These differences are likely to be significant in terms of evaluating the service department costs, particularly in cases where a “make or buy” decision is involved. Compare dual rate and single rate methods for stage I cost allocations.
Compute the overhead allocation rates for each department. Compute overhead allocation rates for each activity. When using multiple departmental rates, overhead c… This provides the overhead rate calculations for the Company for each activity. Calculate a predetermined overhead rate for each activity. The next step is to find an allocation base that drives the cost of each activity.
The decision should be based on a comparison of the additional market value created by further processing, with the additional cost required beyond the split-off point. Revised the cost object of the plantwide overhead rate method is: income statements are presented in Exhibit 6-19 to underscore this point. The values added beyond the split-off point are $280,000 for product W and $160,000 for product D.
Total annual direct labor costs are expected to be $160,000. The Cut and Polish department expects to use 25,000 machine hours, and the Quality Control department plans to utilize 50,000 hours of direct labor time for the year. What is cost object of activity-based costing overhead allocation method? Cost objects of activity-based https://business-accounting.net/ costing are production activities in first stage and unit of product in second stage. To calculate the plantwide overhead rate, first divide total overhead by the number of direct labor hours used to find the overhead per labor hour. Next, multiply the overhead per labor hour by the number of labor hours used to produce each unit.
Plantwide overhead rate definition
When we compare the original direct costs before allocations to the producing department costs after all allocations, it is clear that the double counting has not caused an overstatement in the final results. The total producing department cost after all allocations is equal to $500,000 as indicated at the bottom of Exhibit 6-7. Facility-level costs do not vary with what is manufactured, how many batches are produced, or the output quantity.
The key to the correct decision is to only consider the differences between the alternative courses of action. Following this decision rule, the joint costs are not relevant because they will not be different regardless of the decision to sell at the split-off point or to process the products beyond this point.
Discuss the advantages and disadvantages of the NRV less an average gross profit method of allocating joint costs. Why do joint costs need to be allocated to the products involved? Describe several types of supporting logic for cost allocations methods including the concepts of “cause and effect”, “ability to bear” and “fairness and equity”. Briefly discuss when each concept appears to be appropriate. For example, suppose the Virginia Chicken Company can sell chicken parts such as feet, beaks and gizzards for five cents per pound at the split-off point. Since these parts of the chicken have relatively little value, they tend to fall into the category of by-products. Suppose the after split-off costs, such as collecting and packaging the parts are estimated to be $25 for 2,000 pounds of feet, beaks and gizzards.
The objective of this approach is to create equal gross profit percentages for all joint products. The average, or overall profit margin is the relevant measurement for the decision to produce or discontinue the joint process, i.e., produce all or none. However, critics of this method argue that since all joint products are not equally profitable, the joint cost allocation method should not imply that they are5. A counter argument is that all joint cost allocations are arbitrary in that the true profitability of individual products is indeterminable. Therefore, the joint cost allocations should not imply that true profitability has been obtained. Critics rebut the previous argument by pointing out that this method sometimes produces a negative cost allocation to some of the less profitable products . Certainly, approximations of the true costs are better than these confusing cross-subsidies.
Step 3: Determine Activity Rates
Discuss the different conceptual bases for allocating costs to cost objects. Product-level activities are performed on each product line and are not affected by either numbers of units or batches. Let’s take a closer look at the four basic steps of activity based costing.
How is plantwide overhead rate used in Job Order costing?
The plantwide method is applied as follows: 1. Total budgeted overhead costs are combined into one overhead cost pool. 2. Next, the cost pool is divided by the chosen allocation base, such as total direct labor hours, to arrive at a single plant wide allocation rate.
For packaging, we could use the number of items to be packaged or the cubic feet of product to be packaged. Sending statements would be based on the number of statements sent. Technical support could be based on the number of calls received by tech support or on time. The example of activity-based allocation method of overhead costs is any production company that simultaneously produces different types of goods that have different rates of overhead costs. Remember, these are overhead costs, not direct materials or direct labor costs. What overhead rate method results in more accurate overhead allocations as compared to the plantwide overhead rate method. When are activity based overhead rates needed to provide accurate product costs?
OF ACTIVITY BASED COSTING
Next, we can compare the allocated overhead costs for standard and custom go-karts under the single plant wide overhead rate and the departmental overhead rate methods. These differences occur because the custom go-kart requires more hours in the machining department than the standard go-kart requires . Manufactures two models of go-karts, standard and custom. They use a plantwide rate and use direct labor hours as the allocation base To calculate total direct labor hours, multiply the number of product units by direct labor hours per unit per product. Kartco’s budgeted overhead cost consists of indirect labor costs of $4,000,000 and factory utilities of $800,000 for a total of $4,800,000. This number will also be needed to calculate the plantwide overhead rate. When using the plantwide overhead rate method, total budgeted overhead costs are combined into one overhead cost pool.
Total cost to account for is divided by the equivalent units of production. Cost accounting systems accumulate costs and then assign them to products or services. A manufacturing firm that produces a large numbers of standardized units would normally use a job order cost accounting system. Determination of cost drivers completes the last stage of the model. Cost drivers trace or links the cost of performing certain activities to cost objects.
When should you use a plantwide overhead rate?
Overhead costs can be controlled by managing cost drivers. This is done by dividing the estimated overhead costs by the estimated level of cost driver activity . At this point, we have identified the most important and costly activities required to make products, and we have assigned overhead costs to each of these activities. • Predicting overhead can sometimes be hard because you might have more or less actual indirect labor, indirect material or factory expenses. Prior period costs are combined with costs incurred in the current period and then divided by the equivalent units of production. Activity-based costing is a system that tallies the costs of overhead activities and assigns those costs to products. Indirect costs are the overhead costs or costs that are not directly tied to the production of a product or service.
- Describe several types of supporting logic for cost allocations methods including the concepts of “cause and effect”, “ability to bear” and “fairness and equity”.
- Also, it’s important to compare the overhead rate to companies within the same industry.
- However, the allocations for these methods show the dilemma that system designers face when there are no identifiable values at the point of separation.
- Prevention and appraisal costs are incurred before a good or service is provided to a customer.
Another advantage of the dual rate method is that spending variances for both fixed and variable costs can be calculated when the actual service costs differ from budgeted costs. A disadvantage of using the dual rate method is that idle capacity costs for the service departments are allocated to the user departments. This problem is eliminated by using the single budgeted rate method illustrated below.
e. the time period.
Overhead allocation to the standard go-karts is much less under ABC than under either of the volume-based costing methods. ABC differs from using multiple departmental rates in how overhead cost pools are identified and in how overhead cost in each pool is allocated.
Defining outputs to be reviewed is an important step in a successful Activity Based Costing implement action. Overhead rate is a cost allocated to the production of a product or service. The accounting techniques that relate to joint and by products are placed in this chapter because these products create special cost allocation problems for system designers. However, this section is placed in an appendix because it represents a sideline topic in the sense that it can be omitted without interfering with the flow of the learning process. A complete picture of the reciprocal allocations appears in Exhibit 6-7. There may appear to be some double counting in the Power and Maintenance Departments, but this a normal result when solving simultaneous equations.