Costs overheads

The difference between life cycle costs and the traditional accounting cost is that traditional costs are fairly easy to quantify, whereas life cycle costs are usually difficult to quantify and are usually either lumped iato general overhead costs or ignored altogether. They are very real, however, and when examined ia detail and fully quantified, the economics of composites allow them to displace the traditional materials. 

Accounting is also the language of business, and the different departments of management use it to communicate within a broad context of financial and cost terms. Engineers involved in feasibihty studies and detailed process evaluations are dependent for financi information on the company accountants, especially for information on the way in which the company intends to allocate its overhead costs. It is vital that engineers correctlv interpret such information and that they can, if necessaiy, make tlie accountants understand the effect of the chosen method of allocation. 

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. 

However, it is sometimes quite difficult to separate costs and particularly manufacturing overhead costs into fixed and variable components. In the long term virtually all costs are variable. The difference between the two methods assumes great importance in inventory evaluation. In cost accounting, costs are identified with cost centers. These are accounting devices which may or may not have a physical existence. In the simplest case of a plant manufacturing a single product, the entire plant may be the cost center. 

The modern trend is for overhead costs to become an increasing proportion of total product costs. This results from the ever-greater sophistication of process plants. Therefore, it is highly desirable that chemical engineers should have some say in the location of overheads and that this should not be left entirely to accountants. 

However, many costs cannot be directly charged to an individual produc t. These so-called indirect, burden, or overhead costs range From the lighting and heating required for the plant and offices to the cafeteria and medical facihties provided. When several products are made in a plant, it becomes increasingly difficult to allocate overheads correctly among the various products. 

Example 19 Overhead in Two Dijferent Projects Let us consider a plant that can make either product A or product B. At normal capacity, the overhead cost is known to he 2.50 per unit. Product A has a direct materials cost of 8 per unit and a direct labor cost of 2 per unit. For simplicity, the prime cost is here taken as the sum of these two costs, i.e., 10 per unit. 

In Table 9-28, a correct overhead cost of 2.50 per unit at normal capacity is calculated by taking either 31.25 percent of the direct materials cost, 125 percent of the direct labor cost, or 25 percent of the prime cost. AU these methods give a total cost of 12.50 per unit and a profit of 1.50 per unit for a selling price of 14 per unit. 

Total variable production cost plus fixed production overhead cost. 

The annual manufacturing cost or expense A e be written as the sum of the direct manufacturing or prime cost Adme. ud the indirect manufacturing or overhead cost A E ... 

The determination of direct or prime costs is more straightforward than the determination of indirect or overhead costs. When more than one product is involved, the question arises as to the correct distribution of overhead costs between the various products. 

Standard Costs for Budgetary Control For convenience and simplicity, we shall consider the total cost of a manufac tured product to be the sum of the material, labor, and overhead costs. Standard costs are those that have been predetermined and budgeted for the manufacture of a given amount of product in a given time. The deviation of the actual cost from the standard cost is called the variance. It is far easier to make comparisons between periods by using variances than by using actual production data. The different variances for materi, labor, and overhead costs are listed in Table 9-38. 

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-... 

Overhead cost, /month Production, 1 million Ib/month ... 

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. 

Direct materials cost Direct labor cost Overhead cost Manufacturing cost Revenue from sales Gross profit... 

The individual variances in Table 9-40 show that the increased profit is due to reduced material costs, which affect manufacturing costs to a greater extent than increased labor and overhead costs. The individual variances also show that to an even greater extent the increased profit is due to the increase in sales revenue. 

Clearly, management will wish to investigate both labor and overhead costs for any inefficiencies and to ascertain the reasons for the improved sales revenue. If necessary, the standard values can be revised. 

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... 

Variances Overhead Cost The variance in overhead cost ACqh is the difference between actual overhead cost and static standard overhead cost,... 

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. 

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). 

We shall write the fixed overhead cost for the budget period as C° fOH, the semivariable overhead cost as. nd the standard hours... 

For production rates that differ from the agreed normal rate, the flexible budgeted overhead cost is given by... 

For production rates lower than normal, the fixed overheads are underused, and the flexible budgeted overhead cost Cboh is greater than the standard overhead cost c°iqh. For production rates higher than normal, Cboh is less than c°iqh. 

By using the data of Table 9-40 in Eq. (9-227), we calculate the standard overhead cost to be... 

The overhead cost variance comprises (I) budgeted overhead-cost variance, (2) overhead-volume variance, and (3) overhead-efficiency variance. The calculations for each follow ... 

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