Chapter 8 Notes
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components to cost:
Direct Materials, and
As noted previously, it is relatively easy to allocate Direct Labor and Direct Materials to
the products produced, but it is difficult to allocate Manufacturing Overhead costs.
Because of this, we have Normal Costing and the allocation of Manufacturing Overhead
using Predetermined Overhead Rates.
In Chapter 3, we used a single, Predetermined Overhead Rate to allocate the
Manufacturing Overhead costs to the products being produced.
If all of the products are
similar, this approach may produce a fairly accurate allocation of Manufacturing
On the other hand, if you have widely diversified product lines and production
operations, then a Plant-Wide Application Rate may not be very accurate.
You may find
that some products are being under-costed and others are being over-costed. In this
case, you might obtain more accuracy in the allocation of Manufacturing Overhead to
the units that generated it by using more than one overhead cost pools.
The number of
cost pools to use always involves a cost-benefit analysis, because of the additional
record keeping involved.
Why should you care whether your products being over-costed or under-costed?
Having more accurate cost information can lead to an improvement in your bidding
process. If you base your customer bid prices on your costs, you could charge the
If you charge more than your competitors, then you will lose business.
If you charge less than your competitors, you will get more business, but your profits will
be less than you expected because you are not charging your customers enough.
Having more accurate cost information could improve a firm’s product mix.
Even if your
prices are not based on your costs (
, set by the free market), you still may have
problems. For example, you may not actively go after certain business because you
don't think it is very profitable when that business actually is profitable.
may go after other business that you believe is very profitable, when it is not profitable
or less profitable than you believe.
Another way that over-costing or under-costing can affect a business is in the decision
whether to offer a product or discontinue a product. Having misinformation on the