Cost-overhead rate

In Eq. (9-223), Cqh — 0Cboh) E known as the budgeted overhead-cost variance, 0(cboh oh). s the overhead-volume variance, and voh(Q Q ) 3.S the overhead-efficiency variance. The last is analogous to the labor-efficiency variance and is the standard overhead rate multiplied by the deviation in time taken to produce a given output. 

William Wakeham We have worked out our full overhead rate using fairly simple, but government-approved, rules as to how to cost our activities. We know, for example, by survey, how much time our academic faculty spend on research and how much time they spend teaching. Once you have this information, you can cost all of your research activity and prove what the costs are. And in negotiations with a multinational company, you have to prove this and a lot of other things about what you say. If you say your overhead is x, they want you to prove it. And you have to be able to. Traditionally this is not easy for a university. One of the points I made in my presentation was that we employ people who are from industry in our industrial liaison office. They can do these calculations in a hard-nosed way and in a way that the people on the other side of the table will appreciate. 

Labor ( of hours), labor cost per hour, and appropriate overhead rates... 

Up to this point in this chapter, we have presented what is called traditional cost/managerial accounting. The traditional methods have helped finance departments monitor operations and value inventory, but some people feel that rather than providing accurate picture of a company s costs, this approach focused on direct costs and relied on arbitrary cost allocations such as labor-based overhead rates. 

Machining cost can be calculated by the machining time times a machine and operator overhead rate. 2.7.2. Estimated Product Quality... 

Performance evaluation in these companies usually focuses on cost, with the budget as the primary control. Procurement is measured on the purchase cost of material and material overhead rates. Manufacturing has measures such as direct labor productivity and the cost of quality of delivered products. Distribution effectiveness is measured on the percentage of selling price represented by distribution cost and inventory turnover rates. 

Accounting procedure takes these costs, amounting to 45 percent of all costs, and divides them by direct labor to produce an overhead rate. In this case, the overhead rate is (45/25) x 100% = 180%. Thus, for each direct labor dollar incurred, an additional 1.80 would be charged, for a... 

Because the stepstool was the highest-volume product in the plant, the organization had become quite proficient in producing it. However, the overhead rate was full of costs for inefficiencies incurred in making lower-volume products. In effect, the efficient stepstool production subsidized the inefficient products. Actual variable costs for the stepstool were 5. With fully absorbed costs, the client would appear to lose 2 on every unit. In direct costing, the client would put 3 in his pocket. Despite this, he refused Sears offer. 

There are a number of traps in this process, a few of which we have already mentioned. Because Old Line has a plant-wide overhead rate, each department absorbs overhead based on the direct labor incurred in its department. The problem arises when overhead items are unevenly distributed among the departments. It so happens that Activity 5 is a heat-treat operation supported by a large investment in equipment. Activity 5 also consumes large amounts of energy. In Old Line s case, depreciation on the equipment, interest on debt taken on to finance the equipment, and the energy costs are all overhead items. Old Line allocates them over... 

Facilities available or underutilized. This is considered the least effective reason for manufacturing choice, but it regrettably seems to be the most prevalent. The history of the composite manufacturing business has been that an independent composite manufacturer would never be expected to reject a contract because of the lack of the optimum facilities or experienced personnel. The independent contractor would find a way to build it or would, in turn, subcontract. The same comment can be extended to most larger companies, such as the large aerospace manufacturers with adequate, but not infinite, facilities in house. Usually, the capital cost and overhead rate of a particular machine will be a strong consideration in the choosing process manufacturers do not want to see valuable machinery idle. 

In the world of manufacturing, there are a number of rate-based transactions that affect the cost of goods. These include labor rates, machine rates, and overhead rate, which is a proportional number based on an allocation of the fixed and variable costs that are incurred in operating a factory. A process rate is the total of the labor rates, machine rates, and overhead rates for all of the labor and machinery involved in a given process. 

As an example, for a molding process, it involves the machine rate of the molding machine itself, plus the labor rate of the operator (assuming there is one), plus the overhead rate of the factory. These rates can be calculated a number of different ways, depending on how asset costs are amortized, how overhead is allocated, how maintenance and repairs are accounted for, etc. Labor rates will vary, depending on the skills involved, and the region where the factory is located. Machine rates will vary based on the size and complexity of the equipment, as well as its age. 

The method of allocating overheads can seriously affect the assigned costs of a project and hence the apparent cash flows for that project . Since these cash flows are used to assess profitability by the net-present-value (NPV) and discounted-cash-flow-rate-of-return (DCFRR) methods, unfair allocation of overhead costs can result in a wrong choice between alternative projec ts. 

Equation (9-214) gives the overpricing Acs per unit of produc tion for an increase in annual production rate AR. Equation (9-214) also gives the underpricing Acs per unit of production for a decrease in annual production rate AR. In the first case the fixed costs or overheads are said to be overabsorbed and in the second case underabsorbed. 

Static and Flexible Budgets Overhead cost can significantly affect the profitability of a projec t and is the only cost outside the control of the project manager. The project is expected to contribute a definite amount toward the expenses of the company and will be charged this amount even if the production rate is zero. This is the fixecTcomponent of the overhead cost and will include directly allocable costs such as depreciation and a proportion of general costs such as office salaries and heating. 

Other nonproduction costs such as indirect labor may vary hnearly with the production rate and represent the variable component of the overhead. Costs that are neither fixed nor variable but occur in dis-... 

Crete steps at various production levels (such as supervisory labor) are the semivariable component of the overhead cost. It is an easy matter to determine these various components for various production rates and list them as shown in Table 9-39. 

Two types of overhead budget are currently in use. The static (often referred to as the fixed) budgeted overhead cost is related to the standard budgeted production rate. The flexible budgeted overhead cost is that shown as the total cost in Table 9-39. Values for intermediate production rates are often obtained by interpolation. This is justifiable only when semivariable costs are a negligibfe part of overhead costs. 

Let us consider the overhead-cost data for Table 9-39 with 10 million kg per month as the standard production rate. The static budgeted overhead is then 150,000 per month, or 1.5 cents per kilogram. We assume that the actual overhead is 186,000 for a month in which 12 milhon kg was produced. Then, the static budgeted overhead cost would be 12 million(I.5), or 180,000 per month. Therefore, the variance is 186,000 — 180,000 = -t- 6000, which is unfavorable because 6000 more was spent than was anticipated. 

From Table 9-39 we find that the flexible budgeted overhead cost for a produc tion rate of 12 million kg per month is 190,000. The corresponding variance is 186,000 minus 190,000, or — 4,000, which is favorable Because 4,000 less was spent than was anticipated. Thus, the use of flexible budgeting makes this particular performance look better without changing either the production rate or a single cost of the planned budget. 

Raw-materials cost, /unit Direct labor cost, /unit Production rate, units/period Production time h/period Fixed and semivariahle overhead cost, /period Variable overhead cost, /h Overhead cost, /period... 

Also in Eq. (9-224), Cboh E simply the flexible budgeted overhead cost in dollars per hour for the actual production rate, and the overhead-volume variance 0(cboh oh) is the actual time taken to produce a given output multiplied by the difference between the flexible budgeted overhead cost and the standard overhead cost in dollars per hour. The budgeted overhead-cost variance (Cqh — 0Cboh) is the difference between the actual overhead cost and the actual time (in hours) required to produce the given output multiphed by the flexible budgeted overhead cost (in dollars per hour). 

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