Predetermined overhead rate is used to apply manufacturing overhead to products or job orders and is usually computed at the beginning of each period by dividing the. Download Beatles Songs On Napster Customer. Hurricane Sandy left many electric utility executives, their customers, local and state government leaders and regulators contemplating placing overhead power lines.

Activity based costing is a costing method that has been developed to deal with the perceived weaknesses of traditional absorption costing. Problems with traditional absorption costing Traditional absorption costing is based on the principal that production overheads are driven by the level of production. This is reflected in the choice of activity level in the overhead absorption rate (OAR) calculation - typically units, labour hours or machine hours. These all increase as the level of production increases. This was true in the past, because businesses only produced one simple product or a few simple and similar products. However, the following points are significant: Overheads used to be small in relation to other costs in traditional manufacturing In addition, production overheads, such as machine depreciation, will have been a small proportion of overall costs. This is because production was more labour intensive and, as a result, direct costs would have been much higher than indirect costs.

A rough estimate of the production overhead per unit was therefore fine. Overheads are now a larger proportion of total costs in modern manufacturing Manufacturing has become more machine intensive and, as a result, the proportion of production overheads, compared to direct costs, has increased.

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7. 103 Chapter Nine OVERHEAD, GENERAL, AND ADMINISTRATIVE COSTS INTRODUCTION Much of the attention to improvements in the factory goes to the most obvious source of cost.

Therefore, it is important that an accurate estimate is made of the production overhead per unit. The nature of manufacturing has changed.

Many companies must now operate in a highly competitive environment and, as a result, the diversity and complexity of products has increased. Calculating the full production cost per unit using ABC There are five basic steps: Step 1: Group production overheads into activities, according to how they are driven. A cost pool is an activity which consumes resources and for which overhead costs are identified and allocated. For each cost pool, there should be a cost driver. The terms 'activity' and 'cost pool' are often used interchangeably.

For example, one activity could be . A cost driver is a factor that influences (or drives) the level of cost.

For example, we could argue that the cost of quality control is driven by the number of inspections made, rather than the total number of units produced. Step 3: Calculate an OAR for each activity. The overhead absorption rate (OAR) is calculated in the same way as the absorption costing OAR. However, a separate OAR will be calculated for each activity, by taking the activity cost and dividing by the cost driver information. For example, we could determine a cost per inspection for quality control costs. Step 4: Absorb the activity costs into the product.

The activity costs should be absorbed back into the individual products. For example, if we know how many inspections were made on product X then we can absorb a corresponding quantity of quality control costs. Step 5: Calculate the full production cost per unit and/ or the profit or loss. Total activity costs can them be added to labour and material costs as normal. Advantages and disadvantages of ABC Advantages: ABC provides a more accurate cost per unit.

As a result, pricing, sales strategy, performance management and decision making should be improved. It provides much better insight into what drives overhead costs. ABC recognises that overhead costs are not all related to production and sales volume. In many businesses, overhead costs are a significant proportion of total costs, and management needs to understand the drivers of overhead costs in order to manage the business properly. Overhead costs can be controlled by managing cost drivers. It can be applied to derive realistic costs in a complex business environment.

ABC can be applied to all overhead costs, not just production overheads. ABC can be used just as easily in service costing as in product costing. Disadvantages of ABC: ABC will be of limited benefit if the overhead costs are primarily volume related or if the overhead is a small proportion of the overall cost.

It is impossible to allocate all overhead costs to specific activities. The choice of both activities and cost drivers might be inappropriate. ABC can be more complex to explain to the stakeholders of the costing exercise. The benefits obtained from ABC might not justify the costs. Other systems may need to be changed - for example, how variances are calculated. Created at 8/7/2.

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Traditional Costing Vs. Activity- Based Costing. Nonmanufacturing companies can use activity- based costing. John Foxx/Stockbyte/Getty Images. Costing systems helps companies determine the cost of a product related to the revenue it generates.

Two common costing systems used in business are traditional costing and activity- based costing. Traditional costing assigns manufacturing overhead based on the volume of a cost driver, such as the amount of direct labor hours needed to produce an item. A cost driver is a factor that causes cost to incur, such as machine hours, direct labor hours and direct material hours. Activity- based costing allocates the costs of manufacturing a product according to the activities needed to produce the item.

Managers should understand the advantages and disadvantages of both systems to meet the needs of their business. Understanding Traditional Costing. Many manufacturing companies use the traditional costing system to assign manufacturing overhead to units produced. Users of the traditional costing method make the assumption that the volume metric is the underlying driver of manufacturing overhead cost. Under traditional costing, accountants assign manufacturing costs only to products.

Traditional accounting fails to allocate nonmanufacturing costs that also are associated with the production of an item, such as administrative expenses. Companies commonly use traditional accounting in external financial reports because it provides a value for the cost of goods sold.

Pros and Cons of Traditional Costing. An advantage of using traditional- based costing is that it aligns with Generally Accepted Accounting Principles, or GAAP. Easy implementation for companies that provide one product also is a plus.

However, traditional costing is an outdated costing system in many companies because those manufacturing companies now use machines and computers for much of their production. Computers and machines make the system outdated because it often uses direct labor hours to calculate cost.

Cost is not appropriately assigned because direct labor hours is not the best cost driver to use. Traditional costing negates other cost drivers that may contribute to the cost of an item. Another disadvantage of solely using the traditional costing system is that it can lead to bad management decisions because it excludes certain nonmanufacturing costs. Understanding Activity- Based Costing. Activity- based costing provides a more accurate view of product cost, but companies typically use it as a supplemental costing system. The allocation bases used in activity- based costing differ from those used in traditional costing.

Activity- based costing determines every activity associated with producing an item and allocates a cost to the activity. The cost assigned to the activity is then assigned to products that require the activity for production. Pros and Cons of Activity- Based Costing. Greater costing accuracy is the primary benefit of activity- based costing.

Companies assign cost only to the products that require the activity for production. Tune Up Utilities 2008 Cracker more. This method eliminates allocating irrelevant costs to a product.

Other advantages of activity- based costing include an easy interpretation of cost for internal management, the ability to enable benchmarking and a greater understanding of overhead costs. Implementing an activity- based costing system within a company requires substantial resources.

This can prove a disadvantage for companies with limited funds. Another disadvantage of using activity- based costing is that it is easily misinterpreted by some users. Photo Credits. John Foxx/Stockbyte/Getty Images.