Assignment 2: Manufacturing Overhead
Borealis Manufacturing has just completed a major change in its quality control (QC) process. Previously, products had been reviewed by QC inspectors at the end of each major process, and the company’s 10 QC inspectors were charged to the operation or job as direct labor. In an effort to improve efficiency and quality, a computerized video QC system was purchased for $250,000. The system consists of a minicomputer, fifteen video cameras, and other peripheral hardware and software. The new system uses cameras stationed by QC engineers at key points in the production process. Each time an operation changes or there is a new operation, the cameras are moved, and a new master picture is loaded into the computer by a QC engineer. The camera takes pictures of the units in process, and the computer compares them to the picture of a “good” unit. Any differences are sent to a QC engineer, who removes the bad units and discusses the flaws with the production supervisors. The new system has replaced the 10 QC inspectors with two QC engineers.
The operating costs of the new QC system, including the salaries of the QC engineers, have been included as factory overhead in calculating the company’s plant-wide manufacturing-overhead rate, which is based on direct-labor dollars. The company’s president is confused. His vice president of production has told him how efficient the new system is. Yet there is a large increase in the overhead rate. The computation of the rate before and after automation is as follows:
|Budgeted Manufacturing Overhead||1,900,000||2,100,000|
|Budgeted Direct Labor Cost||1,000,000||700,000|
|Budgeted Overhead Rate||190%||300%|
“Three hundred percent,” lamented the president. “How can we compete with such a high overhead rate?”
Using the module readings and the Argosy University online library resources, research manufacturing overhead.
Review the situation. Complete the following:
- Define “manufacturing overhead,” and:
- Cite three examples of typical costs that would be included in manufacturing overhead.
- Explain why companies develop predetermined overhead rates.
- Explain why the increase in the overhead rate should not have a negative financial impact on Borealis Manufacturing.
- Explain how Borealis Manufacturing could change its overhead application system to eliminate confusion over product costs.
- Describe how an activity-based costing system might benefit Borealis Manufacturing.
Sample Answer – Manufacturing overhead
Manufacturing overhead refers to all costs which a company incurs excluding the variable cost needed to develop products such as direct labor and direct materials. It refers to indirect manufacturing related costs which are experienced. These costs are continuing expenses that are incurred by a business in its operation, but cannot be mapped out to particular production units. Just like other cost that include direct labor and direct material, the manufacturing overhead cost have to be assigned to every produced unit so that cost of goods sold and inventory are reported and valued based on generally accepted according principles (GAAP). The manufacturing overhead incorporates costs that include electricity and gas utilized in operating the company’s production equipment, factory building and equipment depreciation or rent fee, factory personnel especially in maintenance and quality control of the factory, except the direct labor, and the factory supplies. In this case, some of manufacturing overhead includes the salaries of the QC engineers. The QC engineers are specific personnel needed to operate the automated quality control computer system. The computers and other factory equipment depreciation, and electricity cost (Stewart, 1991).
Read also Manufacturing Overhead
Predetermined overhead rate refers to an allocation rate which is utilized to apply the approximated manufacturing overhead cost to objects cost for a particular reporting duration. Predetermined overhead rate is utilized in applying production overhead to job or products orders and is normally calculated at the start of each period. This rate is normally utilized to help in speedy books closing, since it evades the difficulty of the real manufacturing overhead expenses as part of the end of period closing process. Nevertheless the variation between estimated and actual overhead amount need to be reconciled at the end of every fiscal year. The predetermined overhead rate is derived by dividing the approximated quantity of manufacturing overhead to be experienced during the period with approximated allocation base for that period. In this case, there are various possible available denominator allocation bases that include machine hours, labor dollars and hours of direct labor. Predetermined rate assists the company in resources allocation and also in setting products pricing, instead of waiting until the production is over to do product costing (Heisinger, 2009).
Increase in Overhead Rate Should Not Have a Negative Impact on Borealis Manufacturing
Based on the provided statistics, the budgeted manufacturing overhead before automation was 1.9 million while after automation was 2.1 million. The statistics also show that the budgeted direct labor cost before automation was one million while after the automation it was seven hundred thousand. This implies that the total budgeted cost before automation was 2.9 million while the total budgeted cost after automation was 2.8 million. This is a clear indication that although automation has added the manufacturing overhead cost, it has also offset the direct labor costs, even with a higher percentage compared to the level in which it had increases the overhead cost. Thus, this adjustment has thus created a balance in the total cost incurred, giving the company an advantage of saving about one hundred thousand in the total manufacturing cost. Thus the increase in overhead cost will not have a negative impact on Borealis manufacturing company since the rise in the indirect costs was counterbalance by a decline in the direct labor cost.
How to Change Borealis Manufacturing Overhead Application System to Eliminate Confusion Over Product Costs
The company can alter its overhead application system to shun confusion by shifting from single general overhead rate to utilize separate activities pools of cost. For instance the overhead accounts can be computed as per individual department, with separate service and production division in each department. The divisions for service and production would separately allocate their own products overhead founded on the best correctly overhead services reflection. The division can also be based on the available machine where each production machine can be allocated its own overhead cost, and total overhead cost should be the summation of all costs recorded by each machine (Stewart, 1991).
How Activity-Based Costing System Might Benefit Borealis Manufacturing
Activity-based costing (ABC) refers to a costing method that is extra exact in overhead allocation to items which use it. The system can be utilized for the targeted overhead costs reduction. ABC is said to work more effectively in complex settings, where there are numerous products and machines, and twisted processes which are hard to sort out. On the contrary, it is of less importance in a streamlined setting where processes of production are abbreviated. This accounting technique recognizes the activities which a company performs and allocates indirect expenses to products. The ABC system acknowledges the association between products, activities and costs, and via this association, it allocates indirect expenses to products less randomly compared to traditional technique. In this regard, ABC system may be of benefit to Manufacturing since it regards all expenses of an organization as variable, distinguish cost between non-value adding and value adding activities, products cost based on the involved activities in the process of production. It may also be of great benefit to the company especially if the manufacturing process is considerably complex, involving various machines that may need more subjective costing technique (Heisinger, 2009).