Traditional approaches to cost assignment 2: Plant-wide overhead rates

Summary

This video explains how plant-wide overhead rates are used to allocate fixed manufacturing costs in a factory setting. It revisits key steps, including identifying total overhead, selecting a single cost driver, and calculating an overhead absorption rate. Through a practical example, the video demonstrates how a company assigns overhead using direct labor hours, ultimately determining the full cost per unit. By breaking down direct materials, direct labor, and allocated overhead, viewers gain a clear understanding of how total production costs are calculated, making complex cost accounting concepts more accessible and practical.

Takeaways

• 😀 The video focuses on plant-wide overhead rates for allocating fixed manufacturing overhead costs.
• 😀 The main learning objective is to understand the workings of plant-wide overhead rates and apply them to a practical example.
• 😀 To calculate plant-wide overhead rates, the total manufacturing overhead cost for the factory must be determined first.
• 😀 A single volume-based cost driver needs to be identified, which best explains the usage of overhead costs.
• 😀 The overhead rate is calculated by dividing the total overhead cost by the chosen cost driver.
• 😀 The overhead rate is then used to allocate the overhead cost to the product or cost object.
• 😀 The example company, ABC PTR Limited, manufactures widgets with a direct material cost of 60 rand per widget.
• 😀 Each widget uses 5 direct labor hours at a rate of 20 rand per hour, resulting in a direct labor cost of 100 rand per widget.
• 😀 The total fixed manufacturing overhead cost for the factory is 1 million rand per annum.
• 😀 The fixed overhead rate is calculated by dividing the total overheads (1 million rand) by the total cost driver (250,000 direct labor hours), resulting in an overhead rate of 4 rand per direct labor hour.
• 😀 The fixed overhead cost per widget is 20 rand (calculated by multiplying the 4 rand rate by the 5 direct labor hours per widget), leading to a total product cost of 180 rand per widget.

Q & A

What is the main focus of this video in the series on traditional approaches to cost assignment?

The video focuses on plant-wide overhead rates and how to allocate fixed manufacturing overhead costs using a single cost driver.

What are the first steps in calculating plant-wide overhead rates?

First, determine the total manufacturing overhead cost for the entire factory, then identify a single volume-based cost driver that best explains the usage of the overhead.

How is the overhead rate calculated?

The overhead rate is calculated by dividing the total overhead cost by the total cost driver (e.g., total direct labor hours for all units in the period).

In the example, what are the direct costs for one widget?

Direct material costs 60 rand, and direct labor costs 5 hours × 20 rand/hour = 100 rand, making the prime cost 160 rand per widget.

What information is needed to allocate fixed overhead costs to products?

You need the total fixed manufacturing overhead, the cost driver, and the total estimated activity (e.g., normal operating capacity) to calculate the overhead rate per unit of the cost driver.

How do you calculate the total cost driver for the period in the example?

Multiply the number of direct labor hours per widget (5) by the total number of widgets at normal capacity (50,000), resulting in 250,000 hours.

What is the fixed overhead rate per direct labor hour in the example?

The fixed overhead rate is 1,000,000 rand ÷ 250,000 hours = 4 rand per direct labor hour.

How do you find the fixed overhead cost per unit?

Multiply the overhead rate per direct labor hour (4 rand) by the number of direct labor hours per unit (5 hours), resulting in 20 rand per widget.

What is the total production cost of one widget in the example?

The total production cost is the prime cost (160 rand) plus the allocated fixed overhead (20 rand), totaling 180 rand per widget.

Why are variable overheads excluded in this example?

The scenario provides no information about variable overheads, so they are assumed to be zero for this calculation.

What is the significance of using a plant-wide overhead rate?

A plant-wide overhead rate simplifies overhead allocation by using a single cost driver across all products, making it easier to estimate total production costs.

Why is it important to use total estimated hours rather than per-unit hours when calculating the overhead rate?

Using total estimated hours ensures the overhead rate reflects the entire production period, not just one unit, providing an accurate allocation of fixed overhead costs.