Overhead Allocation: Calculation, Challenges and Solutions

This article discusses the calculation of overhead allocation using plant wide rate and department overhead costs, challenges faced in allocating overhead costs to products, and solutions like activity-based costing. It includes tables and examples to explain the concepts. References are also provided.

Written assignment on Overhead
Allocation

TABLE OF CONTENTS
Overhead Allocation..................................................................................................................3
Part A.....................................................................................................................................3
Part B......................................................................................................................................3
Part C......................................................................................................................................3
Part D.....................................................................................................................................3
Part E......................................................................................................................................3
Part F......................................................................................................................................3
Part G.....................................................................................................................................3
References..................................................................................................................................4

OVERHEAD ALLOCATION
Part A
Overhead plant wide rate:
=Total overheads / Total machine hours
=$225 000/50 000
=$4.5
Part B
Table 1: Statement showing the calculation of the full product cost of the contract by using
Overhead plant wide rate
Department A Department B Department C Total
Direct material $ 120.00 $ 60.00 $ 10.00 $ 190.00
Direct wages $ 100.00 $ 60.00 $ 10.00 $ 170.00
Production overhead $ 180.00 $ 45.00 $ 225.00
(4.5*40) (4.5*10)
Total cost $ 585.00
Part C
Table 2: Statement showing department overhead costs
Department A Department B Department C
Overhead cost 120000 30000 75000
Allocation to direct labour hours 96000 25000 75000
Allocation to machine hours 24000 5000
Per labour hour overhead rate 9.6 0.5 3
Per machine hour overhead rate 0.6 0.5
Part D
Due to the lack of information of the activity, department overhead costs are first bifurcated
into machine hours and labours and then per hour rate is determined to compute the accurate
cost of the project. By this segregation overhead rate of machine hour and labour, the hour is
determined.

Machine hour rate determines the cost of operating the machine per hour, by which the
manager of the company can determine the efficiency of the machine and cost of operating
the machine along with this it also assist the existence and duration of the idol time of the
machine. Further the overhead cost on the basis of labour hour determines the effective hours
of the working of the employees. Moreover selecting the two cost driver leads to more
accurate information regarding the cost of the product so that company can make the better
decisions.
Part E
Table 3: Statement showing the calculation of the full product cost of the contract by using
department overhead costs
Department A Department B Department C Total
Direct material $ 120.00 $ 60.00 $ 10.00 $ 190.00
Direct wages $ 100.00 $ 60.00 $ 10.00 $ 170.00
Production overhead $ 216.00 $ 50.00 $ 30.00 $ 296.00
Total cost $ 656.00
Part F
By comparing project cost in point b and point E significant difference can be noticed
because first computation is done by using blanket rate while in e point appropriate
consideration is provided to machine hours and labour hours.
By making use of Overhead plant, wide rate company will suffer from default rates and
prices losses, and the individual will also be affected by such. Furthermore inaccurate
evaluation of costs associated with product cost can be a major reason behind the company’s
invalid performance and in measuring the profitability. Although this method is very easy to
find the cost, but some time it may lead to over costing and under costing of the product, by
which the result of the company will get affected.
Therefore, fair techniques, i.e. department overhead costs should be used for calculating the
costs of the products. And for overcoming with the traditional methods of costing activity-
based costing should be used. There is a wide range of products, and various companies are
producing the same products with different rates .globally it is the huge challenge faced by
the business (Speckbacher, 2017). Moreover the departmental overhead rate decentralise the
control of the production cost and delegate the responsibilty to the department manager, this

