PredeterminedOverheadRates,FlexibleBudgets,and.pdf

3 Predetermined Overhead Rates, Flexible Budgets, and Absorption/ Variable Costing Objectives After completing this chapter, you should be able to answer the following questions: LO.1 LO.2 LO.3 LO.4 LO.5 LO.6 LO.7 Why and how are overhead costs allocated to products and services? What causes underapplied or overapplied overhead, and how is it treated at the end of a period? What impact do different capacity measures have on setting predetermined overhead rates? How are the high–low method and least squares regression analysis used in analyzing mixed costs? How do managers use flexible budgets to set predetermined overhead rates? How do absorption and variable costing differ? How do changes in sales or production levels affect net income computed under absorption and variable costing? ? AXL 2009/USED UNDER LICENSE FROM SHUTTERSTOCK.COM 66 Chapter 3 Predetermined Overhead Rates, Flexible Budgets, and Absorption/Variable Costing Introduction Any cost incurred to make products or perform services that is not direct material or direct labor is overhead. Overhead costs are incurred both in the production area and in selling and administrative departments. Manufacturers traditionally considered direct material and direct labor as the primary production costs, and overhead was often an “additional” cost that was necessary but not of an exceptionally signi?cant amount. However, many manufacturing ?rms have begun to heavily invest in automation, which has increased the costs of manufacturing overhead. Regardless of where costs are incurred, a simple fact exists: for a company to be pro?table, product or service selling prices must cover all costs. Direct material and direct labor costs can be easily traced to output and, as such, create few accounting di?culties. In contrast, indirect costs (overhead) cannot be traced directly to separately distinguishable outputs. Whereas Chapter 2 discusses and illustrates actual cost systems in which actual direct material, direct labor, a