Business and Management
Submitted By vishibroker
A noted earlier, all product costs are charged to inventory. To facilitate this process, manufacturers break inventory into three categories: RM inventory, WIP inventory, and FG inventory. There are two categories of direct cost (DL & DM) and then there is overhead, which is a catch-all term for everything except DL and DM. Raw materials are charged to RM inventory when purchased and transferred to WIP inventory when it is used. DL is charged directly to WIP. Indirect product costs are charged to an overhead account. Then just one number is transferred from OH to WIP.
In a company that produces a variety of products in specific batches, the total costs that are charged this way are made up of a series of jobs. Think of Kinko’s. They do thousands of jobs – each of them has some DM (paper mainly), some DL (the operator), and a lot of OH (store rent, electricity, supplies etc and etc.)
Each job is numbered – the number you see on your invoice. They know how much paper was used on a job and how much time it took.
For each individual job: DM = Pages used x cost of paper per page DL = Time taken by operator x hourly wage of operator
Then, for the year as a whole – or for a day, a week, a month – they just add up the costs of all the individual jobs to see how much cost they incurred for that period.
The big problem is how to charge overhead costs to an individual job. These accumulate over a year and are all indirect costs i.e., they aren’t collected on an individual job like paper and wages. These indirect costs need to be spread out over the individual jobs or share among the individual jobs. Most businesses use the following method to achieve this “spreading out” process that is called “applying overhead.” They start by computing an “overhead rate” using a “base” like direct labor hours (DLH).
Overhead rate = Total…...