Chapter 7 A closer look at overhead costs Copyright ª 2006 McGraw­Hill Australia Pty Ltd 7­ 1 What are overhead costs? • For product costing, these are indirect product costs • For responsibility costing, these are the indirect costs of responsibility areas • Manufacturing overhead costs – All manufacturing costs other than direct material and direct labour continued Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 7-2 What are overhead costs? • Incurred for a variety of products that cannot be traced to individual products • Can be traced to individual product but not worth the trouble • Can be traced to individual products but it’s more appropriate to treat this cost as a cost of all output • Includes depreciation, factory insurance, factory electricity costs, cost of manufacturing support departments, indirect materials, indirect labour • Non-manufacturing costs are all costs incurred outside of manufacturing Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 7-3 Allocating indirect costs: some general principles • Using cost pools – Cost assignment can take two forms Direct costs can be traced directly to products Indirect costs cannot be traced to cost objects; therefore, they need to be allocated – Acost pool is a collection of costs that are to be allocated to cost objects Have a common allocation base Often used to simplify the allocation process continued Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 7-4 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 7-5 Allocating indirect costs: some general principles • Determining cost allocation bases – Acost allocation base is some factor or variable that allows us to allocate costs in a cost pool to cost objects Ideally should be a cost driver – Acost driver is an activity or factor that causes costs to be incurred – Ideally cost should increase or decrease in direct proportion to the allocation case (or cost driver) Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 7-6 Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 7-7 Allocating overhead costs to products • Reliable product costs are important in a range of management decisions • An important issue is how to allocate indirect costs to obtain a reliable estimate of a product’s cost • Three possible approaches – A plantwide rate – Departmental rate – Activity-based costing continued Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 7-8 Allocating overhead costs to products • Using a plantwide rate – A plantwide rate is a single overhead rate that is calculated for the entire production plant • Three steps – Identify the overhead cost driver – Calculate the overhead rate per unit of the cost driver – Apply the manufacturing overhead cost to the product based on the predetermined overhead rate continued Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 7-9 Allocating overhead costs to products • Using departmental overhead rates to allocate overhead to products • Two-stage cost allocation for department overhead rates – Stage one: where overhead costs are assigned to production department – Stage two: overhead costs are applied to products continued Copyright 2006 McGraw-Hill Australia Pty Ltd PPTs t/a Management Accounting: Information for managing and creating value 4e Slides prepared by Kim Langfield-Smith 7-10 Allocating overhead costs to products Predetermined manufacturing overhead rate = Budgeted manufacturing overhead