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Chapter 8: Problem 4

What are the steps in developing a budgeted variable overhead cost-allocation rate?

Short Answer

Expert verified
To develop a budgeted variable overhead cost-allocation rate, follow these steps: 1. Identify the variable overhead costs that vary with production levels. 2. Determine a suitable cost driver that represents changes in variable overhead expenses with changes in production level. 3. Calculate the total budgeted variable overhead costs by estimating variable cost per unit and multiplying it by the projected volume of the cost driver. 4. Calculate the total budgeted cost driver for the upcoming period by multiplying the budgeted number of units to be produced with the budgeted cost driver per unit. 5. Calculate the budgeted variable overhead cost-allocation rate by dividing the total budgeted variable overhead costs by the total budgeted cost driver: \(Budgeted\: Variable\: Overhead\: Cost-Allocation\: Rate = \frac{Total\: Budgeted\: Variable\: Overhead\: Costs}{Total\: Budgeted\: Cost\: Driver}\)

Step by step solution

01

Identify the Variable Overhead Costs

Variable overhead costs are the indirect costs associated with the production process that vary with changes in production levels. Examples of variable overhead costs include indirect materials, supplies, and utilities. The first step involves identifying these costs and listing them down. Make sure to only include costs that vary with production levels, not fixed overhead expenses.
02

Determine the Cost Driver

A cost driver is an activity or factor that drives the cost. For variable overhead costs, you need to determine a suitable cost driver that changes with the production level. Common cost drivers used for variable overhead costs are direct labor hours, machine hours, or units produced. Choose a cost driver that best represents the changes in variable overhead expenses with changes in production level.
03

Calculate the Total Budgeted Variable Overhead Costs

Once you have identified the variable overhead costs and selected a cost driver, you need to estimate the total budgeted variable overhead costs for the upcoming period. To do this, estimate the variable cost per unit for each item and multiply it by the projected volume of the cost driver (e.g., direct labor hours, machine hours, or units produced).
04

Calculate the Total Budgeted Cost Driver

Next, calculate the total budgeted cost driver for the upcoming period. This can be done by multiplying the budgeted number of units to be produced with the budgeted cost driver per unit (e.g., total labor hours per unit or total machine hours per unit).
05

Develop the Budgeted Variable Overhead Cost-Allocation Rate

Finally, to calculate the budgeted variable overhead cost-allocation rate, divide the total budgeted variable overhead costs (from Step 3) by the total budgeted cost driver (from Step 4). Budgeted Variable Overhead Cost-Allocation Rate = \(\frac{Total\: Budgeted\: Variable\: Overhead\: Costs}{Total\: Budgeted\: Cost\: Driver}\) After calculating the budgeted variable overhead cost-allocation rate, you can use this rate to allocate variable overhead costs to each unit of the production to determine the total product cost.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Variable Overhead Costs
Variable overhead costs are the indirect costs that occur in the production process, which fluctuate with production levels. These costs differ from fixed overhead costs, which remain constant regardless of output levels. Examples of variable overhead costs can include expenses like:
  • Indirect materials
  • Supplies
  • Utilities
Identifying variable overhead costs involves recognizing those expenses that increase or decrease in direct proportion to the amount of production. This characteristic helps in better budgeting and financial planning as expenses can be foreseen depending on expected output levels.
Cost Driver
A cost driver is an element or activity that has a direct impact on the cost incurred during production. Identifying the right cost driver for variable overhead costs is crucial because it leads to more accurate financial management and resource allocation. Common cost drivers in determining variable overhead include:
  • Direct labor hours
  • Machine hours
  • Units produced
Selecting an appropriate cost driver greatly depends on which element best reflects the changes in overhead cost with different output levels. For instance, if the expenses are most related to the use of equipment, machine hours might serve as an ideal cost driver.
Budgeted Variable Overhead Costs
Determining the estimated variable overhead costs for a specific period involves calculating how much you expect to spend based on the cost driver identified. The process usually involves:
  • Calculating the variable cost per unit for each overhead expense
  • Multiplying this cost by the expected volume of the chosen cost driver
This helps in setting up a budget that aligns with the expected production level. The accuracy in estimating these costs affects how well an organization can control expenses and predict profit margins.
Production Levels
Production levels refer to the quantity of output that a company plans to produce within a specified time frame. Variable overhead costs and their allocation are directly influenced by production levels. When setting production budgets, it鈥檚 important to consider:
  • Market demand forecasts
  • Resource availability
  • Operational capacities
Matching production levels with variable expenses helps in achieving effective cost control and optimizing manufacturing processes. A close alignment naturally leads to a more precisely developed budgeted variable overhead cost-allocation rate.

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Most popular questions from this chapter

"The production-volume variance should always be written off to cost of Goods Sold." Do you agree? Explain.

What are the factors that affect the spending variance for variable manufacturing overhead?

As part of her annual review of her company's budgets versus actuals, Mary Gerard isolates unfavorable variances with the hope of getting a better understanding of what caused them and how to avoid them next year. The variable overhead efficiency variance was the most unfavorable over the previous year, which Gerard will specifically be able to trace to: a. Actual overhead costs below applied overhead costs. b. Actual production units below budgeted production units. c. Standard direct labor hours below actual direct labor hours. d. The standard variable overhead rate below the actual variable overhead rate.

Steed Co. budgets production of 150,000 units in the next year. Steed's CF0 expects that each unit will take 8 hours to produce at an hourly wage rate of \(\$ 10\) per hour. If factory overhead is applied on the basis of direct labor hours at \(\$ 6\) per hour, the budget for factory overhead will total: a. \(\$ 7,200,000\) b. \(\$ 9,000,000\) c. \(\$ 12,000,000\) d. \(\$ 19,200,000\)

Provide one caveat that will affect whether a production-volume variance is a good measure of the economic cost of unused capacity.
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