Question

Vallerina Ltd manufactures girls’ clothing. They have only one product being produced in 2014, girls ballerina dresses. Vallerina Ltd has 25 staff and is an established business with a good reputation. Overhead is applied on the basis on sewing machine hours. A predetermined overhead application rate of $5.85 was established for 2014. During the production of 800 dresses, raw materials totalled $12,500; direct labour totalled $8,500 and there were 3500 sewing machine hours during the period.

1. Give two examples of indirect costs and two examples of direct costs for Vallerina Ltd.
2. How would the allocation base for overheads be decided?
3. In one sentence, state what happens to the over or under allocated overhead at the end of the period?
4. Calculate Vallerina Ltd’s cost of goods manufactured and the product cost per dress for 201
5. How do managers calculate the predetermined overhead application rate?

Answer 1

Solution

Vallerina Ltd

Two examples of indirect cost –

Staff salaries, utilities cost as well as rent of facility are examples of indirect costs.

Two examples of direct cost –

Direct material and direct labor are two examples of direct cost.

How to decide an allocation base –

Indirect costs are allocated to units based on a measure of activity. The allocation base expresses relation to the incurrence of the cost and the allocation base.

In the given question, the overhead cost could be allocated based on sewing machine hours. The allocation base allows to estimate how a cost object uses the resources.

For instance, allocation of staff salaries based on sewing hours;

The staff salaries are computed based on number of sewing hours the staff spent during an accounting period multiplied by the rate per sewing hour.

Treatment of under or over allocated overhead at the end of the period:

Overhead cost is usually allocated to production based on a predetermined overhead rate. However, the actual overhead incurred could be either higher or lower than the allocated overhead.

When the actual overhead incurred is higher, the overhead is said to be underapplied and when the actual overhead incurred is lower, the overhead is said to be overapplied.

The under or over applied overhead is normally adjusted to cost of goods sold.

Vallerina Ltd’s cost of goods manufactured and the product cost per dress for 2014:

Cost of goods manufactured:

Direct materials cost   $12,500

Direct labor cost          $8,500

Manufacturing overhead         $20,475

Total cost of goods manufactured $41,475

Number of dresses 800

Product cost per dress = total cost of goods manufactured/number of dresses

= $41,475/800 = $9,300 per dress

Note: the manufacturing overhead cost is computed as follows,

= predetermined overhead rate x number of sewing hours

= $5.85 x 3,500 = $20,475

Calculation of predetermined overhead rate:

The predetermined overhead rate is calculated as follows,

Predetermined overhead rate = estimated manufacturing overhead cost/total estimated number of machine hours