Skip to ContentGo to accessibility pageKeyboard shortcuts menu

## 6.1Calculate Predetermined Overhead and Total Cost under the Traditional Allocation Method

• Manufacturing overhead is estimated for the upcoming period.
• An activity base is selected to allocate overhead. This is traditionally direct labor hours, direct labor cost, or machine hours.
• A predetermined overhead rate is calculated by dividing the estimated overhead by the allocation base.
• Overhead is allocated to each product based on the estimated predetermined overhead rate and the number of units in the selected activity base.

## 6.2Describe and Identify Cost Drivers

• Overhead costs are analyzed and grouped based on similar activity bases. A cost driver, such as inspections, machine setups, or order taking, is selected for each cost grouping.
• Analysis of cost drivers allows for better selection of true overhead cost drivers and more appropriate allocation of overhead.

## 6.3Calculate Activity-Based Product Costs

• Costs can be traced to the unit level or batch level.
• There are five steps in the ABC process:
• identify activities needed for production
• assign overhead expenses
• assign a cost driver for each expense
• determine a predetermined overhead rate
• allocate overhead to each product

## 6.4Compare and Contrast Traditional and Activity-Based Costing Systems

• Traditional allocation assigns overhead based on a single overhead rate, while ABC assigns overhead based on several cost pools and the activities that drive costs.
• Traditional allocation is optimal when the manufacturing process is labor driven and overhead increases based on traditional activity bases, such as direct labor hours, direct labor dollars, or machine hours.
• ABC costing is optimal when the manufacturing process is technology driven and overhead increases based on various activities that differ for each product.

## 6.5Compare and Contrast Variable and Absorption Costing

• Absorption costing assigns all manufacturing costs to products, whereas variable costing only assigns variable costs to the products.
• Income statements from both methods can be reconciled by starting with the net income or loss using variable costing and adding the amount of fixed costs included in ending inventory and subtracting the fixed costs included in beginning inventory.
• Variable costing is not considered GAAP compliant but lends itself to cost-volume-profit analysis.
Citation/Attribution

This book may not be used in the training of large language models or otherwise be ingested into large language models or generative AI offerings without OpenStax's permission.

Want to cite, share, or modify this book? This book uses the Creative Commons Attribution-NonCommercial-ShareAlike License and you must attribute OpenStax.

Attribution information
• If you are redistributing all or part of this book in a print format, then you must include on every physical page the following attribution:
Access for free at https://openstax.org/books/principles-managerial-accounting/pages/1-why-it-matters
• If you are redistributing all or part of this book in a digital format, then you must include on every digital page view the following attribution:
Access for free at https://openstax.org/books/principles-managerial-accounting/pages/1-why-it-matters
Citation information

© Jul 16, 2024 OpenStax. Textbook content produced by OpenStax is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike License . The OpenStax name, OpenStax logo, OpenStax book covers, OpenStax CNX name, and OpenStax CNX logo are not subject to the Creative Commons license and may not be reproduced without the prior and express written consent of Rice University.