Cost Determination

&
Overhead Analysis

by: MUHAMMADH FARZAN

CGMA, ACMA, ACSI, CDIF
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 Cost Determination
Following are the main types of costs incurred
by a typical manufacturing company;
(Illustration based on a garments manufacturer)

❖ Direct Material Costs – This includes all the

raw material costs which can be directly
linked to the product. (Fabric, Thread …)

❖ Direct Labour Costs – Payments made to

employees directly involved in the
production. (Wages of operators…) 2
 Cost Determination
❖ Overhead Costs – All the general costs
incurred for the organisation as a whole
will be put in to this category.
(Rent, Electricity, Salaries…)

When attempting to establish the cost per unit

of output, we can easily establish the ‘Direct
Cost’ (material & labour). Estimating the
‘Indirect Cost’ (overhead cost) per unit can be
tricky and needs special treatment.
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 Cost Determination
We can determine the cost per unit of output
based on the following format;
£
Direct Material Cost XX
(Quantity x RM Price)
Direct Labour Costs XX
(Hrs Used x Rate)
Overhead Cost XX
(Estimate)
Total Cost per Unit XX
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 Overhead Analysis
❖ Estimating the overhead cost per unit of
output is called Overhead Analysis.

❖ Overhead cost per unit can be estimated

using three different methods.

(1) Based on Output

(2) Based on Labour & Machine Hours

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 Overhead Analysis
(1) Output Based Method

Overhead cost per unit can be calculated

with the following equation.

OH Recovery Rate = Budgeted OH Cost

Budgeted Output

= £ XX per unit
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 Overhead Analysis
(2) Labour / Machine Hour Based Method

OH Recovery Rate = Budgeted OH Cost

Budgeted Labour Hrs

= £ XX per labour hour

Cost per Unit = OH Rate X Labour hrs per Unit

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 ACTIVITY BASED COSTING
X Limited is a car manufacturing Company which has a modern
production facility. The production is fully automated where once setup,
the computerized machines and robots can continue to manufacture cars
with minimum human involvement.

The 'machine setup' process includes a quick maintenance round,

adjusting the timing of the production line, tuning the machines, a test
run and re-adjustments. Once the machines are setup, the factory can
produce 1,000 cars before another setup.

The Company has received two independent orders for 5,000 cars each.
The details of the orders are as follows.

Order # 1 – 5,000 cars of the same model

Order # 2 – 1,000 cars each from 5 different models

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 ABC
ABC refines traditional costing systems by..

 Calculating the costs of individual activities

 Assigning costs to cost objects (i.e., products or services) on
the basis of the activities undertaken to produce each
product or service.

So, ABC is system based on activities linking organizational spending on

resources (overheads) to the products and services produced and delivered
to customers.

 Objective is to measure and then price out all the resources

used for activities that support the production and delivery of
products.

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 Examples of cost drivers
❖ Activity ❖ Cost driver

➢ Set up machines ➢ Set up hours

➢ Handle production runs ➢ Number of production runs

➢ Invoicing ➢ Number of invoices

➢ Order processing ➢ Number of orders

➢ Quality control ➢ Number of inspections

➢ Buying materials ➢ Number of purchase orders

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 Traditional v. ABC System

❖ Traditional costinSg ❖ Activity based costing:

➢ Uses actual departments ➢ Uses activities, for
or cost centers for accumulating costs and
accumulating and redistributing costs
redistributing costs
➢ Asks what activities are
➢ Asks how much of an being performed by the
allocation basis (usually resources of the support
based on volume) is department
used by the production
department
➢ Resource expenses are
➢ Support department assigned to activities
expenses are allocated based on how much of
to a production the resource is required
department based on the or used to perform the
ratio of the allocation activities
basis used by the
production department
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