Question

What are the three categories of manufacturing costs? Why must a company use predetermined overhead rates when using job order costing?

Answer 1

Manufacturing Cost includes the sum of direct materials, direct labor and all indirect factory costs.

The three different types of costs are;

1. Direct material
2. Direct labor
3. Manufacturing or factory Overheads

1. Direct Material; this type of cost can be easily traceable to the product and also constitute of the major component in the total cost. It is a part of the prime cost.
2. Direct labor; Direct labor is the portion of labor that can be easily assignable to a specific product. It is also a part of the prime cost.it is also known as conversion cost.
3. Manufacturing Overheads or factory Overheads; manufacturing overheads are not directly traceable to a particular product such as indirect material, indirect labor rent of the factory, depreciation of the machinery etc. This cost is also known as conversion cost.

A predetermined overhead rate is used to apply overhead to jobs .it is calculated by dividing the total estimated overheads with the allocation base. A company uses predetermined overhead rates due to the following reasons;

1. It helps the cost accountants to fulfill the GAAP matching principal by assigning overhead costs while products are still in production.
2. It helps the company to easily race the cost which has been associated to the particular product.
3. It helps managers to estimate and allocate overhead costs to the products which are still in production, which in turn helps the management in taking cost-based business decisions.