Difference Between Actual Overhead And Applied Overhead: Costing Methods And Analysis

Calculating Cost per Unit under Activity Based Costing

Costing is the act of breaking down the costs and analysing the individual constituents and preparing a report to be submitted to the management of the company. The analysis of the costing is necessary to understand the impact of the costs on the earnings of the company and rectifying the same if there is any need. The methods to measure the overhead costs are the traditional method, activity based costing, prorated based costing. All the three methods have been described in this report and a detail analysis is done in this report (Manunen, 2013).

Traditional costing is the method under which the factories overheads are allocate on the basis of the volume of the total resources produced. Generally under this method the overheads are assigned taking the labour hours or the machine hours as the base. Above is the table in which the cost per units is calculated by using the traditional method. The overhead cost is calculated using the machine hours therefore the figure of $615 and $935 is arrived after dividing the total indirect overhead costs by the machine hour. Further the second table displays the cost per unit taking into consideration the cost of the direct labour materials per unit and the labour per unit (Patiar, 2016).

Calculation of cost per unit under activity based costing  method
Particulars	Basic Model Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	Advanced Model
Direct Material cost per unit	350	580
Direct Labor cost per unit	175	280
Overhead costs per unit	52	120
Other operating Expenses		383500
Operating Expenses per unit		240
Total cost per unit a	577	1220

Indirect Overheads Cost		Estimated cost Driver Activity		Overhead Rate		Allocation of overhead costs		Allocation of overhead costs
Inspection (hours)	30000	Inspection	970	31	210	6495	760	23505
Assembly   (direct machine hours)	100000	Assembly	8200	12	4700	57317	3500	42683
Production Scheduling	110000	Production Scheduling	570	193	60	11579	510	98421
Machine set up	40000	Machine Set-up	390	103	120	12308	270	27692
Total						87699		192301
Manufacturing overhead cost**
Total overhead cost/ no of units produced						52		120

 

Activity based costing method is the method which is mainly featuring the costs to overhead activities and thereafter the costs are segregated on the basis of their relevant products.  This method showcases the relationship between the costs, overhead activities and the products so manufactured. Under this method the individual overhead rate is assigned to the manufacturing overhead. For example the inspection rate is calculated by dividing the inspection cost by the inspection driver to get the overhead rate. Similar is the case for all the other indirect manufacturing costs (Freiesleben, 2014).

Selling price		Advance model
Cost plus 30%		1215.10

Further it can be observed from the above table that the selling price of the advance model is cost plus 30% which equals to the cost of the advanced model in the activity based costing at $1220 and this lures the attraction of the overseas buyer to buy the advanced model under the current system which is known as the traditional based costing system (Innes and Mitchell, 2015).

Traditional Costing System
Sewing Easy
Income Statement
For the year ending 31st March 2017
Particulars	Advanced Model
			Amount
Sales			1944166
Cost of goods sold
	Direct materials	928000
	Direct labors	448000
	overheads	503012
Total Expenses		1879012
Gross Profit		65154
Net Income		65154

Activity Based Costing System
For the year ending 31st March 2017
Particulars	Advanced Model
Sales		1944166
Cost of goods sold
	Direct materials	928000
	Direct labors	448000
	overheads	575801
Gross profit	1951801
Total		-7636
Net Income	-7636

From the calculations above it can be stated that the cost per unit under the traditional method is $619 and $935, whereas in case of the activity based costing model the cost per unit of the basic model is $577 and the $1220 for the advanced model. The interest of the overseas buyer is more towards the advanced model as the advanced model would cost less under the traditional based costing system and will provide the difference of $285, whereas in activity based costing method the price of the advanced model is $1220 which is costly for the overseas buyer hence he is more interested in the lower price (Plank, 2018). Also if the overall overhead cost is reviewed from the profit and loss account the company is earning profit under the traditional costing method, and facing losses in case of the activity based costing henceforth the interest of the buyer is more towards the traditional costing.

Profit and Loss Statement for Advanced Model under Traditional Costing and Activity Based Costing

Accurate product costing helps in assisting the products and lets the investor makes important decisions of the business easily. The accurate product costing helps the users of the financial statements in the different manner. For example the importance of the accurate costing for the investors can be with regard to the information of the net worth and for the managers of the company the information regarding the earnings will be of core importance. This also helps the managers to take the decisions accurately. The accurate product costing is the only method which is a reliable method and which helps in checking the profitability of the business. Moreover the gross profit margin can be measured along with the valuation of the assets and the optimal choices. The management can formulate the strategies to gain the competitive advantage and stay longer in the game of the survival. The accurate product costing will help to check the authenticity and the accuracy of the product costing; otherwise the operations of the business will fall in the category of the grey areas (Haddadi and Seyednezhad, 2015).

