This needs to be done because total manufacturing overhead cost includes variable overhead costs that depend on the amount of the allocation base. Many companies use job- order costing systems that assume direct labor-hours (or direct labor cost) is the only manufacturing overhead cost driver.
Job-Order Costing Using Multiple Predetermined Overhead Rates
To improve job cost accuracy, the allocation base in the predetermined overhead rate should drive the overhead cost. Overhead applied to Job 407 = Predetermined overhead rate × Actual amount of the allocation base used by Job 407.
Job-Order Costing—An External Reporting Perspective
When a company creates overhead rates based on the activities that it performs, it is employing an approach called activity-based costing. For now, our goal is to simply introduce you to the idea of activity-based costing—. The company’s cost system uses a plantwide overhead rate that allocates overhead costs based on the number of chocolate bars produced.
In other words, a company’s job costs sheets provide an underlying set of financial records that explain what specific jobs comprise the amounts reported in Work-in-Process and Finished Goods on the balance sheet as well as Cost of Goods Sold on the income statement. For example, the combined costs of Jobs A and B equal Work in Process ($498) on the balance sheet, whereas the combined costs of Jobs D, E, and F equal Cost of Goods Sold ($1,088) on the income statement.
Job-Order Costing in Service Companies
A job cost sheet accumulates the total direct materials, direct labor, and manufacturing overhead costs assigned to a job. When all of a company’s job cost sheets are viewed col- lectively they form what is known as a subsidiary ledger. This brief example illustrates the interrelationship between a company’s job cost sheets and its financial statements.
Normal costing systems allocate overhead costs to jobs using predetermined overhead rates that are estimated before the period begins. The second set of data relates to one particular job completed during the year—Job A200.
Summary
When used in a manufacturing context, job-order costing systems accumulate a job’s direct materials, direct labor, and manufac- turing overhead costs on a job cost sheet. Job-order costing systems use materials requisition forms and labor time tickets to trace direct materials and direct labor costs to jobs. Ideally, the allocation base used to allocate overhead costs to jobs should be a cost driver—it should cause the consumption of overhead costs.
The most frequently used allocation bases in job-order costing systems are direct labor-hours and machine-hours. Job-order costing systems can use only one predetermined overhead rate (also called a plantwide rate) or multiple predetermined overhead rates.
Review Problem: Calculating Unit Product Costs
Selling and administrative costs are not assigned to jobs because they are treated as period costs. A predetermined overhead rate is computed by divid- ing the estimated total manufacturing overhead cost for the period by the estimated total amount of the allocation base for the period. Throughout the period, overhead is applied to jobs by multiplying the predetermined overhead rate by the actual amount of the allocation base recorded for each job.
If Redhawk uses predetermined departmental overhead rates with direct labor-hours as the allocation base in Assembly and machine-hours as the allocation base in Fabrication, how much total manufacturing overhead cost would be applied to Job A200. Assume that Redhawk uses the departmental overhead rates mentioned in requirement 2 and that Job A200 includes 50 units.
Questions
Glossary
Applying Excel
Change the total fixed manufacturing overhead cost for the Milling Department in the Data area back to $390,000, keeping all of the other data the same as in the original example. What happens to the selling price for Job 408 if the total number of machine-hours in the. What happens to the selling price for Job 408 if the total number of direct labor-hours in the Assembly Department decreases from 80,000 direct labor-hours to 50,000 direct labor- hours.
For questions 1–8, assume that Sweeten Company uses a plantwide predetermined overhead rate with machine-hours as the allocation base. What were the company’s predetermined overhead rates in the Molding Department and the Fabrication Department.
Exercises
Tech Solutions computes its predetermined overhead rate annually on the basis of direct labor- hours. During the year, the company started and completed only two jobs—Job Alpha, which used 54,500 direct labor-hours, and Job Omega. It uses a job-order costing system with a plantwide predetermined overhead rate based on machine-hours.
The company uses a job-order costing system and computes a predetermined overhead rate in each department. Would you expect substantially different amounts of overhead cost to be assigned to some jobs if the company used a plantwide predetermined overhead rate based on direct labor- hours, rather than using departmental rates.
