Overhead Allocation Flashcards
How do you allocate overheads/indirect costs to cost objects?
By using either the:
traditional approach or
the activity based costing (ABC) system
Is there a one size fits all approach to cost allocation?
No
What can the basic techniques of cost allocation be divided into?
Volume- and value-based techniques and
Activity-based techniques
What is a volume-based overhead allocation system?
It refers to any method of allocating overheads that is based on some measure related to production or service volumes.
What is a volume-based system frequently referred to?
TRADITIONAL overhead allocation system
What is another ‘traditional’ overhead allocation method?
Relative sales values (Value-based system)
How is the overheads allocated in a value-based system?
In proportion to the selling prices of products.
What is the 2 basic considerations that apply to a traditional system?
- What volume or value measure should be used?
2. What is the level of detail required in order to receive a reasonably accurate allocation?
When may a volume-based measure be appropriate?
When the products produced are largely the same.
Why is overheads sometimes assigned based on sales value?
Reflects the believe that a product with a higher sales value has been more costly to produce.
What is the financial accounting objective?
To calculate the cost at which the inventory will be reflected on the FS, before it is sold
What is the management accounting objective?
To calculate the amount by which the product contributes to profit when the product is sold.
What is a plant-wide rate?
The organization determine a single overhead rate for the organization in its entirety
What is a departmental rate?
A rate determined for each department.
How is a single plant-wide rate determined?
By accumulating the total overheads and dividing by the allocation base determined as most suitable.
Comparison between plant-wide and departmental rate
PW: single overhead rate calculated as a whole
D: Multiple overhead rates
PW: one allocation base is used
D: different allocation base for different departments (labour hours, machine hours, nr of employees, etc.)
PW: Overheads assigned to products based on total use of a single resource (allocation base)
D: overheads assigned to products based on amount of resources used by product in each department
Result
PW: overheads averaged between products
D: overheads are averaged, but less extensively
What is a cost centre?
A sub-unit of a department
What is production departments?
They are directly involved in producing the product.
What is support service departments?
They have no direct input into products, they support or service the departments that have a direct input
What is typical examples of support service departments?
IT or
Admin departments
Is support service department costs allocated too the production departments?
Yes, before the departmental overhead allocation rate is calculated.
What is the DIRECT approach to allocate support service department costs?
Requires management to allocate the costs directly to production departments.
Often done in how the production departments make use of the support service departments.
Is the direct approach preferred?
Sometimes, because of its simplicity
When will the results of a direct approach be less accurate?
If the support service departments consume a significant amount of each other’s resources
What is the STEP-DOWN approach to allocate support service department costs?
Support service departments are ranked in order of total costs and the costs of the highest ranking departments are allocated to production and other departments first and then ‘closed-off’
What is a disadvantage of the step-down approach?
If lower-ranked departments use higher-ranked departments’ services, this is ignored.
What is the REPEATED DISTRIBUTION approach to allocate support service department costs?
Expanded version of the step-down approach.
The fact that support service departments use each other’s services are taken fully into account.
What is the SIMULTANEOUS EQUATION approach to allocate support service department costs?
Based on the same principles as the repeated distribution.
The problem is solved mathematically instead of through repetition.
Requires total overheads for each department, including cost of using services of other departments, to be formulated as an equation.
What is activity-based costing (ABC)?
overhead costs are assigned to cost objects based on the activities that drive those costs
What is cost drivers?
The activities that cause the overhead costs to be incurred
What is an example of a cost driver?
Number of orders received
Number of batches manufactured
What is a cost pool?
Different costs that have the same cost driver that was grouped to form the cost pool
What is the steps in ABC?
- Identify activities and group them into cost pools
- Identify cost drivers
- Calculate activity rates
- Assign costs to cost objects
What 4 levels are activities organised in?
- Unit-level activities
- Batch-level activities
- Product-level activities
- Facility-sustaining activities
What are the 3 categories of cost drivers?
- Transaction driver: (most common) overhead cost driven by number of times activity is performed
- Duration driver: driven by the length of time it takes to perform an activity
- Intensity driver: certain types of products may use resources more intensely
How is the activity rate calculated?
Divide the TOTAL cost per activity cost pool by the CAPACITY for that cost driver
What is practical capacity?
Not a theoretical capacity and allows for downtime
What is normal capacity?
Average capacity over the number of periods
What is the cost of idle?
the remaining unallocated overheads
How is overheads assigned?
By multiplying the activity rate by the number of activity measures for that cost object
Does ABC allocate only manufacturing overheads?
No, both manufacturing and non-manufacturing overheads.
Does traditional allocate only manufacturing overheads?
Yes
What is some limitations of ABC?
Process of gathering info and identifying activities can be expensive and time consuming.
The reliability of cost info is undetermined by certain impracticalities.
Can create a false impression of the relevance of overhead costs to decision-making.
What is activity-based management (ABM)?
When ABC is used, management becomes aware of how activities drive costs and is likely to focus on minimizing activities
