Digi-In Technology Ltd: Case Study

The current cost system allocates overhead costs once a year, as a function of direct labor dollars. This allocation strategy results in:

Only the incremental costs and benefits are relevant. In particular, only the variable manufacturing overhead and the cost of the special tool are relevant overhead costs in this situation. The other manufacturing overhead costs are fixed and are not affected by the decision.

Overhead costs are not in proportion to the production output because of the method they are using. This leads to inaccurate pricing and costing decisions. An Activity Based Costing System would help find the real relationship between the products produced and overhead.

when overhead is underapplied a must be made to the manufacturing overhead account to close it out

5. Regardless of the allocation system used, the total net income for the year will not change because the overall manufacturing overhead cost does not change. However, it is important to use a more accurate allocation method because it allows company’s to make decisions based on specific areas that might be driving costs up that may not show up when costs are allocated based on one driver.

3. Briefly describe how the current production cost assignment system works. What are the consumption ratios (activity percentages) for assigning manufacturing overhead to each product at present?

Abby could allocate indirect costs to special orders using a company-wide overhead rate. Frequently, these indirect costs are allocated by selecting an allocation base common to all of the company’s products or services. Many companies base overhead allocations on direct labor-hours

Under a traditional system, overhead cost is allocated to an activity based on hours or rates for direct labor or machine usage. However, this approach does not clearly indicate how much overhead cost will be needed in order to complete a job through a particular function. ABC methodology is to be used as an alternative to traditional accounting where a business 's overhead costs (indirect costs such as electrical energy consumption for heating or cooling, or indirect cost associated with marketing) are allocated as a proportion of direct costs, to an activity. This approach is unsatisfactory because there can be cases where two activities could absorb the same direct costs

3. Under the new activity-based costing (ABC) system, compute the indirect cost allocation rates for each of the three activities:

1. Use the Overhead Cost Activity Analysis in Exhibit 5 and other data on manufacturing

Therefore, there is no doubt that it is significant to allocate overhead cost accurately for every production. If the overhead is calculated incorrectly, the selling price of the product will change. The company will not cover the cost and make a loss.

The predetermined overhead rate is used for estimating the manufacturing overhead cost because companies cannot assign the actual overhead cost to specific job. From the case, Wall Décor uses a traditional job-order costing system. The actual costs of direct materials and direct labor are charged to its specific jobs which are unframed prints, steel-framed with no matting prints, and wood-framed with matting prints.

Check book system with authorization system for the release of indirect material were followed. This helps in reducing the overhead expenses. The respective team is responsible for this control. Also, the teams were given freedom to purchase indirect materials from suppliers through negotiation which help in controlling expenses. Teams got the expense report charged to their department which helps in monitoring the cost.

The current method of apportioning production overheads based on direct labour hours can be described as a traditional approach to product costing. In a manufacturing company’s financial statements, each item produced must be allocated some of the production overheads to make the statements compliant. Sometimes the individual costs of these items can be calculated incorrectly based on overall production overhead and the system of allocating in place, however the overall financial statement can still be accurate. This traditional method of allocating the production

Standard cost of direct labour is calculated by multiplying the standard labour hour (comprised of both the manufacturing standard hour and packing standard hour) and standard labour hour rate. Finally, to calculate the standard cost of overhead, the overhead costs are distributed to different departments say production department and service department which is called primary distribution and then the costs of service departments are redistributed to production departments which is called secondary distribution. From that, the variable and fixed overhead rate is calculated. By multiplying the rates with the standard labour hour of a product, the fixed and variable overhead can be got. At last, standard direct material cost, standard direct labour cost and standard overhead cost are added to get the total standard cost of a product.