we discuss three overhead allocation methods 1 single plantw

we discuss three overhead allocation methods. 1) single plant-wide factory overhead rate; 2) multiple production department overhead rates; 3) activity-based costing. How do we know when to use which overhead allocation method? Why wouldn\'t I just use theactual overhead cost and avoid making an allocation altogether?

Solution

Using a plant-wide rate is logical when there is one root cause of the indirect production costs and the company manufactures similar products. For example, a company with a simple manufacturing operation that produces similar products could have a plant-wide overhead rate of $40 per machine hour if it has budgeted $800,000 of total manufacturing overhead costs and it expects to produce 20,000 machine hours of good output.

for example- If Product X consumes 10 percent of one indirect resource, it must consume 10 percent of all indirect resources for a single plant wide rate to provide accurate product costs. If a firm produces many different products that consume indirect resources in different proportions, then a two stage approach is needed to provide accurate product costs.

2. Multiple production department overhead rate-

If the company manufactures diverse products, some of which use expensive equipment while some use only inexpensive equipment, a plant-wide rate is not appropriate. In response to this situation, manufacturers have developed departmental overhead rates. Thus, only the products that use the expensive equipment in a specific department will be assigned a higher overhead rate of perhaps $70 per departmental machine hour. The products requiring a simpler operation such as assembling may be assigned overhead at a rate of perhaps $20 per direct labour hour.

3. Activity based costing-

Each department produces many products that consume resources within each department in different proportions, e.g., Product X consumes 30% of the power, 15% of the engineering work and 20% of the repair in Department A. Multiple rates are needed in Department A.