Manufacturing Overhead Paper - Assignment Example

Manufacturing Overhead Manufacturing Overhead Overheads are costs that are not associated with nor include direct material or directlabor. (“Overhead”, n.d, Investopedia). Manufacturing overheads are expenses that are indirectly related to the final manufactured product. (Weygandt, Kimmel and Kieso, 2009). Manufacturing overheads can include costs like: i. Indirect material, ii. Indirect labor, iii. Electricity, gas and water bills etc for the operation of factory equipment during production, iv.

Cleaning, repair and maintenance of machinery and equipment used during production, v. Wages of non-production factory employees like the factory’s accountant, or a person employed to check stock levels. This category of employees also include people who have been employed to handle and operate, clean and maintain equipment and machinery and people who perform quality checks on the products being produced in the factory, vi. Insurance expense, vii. Any costs incurred to make the production safer, viii.

Any costs incurred to increase the quality of production, ix. Tax expense. x. Depreciation expense on factory machinery and equipment Manufacturing overheads apply to the production process as a whole and thus technically cannot be allocated to a particular work. Therefore, managers in a factory allocate manufacturing overheads to specific work by using a predetermined over head rate. Predetermined overhead rates depend upon two factors; the estimated annual overhead cost and the expected annual operating activity.

They are calculated using the following formula: Predetermined overhead rate = Estimated annual overhead cost / Expected annual operating activity Predetermined overhead rates are calculated at the start of the new accounting year. Small companies often use a company-wide predetermined overhead rate however, for large companies the predetermined overhead rate may fluctuate between departments. Technically, manufacturing overheads should be calculated at the end of the fiscal year because they need to be applied to the total amount of production which can only be determined through the closing balances.

However, practicality doesn’t allow this. Therefore, accountants use predetermined overhead rates so that they can calculate overheads at any point in the accounting year, especially in the beginning when they need overheads to be able to calculate the correct price for the product. In the past companies used direct labor as the base for this calculation, however due to the increased number of automates processes in production nowadays the basis for this calculation has become machine hours.

(Weygandt, Kimmel and Kieso, 2009). Borealis Manufacturing has just incorporated a major change in its quality control process. Previously, it employed 10 inspectors for this job, whose cost was included in the books as addition to direct labor. Now, Borealis Manufacturing has the same job done using a computerized video quality control system with the aid of two quality control engineers. This change in the process has also changed the cost structure of production. The increase in overhead rate after the change has been from 190% to 300% and looks to be quite significant.

However, this increase will not impact the Borealis Manufacturing negatively. This is can be seen after analyzing what causes this increase. Budgeted overhead rate is calculated by dividing budgeted manufacturing overhead by budgeted direct labor cost. After the change in the QC process, the direct labor cost has decreased significantly, while due to the initial expenditure the budgeted manufacturing overheads have also increased a little. In calculating the latter budgeted overhead rate, the numerator is a little bigger and the denominator figure is significantly smaller and thus the resulting answer is dramatically larger and seems to have a negative impact until its causes are realized and it is seen that it has been caused by a sharp drop in direct labor cost.

Borealis Manufacturing could shift from using direct labor as the base for calculating costs to using machine hours or activity rate as a base. This is because since they are mechanizing the production process, direct labor may no longer be an accurate base figure and activity rate may be more appropriate. Doing this will also eliminate any confusion that could have resulted post mechanization, had Borealis Manufacturing still kept using direct labor costs as a base for calculating its predetermined or budgeted overhead rate.

Activity Based Costing system or ABC system is works through the established relationship between costs, activities and products and through this methods allocates the overheads to specific jobs. (“Activity Based Costing”, n.d., Investopedia). There are many benefits of ABC system, which become reasons for Borealis Manufacturing to implement this system and some of them are mentioned below: i. Enables better understanding of cost overheads being used ii. Improves profitability iii. Improves cost-performance relationship iv.

Links corporate strategy to operational decisions v. Ensures minimization of wastage vi. Improves estimation and price decisions. (“Activity Based Accounting System Benefits”, n.d.). References: Weygandt, J. J., Kimmel, P. D., and Kieso, D. E. (2009) Accounting Principles. United States: Wiley. Overhead. (n.d) Investopedia. [online] Retrieved from: http://www.investopedia.com/terms/o/overhead.asp#axzz22J2cAtw6 Activity Based Costing. (n.d) Investopedia. [online] Retrieved from: http://www.

investopedia.com/terms/a/abc.asp#axzz22J2cAtw6 Activity Based Accounting System Benefits. (n.d) Retrieved from: http://www.valuecreationgroup.com/activity_based_costing_benefits.htm