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MAC1501 Notes

The document discusses methods for assigning fixed overhead costs to production, emphasizing the importance of understanding cost drivers and using historical data for budgeting. It outlines two main methods for allocating overheads: traditional costing, which pools all overheads and uses a single cost driver, and activity-based costing (ABC), which groups overheads into activity-based cost pools with specific cost drivers. Both methods aim to accurately assign overhead costs to units produced based on production activities.

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96 views1 page

MAC1501 Notes

The document discusses methods for assigning fixed overhead costs to production, emphasizing the importance of understanding cost drivers and using historical data for budgeting. It outlines two main methods for allocating overheads: traditional costing, which pools all overheads and uses a single cost driver, and activity-based costing (ABC), which groups overheads into activity-based cost pools with specific cost drivers. Both methods aim to accurately assign overhead costs to units produced based on production activities.

Uploaded by

tianesnyman5
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Methods for assigning overheads to

production
Fixed overheads are fixed, regardless of the number of units being produced
If fixed overheads do not change with production, how do we know how much overheads to assign to each unit produced?
Important that management accountant bears in mind the drivers of the different costs
Historical data, agreements with suppliers, agreements with trade unions and economic forecasts will assist the accountant in budgeting for the direct material and direct
labour cost per unit for the coming year
Accountant must also realise that the total number of units produced drives the cost of both direct materials and direct labour also identify the drivers of overheads
Once these drivers are known, he/she can determine rates for assigning the overheads to production
Two methods to determine allocation and apportionment rates for overheads, namely the traditional costing method and the activity-based costing method

Traditional costing Activity-based costing


also referred to as ABC
1. All production overheads are pooled together – either for the factory We group production overheads into several activity-based cost pools;
as a whole, or per production department the cost driver is the activity that causes a change in the cost of that
2. Select the most suitable cost driver to determine the apportionment activity
rate and determine the rate by using either a volume-based or a cost-
based driver Activity cost pool Cost driver
3. Then apportion the overheads to the cost objects (units produced) by Number of setups
Setting up machines in the factory
applying the rate to the selected activity level Number of orders
Ordering of materials
Examples of volume-based cost drivers - The number of units produced, Number of inspections
Inspecting for quality control purposes
the number of direct labour hours and the number of machine hours.
Every machine setup will cause a change in the cost of the activity setting up
Examples of cost-based cost drivers - Direct labour cost, direct
machines
materials cost and prime costs
Every order will cause a change in the cost of the activity ordering of materials
Where only a single rate is determined for the entire production
Every inspection will cause a change in the cost of the activity inspecting for
department, we talk of a plantwide rate.
quality
The costs collected in the cost pools are assigned to units of production based on
the volume of activity of the cost driver.

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