Accounting. Costing systems. Overheads

Use activity-based costing, including recurring cost allocation, customer profitability management, and pricing in both manufacturing and service organizations. Key implementation challenges associated with activity-based costing systems.

Activity-Based Costing (ABC)
In order to use ABC efficiently in a business, certain steps need to be followed:

• Define activities, activity cost pools, and activity measures.
• Assign overhead costs to activity cost pools.
• Calculate activity rates.
• Assign overhead costs to cost objects using the activity rates and activity measures.
• Prepare management reports.

Variable Costing
So, for example, if we produced 100 units that had $8 in direct materials, $9 in direct labor, $5 in variable manufacturing overhead, and $1,000 of total fixed costs for the period, the unit product cost would be calculated like this:

Direct Material $8 + Direct Labor $9 + Variable Manufacturing Overhead $5 = Unit Product Cost $22

Standard Costs
Accountants, engineers, purchasing, and production managers combine efforts to set standards that encourage efficient production. Two types of standards are commonly used—quantity standards that show how much quantity should be used and price standards that specify how much should be paid for each unit of input.

Overhead Variances
If we had a rate of $10 per machine hour and we had the budgeted level of activity set at 20,000 machine hours and 23,000 hours were allowed for the actual level of output, the formula would look like this:

$10 (20,000 MHs – 23,000 MHs) = $30,000 F

Process and job order cost systems are similar in that each system: 

Records and summarizes product costs. 

Classifies product costs as direct materials, direct labor, and factory overhead. 

Allocates factory overhead costs to products. 

Uses a perpetual inventory system for materials, work in process, and finished goods. 

Provides useful product cost information for decision making. 

Process and job costing systems are different in several ways.  

Job costing involves the detailed accumulation of production costs attributable to specific units or groups of units. For example, the construction of a custom-designed piece of furniture would be accounted for with a job costing system. 

Process costing involves the accumulation of costs for lengthy production runs involving products that are indistinguishable from each other. For example, the production of 100,000 gallons of gasoline would require that all oil used in the process, as well as all labor in the refinery facility be accumulated into a cost account, and then divided by the number of units produced to arrive at the cost per unit. 

Activity-based costing (ABC method) provides an alternative approach for allocating factory overhead that uses multiple factory overhead rates based on different activities. Activities are the types of work, or actions, involved in a manufacturing or service process. For example, the assembly, inspection, and engineering design functions are activities that might be used to allocate overhead.

Overheads are expenses spent throughout the production process. They help with production but aren't immediately related to it like direct materials and direct labor are. For example, factory supervisor charges, indirect material, indirect labor, factory depreciation, factory supplies, and so on are examples of indirect manufacturing expenses.

Overhead application process:

The overhead rate is set at the start of the year based on the projected total overheads and overall cost driver. Labor hours, machine hours, or direct labor costs can all be cost drivers. This pre-determined overheads rate is added to the actual cost driver incurred during the year to apply manufacturing overheads to a project or process. The goal of applying pre-determined overhead to products is to aid in product costs and ensure uniformity in overhead application.

Over-applied  or under-applied overheads:

Over or under application of manufacturing overheads can occur when the discrepancy between manufacturing overhead applied to production and actual manufacturing overheads exists. Over-applied overheads occur when manufacturing overheads are higher than actual overheads. Under-applied overheads occur when actual overheads exceed applied manufacturing overheads.

Impact on financial statements and decision-making:

When overheads are over-applied, the cost of items sold will rise, as will the cost of work-in-process and finished items inventory in financial statements.

When overheads are under-applied, the cost of items sold is reduced, and the cost of work-in-process and finished goods inventories is reduced in financial statements.

Correction in accounting records:

At the end of the year, any overheads that have been over-or under-utilized are disposed of. There are two ways to account for the same thing. 

If the excess or under-applied overheads are modest, they are charged to the cost of goods sold.

If there are considerable over or under applied overheads, they are disposed of proportional to Cost of goods sold, Work in process inventory, and Finished goods inventory. As a foundation for allocation, the proportion of the cost of goods sold, work in progress, and finished items inventory is used.