When using the plantwide overhead rate method the cost object is?
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In previous posts, we discussed plantwide overhead rates and departmental overhead rates to allocate overhead costs to cost objects. Another method for applying overhead is activity-based costing (ABC). Show
Activity-based costing is a more precise way to allocate costs to cost objects. Plantwide rates are the easiest to apply but can cause cost distortion because all overhead resources are treated as though they are equally consumed by all cost objects. Departmental rates were more refined because at least we were breaking costs down by department and applying overhead based on the actual activity a cost object used in each department. ABC goes one step further. Rather than just looking at each department, with ABC we are breaking down activities within the production process and calculating a rate for each activity. This allows a very refined allocation of overhead to the cost objects. In order to use ABC, we first must identify the activities that make up the processes important to our cost object. It is important to note that ABC can be used by any type of business. Even service companies can benefit from using ABC, especially in competitive markets. Activities could include things like machine setup, inspecting, packaging, sending statements, and providing technical support. Once the company has identified the activities, the company should identify the estimated cost of each of these activities. The cost of each activity is called an activity cost pool. These cost pools are used to accumulate costs associated with each activity. Next, select an allocation base or activity that best acts as a driver for each activity cost pool. If machine set up is one of your activity cost pools, the allocation base could be the number of setups that will be done over the year. For inspections, it makes sense to use the number of inspections that are done. For packaging, we could use the number of items to be packaged or the cubic feet of product to be packaged. Sending statements would be based on the number of statements sent. Technical support could be based on the number of calls received by tech support or on time. Now that you have your allocation bases set for each activity, estimate the quantity for each allocation base. The next step is to calculate the rate for each activity, using the estimated cost of each activity cost pool and the estimated quantity for each allocation base. At this point, this should start to look familiar because we did this using plantwide rates and departmental rates. To calculate the ABC rate: Total estimated activity cost pool / Total estimated activity allocation base = ABC rate This is the exact same formula we used for plantwide rates and departmental rates. Total cost divided by total activity equals rate. The only thing that is different about ABC rates is that you will have more of them. With plantwide rates we had one rate for the entire company. For departmental rates, we had one for each department. For ABC, we will have one rate for each activity that has been identified. It is extremely important to label each of your rates. If you are calculating the rate for machine setups, label your rate “$/setup”. This makes it much easier when you are applying your rates. Don’t skip this step. When students make mistakes, the mistakes are made in the application of the rates because students use the wrong driver to apply the rates. When you label your rates, it is so much easier to apply the rates because you don’t need to think about which rates to use for each activity. If the problem states that there are 15 setups, look at your rates for the one that is marked “$/setup” and use that one. To apply the rates, multiply the actual amount of activity by the rate for that activity. Again, that is very similar to what we did for plantwide rates and departmental rates. Just like departmental rates, once you get the amount for each activity, you will need to add up the applied cost for each activity to get the total overhead applied to your cost object. Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes - Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts Operations, Project, & Supply Chain Management Strategy, Entrepreneurship, & Innovation Business Ethics & Social Responsibility Global Business, International Law & Relations Business Communications & Negotiation Management, Leadership, & Organizational Behavior Economic Analysis & Monetary Policy Research, Quantitative Analysis, & Decision Science Investments, Trading, and Financial Markets Banking, Lending, and Credit Industry Business Finance, Personal Finance, and Valuation Principles Update The plantwide allocation method uses one predetermined overhead rate to allocate overhead costs.
Annual overhead costs are estimated and direct labor hours are used for the plantwide allocation base. These estimates are based on the previous year’s overhead costs and direct labor hours and are adjusted for expected increases in demand the coming year. The predetermined overhead rate is applied for each direct labor hour worked. One cost pool accounts for all overhead costs, and therefore one predetermined overhead rate is used to apply overhead costs to products. How to Determine Product Costs Using the Plantwide Allocation ApproachThe calculation of a product’s cost involves three components—direct materials, direct labor, and manufacturing overhead. This information, combined with the overhead cost per unit, gives us what we need to determine the product cost per unit for each model. Given the predetermined overhead rate per direct labor hour, and assuming it takes A hours of direct labor to build a unit product 1, and B hours to build a unit of product 2, we can calculate the manufacturing overhead cost per unit. Manufacturing overhead cost per unit is Base Rate × A direct labor hours + Base Rate × B direct labor hours. Combine the manufacturing overhead with direct materials and direct labor and we are able to calculate the product cost per unit. Although the plantwide allocation method is the simplest and least expensive approach, it also tends to be the least accurate. In spite of this weakness, why do some organizations prefer to use one plantwide overhead rate to allocate overhead to products? Organizations that use a plantwide allocation approach typically have simple operations with a few similar products. Management may not want more accurate product cost information or may not have the resources to implement a more complex accounting system. As we move on to more complex costing systems, remember that these systems are more expensive to implement. Thus the benefits of having improved cost information must outweigh the costs of obtaining the information. What is the plantwide overhead rate?The plantwide overhead rate is a single overhead rate that a company uses to allocate all of its manufacturing overhead costs to products or cost objects. It is most commonly used in smaller entities with simple cost structures.
What is the plantwide rate formula?Plantwide Overhead Rate = Total Overhead / Direct Labor Hours. It means the total number of direct labor hours is taken as the denominator, which is divided by the numerator as the total overhead cost of the company.
How are overhead costs allocated to products with the plantwide rate method?Annual overhead costs are estimated and direct labor hours are used for the plantwide allocation base. These estimates are based on the previous year's overhead costs and direct labor hours and are adjusted for expected increases in demand the coming year.
When a plantwide factory overhead rate is used the amount of overhead costs allocated to each product is the same?When a plantwide factory overhead rate is used, the total overhead costs allocated to all products are the same. Panamint Systems Corporation is estimating activity costs associated with producing disk drives, tapes drives, and wire drives. The indirect labor can be traced to four separate activity pools.
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