IMPORTANT NOTES: OVERHEAD ALLOCATION* *scale 10 to 15...100% chances
*US CMA PART 1 Cost Management*
_By Prof. Mahaley | Gmsisuccess Mumbai_
Overhead = All indirect costs. You CANNOT trace them directly to 1 product. So we *ALLOCATE* them.
*1. THE 4-STEP OVERHEAD ALLOCATION PROCESS*
This is the foundation for CMA. 1-2 MCQs direct from this every exam.
**Step** **What We Do** **Example**
**1. Accumulate OH** Group all Mfg OH into Cost Pools Setup OH Pool, Inspection OH Pool
**2. Choose Allocation Base** Find Cost Driver that causes the OH Machine Hours, DL Hours, No. of Setups
**3. Calculate OH Rate** `OH Rate = Total OH in Pool / Total Driver Units` $50,000 / 10,000 MH = $5/MH
**4. Apply OH** `Applied OH = OH Rate x Actual Driver Used by Job` Job A used 200 MH x $5 = $1,000
---
*2. 3 MAIN METHODS OF OVERHEAD ALLOCATION*
*A. PLANTWIDE OVERHEAD RATE METHOD*
*Concept*: 1 Rate for whole factory. Simple but least accurate.
*Formula*: `Plantwide Rate = Total Mfg OH / Total Allocation Base`
*Base Used*: Usually DL Hours or Machine Hours
*Use When*: Only 1 product or all products use resources equally
*CMA Trap*: Causes *Cross-Cost Subsidization*. Overcosts simple products, Undercosts complex products.
*B. DEPARTMENTAL OVERHEAD RATE METHOD*
*Concept*: Different rate for each department. More accurate than plantwide.
*Formula*: `Dept Rate = Total OH of Dept / Total Driver of Dept`
*Base Used*: Machining Dept = Machine Hours. Assembly Dept = DL Hours
*Use When*: Departments are very different in technology
*CMA Favorite*: 2-Stage Allocation
Stage 1: Allocate Service Dept OH to Production Depts
Stage 2: Calculate rate for each Production Dept
*C. ACTIVITY BASED COSTING - ABC*
*Concept*: Most accurate. Allocate based on activities that actually cause cost.
*Formula*: `Activity Rate = Cost Pool / Total Cost Driver`
*Base Used*: Multiple Cost Drivers. Ex: No. of Setups, No. of Inspections, No. of POs
*Use When*: High OH, Diverse products, Complex operations
*Benefits*: Reduces Overcosting/Undercosting. Better product pricing decisions
*CMA Must Know*: ABC is NOT for external reporting. Used for internal decisions only.
---
*3. CHOOSING THE ALLOCATION BASE - COST DRIVER*
Good driver has *Cause & Effect* relationship.
*Common Drivers:*
1. *Volume Based*: DL Hours, Machine Hours, Units Produced - for traditional methods
2. *Activity Based*: No. of Setups, No. of Inspections, Square Feet - for ABC
*Rule for CMA*: If OH is related to machine use → Use Machine Hours. If related to labor → Use DL Hours.
---
*4. OVERAPPLIED vs UNDERAPPLIED OVERHEAD*
This comes EVERY exam. 2-3 MCQs.
`Applied OH = OH Rate x Actual Driver Used`
`Actual OH = Real OH Incurred`
**Case** **Meaning** **Balance** **3 Ways to Close**
**Overapplied** Applied > Actual Credit 1. Prorate to WIP, FG, COGS 2. Write-off to COGS 3. Carry forward
**Underapplied** Applied < Actual Debit Same 3 ways
*CMA Exam Rule*: If amount is *IMMATERIAL* → Close to COGS directly
*Journal*: Dr. Mfg OH Cr. COGS for Overapplied. Reverse for Underapplied
---
*5. ALLOCATION OF SERVICE DEPT COSTS*
Service Depts don't make product. Ex: Maintenance, HR, QC
*3 Methods - In order of Accuracy:*
1. *Direct Method*: Allocate Service Dept to Production Depts only. Ignore service-to-service. _Easiest_
2. *Step/Sequential Method*: Allocate in order. Once allocated, that dept gets no cost back. _Medium_
3. *Reciprocal Method*: Most accurate. Considers service-to-service. Uses equations/matrix. _Hardest - CMA rarely asks calculation_
*6. KEY CMA CONCEPTS & TRICKS*
1. *Overcosting vs Undercosting*
Plantwide rate → Complex products are *Undercosted*, Simple products are *Overcosted*. ABC fixes this.
