Question

You are responsible for updating the predetermined overhead rate for your company, analyzing the current costs, using projected changes, and creating the rate for the next year. You notice the maintenance cost had almost doubled last year compared to prior years. You need to analyze this situation more and determine ways to better track this increase. The factory manager has suggested you spread the costs over all the departments to smooth the increase.

1. Determine a costing system to use to help better analyze the increase. Explain how this system will allow for future analysis to identify the increases.
2. If the manager pushes to spread the costs, what are the options you have to ensure you are protecting the company from irregular increases?

Answer 1

1. The company must use Activity based costing system to allocate overheads. ABC Costing involves allocation of costs on the basis of activity drivers which are different for each activity undertaken in the company. This can help allocate costs to the activities on the actual usage rather than a single overhead rate irrespective if the activity has occurred or not. Also, it assists in cutting down the bottleneck activities of the business and focus on efficiency. ABC assists in reducing costs or eliminating activities that do not add value.

2. If the manager pushes to spread costs and not adopt a new costing system, then the department that incurs the highest cost must be allocated the maximum overheads to protect other department from irrational increases. Also, the actual figures must be compared with the budget figures and any variances must be analyzed to understand the reason behind irrational increase in costs.