How can a company fairly allocate indirect costs while taking into account both the machine and...

How can a company fairly allocate indirect costs while taking into account both the machine and labor hours?

Solutions

Expert Solution

1. Direct Costs are traceable directly to a particular product or service. But, this is not the case with Indirect Costs. They need to properly allocated to the respective activity so as to present a true and fair view of Cost Records or Financial Statements.

2. To fairly allocate indirect costs to respective labour or machine hours, we have

ACTIVITY BASED COSTING WHICH USES PRE-DETERMINED OVERHEAD RATE.

3. Activity Based Costing calculates the cost of individal activities based on the type of product or service i.e. labor hours or machine hours.

4. Here, we identify individual activities (Labor Overheads and Machinery related overheads) and the cost drivers related to the activities (no.of labor hours and no.of machinery hours).

5. Then, we calculate Pre-determined Overhead Rate of each activity, with formula as

Pre-Determined Overhead Rate = Budgeted Overheads of an Activity/No.of Cost Drivers.

6. We multiply the Overhead Rate thus derived to the actual cost drivers of a particular period.

7. Thus, there is fair allocation between both labor and machine hours.

ekkarill92 answered 1 year ago

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