You have an appropriate system to deal with overheads when determining cost of production
 
Companies must accurately determine the production cost for each of their product lines in order to arrive at an appropriate price. The way that business overheads are apportioned can have a significant impact on product costs and, hence, influence the price a business must charge in order to return a profit on the transaction. 
Key Issues
·         Business overheads are notoriously difficult to assign accurately to specific product lines. If they can be reliably identified in your company, they should be charged as a percentage of the direct labour and machine costs
·         It is essential to allocate business overheads based on actual usage, in order to prevent products that consume more resources appearing less expensive because they are being subsidised by the higher volume items, attracting disproportionate levels of overheads
·         Where direct charging is not feasible, then contribution principles can be applied: i.e. the contribution from each product line, over and above the direct costs covering fixed overheads and profit, can be factored into the cost
·         One benefit of modular/cellular manufacturing is that associated overhead costs can be more accurately identified and assigned to particular product lines
·         Business costs included in business overheads to be charged directly e.g.:
o      Local management costs and head office charges
o      Utility costs - electricity, gas, water, fuel oil, waste disposal
·         Production costs included in business overheads to be charged directly e.g.:
o      Depreciation on equipment, maintenance, repair, servicing
o      Heat treatments, surface modification, autoclaving, cleaning
o      Consumable items – tools, solvents, stationery, packaging
o      Cost of quality – rejects, rework, quality assurance systems
o      Environmental health and safety requirements, factory cleaning
o      Lost time, absenteeism, recruitment, training costs
·         In some instances the business overheads can represent over 50% of the cost of production, making it almost impossible to ascertain realistic costs
·         Your company should review how you treat your business overhead costs, as many management decisions are based on production costs; if these are inaccurate, poor decisions could be made, possibly ruining the business
·         Activity-based costing methods should be considered. This method calculates costs based on usage, reflecting as accurately as possible the actual costs incurred
·         Product introduction costs can be calculated and allocated based on predicted volumes and expected life, using life cycle costing techniques
Factors for Success      
Factors to  Avoid
1.     You allocate actual overhead costs directly to particular products, wherever possible
1.     Spreading overhead costs across all products irrespective of their usage
Who does this apply to?
Senior management teams
Realisable Benefits
A sound product cost base for making informed management decisions

Guides:

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Determining the cost of productionDetermining the cost of production

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Managing creditorsManaging creditors

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BudgetingBudgeting

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Providing management informationProviding management information

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