2. *Mfg OH vs Non-Mfg OH*
*Mfg OH* = Inventoriable. Goes to Inventory first. Ex: Factory Rent
*Non-Mfg OH* = Period Cost. Expensed immediately. Ex: Sales Manager Salary
3. *Capacity Levels for OH Rate*
`OH Rate = Budgeted OH / Capacity Level`
*Theoretical*: 100% capacity. No downtime
*Practical*: Max minus normal downtime. _Most used for budgeting_
*Normal*: Average over long term. _Used for product costing_
*Expected*: This year's budget.
Using higher capacity → Lower OH Rate per unit
4. *Proration Formula*
`Prorated Amount = Total Variance x (Account Balance / Total of WIP+FG+COGS)`
---
*7. QUICK FORMULAS TO MEMORIZE*
1. `Applied OH = Predetermined OH Rate x Actual Activity`
2. `Predetermined OH Rate = Budgeted OH / Budgeted Activity`
3. `COGM = Beg WIP + DM + DL + Applied OH - End WIP`
4. `Underapplied OH = Actual OH - Applied OH`
---
*CMA EXAM PATTERN*
1. *MCQ*: 50% on ABC vs Traditional. "Which product is overcosted?"
2. *Problem*: Calculate Departmental OH Rate + Apply to Job + Close Underapplied OH
3. *Essay*: Explain why ABC is better + limitations
*Golden Rule*: More cost pools + More cost drivers = More accurate = Less cross-subsidization
*Best Wishes 🍀*
*Prof. Mahaley*
*1-PAGE CHEAT SHEET: OVERHEAD ALLOCATION*
*US CMA PART 1* | _By Prof. Mahaley | Gmsisuccess Mumbai_
*A. 4-STEP PROCESS*
1. *Accumulate* OH into Cost Pools
2. *Select* Allocation Base / Cost Driver
3. *Calculate* Rate = `Budgeted OH / Budgeted Driver`
4. *Apply* OH = `Rate x Actual Driver Used`
*B. 3 METHODS*
**Method** **# of Rates** **Accuracy** **Best For** **CMA Key Point**
**Plantwide** 1 for whole plant Low Single product, similar products Causes Cross-Cost Subsidization
**Departmental** 1 per dept Medium Different depts like Machining vs Assembly 2-Stage: Service→Production→Product
**ABC** Many Activity Rates High Multiple products, High OH, Complex Uses Multiple Drivers. Reduces Over/Undercosting
*C. OVERAPPLIED / UNDERAPPLIED*
`Applied OH = Rate x Actual Activity`
`Variance = Actual OH - Applied OH`
**Variance** **Meaning** **Treatment**
**Overapplied** Applied > Actual Credit Balance. Dr Mfg OH Cr COGS
**Underapplied** Applied < Actual Debit Balance. Dr COGS Cr Mfg OH
*Rule*: If *Immaterial* → Close to COGS. If *Material* → Prorate to WIP, FG, COGS