In accounting the term overhead refers to the indirect manufacturing costs. These manufacturing costs are those costs that are apart from the regular ad the direct costs. The applied overhead is the overhead where the indirect costs relating to the manufacturing have been assigned to manufactured goods. This overhead is generally applied on the basis of the predetermined overhead rate (Vaxevanidis and Petropoulos, 2018).  The actual overhead refers to the indirect manufacturing costs that have been occurred actually. The example of such costs is gas, electricity, rent, water, property, depreciation, repairs and other regular indirect costs (Accounting Coach 2018).

By the definition it can be fixed that the overhead cannot be traced correctly, most of the companies therefore make use of the overhead already decided instead of the actual overheads due to the following reasons.

There are certain costs such as the factory building depreciation which are fixed in nature. The possibility here arises a lot in case of the variation of the rates on the monthly basis and on the other hand the actual overhead rate varies. In this case there is no balance between the predetermined rate and the actual rate (Tsai, 2016).

Furthermore, if excessive overheads are assigned to the jobs then they are called as the over applied whereas the reverse of the same is termed as the under applied. The situation of the over applied arises when the amount of the cost of goods sold is more and the same has been included in the amount of the overheads and the reversal of the situation falls under the category of the under applied. Further for the purpose of understanding the company opens up the account of the factory overhead is created and the application of the work in progress is credited to the same (Dale and Plunkett, 2017).

Importance of Accurate Product Costing

• There is a carry forward of the amount into the period belonging to next financial year
• Secondly an entry to write off the amount to the profit and loss account can be passed.
• For bringing the positive changes a supplementary rate can be utilised (Pitel and Alioshkina, 2016).

			Actual Overhead	Applied overhead
			300000	210000
	Account balance				Account balance
	before Proration				After Proration
Work in progress	60500	3%	9073	6351	75924
Finished Goals	90000	4%	13497	9448	112944
cost of goods sold	1850000	92%	277431	194201	2321632
Total	2000500		300000	210000	2510500

For the purpose of the report the most consistent and the accurate amount of the inventory and the cost of goods sold, the most preferential method is the prorated method under which the balances of the work in progress, the finished goods and the cost of goods sold are written in the vertical format. The first heading made is of the account balances before the proration method (Plunkett and Dale, 2018). Each figure is calculated in terms of the percentage of the total amount of all the three figures and thereafter the percentage value is multiplied with the value of the respective overhead. Under this situation the actual overhead is $300000 and the applied overhead is the $210000. The percentage value is multiplied with the respective values of the overhead and finally the summation of all three figures is calculated to arrive at the total figure termed as the account balance after the proration method (Christopher, 2016).

References

Accounting Coach (2018) What is the difference between actual overhead and applied overhead? [online] https://www.accountingcoach.com/blog/dfifference-actual-overhead-applied-overhead [Accessed on 15th January 2018].

Christopher, M., 2016. Logistics & supply chain management. Pearson UK.

Dale, B.G. and Plunkett, J.J., 2017. Quality costing. Routledge.

Freiesleben, J. (2014) On the limited value of cost of quality models, Total Quality Management and Business Excellence, 15(7), 959-969.

Haddadi, D. and Seyednezhad, M., 2015. Comparative study of traditional and activity-based costing in forging companies of Iran tractor.

Innes, J. and Mitchell, F., (2015) A survey of activity-based costing in the UK’s largest companies, Management accounting research, 6(2), pp.137-153.

Lee, J., Park, M., Lee, H.S., Lee, K.P. and Hyun, H., 2015. Application of Activity-Based costing (ABC) for Modular Building Construction Indirect Costs Calculation at the Manufacturing Stage. Korean Journal of Construction Engineering and Management, 16(4), pp.139-145.

Manunen, O. (2013) An activity-based costing model for logistics operations of manufacturers and wholesalers, International Journal of Logistics, 3(1), 53-65.

Patiar, A., (2016) Costs allocation practices: Evidence of hotels in Australia, Journal of Hospitality and Tourism Management, 26(1), pp.1-8.

Pitel, N.Y. and Alioshkina, L.P., (2016) ABC analysis as a tool of optimization of marketing management of export-led enterprises, New York: Springer.

Plank, P., 2018. Introduction. In Price and Product-Mix Decisions Under Different Cost Systems (pp. 1-5). Springer Gabler, Wiesbaden.

Plunkett, J. J., and Dale, B. G. (2018) Quality costs: a critique of some ‘economic cost of quality’models, The International Journal of Production Research, 26(11), 1713-1726.

Tsai, W.H., (2016) Activity-based costing model for joint products, Computers & Industrial Engineering, 31(3), pp.725-729.

Vaxevanidis, N. M., and Petropoulos, G. (2018) A literature survey of cost of quality models, Journal of engineering, 6(3), pp. 274-283.