8/23/2023 Assuming the company uses normal costing (as described in chapters 2 and 3): course heroRead Now![]() Likewise, a manufacturer of frozen french fries uses a different type of solution to clean potatoes prior to making the french fries and would allocate the cost of the solution based on how much is used to make each batch of fries. It is not practical to measure every ounce of cleaning solution used in the manufacture of an individual pop socket rather, it makes sense to allocate to a particular batch of pop sockets the cost of the cleaning solution needed to make that batch. For example, one type of cleaning solution is used in the manufacturing of pop sockets. An example of an indirect material in some manufacturing processes is cleaning solution. A similar amount of information can be derived for indirect material. However, it is possible to track some indirect labor to several jobs or batches. By definition, indirect labor is not traced to individual products. A factory-level cost is incurred because products are being produced and includes costs such as the plant supervisor’s salary and rent on the factory building. A product-level cost is incurred each time a product is produced and includes costs such as engineering costs, testing costs, or quality control costs. A batch-level cost is incurred every time a batch of items is manufactured, for example, costs associated with purchasing and receiving materials. A unit-level cost is incurred each time a unit of product is produced and includes costs such as materials and labor. The idea behind these various levels is that at each level, there are additional costs that are encountered, so a company must decide at which level or levels it is best for the company to accumulate costs. In addition, technology has made it easier to track the various activities and their related overhead costs.Ĭosts can be gathered on a unit level, batch level, product level, or factory level. 5 Technology has changed the manufacturing labor force, and therefore, the type and cost of labor associated with those jobs have changed. ![]() For example, in the last few years, many industries have increased technology, and the amount of overhead has doubled. For many companies, and in many cases, overhead costs are now significantly larger than labor costs. Based on the number of direct labor hours and the number of units produced for each product, the overhead per product is shown in Figure 6.4.Īs technology costs decreased and production methods became more efficient, overhead costs changed and became a much larger component of product costs. Under the traditional method of costing, the predetermined overhead rate of $2 per direct labor hour was computed by dividing the estimated overhead by the estimated direct labor hours. For example, as shown in Figure 6.3, Musicality determined the direct costs and direct labor for their three products: Solo, Band, and Orchestra. ![]() Manufacturing overhead was not a large cost of the product, so an overhead allocation method based on labor or machine hours was logical. Historical Perspective on Determination of Manufacturing Overhead AllocationĪll products consist of material, labor, and overhead, and the major cost components have historically been materials and labor. Activity-based costing (ABC) is the process that assigns overhead to products based on the various activities that drive overhead costs. Making this change allows management to obtain more accurate product cost information, which leads to more informed decisions. This shift in costs gives companies the opportunity to stop using the traditional single predetermined overhead rate applied to all units of production and instead use an overhead allocation approach based on the actual activities that drive overhead. As technology changes the ratio between direct labor and overhead, more overhead costs are linked to drivers other than direct labor and machine hours.
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