The Manufacturing Overhead

MANAGEMENT ACCOUNTING

(a)
All the cost that is involved in the production process is known as manufacturing overhead.
The manufacturing overhead is a wide term which comprises of various other factory cost
also. However, the cost incurred with respect to direct material and direct labour is excluded
from the manufacturing overhead. As there is no direct cost and it is a kind of overhead it is
also known as indirect cost. Apart from the manufacturing cost there are also certain cost in
relation to selling and distribution and various other general and administrative expenses that
are not added to the product cost. These cost are shown in the income statement of the
company as and when they are incurred. Such cost may include inspection cost, maintenance
and repair of any asset, depreciation of an equipment, etc. Based on the general accounting
principle, it is necessary to value the inventories and the cost of goods sold on the basis of
direct cost and manufacturing overheads(Berman, Knight and Case, n.d.).
It is a common practise that the overhead has to be allocated and assigned to all the particular
units if the company produces more than a single product. Manufacturing overhead is also
distributed in this manner. For example, depreciation of the machine is calculated taking into
consideration the value of the machinery, electricity is based on the units consumed and so on
(Shim and Siegel, 2008).
There are a large number of ways by which the company can assign and allocate overhead.
These methods are chosen by the companies depending on the market forces and the nature
of operations the company carries out. These can be divided into two broad groups-
conventional approach and activity based method (modern).
Let us now understand the concept of conventional approach first, in this method the
manufacturing overhead was simply allocated on the basis of machine hours or the labour
hours or any changes in the degree of the prime cost (Bruner, Eades and Schill, 2017). It is
observed that the manufacturing overhead is increased with the decrease in the labour hours
or machine hours. When the accountant of the company does not use different cost drivers
but uses a single cost driver for all the overheads, then the rate calculated is said it be single
blanket rate (Saltelli, Chan and Scott, 2008).
In the question, we are asked to calculate the cost per unit using the single blanket rate. The
formula for calculating the single overhead rate is budgeted cost divided by the number of
hours required for production. On calculating on the basis of labour hours we have found out
that the manufacturing rate is 48/product unit. This means that for Fred it costs $96 (48*2) as
he took two hours to complete one unit whereas for Martha it costs $144 (48*3) as it took
three hours for him to complete one unit.
CACLCULATION OF COST PER UNIT USING CONVENTIONAL
APPROACH :
(In $)
PARTICULARS
FRE
D MARTHA

Production units 1000 5000
Direct materials 40 60
Direct labours 30 45
Manufacturing overheads 96 144
Total Cost Per Unit 166 249
Notes :
Total Manufacturing Costs $8,16,000
Total Hours Required 17000 hours
(1000 units of Fred *2 + 5000 units of
Martha*3 hours)
Manufacturing Overhead Per Hour =
Total Manufacturing
Costs
Total Hours
Manufacturing Overhead Per Hour = 816000
17000
=$48/hour
(b)
In this question, we have been asked to calculate the cost involved in the cost activity based
on different cost drivers. The word “cost activity” is a technical term used in cost accounting
which can be explained as different types of activities that are involved in the manufacturing
process. The cost activities together form a cost pool. Although these cost are not directly
attributable to the product still they form a part of the cost. The other word used “cost driver”
is a factor on which the cost of a activity is dependent (Taylor, 2008).
Following is the table that shows the rate of each activity as per the cost driver. For example,
the expenses related to machine are $450000 which is divided by the budgeted cost driver of
9000 hours resulting in the rate of absorption $50/ machine hour. In the given table the rate of
absorption has been calculated based on their respective cost drivers.
CACLCULATION OF COST PER ACTIVITY :
ACTIVITY COST($
) COST DRIVER Budgeted Level RATE
($)
Machine Related
Costs 450000 Machine hours 9000 hours 50/hour
Setup & Inspection 180000 Number of production
runs 40 runs 4500/run
Engineering 90000 Engineering change 100 change 900/