Overhead can be applied to products using one of three different methods: single plantwide rate, multiple production department rates, and activity-based costing. A) True B False
The correct answer and explanation is:
Correct Answer: A) True
Explanation:
Overhead refers to the indirect costs of production that cannot be traced directly to a specific product or service, such as factory rent, utilities, or administrative salaries. These costs must be allocated to products using appropriate costing methods. The three primary methods for applying overhead to products are:
1. Single Plantwide Rate:
This is the simplest method. It uses one overhead rate for the entire factory. The rate is typically based on a single cost driver, such as direct labor hours or machine hours.
- Example: If a company has $100,000 in total overhead and 10,000 machine hours, the overhead rate is $10 per machine hour.
- Advantage: Easy to implement.
- Limitation: It assumes all products consume overhead in the same proportion, which can lead to inaccurate cost assignments in complex manufacturing settings.
2. Multiple Production Department Rates:
In this method, each production department has its own overhead rate. Overhead is applied based on how much time or resources each product uses in a specific department.
- Example: The machining department may use machine hours, while the assembly department may use labor hours.
- Advantage: More accurate than the plantwide rate for companies with diverse operations.
- Limitation: Requires more data collection and analysis.
3. Activity-Based Costing (ABC):
This is the most detailed and accurate method. ABC assigns overhead based on specific activities that drive costs (e.g., setup, inspection, material handling).
- Advantage: Most accurate method; helps identify inefficient processes and improve costing accuracy.
- Limitation: Time-consuming and expensive to implement.
Conclusion:
All three methods are valid and are used depending on the company’s complexity, cost structure, and need for accuracy. Therefore, the statement is True—overhead can be applied using any of the three methods.