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Milan Vaishnav
Milan Vaishnav, Financial Advisor
Category: Finance
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Experience:  Technical Analyst in Financial Markets -- Experience of more than 10 years in consulting
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Sometimes direct-labor cost is the best cost-allocation base

Resolved Question:

“Sometimes direct-labor cost is the best
cost-allocation base for overhead application
even if wage rates vary within a department.” Do
you agree? Explain.


In the United States, about one in every
four companies uses variable costing for internalreporting
purposes. These companies must make
adjustments to these reports for external-reporting
purposes. Explain
Submitted: 7 years ago.
Category: Finance
Expert:  Milan Vaishnav replied 7 years ago.

Dear Friend,

 

(1) There are debatable opinions on this issue but I basically agree that sometimes direct-labor cost is the best cost-allocation base for overhead application even if wage rates vary within a department. so long as Regardless of why overhead costs are allocated, the method and basis of the allocation process should be rational and systematic so that the resulting information is useful for product costing and managerial purposes. This is because, Direct material and direct labor are easily traced to a product or service. Overhead, on the other hand, must be accumulated over a period and allocated to the products manufactured or services rendered during that time. Cost allocation refers to the assignment of an indirect cost to one or more cost objects using some reasonable basis. This post discusses: underlying reasons for cost allocation, use of predetermined overhead rates, separation of mixed costs into variable and fixed elements, and capacity measures that can be used to compute predetermined overhead rates.

 

Many accounting procedures are based on allocations. Cost allocations can be made over several time periods or within a single time period.

 

The first reason relates to financial statement valuations. Under generally accepted accounting principles (GAAP), "full cost" must include allocated production overhead. In contrast, the assignment of non-factory overhead costs to products is not normally allowed under GAAP. The other two reasons for overhead allocations are related to internal purposes and, thus, no hard-and-fast rules apply to the overhead allocation process.

 

(2) Even though In the United States, about one in every four companies uses variable costing for internalreporting purposes. These companies must make adjustments to these reports for external-reporting purposes.

 

THIS IS BECAUSE, using multiple sets of financial reports, all deriving from a single, common database, to meet external reporting requirements while addressing the distortions and limitations of GAAP for internal purposes. In particular, he has developed a new approach called Value Added Accounting that eliminates the distortions of full-absorption accounting but that uses GAAP financial statements as its starting point.

 

I hope the above helps...

Regards,

Milan Vaishnav, Financial Advisor
Category: Finance
Satisfied Customers: 972
Experience: Technical Analyst in Financial Markets -- Experience of more than 10 years in consulting
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