6.1 Calculate Predetermined Overhead and Total Cost under the Traditional Allocation Method
2 min read•june 18, 2024
Predetermined overhead rates help companies allocate to products before actual costs are known. This method uses estimates of total overhead and production activity to create a consistent rate for assigning costs throughout the period, improving cost control and decision-making.
Calculating total product cost involves combining direct materials, direct labor, and allocated overhead. By understanding and using appropriate allocation methods, companies can more accurately determine the true cost of their products, supporting pricing and profitability analysis.
Calculating Predetermined Overhead and Total Cost
Predetermined overhead rate calculation
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- Estimates total for a future period divides by estimated total units in the (, , or )
- Helps allocate overhead costs to products before actual costs are known
- Provides a consistent rate for assigning overhead costs throughout the period
- Allows for better cost control and decision-making
- Example: \text{[Predetermined overhead rate](https://www.fiveableKeyTerm:predetermined_overhead_rate)} = \frac{\200,000 \text{ estimated overhead}}{20,000 \text{ estimated machine hours}} = $10 \text{ per machine hour}$
Overhead application using labor hours
- Applies overhead costs to products based on the predetermined rate actual quantity of the allocation base used
- Allocation base is often direct labor hours, representing time spent on each product
- Allows for more accurate costing by assigning overhead based on the resource consumption of each product
- Example:
- Product X consumes 1,000 direct labor hours
- is $20 per direct labor hour
- \text{Allocated overhead for Product X} = 1,000 \text{ hours} \times \20 \text{ per hour} = $20,000$
Components of total product cost
- Direct materials
- Raw materials directly incorporated into the final product (wood, steel, plastic)
- Traced directly to each product based on the quantity consumed
- Direct labor
- Wages of workers directly involved in production (assembly line workers, machine operators)
- Traced directly to each product based on time spent
- Allocated overhead
- Indirect costs not easily traceable to individual products (rent, utilities, supervisor salaries)
- Assigned to products using the predetermined overhead rate allocation base
- methods may include traditional or approaches
- Example:
- Direct materials for Product Y: $25,000
- Direct labor for Product Y: $15,000
- Allocated overhead for Product Y: $20,000 (calculated using the predetermined overhead rate)
- \text{Total product cost for Product Y} = \25,000 + $15,000 + $20,000 = $60,000$
Cost behavior and classification
- : Change in proportion to activity level (e.g., direct materials)
- : Remain constant regardless of activity level (e.g., rent)
- Understanding cost behavior helps in accurate cost allocation and decision-making
- : Groups of individual costs, often used in more complex allocation systems
- : Factors that cause changes in cost, used to allocate costs from cost pools to products
Key Terms to Review (29)
Activity base: An activity base is a measure used to allocate overhead costs to products or services based on their consumption of activities. Common examples include direct labor hours, machine hours, or units produced.
Activity-based costing: Activity-Based Costing (ABC) is a costing method that assigns overhead and indirect costs to related products and services. It identifies specific activities within an organization and assigns the cost of each activity to all products and services according to the actual consumption by each.
Activity-Based Costing: Activity-based costing (ABC) is a costing methodology that identifies activities in an organization and assigns the cost of each activity with resources to the various products and services according to the actual consumption by each. It is a more accurate way of allocating overhead costs compared to traditional volume-based costing methods.
Allocation Base: The allocation base is the measure used to distribute or allocate overhead costs to individual products or jobs in a cost accounting system. It serves as the basis for assigning indirect costs to cost objects in a fair and systematic manner.
Common fixed costs: Common fixed costs are fixed costs that support more than one business segment. These costs do not change with the level of production or sales and cannot be traced directly to any single segment.
Cost Allocation: Cost allocation is the process of assigning indirect or overhead costs to specific cost objects, such as products, services, or departments, based on a rational and systematic method. It is a crucial concept in managerial accounting that helps organizations accurately determine the true cost of their operations and make informed decisions.
Cost Behavior: Cost behavior refers to the relationship between a company's costs and its level of business activity or output. It describes how different types of costs, such as variable costs and fixed costs, respond to changes in the volume of production or sales.
Cost behaviors: Cost behaviors describe how costs change in relation to changes in a company's level of activity. These behaviors are essential for budgeting, forecasting, and decision-making processes.
Cost Drivers: Cost drivers are the factors that directly influence the incurrence of costs within an organization. They are the underlying causes that determine the level of resources consumed and the resulting costs associated with business activities or operations. Cost drivers play a crucial role in various managerial accounting concepts, including the estimation of variable and fixed costs, the application of job order and process costing methods, the calculation of activity-based product costs, and the analysis of overhead variances.
Cost Pools: Cost pools are groups of indirect costs that are accumulated and then allocated to cost objects, such as products, services, or departments, based on a common cost driver. They are an essential component in various costing methods, including job order costing and activity-based costing, as they help to accurately assign overhead costs to the appropriate cost objects.
