Key Terms
Definition
Allocates factory overhead to products based on volume of production resources consumed.
Works best when
Direct labor is a dominant component in production.
Limitation
As technology replaces labor, overhead grows larger and is driven by multiple factors; a single rate misallocates costs.
Formula
Predetermined Overhead Rate = Estimated Manufacturing Overhead / Estimated Activity Base
Estimated overhead
$2,500,000 Estimated direct labor hours: 1,250,000
Predetermined rate
$2,500,000 / 1,250,000 = $2.00 per direct labor hour
Overhead applied
350,000 x $2.00 = $700,000 Overhead per unit: $700,000 / 140,000 = $5.00
Cost driver
Activity that causes increase or decrease in another cost; has cause-and-effect relationship with overhead
Unit-level cost
Incurred for each unit produced
Value-added costs
Drive overhead AND increase product quality or customer satisfaction Non-value-added costs: necessary to sell the produc
Goal
Eliminate as many non-value-added costs as possible to reduce overhead.
Activity-based costing (ABC)
Assigns overhead to products based on the activities that drive overhead costs; uses multiple cost drivers instead of on
ABC works best when
Technology is a large portion of product cost and overhead is driven by multiple diverse activities.
Proper order
Identify cost pools -> identify cost drivers -> calculate overhead rate -> assign costs to products
Activity
Any action or process involved in the production of inventory that consumes company resources