The predetermined overhead rate is the amount of manufacturing overhead that is estimated to be applied to each product or department depending on the cost system used (job order costing or process costing). It typically is estimated at the beginning of each period by dividing the estimated manufacturing overhead by an activity base. While it is most commonly a year, the period can be a year, quarter, or month as determined by management. In traditional allocation systems, that base is typically direct labor hours, direct labor dollars, or machine hours. In activity-based costing systems, the activity base is one or more cost drivers.
Non-value-added costs can often be eliminated since they are rarely essential, and identifying them helps managers reduce their costs.
Answers may vary but should be similar to the following: A. number of orders; B. number of customers; C. number of meals; D. number of material requisitions received.
Activity-based costing has multiple cost drivers and focuses on the overhead-related activities performed during manufacturing. Traditional allocation has a single unit-level base for allocating overhead and focuses on the units of production.
Estimated overhead costs are first allocated to activity cost pools. Then, an allocation rate is determined based on the estimated usage of the cost driver for that pool. Then the costs are allocated to each product based on that product’s cost driver usage.
The traditional method of applying overhead does not allocate overhead as precisely as with the ABC method. Management relies on the costing information when setting selling prices and bidding on service jobs. If the costing method is not accurate, some products may be considered profitable under traditional allocation, when those products are actually operating at a loss.
While variable costing is not acceptable for financial reporting purposes, some managers prefer variable costing because they believe fixed costs are period costs and do not change during the period. Variable costing separates variable and fixed manufacturing overhead, and using only variable costs allows them to make decisions based on the more reliable variations in unit costs.
Yes, as long as the system computes the amount of fixed manufacturing overhead per unit. The total amount can be expensed under variable costing and assigned to overhead produced during absorption costing. This will allow a portion to be included in ending inventory for absorption costing and not included for variable costing.