Define Manufacturing Overhead And Cite Three Examples 974165

Define “manufacturing overhead,” and: Cite three examples of typical costs that would be included in manufacturing overhead

Manufacturing overhead, also known as factory overhead or production overhead, encompasses all indirect costs associated with manufacturing a product that are not directly traceable to a specific product or service. These costs are necessary for the production process to occur but cannot be directly linked to individual units of output. Manufacturing overhead includes expenses incurred in supporting the manufacturing process, such as maintenance, utilities, and factory supervision. Proper allocation of these costs is critical for accurate product costing and financial analysis.

Three examples of typical costs included in manufacturing overhead are:

1. Factory Utilities: Expenses such as electricity, water, and gas used in the manufacturing facilities. These utilities are essential for operating machinery and maintaining a conducive environment for production.
2. Factory Depreciation: The allocated depreciation on manufacturing equipment, machinery, and factory buildings. This represents the wear and tear or obsolescence of long-term assets used directly or indirectly in production.
3. Manufacturing Supplies: Indirect materials like lubricants, cleaning supplies, and small tools that are consumed during production but do not become part of the finished product.

Explain why companies develop predetermined overhead rates

Companies develop predetermined overhead rates to estimate and allocate manufacturing overhead costs to products in a systematic and consistent manner throughout the accounting period. This approach facilitates timely product costing, pricing decisions, and cost control. By establishing an estimated overhead rate based on expected costs and activity levels—such as direct labor hours, machine hours, or direct labor costs—companies can allocate overhead costs to products as production occurs, rather than waiting until all costs are incurred at the end of the period.

Predefined rates also help in budgeting, planning, and performance evaluation. They enable management to compare actual costs against estimated costs, facilitating cost control and operational efficiencies. Additionally, predetermined rates are essential for establishing cost standards and simplifying the accounting process, especially in high-volume or complex manufacturing environments where many products are produced simultaneously.

Explain why the increase in the overhead rate should not have a negative financial impact on Borealis Manufacturing

The increase in the overhead rate at Borealis Manufacturing is primarily a result of changes in how factory costs are allocated rather than actual increases in overall manufacturing costs. Previously, the manufacturing overhead was based on the actual or estimated costs, with a rate of 190%. The current rate has increased to 300%, reflecting the new system of allocating costs using the plant-wide overhead rate based on direct labor costs.

This increased overhead rate does not inherently imply higher total costs or reduced profitability. Instead, it signifies a shift in how costs are distributed across products. When overhead is allocated more precisely—such as through activity-based costing (ABC)—the apparent expense per product might increase, but the overall total manufacturing costs stay consistent if actual costs are accurately captured. Essentially, the increase does not mean Borealis is costing products more in a cash sense; it means the accounting system is now allocating overhead more appropriately, aiding better product cost management in the long term.

Explain how Borealis Manufacturing could change its overhead application system to eliminate confusion over product costs

To eliminate confusion over product costs, Borealis Manufacturing could transition from the traditional plant-wide overhead application system to a more refined and activity-based costing system. This change involves identifying activities that consume overhead resources and assigning costs to products based on the actual activities they require. Instead of using a single overhead rate based solely on direct labor costs, an activity-based costing (ABC) system recognizes multiple cost drivers, such as machine setups, inspections, or movement of materials.

Implementing ABC would involve analyzing activities involved in production, assigning costs to each activity, and then linking those costs to products based on their consumption of activities. This more accurate reflection of resource usage can help management understand the true costs of products, reduce cross-subsidization, improve pricing strategies, and enhance cost control efforts. It also enhances decision-making with clearer insights into which products are more profitable and which activities are driving overhead costs.

Describe how an activity-based costing system might benefit Borealis Manufacturing

An activity-based costing (ABC) system offers significant benefits to Borealis Manufacturing by providing a more accurate and detailed view of product costs. Unlike traditional costing methods that allocate overhead based on a single cost driver, ABC recognizes multiple activities and their respective costs, resulting in a finer granularity of cost distribution.

One major benefit is improved cost accuracy, which supports better pricing decisions and profitability analysis. For example, products requiring complex setups, multiple inspections, or extensive handling would be identified as consuming more resources. This detailed insight allows Borealis to identify high-cost activities and explore opportunities for process improvements or cost reductions.

Moreover, ABC can improve strategic decision-making by highlighting profitable and unprofitable products or product lines. It helps management understand the true cost contributions of various activities, supporting decisions related to product design, process improvements, and outsourcing strategies. Implementing ABC can also lead to enhanced cost control and efficiency, as it reveals wasteful or unnecessary activities that could be streamlined or eliminated.

While ABC implementation involves additional effort in data collection and analysis, the long-term benefits of precise costing and improved managerial insights make it a valuable tool for Borealis Manufacturing to remain competitive and profitable in a cost-conscious marketplace (Kaplan & Cooper, 1998; Hopp & Spearman, 2011).

References

• Kaplan, R. S., & Cooper, R. (1998). Cost & Effect: Using Integrated Cost Systems to Drive Process Improvement and Performance. Harvard Business School Press.
• Hopp, W. J., & Spearman, M. L. (2011). Factory Physics (3rd ed.). Waveland Press.
• Drury, C. (2013). Management and Cost Accounting (9th ed.). Cengage Learning.
• Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial Accounting (16th ed.). McGraw-Hill Education.
• Horngren, C. T., Datar, S. M., & Rajan, M. (2015). Cost Accounting: A Managerial Emphasis (15th ed.). Pearson.
• King, H., & Wallace, W. (2012). Financial Accounting: An International Introduction. Pearson Education Limited.
• Horvath, P., & Zemplen, G. (2019). Implementing Activity-Based Costing in Manufacturing. Journal of Manufacturing Processes, 45, 124–134.
• Jensen, M. C., & Meckling, W. H. (1976). Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure. Journal of Financial Economics, 3(4), 305–360.
• Cooper, R., & Kaplan, R. S. (1991). Profit Priorities from Activity-Based Costing. Harvard Business Review, 69(3), 130–135.
• Anthony, R. N., & Govindarajan, V. (2007). Management Control Systems (12th ed.). McGraw-Hill Education.