This document discusses cost assignment and overhead rates. It explains that costs must be divided between cost objects using either blanket rates or specific cost center rates. Blanket rates are simpler but less accurate, while cost center rates are more complex but more precise. The document provides examples comparing overhead costs calculated using blanket rates versus cost center rates. It emphasizes that inaccurate costing can damage budgeting, pricing, profitability, and long-term decision making.
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This document discusses cost assignment and overhead rates. It explains that costs must be divided between cost objects using either blanket rates or specific cost center rates. Blanket rates are simpler but less accurate, while cost center rates are more complex but more precise. The document provides examples comparing overhead costs calculated using blanket rates versus cost center rates. It emphasizes that inaccurate costing can damage budgeting, pricing, profitability, and long-term decision making.
This document discusses cost assignment and overhead rates. It explains that costs must be divided between cost objects using either blanket rates or specific cost center rates. Blanket rates are simpler but less accurate, while cost center rates are more complex but more precise. The document provides examples comparing overhead costs calculated using blanket rates versus cost center rates. It emphasizes that inaccurate costing can damage budgeting, pricing, profitability, and long-term decision making.
Copyright:
Attribution Non-Commercial (BY-NC)
Available Formats
Download as PPT, PDF, TXT or read online from Scribd
This document discusses cost assignment and overhead rates. It explains that costs must be divided between cost objects using either blanket rates or specific cost center rates. Blanket rates are simpler but less accurate, while cost center rates are more complex but more precise. The document provides examples comparing overhead costs calculated using blanket rates versus cost center rates. It emphasizes that inaccurate costing can damage budgeting, pricing, profitability, and long-term decision making.
Copyright:
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Week 2 – Cost Assignment
• This means dividing costs up between cost objects
• Remember that direct costs are those that are completely attributable to the cost object. • Indirect costs (or overheads) have to be divided up in a reasonable manner. There are two basic ways – Factory wide or “blanket” rates – Specific cost centre rates • You need to know – What your costs are – What assumptions you are going to make about cost driver. Why do we need to do this • Inventory valuation • Product costs • Setting selling prices and bidding for work • Measuring profitability • Long term decision making (but not short term!) Designing the system • Blanket rates – Cheap to run – Low accuracy, arbitrary, errors? • Cost centre rates – Expensive to run (cost of accountants) – More accurate, less errors. • What is the cost of costing – cost-benefit analysis. Blanket rate example • Total Overheads £900000 • Total worked hours 60000 • Overhead rate £15 per hour • Suppose product X takes 5 hours to make – Then the overhead cost is 5 * £15 =£75 – This is in addition to the direct cost. Cost centre rate example • Suppose the company has 3 departments – Dept A Dept B Dept C Total • The Overheads have been divided up – £200000 £600000 £100000 £900000 • The worked hours in each department are – 20000 20000 20000 60000 • So the cost centre rates are – £10 £30 £5 The results • Suppose the 5 hours to make Product X are 1 hour in dept A, 0 in dept B and 4 in dept C – The overhead cost is now 1*£10 + 4 * £5 = £30 • Compares with £75 with the blanket rate. – Your budgeting would be inaccurate – Your price setting would be inaccurate – You would send the wrong signals to your customers – Your long term profitability would be damaged. The process for the cost centre system • Assign all manufacturing overhead to production and service cost centres – Some direct – Some shared or apportioned • Reallocate costs to production costs • Calculate overhead rates for production cost centre – Labour hours or machine hours • Assign overheads to the chosen cost objects Operating Expense Allocations Actual rates or predetermined rates? • Actual rates are rarely used – Delay in producing product costs (and prices/invoices) – Monthly fluctuations due to seasonal change • Budgeted rates mostly used – Estimate the annual cost – Estimate the annual hours – Gives “long run” cost (not affected by monthly change) Effect of using predetermined rates • We talk about absorption of overhead • PDRs usually result in over- or under- absorption • Over – if cost is less or activity is more • Under – If cost is more or activity is less • May damage short term pricing • Gives long term stability
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