Costing and Overhead Allocation

This assignment focuses on cost accounting principles applied to Wonder Products. It requires calculating manufacturing and administrative overhead allocation rates based on machine hours and direct labor hours, respectively. Students must determine the price quote for a specific product, 'Wonderful Creation', considering all costs and a 40% markup. The assignment also explores the importance of accurate overhead allocation for pricing decisions and discusses traditional costing versus activity-based costing methods.

Accounting For Managers
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Question 1
a) Flexible budget is a budget where the budgeted costs differ for different levels of activity.
The expenses of a business are classified into variable, semi variable and fixed costs with
utmost accuracy as the importance of the budget depends upon the accuracy to which the
costs have been properly classified. Flexible budget helps in identifying the deviation of the
actual costs of the actual quantity from the budgeted costs of the actual quantity (Hilton &
Paltt, 2016) .This is very important for cost control as the reason of the deviation of actual
performance from the planned performance can be known. For example, management has
prepared a budget for production of 2000 units of product A as follows:
Standard Budget Flexible budget Actual
2000 1500 1500
Variable costs ($10 per
unit)
$20,000 $15,000 $17,000
Fixed cost $50,000 $50,000 $50,000
From the above we see that the actual deviation of variable costs has been an excess of $2000
over budgeted. If we were to go by standard budget, the deviation would be favourable
$3,000 which is unrealistic.
Flexible budgets overcome the shortcoming of the static budgets in performance evaluation.
Under static budget, the actual results are compared to the budgeted ones irrespective of the
level of sales. So if the sales volume increase, the corresponding variable costs are bound to
increase, however, static budget does not consider this. Flexible budgets increase the
budgeted costs with an increase in the volume of sales and thus provide for a more realistic
performance evaluation thus eliminating the scope of volume variances.
b) Before a cash budget is prepared, the budgets that need to be prepared include Sales
budget, Materials budget, and Selling and expenses budget. The likely timing of the cash
flows and their impact on the cash budget is discussed below:
i) Sales budget – this is the first budget and depending on the sales forecasted, other budgets
follow. The sales budget will increase the cash flows as the revenues will result in receipts.
The timings of the cash flow depend on the collection policy of the company. If sales are

made for cash, the cash flow will increase in the month of sale. For credit sales, the cash flow
will increase in the month the cash is collected for the credit sales.
ii) Materials budget – depending on the production budget, the materials required to produce
the required quantity is determined by the materials budget. The materials are purchased to be
used in production and hence will result in outflow/disbursements in the cash budget. The
cash outflow depends on the credit the company gets from its suppliers. For cash purchases,
the month in which the material is purchased is effected and for credit purchases, the month
in which the payment is being made is affected.
iii) Selling expenses budget – this budget results in cash outflow and hence will increase the
cash disbursements in cash budget. The cash is normally paid when such expenses are
incurred.
c) Operating cycle is the time required to acquire the inventory, sell it and receive cash from
the customers for the inventory sold. A cash cycle is the time taken to release cash tied up in
production and sales processes. Operating cycle and cash cycle can be used interchangeably
however; operating cycle measures the operating efficiencies whereas cash cycle measures
the effectiveness of cash flow management. Operating cycle is a sum of the day’s inventory
outstanding and day’s sales outstanding whereas the cash cycle is the sum of day’s inventory
outstanding and day’s sales outstanding less the days payables outstanding. A shorter
operating and cash cycle means effective working capital management as the inventory is
converted into sales and the sales are paid for in a shorter time period. Also the time taken to
pay the suppliers is more than the time taken to receive payment. The various ratios that can
be used in measuring the working capital efficiency include inventory turnover, receivables
turnover and payables turnover. Inventory turnover is the number of times the company is
able to turn its inventory into sales in a year. Higher the ratio, the better it is. Receivables
turnover is the number of times a company can convert its receivables into cash during the
year. A higher ratio means the receivables are fast moving and debtors are paying on time.
Higher the ratio, the better it is. Payables turnover is the number of times the company is
paying its average accounts payables in a year. Higher the ratio the better it is because this
means the company is able to pay its bills on time and the ratio can be used to negotiate
favourable credit terms for the company.
d) No, we do not agree that government organisations do not need accounting; rather it is
important for these organisations to have transparency and uniformity in the financial data

being reported. Accounting refers to recording all financial transactions and thereby
interpreting, reporting and summarizing this data. The source of funding for these
organisations is grants or taxes both of which are public money. The government uses this
money to provide valuable goods and services to the public like roads, infrastructure, and
other public amenities. The source and use of such funds should be properly recorded in the
books of accounts to be reported to the public as the public would want to know where their
money is being spent. The financial data can also be used by the government agencies for
preparing annual budgets. Accounting helps to keep a check on the expenditures so that the
expenditures remain within the limit of the budget as approved by the government also to
ensure that the expenditures are made as per the rules, regulations and the legal provisions of
the government. The accounting data can be used to prepare financial statements and various
reports of use to the government and the public. The government organisations should use
Generally Accepted Accounting Principles for accounting purposes.
e) A costing system is used by a company to accurately estimate the costs of the products in
order to determine the selling price of the products. The system uses various cost control
measures, reports, processes and forms to report on the revenues and a cost incurred for the
product and therefore measures the profitability of the product. A costing system also helps in
multiple product profitability analysis, comparison of budgeted and actual results, and
accurate estimation of future costs, and inventory valuation (Weygandt, Kimmel, & Kieso)
Question 2
a) Manufacturing overheads allocation rate for Wonder Products on the basis of machine
hours.
Manufacturing overhead rate = total manufacturing overheads / total machine hours
= 598080 / 7000
= $85.44
b) Administrative overheads allocation rate for Wonder Products on the basis of direct labour
hours.
Administrative overhead rate = total administrative overheads / total direct labour hours
= 695520 / 14000

= $49.68
c) Price to be quoted to Bushy for the wonderful creation is calculated below:
Particulars Amount
Direct material $19,000
Manufacturing overhead (400*85.44) $34,176
Administrative overhead (750*49.68) $37,260
Total costs $90,436
Mark up of 40% on total costs $36,174.4
Price of Wonderful Creation $126,610.4
d) It is important to carefully allocate overhead expenses to products for accurate pricing. The
prices are determined on the basis of costs for products. Overhead expenses are not directly
incurred in manufacturing the product rather these may relate to support services costs. Since
the product is indirectly using such services, it is necessary to include these costs in the total
product cost as it also helps in decision making.
The most common and old method of overhead allocation is traditional costing where the
overheads are allocated to the products on the basis of a predetermined rate irrespective of the
complexity of the activities undertaken to incur the cost. Hence, this method does not
accurately allocate the overhead costs. Another costing method Activity Based Costing solves
the problem by allocating overhead costs by dividing overheads into various activities and
identifying cost drivers. On the basis of the usage of the various activities, the costs are
allocated.
e) The companies use a predetermined rate rather than actual overhead costs in allocating
overheads because these overheads are not directly incurred in manufacturing the product.
Administrative and manufacturing overheads like salaries, rent, electricity, insurance are not
incurred for production but are rather support services. Hence, these costs need to be
allocated on a predetermined basis.
Bibliography
Hilton, R., & Paltt, D. (2016). Managerial Accounting: Creating Value In a Dynamic Business
Environment. Australia.

Weygandt, J., Kimmel, P., & Kieso, D. (n.d.). Managerial Accounting: Tools for Business Decision
Making, 7th Edition. Australia: Wiley.