Predetermined Overhead Rates, Flexible Budgets and Absorption

Topics: Variable cost, Costs, Fixed cost, Total cost / Pages: 36 (5391 words) / Published: Nov 25th, 2014
CHAPTER 3

Predetermined Overhead Rates, Flexible Budgets, and Absorption/Variable Costing

Questions
1. Although both variable and mixed costs change in total with activity measure changes, the difference is that variable costs change in direct proportion to such activity changes and mixed costs do not. Since a mixed cost has both a fixed and variable component, the cost per unit at different activity levels is not constant as it is with a variable cost.

2. No, these are not always the best points of observation. First, the points must be within the relevant range of activity. Second, to be useful, the points must be reflective of the entire data set of observation points. If the high and low points do not meet these two conditions, alternative points should be selected.

3. There are several reasons for using predetermined overhead rates. First, the company does not need to wait to assign overhead costs to products or services until the end of the period when actual costs are known. Second, such rates eliminate overhead cost fluctuations that have nothing to do with volume levels. Third, predetermined overhead rates provide a means to control distortions in product costs caused by changes in volume between or among periods, and the resulting product/service cost changes caused by differences in fixed cost per period.

4. Departmental overhead rates are superior to plant-wide overhead rates in that overhead application bases can be identified that more accurately reflect the causes of costs in each department. In effect, use of departmental rates permit more cost drivers to be identified and used as allocation bases. Separation of variable and fixed costs allows managers to make decisions that rely on knowledge of cost behavior. For example, some decisions require that a manager identify costs that will change if a particular decision alternative (such as whether to manufacture and sell additional units) is implemented. Total variable cost responds differently

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