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