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September 23, 2019 at 1:15 pm #547131syedcic
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I am from I.T. background but I stumbled across something at my workplace. I did my MBA recently so I am always curious about the business operations.
The ERP has a feature to add multiple overheads to each item which will eventually be added to the product cost at the time of final production posting.
The strange thing is that nobody is using this feature and many items have some overheads added at the time of inception (2009). There has been no update since.
I discussed this with the Finance guy who overlooks costing. He told that he is not aware of this function but the costing is right as he adds additional value to each labor cost. Example, if the labor cost is 1, they enter it as 1.5.
I am curious. What I basically understand is that the direct costs are the labor and raw material costs and indirect costs are management salaries, utilities, marketing expenses, etc.
To determine the exact cost to produce any item, the indirect costs should be added to the item cost.
I see it this way – for example, 10 products are being manufactured in a plant. The labor cost and material cost is known for each item. The overall overheads are calculated and this amount needs to be distributed to each item cost. The best way to do that is to have a clear production plan and eventually determine the production share percentage of each item from the overall production volume. With the percentage distribute the total overheads to all the items accordingly.
Is my understanding correct?
Thanks.September 23, 2019 at 3:18 pm #547144John MoffatKeymaster
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There is no perfect way of distributing the overheads. The problem with using the production volume of each product is that different products may take different times to produce (and therefore use more overheads).
That is why the most common way is to charge (absorb) the overheads on the basis of the labour cost as your finance guy is apparently doing. This is all explained in my free lectures on allocation, apportionment and absorption of overheads.
Better is to use activity based costing, where each overhead is examined individually and charged according to what is causing each overhead. However this is outside the scope of Paper MA and is not examined until Paper PM (and is explained in my free lectures for Paper PM).
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