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COST Allocation
Techniques
Overhead
Normal Costing
3.4 OH and Normal Costing
All manufacturing costs that are not DM/DL
MOH = Factory OH = Indirect Pdt Cost
(Indirect Materials, Indirect Labor, Supplies,
Utilities, Insurance, Taxes, Depreciation)
Costs outside the product cost (G&A,
Selling) are not inventoriable in COGS = P&L
DL and DM are purely variable costs
OH contains both Variable and Fixed costs
What is Normal Costing?
Normal costing is used to derive the cost of a product. It includes the following
components:
Actual cost of materials
Actual cost of labor
A standard overhead rate that is applied using the product's actual usage of
whatever allocation base is being used (such as direct labor hours or machine
time)
If there is a difference between the standard overhead cost and the actual
overhead cost, then you can either charge the difference to the cost of goods
sold (for smaller variances) or prorate the difference between the cost of goods
sold and inventory.
Normal costing is designed to yield product costs that do not contain the sudden
cost spikes that can occur when you use actual overhead costs; instead, it uses a
smoother long-term estimated overhead rate.
It is acceptable under generally accepted accounting principles and
international financial reporting standards to use normal costing to derive the cost
of a product.
Normal costing varies from standard costing, in that standard costing uses entirely
predetermined costs for all aspects of a product, while normal costing uses actual
costs for the materials and labor components.
Other Definition
Normal costing uses a predetermined annual overhead rate to
assign manufacturing overhead to products. In other words, the
overhead rate under normal costing is based on the expected
overhead costs for the entire accounting year and the expected
production volume for the entire year.
Under actual costing each month’s actual costs and each month’s
actual production volume are used to assign overhead costs. Since
most companies will experience month to month fluctuations in
activity, the actual monthly overhead rates will likely vary from
month to month.
Normal costing will result in an overhead rate that is more uniform
and realistic for all of the units manufactured during an accounting
year.
MOH = definition
Manufacturing overhead (also referred to as factory overhead, factory burden, and
manufacturing support costs) refers to indirect factory-related costs that are incurred
when a product is manufactured. Along with costs such as direct material and direct
labor, the cost of manufacturing overhead must be assigned to each unit produced
so that Inventory and Cost of Goods Sold are valued and reported according to
generally accepted accounting principles (GAAP).
Manufacturing overhead includes such things as the electricity used to operate the
factory equipment, depreciation on the factory equipment and building, factory
supplies and factory personnel (other than direct labor). How these costs are
assigned to products has an impact on the measurement of an individual product's
profitability.
As their names indicate, direct material and direct labor costs are directly
traceable to the products being manufactured. Manufacturing overhead,
however, consists of indirect factory-related costs and as such must be
divided up and allocated to each unit produced. For example, the property
tax on a factory building is part of manufacturing overhead. Although the
property tax covers an entire year and appears as one large amount on just
one tax bill, GAAP requires that a portion of this amount be allocated or
assigned to each product manufactured during that year.
Examples:
Material handlers (forklift operators who move materials and units).
People who set up the manufacturing equipment to the required
specifications.
People who inspect products as they are being produced.
People who perform maintenance on the equipment.
People who clean the manufacturing area.
People who perform record keeping for the manufacturing processes.
Factory management team.
Electricity, natural gas, water, and sewer for operating the manufacturing
facilities and equipment.
Computer and communication systems for the manufacturing function.
Repair parts for the manufacturing equipment and facilities.
Supplies for operating the manufacturing process.
Depreciation on the manufacturing equipment and facilities.
Insurance and property taxes on the manufacturing equipment and
facilities.
Safety and environmental costs.
Steps for Analysis
A. Normal capacity.
B. Expected annual activity.
C. Theoretical capacity.
D.
Master-budget capacity.
SU 3.4 Question 1 Answer
Correct Answer: C
Incorrect Answers:
B.
Smooth seasonal variability of
overhead costs.
C.
Simulate seasonal variability of
activity levels.
D.
Treat overhead as period costs.
SU 3.4 Question 2 Answer
Incorrect Answers:
Total $523,000
Total $459,000
SU 3.5 Question 1 (continued)
Pane’s profit plan for the year included budgeted direct labor of $320,000
and overhead of $448,000. Assuming no work-in-process on December 31,
Pane’s overhead for the year was
A. $11,000 overapplied.
B. $24,000 overapplied.
C. $11,000 underapplied.
D.
$24,000 underapplied.
SU 3.5 Question 1 Answer
Correct Answer: B
Incorrect Answers:
A. $25,000
B. $30,000
C. $45,000
D. $50,000
SU 3.5 Question 2 Answer
Correct Answer: B
Review examples
Page 128 #3.7
SU 3.6 Question 1
Question 1 - CMA1 Study
Unit 3: Cost Allocation
Techniques
In allocating factory
service department costs
to producing
departments, which one
of the following items
would most likely be
used as an activity
base?
Incorrect Answers:
A: Making allocations on the basis of units sold may not meet the cause-
and-effect criterion.
D: Making allocations on the basis of materials usage may not meet the
cause-and-effect criterion.
SU 3.6 Question 2
Question 2 - CMA1 Study Unit 3:
Cost Allocation Techniques
When allocating costs from one
department to another, a dual-rate
cost-allocation method may be
used. The dual-rate cost-allocation
method is most useful when
Incorrect Answers: