Chapter 4 LO 4 Compute a Predetermined Overhead Rate and Apply Overhead to Production ACCT& 203 working
The Cut andPolish department expects to use 25,000 machine hours, and theQuality Control department plans to utilize 50,000 hours of directlabor time for the year. Kline Company expects to incur $800,000 in overhead costs this coming year—$200,000 in the Cut and Polish department and $600,000 in the Quality Control department. 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. One of the advantages of predetermined overhead rate is that businesses can use it to help with closing their books more quickly. This is because using this rate allows them to avoid compiling actual overhead costs as part of their closing process. Nonetheless, it is still essential for businesses to reconcile the difference between the actual overhead and the estimated overhead at the end of their fiscal year.
- The cost of goods sold consists of direct materials of $3.50 per unit, direct labor of $10 per unit, and manufacturing overhead of $5.00 per unit.
- Using activity based costing, it is possible to understand the value of an activity and cost it accordingly instead of using time as a basis for allocating overheads.
- Added to these issues is the nature of establishing an overhead rate, which is often completed months before being applied to specific jobs.
- Estimating overhead costs is difficult because many costs fluctuate significantly from when the overhead allocation rate is established to when its actual application occurs during the production process.
- He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
- If an actual rate is computed monthly or quarterly, seasonal factors in overhead costs or in the activity base can produce fluctuations in the overhead rate.
- The predetermined overhead rate is calculated by dividing the estimated manufacturing overhead by the estimated activity base (direct labor hours, direct labor dollars, or machine hours).
What is the right basis to use to calculate the overhead rate
The predetermined overhead rate allows for the absorption of overheads during the period for which they have been computed and is based on the anticipated amount of overhead and the anticipated quantum or value of the base. This rate is useful from the point of view of cost control as it enables management to plan ahead and budget for the future. The formula for a predetermined overhead rate is expressed as a ratio of the estimated amount of manufacturing overhead to be incurred in a period to the estimated activity base for the period.
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For example, Figure 4.18 shows the monthly costs, the annual actual cost, and the estimated overhead for Dinosaur Vinyl for the year. In our example, the finishing department sees labor hours as the logical cost driver, because it is labor-intensive. In other words, the costs accumulated in the pool are mostly due to the hand labor done by skilled workers. However, instead of using hours worked, we have decided to use wages and benefits at $20 per hour. Remember that by using labor $, we would take into account the relative skill level of the employees, assuming that more skilled workers made more per hour.
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Figure 4.18 shows the monthly manufacturing actual overhead recorded by Dinosaur Vinyl. For example, the total direct labor hours estimated for the solo the predetermined overhead allocation rate is the rate used to product is 350,000 direct labor hours. With $2.00 of overhead per direct hour, the Solo product is estimated to have $700,000 of overhead applied.
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This activity base is often direct labor hours, direct labor costs, or machine hours. Once a company determines the overhead rate, it determines the overhead rate per unit and adds the overhead per unit cost to the direct material and direct labor costs for the product to find the total cost. Added to these issues is the nature of establishing an overhead rate, which is often completed months before being applied to specific jobs. Establishing the overhead allocation rate first requires management to identify which expenses they consider manufacturing overhead and then to estimate the manufacturing overhead for the next year. Manufacturing overhead costs include all manufacturing costs except for direct materials and direct labor. Estimating overhead costs is difficult because many costs fluctuate significantly from when the overhead allocation rate is established to when its actual application occurs during the production process.
3: Approaches to Allocating Overhead Costs
Direct labor standard rate, machine hours standard rate, and direct labor hours standard rate are some methods of factory overhead absorption. That amount is added to the cost of the job, and the amount in the manufacturing overhead account is reduced by the same amount. At the end of the year, the amount of overhead estimated and applied should be close, although it https://www.bookstime.com/ is rare for the applied amount to exactly equal the actual overhead. For example, Figure 8.41 shows the monthly costs, the annual actual cost, and the estimated overhead for Dinosaur Vinyl for the year. Using the predetermined overhead rate formula and calculation provides businesses with a percentage they can monitor on a quarterly, monthly, or even weekly basis.
