Participation Exercise #4 - Assignment Example

Overhead costs In the world of manufacturing it is important for management to control its overhead and understand how it is assigned to products because of its impact on the measurement of individual products profitability. Thereafter it is reported in the company financial statements. Overhead is viewed as two types of costs namely; manufacturing overhead and nonmanufacturing costs. Manufacturing overhead refers to indirect-factory related costs that are incurred when a product is manufactured.

Electricity used to operate the factory equipment is an example of manufacturing overhead (Kimmel, Weygandt and Kieso). Manufacturer’s expenses that occur apart from the actual manufacturing is the second component of overhead (nonmanufacturing costs).Predetermined overhead rate is useful in ‘applying’ overhead cost in a manufacturing setup. It is calculated at the beginning of the company’s accounting cycle. The formula for calculating the pre-determined overhead rate is as follows: Predetermined Estimated total manufacturing overhead costs Overhead Rate.

= Estimated total activity base (Labour hours etc)According to generally accepted accounting principles (GAAP) manufacturing overhead must be included in the cost of Work in Process Inventory and Finished Goods Inventory on a manufacturer’s balance sheet. Pre-determined rate therefore is used to divide and allocate manufacturing overhead costs to each unit produced. It is defined as the rate used to apply manufacturing overhead to work- in- process inventory (Kimmel, Weygandt and Kieso).

Limitations of using a predetermined overhead.From the formula for calculating predetermined overhead rate, overhead is obtained by multiplying predetermined overhead rate by actual driver units. The difference between applied overhead and the amount of overhead actually incurred is referred to as over-or-under-applied overhead. Over-applied overhead increases the cost of production hence lower the company’s level profits. Under-applied overhead gives high rates of profits which may not be the correct position of the organization (Kimmel, Weygandt and Kieso).

Work citedKimmel, Paul D, Jerry J Weygandt, and Donald E Kieso. Accounting. Hoboken, N.J.: Wiley, 2011. Print.