Question

Please discuss

(1) For the financial reporting purpose, we need to allocate manufacturing overhead costs. Please summarize the different ways to allocate manufacturing overhead costs that you have seen from managerial accounting and this class..

(2) What are the other needs to allocate costs in business? How do you allocate or share costs in your experience? (For example, if you share various living expenses (rent, utilities, etc) with a roommate, you may do this cost-sharing simply and roughly, or allocate the costs in a more sophisticated Sheldon Cooper way (a character in Big Bang Theory) with a spreadsheet showing who is paying what exactly.)

Answer 1

Manufactuing overhead cost can be very significant for a business. Most often these costs cannot be directly traced to cost objects the way direct materials and direct labor can. This is why manufacturing overhead costs need to be allocated. Overhead costs are product costs, which flow through inventory accounts such as work-in-process inventory and finished goods inventory. Product costs flow to the income statement as cost of goods sold once the product has been sold.

Fixed costs include depreciation on assets, rentals, leasing costs, and indirect labor incurred in manufacturing. These costs do not change during an accounting period, within the relevant range. Variable costs include power, water, sewage, engineering support, machine maintenance, and indirect materials. Variable costs change in proportion to the changes in a particular allocation base or cost driver. The cost drivers can be either volume or activity based.

Budgeted Fixed Overhead Cost Allocation Rates

Fixed overhead costs are a lump-sum amount that will not change over the course of a time period even if wide variations occur in activity.

Fixed Overhead Application Rate = Total Cost in Fixed Overhead Cost Pool/ Total Quantity of Allocation Base

Budgeted Variable Overhead Cost Allocation Rates

Common variable overhead costs include indirect materials, indirect labor, utility costs, maintenance costs, and engineering support. Management should select the appropriate allocation base for variable overhead costs based on operations

Variable Overhead Application Rate = Total Cost in Variable Overhead Cost Pool / Total Quantity of Allocation Base

Firms with two or more production departments can assign factory overhead costs to jobs or products in these ways:
1 Plant-wide overhead rate
2 Departmental overhead rate
3 Activity-based overhead costing

Plant-Wide Overhead Rate
A plant-wide overhead rate is a single rate used for all overhead costs incurred at a production facility.plant-wide allocation is, by its nature, very general, it should only be used by facilities that have a strong single cost driver that relates to all the types of production.

Plant-Wide Overhead Rate = Total Plant Overhead Costs /Total Units of Cost Driver (Allocation Base) Common to All Jobs

Departmental Overhead Rate
A departmental overhead rate is a single overhead rate calculated for a particular department. Departmental overhead rates are more accurate than plant-wide rates. Each department can have its own rate calculated based on its own cost drivers.

Departmental Overhead Rate = Total Department Overhead Costs / Total Units of Cost Driver Common to All Jobs
for the Department

Activity-Based Overhead Costing
When the plant-wide and departmental overhead allocation methods are not accurate enough, an activity-based costing (ABC) method can be used. ABC assigns factory overhead costs to products or services using multiple cost pools and multiple cost drivers. The cost drivers are selected based on a cause-and-effect relationship and can be both activity based and volume based.Activity-based overhead allocation may help management identify inefficient products, departments, and activities when it attempts to eliminate activities that do not provide value to products and services.

2)

• cost allocation helps to find the true cost of a function or department and also helps to find the profitability of a business
• it helps to reduce the cost
• cost allocation helps the company to use the resources effectively by knowing where the money  is going
• help to reduce unwanted spends in the business