to Responsibility Centres
Allocating Indirect Costs to Responsibility Centres (cont.)(cont.)
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•Using budgeted, not actual, allocation dataUsing budgeted, not actual, allocation data
-Minimises the possibility that the activities of one Minimises the possibility that the activities of one department will affect the costs allocated to other department will affect the costs allocated to other departmentsdepartments
-Provides better information for managers to planProvides better information for managers to plan
and control their use of indirect resources
and control their use of indirect resources
Summary
Summary
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•Most service outputs are intangible, Most service outputs are intangible, heterogeneous, consumed as produced, heterogeneous, consumed as produced, perishable and not storedperishable and not stored
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•Job costing, process costing and hybrid costing Job costing, process costing and hybrid costing systems can be used depending on the type of systems can be used depending on the type of service firmservice firm
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•Service costing is used to support managers’ Service costing is used to support managers’ decision needsdecision needs
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•Overhead cost can be allocated to products Overhead cost can be allocated to products using a plantwide rate or department ratesusing a plantwide rate or department rates
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•As the number of overhead rates increases, the As the number of overhead rates increases, the accuracy of the product cost is likely to increase accuracy of the product cost is likely to increase
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