Direct Labor Costs: Direct labor costs refer to the wages and salaries paid to employees who are directly involved in the production of a specific product or the provision of a specific service. These costs are directly traceable to the individual units being manufactured or the specific jobs being performed.
Direct Labor Hours: Direct labor hours refer to the total number of hours worked by employees directly involved in the production of a specific product or service. This metric is crucial in job order cost systems, traditional overhead allocation methods, cost driver identification, and activity-based costing, as it serves as a key input for various cost accounting calculations and analyses.
Direct material: Direct material refers to the raw materials that are directly used in the production of a product and can be easily traced back to it. These materials form an integral part of the finished goods.
Fixed Costs: Fixed costs are expenses that remain constant regardless of the level of production or sales activity within a business. These costs do not fluctuate with changes in output or revenue and must be paid regardless of the company's performance.
Indirect Costs: Indirect costs are expenses incurred in the production of goods or services that cannot be easily traced to a specific cost object, such as a product or a department. These costs are not directly attributable to the manufacture of a particular item but are necessary for the overall operation of a business. Indirect costs are an important consideration in various managerial accounting topics, including the computation of a predetermined overhead rate, the preparation of journal entries for a job order cost system, the application of a job order cost system to a nonmanufacturing environment, the calculation of predetermined overhead and total cost under the traditional allocation method, and the comparison of traditional and activity-based costing systems.
Indirect material: Indirect materials are supplies used in the production process that cannot be easily traced to a specific product. They are part of manufacturing overhead and not directly included in the cost of goods sold.
Machine Hours: Machine hours refer to the total number of hours that a production machine is in operation during a specific period. This metric is crucial in various managerial accounting contexts, as it helps understand and analyze the relationship between machine usage, costs, and production efficiency.
Manufacturing overhead: Manufacturing overhead includes all indirect costs associated with the production process, such as utilities, maintenance, and factory supplies. It does not include direct materials or direct labor costs.
Manufacturing Overhead: Manufacturing overhead refers to the indirect costs associated with the production of goods in a manufacturing organization. These are the costs that cannot be directly traced to a specific product but are necessary for the overall manufacturing process. Manufacturing overhead encompasses a wide range of expenses, including indirect materials, indirect labor, and other factory-related costs.
Manufacturing overhead costs: Manufacturing overhead costs are indirect costs associated with the production process but not directly traceable to a specific product. They include expenses like utilities, depreciation, and factory supplies.
Overhead Application: Overhead application refers to the process of assigning indirect costs, or overhead, to individual products or jobs within a manufacturing or service environment. This term is crucial in the context of job order costing, journal entries for a job order cost system, and calculating predetermined overhead and total cost under the traditional allocation method.
Overhead Costs: Overhead costs are indirect expenses incurred by a business that cannot be directly attributed to the production of a specific product or service. These costs support the overall operations of the organization but are not directly related to the manufacturing or delivery of a particular item. Overhead costs are an important consideration in various cost accounting topics, including traditional cost allocation methods, cost driver identification, and activity-based costing systems.
Predetermined overhead rate: The predetermined overhead rate is a calculation used to allocate estimated manufacturing overhead costs to products or job orders, based on a specific activity base, such as direct labor hours or machine hours. It is determined before the period begins and helps in budgeting and costing processes.
Predetermined Overhead Rate: The predetermined overhead rate is a method used in job order costing to apply overhead costs to individual jobs or products. It is calculated by dividing the estimated total overhead costs for a period by the estimated activity base, such as direct labor hours or machine hours, for that same period. This rate is then used to apply overhead to each job based on the job's actual usage of the activity base.
Total Cost: Total cost is the sum of all costs incurred in the production or acquisition of a good or service. It encompasses both fixed and variable costs, and is a critical concept in understanding the profitability and efficiency of a business operation.
Total variable costs: Total variable costs are the overall expenses that change in direct proportion to the level of production or sales volume. These costs increase as production increases and decrease as production decreases.
Traditional allocation: Traditional allocation is a costing method where overhead costs are assigned to products based on a single cost driver, typically direct labor hours or machine hours. It is simpler but may not accurately reflect the actual resources consumed by different products.
Traditional Allocation Method: The Traditional Allocation Method is an approach to overhead cost allocation that assigns indirect costs to cost objects, such as products or services, based on a single allocation base, typically direct labor hours or machine hours. This method aims to distribute overhead costs in proportion to the level of activity or resource consumption of the cost objects.
Variable Costs: Variable costs are expenses that fluctuate directly with changes in a company's production or sales volume. These costs increase or decrease in proportion to the level of business activity, unlike fixed costs which remain constant regardless of output. Understanding variable costs is crucial for analyzing cost behavior patterns, calculating contribution margin, and making informed business decisions.