Using the overhead rate of $48 per direct labor hour KartCo can determine the amount of factory overhead to allocate to each go-kart. They can then use this information to determine the total unit cost of each go-kart. A company uses the departmental overhead rate method. 1) Assign overhead costs to departmental cost pools.
Step 4 is to assign overhead costs in each activity cost pool to final cost objects using activity rates. Dividing $4,800,000 by 100,000 hours gives us a plant overhead rate of $48 per DLH . This plantwide overhead rate is then used to allocate overhead cost to products based on the number of direct labor hours required to produce each unit as follows. For this method, the target of the cost assignment, or cost object, is the unit of product. The overhead rate is determined using a volume-related measure such as direct labor hours or machine hours, which are readily available in most manufacturing settings. In allocating indirect costs to products, when will a plant wide overhead rate provide accurate product costs?
What are the advantages of using a plantwide overhead rate?
External failure costs incurred after customer has been provided a defective product/service. Identify and assess advantages and disadvantages of activity-based costing. Take a moment to review how the activity rates were calculated for each of the pools.
C1 Distinguish between the plantwide overhead rate method, the departmental overhead rate method, and the activity-based costing method. The departmental overhead rate is an expense rate calculated for each department in a factory production process.
UNDER ACTIVITY BASED COSTING
Compute Aztec’s departmental overhead rate for the mixing department based on direct labor hours. The overhead rate is a cost allocated to the production of a product or service.
- Cost of quality report lists costs of quality activities by category.
- Allocate overhead costs to products using the plantwide overhead rate method.
- The overhead rate has limitations when applying it to companies that have few overhead costs or when their costs are mostly tied to production.
- To distribute overheads on the basis of activities.
- Defining outputs to be reviewed is an important step in a successful Activity Based Costing implement action.
- Of course, management also has to price the product to cover the direct costs involved in the production, including direct labor, electricity, and raw materials.
These idle capacity costs will in turn be allocated to the Assembly Department’s products. Conceptually, this is the same logical argument discussed in Chapter 4 under the heading of reasons for using a predetermined overhead rate. The various functional areas within a manufacturing facility are usually separated into two types of departments. These include producing departments and service departments. Producing departments convert raw, or direct materials into finished products. Service departments provide support services to the other departments in the plant. Some examples of service departments include purchasing, receiving and storage, engineering, power, maintenance, packing, shipping, inventory control, inspection and quality control.
a. The unit of product.
The reciprocal method is more accurate than the other two methods because it fully recognizes self services and reciprocal services between service departments. However, this method is more involved because it requires the solution to simultaneous equations. The reciprocal method includes three steps as follows. Assume Kline Company allocates overhead costs with the department approach. Calculate the rate used by each department to allocate overhead costs.
- Describe and use one typical method of accounting for by-products.
- To calculate the overhead rate, divide the total overhead costs of the business in a month by its monthly sales.
- As indicated in Exhibit 6-14, X1 requires a larger proportion of cutting time, while X2 requires a larger proportion of assembly time.
- So, if you were to measure the total direct labor cost for the week, the denominator would be the total weekly cost of direct labor for production that week.
- Traditional volume-based methods are easier to use and less costly to implement and maintain.
Job costing is more likely to be used for billings to customers, since it details the exact costs consumed by projects commissioned by customers. Process costing is different from job costing, which is a method used when each customer job is different. As a result, pricing, sales strategy, performance management and decision making should be improved. Thus the cost of activities should be allocated to products based on the products’ use of the activities. We have also incurred payroll, so we need to account for it. But we also must break out our payroll into DL and indirect labor.
(See the note under the table for these calculations.) These values do not change, regardless of the joint cost allocation method, although the individual gross profit amounts vary widely across the four methods. Clearly, selling both white and dark fried chicken is more profitable than selling either product at the point of separation. The three alternative methods of allocating service department costs to users are summarized in Exhibit 6-13. Describe the direct, https://business-accounting.net/ step-down and reciprocal methods of allocating service department costs to producing departments. Discuss the circumstances under which each of the methods referred to in learning objective 3 will provide accurate product costs. In this step the activity rate is determined by dividing the overhead costs assigned to an activity pool by the expected activity level. Activity-based costing attempts to more accurately assign overhead costs by focusing on activities.
As indicated in the exhibit, $11,111 of Power Department costs is allocated to the Maintenance Department recognizing that 100 kilowatt hours of power were used by Maintenance. This improves the accuracy of the allocations to both producing departments by $1,667 which represents about a 5.57% decrease for Cutting and about an 8.29% increase for Assembly.
Determine the difference in the total operating cost if electricity were purchased externally and indicate whether the company should make or buy electricity. the cost object of the plantwide overhead rate method is: Both production volume related and non-production volume related activity measures, e.g., number of purchase orders, number of setups, etc.
The service departments and allocation proportions for the direct variable costs appear in the lower part of Table 1. In addition to allocating costs for inventory purposes, management needs accurate cost allocations for a make or buy decision.