Problems
If Wilmington used a plantwide predetermined overhead rate based on direct labor-hours, how much manufacturing overhead would be applied to Job Bravo. If Wilmington uses departmental predetermined overhead rates with direct labor-hours as the allocation base in Assembly and machine-hours as the allocation base in Fabrication, how much manufacturing overhead would be applied to Job Bravo. The predetermined overhead rate in the Molding Department is based on machine-hours, and the rate in the Painting Department is based on direct labor-hours.
Historically, McCullough has used one predetermined overhead rate based on the number of patient-days (each night that a patient spends in the hospital counts as one patient-day) to allocate overhead costs to patients. If Mason Company uses a plantwide predetermined overhead rate with direct labor-hours as the allocation base, how much manufacturing overhead cost would be applied to Job A.
Case
Determine the amount of manufacturing overhead cost that would have been applied to the Koopers job. Suppose that instead of using a plantwide predetermined overhead rate, the company had used departmental predetermined overhead rates based on direct labor cost. Explain the difference between the manufacturing overhead that would have been applied to the Koopers job using the plantwide approach in question 1 (b) and using the departmental approach in question 2 (b).
What was the company’s bid price on the Koopers job using a plantwide predetermined overhead rate. What would the bid price have been if departmental predetermined overhead rates had been used to apply overhead cost.
Appendix 2A: Activity-Based Absorption Costing
The company has traditionally applied manufacturing overhead costs to these products using a plantwide predetermined overhead rate based on direct labor-hours. Exhibit 2A–1 details how the unit product costs of the two product lines are computed using the company’s traditional costing system. The company’s activity-based approach simply provides an alternative way to allocate the company’s manufacturing overhead across the two products.
The table at the bottom of Exhibit 2A–2 displays the overhead costs per unit and the activity-based unit product costs. In contrast, the unit product cost of the Premium product line, the low-volume product, has increased from $71.60 under the traditional costing system to $78.56 under activity-based costing.
Glossary (Appendix 2A)
The unit product cost of the Standard product line, the high-volume product, has gone down from $53.70 under the traditional cost- ing system to $51.96 under activity-based costing. Instead of using direct labor-hours (which moves in tandem with the volume of the production) to assign all manufacturing overhead costs to products, the activity-based approach uses a batch- level activity measure and a product-level activity measure to assign the batch-level and product-level activity cost pools to the two products.
Appendix 2A: Exercises, Problems, and Case
Compute the unit product costs for the two products using the proposed activity-based absorp- tion costing system. Determine the unit product costs of the Deluxe and Standard products under the activity-based absorption costing system. Assume that the company decides to use activity-based absorption costing to apply overhead cost to products.
Management is considering using activity-based absorption costing to apply manufacturing over- head cost to products. Compute the total amount of manufacturing overhead cost that would be applied to each model using the activity-based absorption costing system.
Appendix 2B: The Predetermined Overhead Rate and Capacity
Determine the total amount of manufacturing overhead cost assigned to Kenya Dark cof- fee and to Viet Select coffee for the year. Using the data developed in (2a) above, compute the amount of manufacturing overhead cost per pound of Kenya Dark coffee and Viet Select coffee. Basing the predetermined overhead rate on the estimated total amount of the alloca- tion base at capacity overcomes the two limitations just discussed.
Then the total manufacturing overhead cost will be the same regardless of the level of activity. Cost of unused capacity = ( Amount of the allocation base at capacity – Actual amount of the allocation base ) × Predetermined overhead rate For example, let’s assume that Prahad Company actually used 6,000,000 seconds on the DVD duplicating machine to produce 600,000 DVDs.
Appendix 2B: Exercises, Problem, and Case
If the company bases its predetermined overhead rate on the estimated overhead cost and the estimated professional staff hours to be charged to clients, how much overhead cost would have been applied to Ms. Suppose that the company bases its predetermined overhead rate on the estimated overhead cost and the estimated professional staff hours to be charged to clients as in (1) above. If the company bases its predeter- mined overhead rate on the professional staff hours available, how much overhead cost would have been applied to Ms.
Suppose that the company bases its predetermined overhead rate on the professional staff hours available as in (3) above. Platinum Tracks computes its predetermined overhead rate at the beginning of each year based on the estimated studio overhead cost and the estimated hours of studio service for the year.
