Problem 18.4 P551 Weld Canning Company Has A Busy Season

Problem 18 4 P551 Weld Canning Company Has A Busy Season Lasting Six M

Weld Canning Company has a busy season lasting six months from September through February and a slack season from March through August. Factory overhead costs are allocated based on direct labor-hours, with each case requiring one direct labor-hour. At year-end, there are 25,000 cases in finished goods inventory. The assignment involves calculating overhead costs under two different methods: month-by-month allocation and using a predetermined annual rate, comparing the overhead component of inventory, and discussing the preferable method of overhead allocation.

Paper For Above instruction

The financial management of manufacturing companies hinges significantly on how overhead costs are allocated to products and inventory. Proper allocation ensures accurate product costing, profitability analysis, and informed decision-making. In the context of Weld Canning Company, which experiences seasonal fluctuations in production, analyzing different overhead allocation methods is critical to understanding their impact on cost control and inventory valuation.

Introduction

Overhead cost allocation is a foundational element of managerial accounting, influencing product costing, financial reporting, and operational decisions. For companies with seasonal production, such as Weld Canning, choosing the appropriate overhead allocation method can significantly affect inventory valuation and cost management strategies. This paper compares two primary approaches: allocating overhead on a monthly basis aligned with production months versus applying a predetermined annual overhead rate. The discussion will focus on the implications of each method, their impact on inventory costs, and their suitability under different managerial and financial reporting contexts.

Method 1: Monthly Allocation of Overhead Costs

In the first approach, Weld Canning allocates factory overhead costs to products in each month based on the actual incurred costs and hours. Since each case requires one labor-hour, the overhead per case would be calculated as total overhead for the month divided by the number of cases produced in that month. During the busy season (September to February), production is higher, and overhead costs are likely to be proportionally greater. Conversely, during the slack season (March to August), costs would be lower.

This method provides a more accurate reflection of costs per case during each period, aligning expenses closely with production activity. It also offers detailed information useful for internal decision-making, such as identifying cost fluctuations or inefficiencies in specific months. However, this method requires meticulous record-keeping of monthly overheads and production volumes, which could be administratively burdensome.

To calculate the overhead cost per case in each season, assume total overheads are allocated proportionally to the actual costs incurred during those months. For instance, if the total annual overhead is \$600,000, and 60% of the overhead is incurred during the busy season, then the overhead for that period would be \$360,000. During the busy months, if 18,000 cases are produced, the per-case overhead would be \$360,000 divided by 18,000, equaling \$20. During the slack season, with 7,200 cases produced and \$240,000 overhead, the cost per case would be approximately \$33.33. These calculations demonstrate the variability based on activity levels, highlighting the importance of seasonally adjusted overhead rates.

For finished goods inventory, which includes 25,000 cases, the overhead component under this method would depend on the specific production months in which they were manufactured. If inventory spans both seasons, the weighted average overhead cost per case, considering the proportion of inventory produced in each period, would appropriately reflect the cost basis.

Method 2: Predetermined Annual Overhead Rate

The second approach involves establishing a fixed overhead rate based on estimated annual costs and activity levels at the beginning of the year. This rate is then applied uniformly across all units produced, regardless of saisonal fluctuations. For Weld Canning, suppose the estimated total overhead for the year is \$600,000, and the estimated labor-hours are 60,000. The predetermined rate would be \$10 per labor-hour, leading to a consistent overhead cost per case of \$10, given each case requires one labor-hour.

This method simplifies accounting and overhead application, facilitating easier cost estimation and pricing decisions. It smooths out seasonal variations, providing a stable cost basis that does not fluctuate with monthly activity levels. However, it can introduce inaccuracies—overcosting slack-season products and undercosting busy-season products—which may distort inventory valuation and profitability analysis.

Regarding inventory valuation, the overhead component of the 25,000 cases in finished goods would be computed uniformly at \$10 per case, summing to \$250,000. This approach assumes that overhead costs are evenly distributed, which might not reflect actual production costs adequately during peak seasons.

Comparison and Preferred Method

The critical difference between the two methods lies in their approach to seasonality. Monthly allocation captures the true cost dynamics of production, offering precise cost data that better informs internal decision-making. It aligns costs closely with production activity, ensuring that inventory costs accurately mirror the expenses incurred.

The predetermined rate, on the other hand, offers simplicity and consistency, making it advantageous for external financial reporting where stable and predictable cost figures are preferred. It reduces administrative burden but risks misallocating costs when seasonal variations are significant.

In choosing the preferable method, companies with pronounced seasonality like Weld Canning generally benefit from periodic (monthly) allocation of overhead costs. This approach provides a more accurate picture of the costs associated with each period’s production, leading to better inventory valuation, cost control, and pricing strategies. Nonetheless, for practical purposes and external reporting, a hybrid approach might be used—applying a predetermined rate but periodically adjusting it based on actual activity data to balance accuracy and administrative efficiency.

In conclusion, the monthly allocation method is superior in environments with high seasonal variation, providing finer cost control and more accurate product costing. Conversely, the predetermined annual rate offers simplicity and stability but at the expense of potential cost distortions.

References

• Drury, C. (2018). Management and Cost Accounting (10th ed.). Cengage Learning.
• Horngren, C. T., Datar, S. M., Rajan, M. V. (2015). Cost Accounting: A Managerial Emphasis (15th ed.). Pearson Education.
• Garrison, R. H., Noreen, E. W., Brewer, P. C. (2020). Managerial Accounting (16th ed.). McGraw-Hill.
• Kaplan, R. S., & Anderson, S. R. (2004). Time-Driven Activity-Based Costing. Harvard Business Review, 82(11), 131–138.
• Hilton, R. W., & Platt, D. (2013). Managerial Accounting: Creating Value in a Dynamic Business Environment (10th ed.). McGraw-Hill Education.
• Anthony, R. N., & Govindarajan, V. (2014). Management Control Systems (13th ed.). McGraw-Hill Education.
• Leach, K., & Jorstad, S. (2017). Effective Cost Allocation Methods for Seasonal Businesses. Journal of Accounting & Finance, 17(2), 56–68.
• Zimmerman, J. L. (2014). Accounting for Decision Making and Control (8th ed.). McGraw-Hill Education.
• 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.
• Parkinson, M. (2016). Cost Management Strategies in Seasonal Industries. Cost Management Journal, 24(4), 23–31.