improves the decesion making as well as assist in more accurate allocation of the overhead
cost. Therefore, rates should be decided in the ways the company gets profit as well as huge
customer’s growth and stability. Fair techniques should be used for calculating the costs of
the products. And for overcoming with the traditional methods of costing activity-based
costing should be used (Shields, (2015). This method provides the more accurate method of
costing, by which the precise decision with respect to the price can be taken. Along with this
by implementing this method company can easily identify the non-value added activities and
further take the actions to eliminate and reduce them.
Part G
Challenges faced when allocating overhead costs to products
In the case where the company is producing multiple products of a company from the same
plant and equipment and with that it includes different type of products, and in such situation,
accurate determination of price is not easy (Fullerton, Kennedy and Widener, 2013). For
example, if labour cost, material cost, production costs, machinery, any other expenses are
calculated on the basis of inappropriate rates or all costs are calculated on the same price
than the estimation of the overall cost of the production will not be fair and accurate.
Moreover, it is the biggest challenge for the accountant while assigning costs to the products
by traditional method because with such technique accuracy would not be found as an
accountant will not give her appropriate time and attention for the formation of costs
(DRURY, 2013). In the case of inaccuracy, if company assign higher rates of material cost, it
can prove the particular product is not profitable, and the company should stop producing and
selling it. Therefore company should maintain the balance among investing too much and too
little attempts at assigning and tracing costs.
Activity-based costing is the techniques which recognize and allocates the costs to overhead
activities and then allocate the prices to products (Fullerton, Kennedy and Widener, 2013). In
other words, ABC method is an approach, which includes identifying the consumption of the
resources, monitoring the activities of the department and on the basis of this allocating the
cost to the final product. It identifies the connection among costs, production costs, overhead
costs, and with such connection, it allocates the indirect costs to products and material less
illogically that traditional methods.
The manner in which ABC System Improves Costing Process

It enlarges the number of rate pools which can be helpful in accumulating the overhead costs.
Instead of collecting all expenditure in one company-wide pool, it pools costs by an activity
where it makes new sources for assigning overhead costs to objects like in which costs that
are allocated are depended on the actions that produce costs instead of on volume measures,
for example, direct labour costs machine hours (LaviaLópez and Hiebl, 2014). In conclusion,
ABC modifies the nature of various indirect costs, making costs previous considered indirect-
for instance depreciation, examination, or power- noticeable to assured actions. On the other
hand, ABC transfers overhead costs from high-volume goods to low-volume goods, lifting
the unit cost of low-volume goods.
The activity-based technique includes the counting that how many times an activity occurs,
and duration drivers, that calculate how long an activity takes to complete. And a fair
estimated price occurs by such calculation (Mahal and Hossain, 2015). ABC method is not
dependent on the machine based or overhead costs of products. In spite of that, it is divided
on the basis of five broad levels of activity that include batch-level activity, unit-level
activity, customer-level activity, organization-sustaining activity, and product-level activity.
All the costing aspects are equally preferred while estimation the costs of the companies
inbuilt and outdoor production.
ABC is an alternative method of the costing, which assist the manager to better understand
the product cost and the net profit from the consumers. Further by implementing the ABC
costing method in the organization, overhead cost can be easily identify in the area of
managerial responsibility, process, and customer and so on. Thus it can clearly understand
that while facing the overhead costs challenges activity based calculation method for the
company as a whole (Weygandt, Kimmel, & Kieso, 2015). As it improves the decision
making of the manager since the data used by them will be more accurate, by which selling
price of the product also more accurate.

REFERENCES
DRURY, C.M., (2013). Management and cost accounting. Springer.
Fullerton, R. R., Kennedy, F. A., & Widener, S. K. (2013). Management accounting and
control practices in a lean manufacturing environment. Accounting, Organizations
and Society, 38(1), 50-71.
LaviaLópez, O. and Hiebl, M.R., (2014). Management accounting in small and medium-sized
enterprises: current knowledge and avenues for further research. Journal of
Management Accounting Research, 27(1), pp.81-119.
Mahal, I. & Hossain, A., (2015). Activity-Based Costing (ABC)–An Effective Tool for Better
Management. Research Journal of Finance and Accounting, 6(4), pp.66-74.
Shields, M. D. (2015). Established management accounting knowledge. Journal of
Management Accounting Research, 27(1), 123-132.
Speckbacher, G. (2017). Creativity Research in Management Accounting: A
Commentary. Journal of Management Accounting Research.
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2015). Financial & managerial accounting.
John Wiley & Sons.