Cost allocation for indirect costs
Cost Pool – Set of costs that are added together before being allocated to cost objects on some common basis
Cost Driver/ Allocation base
Cost Driver Rate = Total Costs in Pool/ Total Quantity of Driver Where total quantity of driver = practical capacity of driver
Cost of excess capacity = Cost Driver Rate * Excess capacity
Predetermined overhead rate - cost per unit of the allocation base used to charge overhead to products.
Predetermined overhead rate=Estimated overhead/Estimated allocation base
One-stage allocation system
* Single cost pool – Entire manufacturing overhead
* Single allocation base / cost driver-Direct materials cost/ Direct labor hours/ Direct labor cost/ Machine hours/ etc. * Predetermined Overhead Rate or Burden rate = Total manufacturing overhead / X * Where X = Total Direct materials cost or Total Direct labor hours or Total Direct labor cost or Total machine hours used * Total product costs of A = Direct materials cost + Direct labor cost + allocated overhead cost where allocated overhead = Burden rate * # of machine hours used by A
Disadvantage: Assumes that all products consume direct labor (or other driver) and overhead in the same proportion.
Two-stage allocation system and Product Costing
Overhead costs are divided into different cost pools. Each cost pool has a cost driver (allocation base). * Split manufacturing overhead into more than one cost pool (e.g. create 2 cost pools whose costs add up to total manufacturing overhead cost) * Calculate burden rate
| Cost Drivers
Overhead related to direct materials
| Direct materials Cost
| Overhead related to direct labor hours
| Direct labor hours
| Overhead related to direct labor cost
| Direct labor cost
| Overhead related to machine-hours
| Machine hours
* Provides most accurate cost information
* Cost system captures differences in the way overhead is consumed in different parts of the production process
* Cost of the system redesign may be high.
The selection of an optimal cost system is based on trade-offs between increased accuracy and the cost of system redesign.
Predetermined Overhead Rate or Burden rate = Overhead cost related to direct materials/ Total Direct materials cost OR Overhead cost related to direct labor hours/ Total Direct labor hours OR Overhead cost related to direct labor cost/ Total Direct labor cost OR Overhead cost related to machine hours/ Total machine hours used
Total product costs of A = Direct materials cost + Direct labor cost + allocated overhead cost where allocated overhead = Burden rate per machine hour * # of machine hours used by A + Burden rate per direct labor $ * direct labor cost of A
Departmental overhead rate - Rates based on a department's direct and indirect overhead costs and some measure of the department's activity, such as the department's machine hours. Departmental rates are more accurate than plant-wide rates when a company manufactures diverse products requiring a variety of processes.
Allocate overhead on a plantwide basis using machine hours – Burden rate per machine hour = total overhead costs of all departments/ total machine hours used by all departments
Allocate overhead using department rate with machine hours as the allocation base - Burden rate per machine hour = Overhead costs of a department/ Machine hours used by that department
Activity Based Costing
1. Identify activities, and identify overhead costs for each activity 2. Identify the cost drivers for each activity
3. Compute cost driver rates (cost per driver unit)= activity overhead cost/ total driver volume 4. Allocate costs to cost objects
Overhead costs allocated to A = cost driver 1 rate * cost driver 1 volume for A + cost driver 2 rate * cost driver 2 volume for A
ABC Costs and Benefits
Costs are very high if:
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