Define "Manufacturing Overhead" And Cite Three Examples

Define “manufacturing overhead,” and: Cite three examples of typical costs that would be included in manufacturing overhead. Explain why companies develop predetermined overhead rates. Explain why the increase in the overhead rate should not have a negative financial impact on Borealis Manufacturing. Explain how Borealis Manufacturing could change its overhead application system to eliminate confusion over product costs. Describe how an activity-based costing system might benefit Borealis Manufacturing.

Manufacturing overhead refers to the indirect costs associated with the manufacturing process that cannot be directly traced to specific products or jobs. These costs include expenses incurred in the production process but are not directly attributable to particular units of output. Manufacturing overhead encompasses a wide range of operational costs that support production activities and are necessary for maintaining manufacturing efficiency and quality control. Examples of typical manufacturing overhead costs include factory rent, depreciation on manufacturing equipment, and maintenance expenses on machinery.

Factory rent is a common manufacturing overhead cost because it is a fixed expense necessary for maintaining the physical space where production occurs. Depreciation on manufacturing equipment similarly reflects the wear and tear of machinery used in production, which is not directly linked to individual units but essential to the manufacturing process. Maintenance costs on machinery enhance the longevity and efficiency of production equipment, indirectly supporting the output without directly involving the cost of raw materials or direct labor. These costs are pooled together under manufacturing overhead because they support overall production operations rather than specific product units.

Companies develop predetermined overhead rates to allocate indirect manufacturing costs to products or jobs systematically and consistently. Since manufacturing overhead costs are incurred over time and can fluctuate due to various factors, using a predetermined rate allows companies to estimate and assign overhead costs during a specific accounting period based on a consistent cost driver, such as direct labor hours or machine hours. Developing this rate before production helps in setting standard costs, facilitating budgeting, pricing, and financial planning, and providing timely cost information for managerial decision-making. It also mitigates the effect of fluctuations in overhead costs and provides a stable basis for cost allocation throughout the period.

While Borealis Manufacturing’s overhead rate appears to have increased significantly after automation, this should not necessarily have a negative financial impact. The increase is primarily due to the change in how overhead costs are allocated, especially with the adoption of a new system that includes the purchase of an expensive QC system and a reevaluation of overhead costs. The rate is a reflection of the allocation basis and does not directly indicate the actual increase in total overhead expenses or the efficiency of production. Since the new system improves quality control and reduces manual inspection labor, the overall production costs may have decreased or remained stable despite the higher overhead rate. The key is that the rate is a tool for allocating costs, not an absolute measure of total costs or profitability.

Borealis Manufacturing could improve its overhead application system by shifting from a traditional volumetric-based rate to an activity-based costing (ABC) system. ABC assigns overhead costs to products based on the actual activities that consume resources, providing a more accurate reflection of the true costs of production. Instead of spreading overhead uniformly based on direct labor or machine hours, ABC recognizes that different products or jobs use activities to varying degrees. By identifying and measuring the activities involved in manufacturing—such as machine setups, quality inspections, or material handling—Borealis can allocate costs more precisely, reducing product cost distortion and enhancing managerial decision-making. Implementing an ABC system would clarify how much each product truly "costs" to produce and eliminate confusion caused by broad, generalized overhead rates.

Adopting activity-based costing offers significant benefits for Borealis Manufacturing. It allows the firm to identify high-cost activities and target areas for efficiency improvements, potentially lowering overall costs. ABC also facilitates more accurate product pricing and profitability analysis, enabling the company to focus on the most profitable products while reconsidering or improving less profitable ones. Moreover, ABC can improve cost control and strategic planning by providing detailed insights into resource consumption across different processes or product lines. In the context of automation and technological improvements, such as the new QC system, ABC helps align overhead costs with actual activities, offering a clearer view of how investments impact production costs and product profitability. Consequently, moving to an activity-based costing system could serve as a powerful managerial tool for cost management and strategic decision-making at Borealis Manufacturing.

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