Question

Volume-based accounting often does not provide sufficiently accurate cost information. What could be the reason for this? Can you give an example?

Answer 1

Volume based accounting is a system of accounting where the overhead costs are allocated based on a single factory wide rate which depends on the volume of production.

The single rate may be on labor hour, machine hour, amount of direct material used, direct labor cost etc. All these parameters vary directly with the volume of production.

These allocation methods do not give sufficiently accurate cost information because the production methods in different department may be different and different products may use varying percentage of different resources. A single factory wide rate may give inaccurate information on overhead costs.

A more accurate cost information of overhead allocation can be achieved by creating several overhead cost pools , with the costs in each one assigned using the most relevant basis of allocation.

A simple example is given below for illustration

Total Overhead Cost =$100,000

Total labor hour =2500

Total machine hour =1000

Assembly department may be labor intensive and should use labor hour.

The machining department may be machine intensive and should use machine hour.

Some jobs may require more machining hours and less labor hour

Some other jobs may require more labor hour and less machine hour.

Using a single rate will give inaccurate cost information on job costs

Hence, the two departments should use two different rates to arrive at accurate cot information