Week 6 -- Overhead Costs

4 types of manufacturing overheads are production costs that:

1. Are incurred for a variety of products and cannot be traced to individual products (eg. utility, salary) 2. Could be traced to individual products but there is little benefit in doing so (eg. amount of glue used to make a product) 3. Could be traced to individual products but it is more appropriate to treat this cost as a cost of all outputs 4. Includes depreciation, factory insurance, indirect labour, indirect materials

What are the 3 levels of cost allocation?

1. Corporate level: Some head office costs are allocated to business units 2. Business units: Administrative costs of business units are allocated to operating units 3. Manufacturing plant: Indirect manufacturing costs are allocated to production departments and products

What are the 3 types of allocation method when allocating support department costs?

1. Direct: Support department costs are allocated to production departments 2. Step-down: Partially recognises the services provided by one support department to another 3. Reciprocal services: Fully recognises the provision of services between support department

What are the 3 steps to allocate overhead costs to products using plantwide overhead rate?

1. Identify the overhead cost driver 2. Calculate the overhead rate per unit of cost driver 3. Apply the manufacturing overhead cost to the products based on the POHR and the product's consumption of the cost driver

Why do we use budgeted and not actual allocation data?

1. Minimise the possibility that the activities of one department will affect the costs allocated to other departments 2. Provides better information for managers to plan and control their use of indirect resources

What are some examples of volume- based cost driver?

1. Output - number of units produced 2. Inputs - overcomes the problem of heterogeneous outputs since inputs are homogeneous eg. Direct labour honors or direct labour costs, machine hours, direct material quantities or costs

What are the 3 possible approaches to allocate overhead costs to products?

1. Plantwide Overhead Rate 2. Departmental Overhead Rates 3. Activity - Based Costing

What are some issues in allocating support department costs?

1. Service organisations do not need to distinguish between production and non-production areas for costs of service outputs 2. In modern manufacturing systems: - Individual products are sometimes created within the one defined work area - When overhead costs are high, the accuracy of allocation methods becomes more critical

Expected supply of cost driver is based on...?

1. Theoretical capacity 2. Practical capacity

What are the 4 reasons why support department costs are charged to production departments?

1. To encourage production departments to wisely use support department resources 2. To provide production departments with more complete cost data for making decisions 3. To help measure the profitability of production departments 4. To create an incentive for support departments to operate efficiently

What are the 3 main reasons for allocating indirect costs to responsibility centres?

1. To help managers understand the economic effect of their decisions 2. To encourage a particular pattern of resource usage 3. To support the product costing system

What is a cost pool?

A cost pool is a collection of costs that are to be allocated to cost objects - Have a common allocation base - Often used to simplify the allocation process - Need to decide appropriate cost driver

What is a denominator volume?

An estimate of the quantity of cost driver used to determine overhead rates

What is a normalised overhead rate?

An overhead rate calculated over a relatively long period to smooth out fluctuations in overheads, and therefore product cost

Expected use of cost driver is based on....?

Budgeted volume and normal volume

What is budgeted volume?

Budgeted volume used over a year

What is a volume-based cost driver?

Cost driver that assumes that costs are driven, or caused by, the volume of production/or sales

What is the relationship of support department to production department?

Costs of the support department become overhead costs to the production department

What is the main difference between absorption costing and variable costing?

Fixed overhead is a product cost in absorption costing but it is a period cost in variable costing. In absorption costing, Sales - COGS = Gross margin In variable costing, Sales - Variable expense = Contribution margin Contribution margin - fixed expense (incl MOH) = Net Income

How do you choose between the 3 methods of allocation method?

If strong relationship between the 2 support department, reciprocal relationship is better

What are the overhead costs for product costing?

Indirect manufacturing costs: manufacturing overheads. Indirect costs: manufacturing overheads and non-manufacturing costs

What is deferred inventory?

Inventory from previous business cycle

What is released inventory?

Inventory released from current and previous business cycle

What is a non-volume based cost driver?

It is a cost driver not directly related to production volume

What is the definition of direct method for allocating support department costs?

It is a method of allocating support department costs where each support department's costs are allocated directly to production departments that consume part of the support department's output

How to reconcile the difference between absorption and variable net income?

MOH for units not sold is added to reconcile

What does departmental overhead rates recognise?

Overheads in each department may be driven by different cost drivers

What is reciprocal services?

Reciprocal services is a mutual service provided between two or more support departments. Interdepartmental services are given full recognition rather than partial recognition as with the step-down method.

What is a cost allocation base?

Some factor or variable that is used to allocate costs in a cost pool to cost objects. Ideally, should be a cost driver. Other criteria that can be used are benefits received and ability to bear additional costs

What are the two-stage cost allocation process to allocate overhead costs to products via Activity-Based Costing?

Stage 1: Overhead costs are assigned to activity cost pools for significant activities (Not departments) Stage 2: Activity costs are applied to products using a rate, based on the product's consumption of the activity

What are the two-stage cost allocation process to allocate overhead costs to products via department overhead rates?

Stage 1: Overhead costs are assigned to production departments Stage 2: Overhead costs are applied to products

What are the overhead costs for responsibility centres?

The indirect costs of responsibility centres

What is practical capacity?

The maximum level of production that a plant will produce under normal, efficient operating conditions (incl normal downtime)

What is theoretical capacity?

The maximum level of production that can be achieved in a specific period where the plant runs at peak efficiency

What is cost distribution?

The process of tracing and allocating all manufacturing overhead costs to production and support departments

What is the step-down method?

The step-down method is a method of allocating support department costs that partially recognises services provided by one support department to another

What does traditional costing system assume?

Traditional costing systems assume that overhead costs vary proportionally with production volume and use only volume-based cost drivers

What is normal volume?

Volume over business cycle, oveer a few years