55. Variable & Fixed Overhead Costs

Question 1

Briefly describe the four stages that many organizations use to allocate or track costs, resulting in a fully costed product that complies with absorption costing standards.

Answer 1

• Stage 1: The direct costs are located within each department.
• Stage 2: The executive-level administrative costs are allocated across all departments.
• Stage 3: The support department costs are assigned to production departments.
• Stage 4: Fully loaded costs from the production departments are assigned to products sold.

Question 2

Describe how organizations use the high–low method to estimate the variable and fixed costs.

Answer 2

• The high–low method focuses solely on the highest and lowest activity levels (e.g., production volume).
• Organizations compare the change in production costs to the change in activity level at these two points to establish a variable cost per unit (rise over run).
• The variable cost per unit is then used to solve for the total fixed costs by using the formula: Total Cost = (Variable cost per unit × Total units) + Total fixed costs.

Question 3

Describe how organizations use regression analysis to estimate the variable and fixed costs.

Answer 3

• Regression analysis is based on all the data provided in a report. Because it uses all the data points instead of just two, regression analysis is a much more comprehensive approach to identifying variable and fixed costs.
• Using Excel™, a line is fitted as tightly as possible to the data points.
• The coefficient or slope of the line (rise over run) represents the variable cost per unit.
• The coefficient for the intercept point represents the total fixed costs.

Question 4

Describe the basic approach that organizations use to establish the cost assignment or allocation rate.

Answer 4

1. Identify the overhead cost pool and establish a budgeted cost for the upcoming period.
2. Identify the basis on which to assign the costs and establish an expected activity level for the upcoming period.
3. Divide budgeted costs by expected activity to form the cost assignment rate

Question 5

Describe the two approaches for reconciling over- or under-applied manufacturing overhead.

Answer 5

• One method is to proportionally adjust the ending balance in all “downstream accounts.” This is the most accurate approach and is the best method to use when the over- or under-applied amount is significant.
• The second method is to simply adjust the cost of goods sold account directly for the full amount of the variance. This method will over-adjust the cost of goods sold and leave inaccuracies in the ending balances for all inventory accounts