Management Accounting Report: Costing and Overhead Analysis

This report analyzes a management accounting case study involving Gibson Fabricators Corporation, which uses a job-order costing system. The report examines the calculation and application of a predetermined overhead rate based on direct labor hours. It explores the impact of installing a new automated milling machine on overhead costs, prime costs, and the total cost of production. The analysis includes a comparative assessment of overhead recovery rates before and after the machine installation, considering factors like direct labor savings and increased overhead expenses. The report emphasizes the importance of managing overhead costs for overall cost minimization and provides recommendations based on the feasibility and cost savings associated with the machine installation, considering scenarios with varying direct labor savings. The report also includes the calculation of prime costs, and the total cost of production of a job, with and without the automated milling machine, highlighting the impact of the overhead rate on the final cost. The report concludes with recommendations on whether to install the machine based on the potential labor savings.

Running head: MANAGEMENT ACCOUNTING
Management Accounting
Name of the Student:
Name of the University:
Author’s Note:

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Table of Contents
Answer to question 1:.................................................................................................................2
Answer to question 2:.................................................................................................................2
Answer to question 3:.................................................................................................................3
Answer to question 4:.................................................................................................................4
Answer to question 5:.................................................................................................................5
References and bibliography:.....................................................................................................6

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Answer to question 1:
Predetermined overhead rate is a method of allocation of overhead expenses or
indirect expenses to the cost centre or cot unit. It is one of the traditional methods of the
overhead allocation system. In this method a plat wide overhead rate is calculated based on
the estimated figures of the total overhead costs and total use of labour hour or machine hour
(Datar & Rajan 2018). If the production process is labour intensive then the predetermined
overhead rate is calculated based on the use of direct labour hour, and if the production
process is machine intensive, then the predetermined overhead rate is calculated based on the
machine hour. In the given case study the predetermined overhead has been calculated based
on the direct labour hour considering it to be a labour intensive production process. Based on
the revised total manufacturing overhead and labour, the overhead recovery rate has been
recalculated as below (Kaplan & Atkinson 2015).
Answer to question 2:
Prime cost of a job includes the total direct materials costs, total direct labour costs
and other direct expenses. The total cost of production of a job is calculated by adding
overheads to the prime cost of the job. In the given case study, the predetermined overhead

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rate has been calculated earlier considering a new milling machine will be installed (Datar &
Rajan 2018). Based on that recalculated overhead rate and taking the given direct labour costs
and direct materials costs, the total cost of production of the job has been calculated as below
(Kaplan & Atkinson 2015).
Answer to question 3:
In the given case study, the company uses a predetermined overhead rate to allocate
the overhead costs to the products or services. The overhead recovery rate has been
calculated based on the estimated total overhead expenses for the coming year and the
estimate use of total labour hour. It has been proposed that, installation of a new automated
milling machine will result in savings of labour which will be reducing the total cost of direct
labour hour for the year. On the other hand, as the overhead rate is also being computed
based on the direct labour hour, there will be savings in overhead costs pre too. But to install
the new machine, it will require additional $345,000 for the lease rentals and operator’s
salaries. Following table shows a comparative analysis of the two overhead rates.

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It can be observed that, if the new milling machine was not installed and the manual
system was continued, then the overhead recovery rate would have been $47.60 per direct
labour hour, and if the new automated milling machine is installed, with the reduced use of
direct labour hour and increased manufacturing overhead, the overhead recovery rate would
be $61.30 per direct labour hour. The stated Job consumes a total of 400 direct labour hours.
If the previous overhead recovery rate is considered then the total allocated overhead costs
for the job would b $19,040 and if the recalculated or revised overhead recovery rate is
considered, then the total allocated overhead costs would be $24,520. Taking the same
amount of direct materials costs and direct labour costs as given in the case study for the
stated job, the total cost of production would be $73,240 in the first case and it would be
$78,720 in the second case. Hence, the total production cost of the job would be higher by
and amount of $5,480 if the revised predetermined overhead rate is considered for overhead
allocation (Datar & Rajan 2018).
Answer to question 4:
Overhead cost is one of the most important parts of the total costs of a product or
service. Overhead costs include costs of indirect materials, cost of indirect labour and other
indirect expenses which cannot be allocated or linked with a cost centre or cost unit. Hence,
there must be certain bases for allocation and absorption of such indirect expenses which is

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known as overhead costs. Cost and management accounting is a process of applying various
management accounting tools and techniques to minimise costs. Indirect costs or the
overhead costs are one of the important parts of the total costs which can be well managed
with the objective of minimisation of total cost of production. On the other hand, as the
manufacturing overhead costs constitutes a significant part of the total cost of the product,
managers must be very much careful in managing the indirect costs or overhead costs,
thereby achieving the objective of overall cost minimisation. In the given case study, it has
been observed that, though there will be a savings in labour hour, the overhead cost per hour
would be increased by $13.70. Therefore, the management must take the decision based on
the feasibility and overall savings in costs (Kaplan & Atkinson 2015).
Answer to question 5:
Overhead cost is an important part of the total manufacturing cost. If the production
process is labour intensive, then the overhead costs becomes a significant amount of the total
manufacturing costs. As the overhead costs or indirect expenses cannot be directly linked
with the production unit or cost unit, it is allocated based on the direct labour hour or machine
hour. In the given case study, the overhead rate was $47.60 per direct labour hour before
installation of the new and automated milling machine. If the new and automated milling
machine is installed then there would be a cost savings of $468,000 in the form of reduced
direct labour hour. To install the machine there will be an additional $345,000 expenses per
annum. Therefore, installation of the new machine will result into an ultimate costs savings.
Now, if the savings in direct labour is only 2,000 hours which implies a cost savings of only
$156,000, the company will be ultimately incurring a loss as the additional expenses on
installation of the machine will be higher. Hence, it can be recommended not to install the
machine if the savings in direct labour is only 2,000 hours (Kaplan & Atkinson 2015).

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References and bibliography:
Balakrishnan, R., Labro, E., & Soderstrom, N. S. (2014). Cost structure and sticky
costs. Journal of management accounting research, 26(2), 91-116.
Datar, S. M., & Rajan, M. (2018). Horngren's Cost Accounting: A Managerial Emphasis.
Kaplan, R. S., & Atkinson, A. A. (2015). Advanced management accounting. PHI Learning.
Klychova, G. S., Zakirova, A. R., Zakirov, Z. R., & Valieva, G. R. (2015). Management
aspects of production cost accounting in horse breeding. Asian Social Science, 11(11),
308.
Kokubu, K., & Kitada, H. (2015). Material flow cost accounting and existing management
perspectives. Journal of Cleaner Production, 108, 1279-1288.
Nelson, A. T., & Miller, P. B. (2014). Modern management accounting. Australasian.
Accounting, Business and Finance Journal, 8, 2.