In today’s competitive economy, manufacturing firms need to invest in areas that generate the desired gains. To determine the success of an investment, companies can make use of the cost analysis tool (Morgan, 2010). Both small and large manufacturing firms strive to gain appropriate returns. They have to make choices that directly and indirectly impact the cost of goods. Direct decisions are made in such areas as material selection, machine hours, and manufacturing processes. On the other hand, indirect considerations apply to such aspects as quality, maintenance, administration, and turnover (Schneider, 2012).
In this paper, the author will help managers at Auerbach Enterprises to allocate overhead costs in Maxi Flow and Alaska manufacturing. To this end, the author will provide calculations for various overhead rates.
Computing Departmental Overhead Rates using Machine Hours
The calculation of most rates is similar. However, major differences emerge as a result of the driver used in each department (Hoggett, 2012). Consequently, it is important to note the specific drivers employed.
Departmental overhead rate = Estimated manufacturing overhead costs ÷ machine hours
Radiator parts fabrication = $ 80,000 ÷ 10,000
Radiator assembly, weld, and test = $100,000 ÷ 20,000
Compressor parts fabrication = $120,000 ÷ 5,000
Compressor assembly and test = $180,000 ÷ 45,000
The department rate is determined by the overhead cost and the total number of machine hours used in the respective section. An analysis of the figures reveals variations between the departments. For example, assembly of parts records the highest cost. The figure stands at 24 dollars per hour.
Calculating Overhead Variations using Machine Hours for the Entire Organization
The component is utilized to allocate all manufacturing costs to the production output. Brewer and Garrison (2013) define the concept as the amount per machine hour, labor hour, or percentage of a merchandise direct cost.
Total company-wide overhead rate = total overhead costs for all departments ÷
total machine hours for all units
= $480,000 ÷ 80,000
= $6 per machine hour
The figure above represents the entire organization’s overhead rate.
Computation of Overhead Cost per Batch for Maxi Flow and Alaska
Company-wide and department-wide overhead costs can be calculated using the formula below:
- Company/department-wide overhead cost=Machine hour cost × overhead rate
Overhead cost per batch is determined by assuming that:
- Company-wide rate = direct material costs × batch size + direct labor cost × batch size
Max Flow = 135 × 20 = 2700
75 × 20 = 1500
Cost per batch = $4200
Alaska = 110 × 20 = 2200
95 × 20 = 1900
Cost per batch = $4100
In terms of the company-wide rate per batch number, the difference between Alaska and Max flow is only $100.
Departmental rate = direct material costs + direct labor cost ÷ each department hour
Maxi Flow = 135 + 75 = $ 210
Radiator parts fabrication = 210 ÷ 28
= $7.50 per batch
Radiator assembly, weld, and test = 210 ÷ 30
= $7 per batch
Compressor parts fabrication = 210 ÷ 32
= $6.60 per batch
Compressor assembly and test = 210 ÷ 26
= $8.10 per batch
Alaska = 110 + 95 = 205
Radiator parts fabrication = 205 ÷ 16
= $12.80 per batch
Radiator assembly, weld, and test = 205 ÷ 74
= $2.70per batch
Compressor parts fabrication = 205 ÷ 8
= $25.60 per batch
Compressor assembly and test = 205 ÷ 66
= $3.10 per batch
There are significant differences between Alaska and Max Flow with regards to departmental rates. On average, Maxi Flow’s rate ranges at $7.30 per batch. On the other hand, Alaska’s rate ranges at $11.05 per batch.
Total Cost per Unit Assuming the Company-Wide Rate
Total cost per unit = direct material cost + direct labor cost ÷ number of units
Direct materials cost = $135 per unit
Direct labor cost = $75 per unit
135 + 75 = 210
Direct materials cost = $110 per unit
Direct labor cost = $95 per unit
110 + 95 = 205
Total cost per unit for both Alaska and Maxi Flow = 210 + 205
= 415+ 480,000 ÷ 40
= $ 12,010.38 per unit
Total cost per unit assuming departmental rates
Radiator parts fabrication= $80,000+415 ÷ 40
=$2010.38 per unit
Radiator assembly, weld, and test=100,000+415÷40
Compressor parts fabrication=120,000+415÷40
Compressor assembly and test=180,000+415÷40
With regards to the total cost per unit, it is evident that prices are increasing in each of the four manufacturing departments.
Conclusion and Recommendations
Departmental rates affect one product more than others. The reason is that the manufacturing cost of merchandise is always different. Auerbach’s management should take into consideration the fact that the differences are caused by the complexity of the product and materials used. An analysis of Maxi Flow and Alaska using the calculations reveals the effect. For example, in terms of departmental costs per batch, Maxi Flow is cheaper than Alaska.
Auerbach should pay attention to cost allocation. The reason is that it helps managers to value inventory for external reporting and monitoring of expenditure on activities and processes. In addition, allocations support price where cost must be justified. The managers should understand that companies are different. Consequently, an approach that works for one firm may not suit another. Aurebach Enterprises majors on two product lines. To guarantee effective cost allocations, the managers can use process costing to calculate the manufacturing expenditure of a single product. The approach tends to be cheap and fast.
Brewer, P., & Garrison, R. (2013). Introduction to managerial accounting (6th ed.). New York: McGraw-Hill/Irwin.
Hoggett, J. (2012). Accounting (8th ed.). Milton, Qld: John Wiley and Sons Australia.
Morgan, K. (2010). Strategic financial management. Jaipur: Mark.
Schneider, A. (2012). Managerial accounting: Decision making for the service and manufacturing sectors. San Diego, CA: Bridgepoint Education.