*D. KEY FORMULAS*
1. `Dept OH Rate = Total Dept OH / Total Dept Driver`
2. `Activity Rate ABC = Cost Pool / Total Cost Driver`
3. `Proration = Total Variance x (Account Balance / Total WIP+FG+COGS)`
4. `COGM = Beg WIP + DM + DL + Applied OH - End WIP`
*E. CAPACITY LEVELS*
*Theoretical* > *Practical* > *Normal* > *Expected*
Higher Capacity used = Lower OH Rate per unit
---
20 PRACTICE MCQs.. SOLVE FIRST THEN CHECK YOURSELF, ANSWERS ARE AT THE END...
*1. The main disadvantage of Plantwide OH Rate is:*
A. Too complex B. Causes Cross-Cost Subsidization C. Not GAAP D. Too many calculations
*Ans:*
*2. ABC is best used when:*
A. Low OH costs B. One product line C. Diverse products + High OH D. For Financial Reporting
*Ans:*
*3. Budgeted Mfg OH = $100,000. Budgeted DLH = 20,000. Actual DLH = 18,000. Applied OH = ?*
A. $90,000 B. $100,000 C. $111,111 D. $80,000
*Ans:
*4. Actual OH = $105,000. Applied OH = $90,000. This is:*
A. Overapplied $15,000 B. Underapplied $15,000 C. Overapplied $105,000 D. Underapplied $90,000
*Ans:*
*5. Journal to close $5,000 Overapplied OH to COGS:*
A. Dr COGS 5000 Cr Mfg OH 5000 B. Dr Mfg OH 5000 Cr COGS 5000 C. Dr WIP 5000 Cr Mfg OH 5000 D. Dr FG 5000 Cr Mfg OH 5000
*Ans:*
*6. Best allocation base for Factory Rent:*
A. DL Hours B. Machine Hours C. Square Feet D. Units
*Ans:*
*7. Service Dept costs should be allocated to:*
A. Only FG B. Only COGS C. Production Departments first D. Directly to Customers
*Ans:*
*8. In ABC, Cost Driver for "Setup Costs" pool is:*
A. DL Hours B. Units Produced C. No. of Setups D. Machine Hours
*Ans:*
*9. Theoretical Capacity is:*
A. Expected output B. Max output with no downtime C. Average output D. Last year output
*Ans:*
*10. Using Practical Capacity vs Theoretical Capacity will result in:*
A. Higher OH Rate B. Lower OH Rate C. Same OH Rate D. No OH Applied
*Ans:*
*11. Which method is required for External Financial Reporting?*
A. ABC B. Variable Costing C. Absorption Costing D. Throughput Costing
*Ans:*
*12. $20,000 Underapplied OH. WIP=10k, FG=30k, COGS=60k. Amount to COGS if prorated:*
A. $6,000 B. $10,000 C. $12,000 D. $20,000
*Ans:
*13. Machining Dept OH = $80,000. Budgeted MH = 10,000. Job used 500 MH. OH Applied = ?*
A. $4,000 B. $8,000 C. $40,000 D. $400
*Ans:
*14. Main reason to switch from Plantwide to ABC:*
A. Reduce Total OH B. Improve Accuracy + Reduce Overcosting C. GAAP Requirement D. Easier
*Ans:*
*15. Non-Manufacturing OH is treated as:*
A. Product Cost B. Inventoriable Cost C. Period Cost D. Direct Cost
*Ans:*
*16. Reciprocal Method is:*
A. Simplest B. Most Accurate C. Not allowed D. Only for Service Companies
*Ans:*
*17. If Applied OH > Actual OH, COGS will be:*
A. Overstated B. Understated C. Correct D. Zero
*Ans:*
*18. Step 1 in Dept allocation is:*
A. Calculate Rate B. Allocate Service Dept to Production Dept C. Apply to Job D. Close Variance
*Ans:*
*19. Cost Pool in ABC is:*
A. Total OH B. Group of OH caused by same activity C. Direct Cost D. Period Cost
*Ans:*
*20. Objective of OH Allocation is:*
A. Reduce OH B. Assign indirect cost to cost objects C. Increase Sales D. Avoid Taxes
*Ans:*
ANSWERS.....
*20 PRACTICE MCQs WITH SOLUTIONS*
*1. The main disadvantage of Plantwide OH Rate is:*
A. Too complex B. Causes Cross-Cost Subsidization C. Not GAAP D. Too many calculations
*Ans: B* _Simple products overcosted, complex undercosted_
*2. ABC is best used when:*
A. Low OH costs B. One product line C. Diverse products + High OH D. For Financial Reporting
*Ans: C*
*3. Budgeted Mfg OH = $100,000. Budgeted DLH = 20,000. Actual DLH = 18,000. Applied OH = ?*
A. $90,000 B. $100,000 C. $111,111 D. $80,000
*Ans: A* _Rate = 100000/20000 = $5. Applied = 18000 x 5 = 90000_
*4. Actual OH = $105,000. Applied OH = $90,000. This is:*
A. Overapplied $15,000 B. Underapplied $15,000 C. Overapplied $105,000 D. Underapplied $90,000
*Ans: B* _105000 - 90000 = 15000 Under_
*5. Journal to close $5,000 Overapplied OH to COGS:*
A. Dr COGS 5000 Cr Mfg OH 5000 B. Dr Mfg OH 5000 Cr COGS 5000 C. Dr WIP 5000 Cr Mfg OH 5000 D. Dr FG 5000 Cr Mfg OH 5000
*Ans: B*
*6. Best allocation base for Factory Rent:*
A. DL Hours B. Machine Hours C. Square Feet D. Units
*Ans: C*
*7. Service Dept costs should be allocated to:*
A. Only FG B. Only COGS C. Production Departments first D. Directly to Customers
*Ans: C*
*8. In ABC, Cost Driver for "Setup Costs" pool is:*
A. DL Hours B. Units Produced C. No. of Setups D. Machine Hours
*Ans: C*
*9. Theoretical Capacity is:*
A. Expected output B. Max output with no downtime C. Average output D. Last year output
*Ans: B*
*10. Using Practical Capacity vs Theoretical Capacity will result in:*
A. Higher OH Rate B. Lower OH Rate C. Same OH Rate D. No OH Applied
*Ans: A* _Denominator smaller = Rate higher_
*11. Which method is required for External Financial Reporting?*
A. ABC B. Variable Costing C. Absorption Costing D. Throughput Costing
*Ans: C*
*12. $20,000 Underapplied OH. WIP=10k, FG=30k, COGS=60k. Amount to COGS if prorated:*
A. $6,000 B. $10,000 C. $12,000 D. $20,000
*Ans: C* _20000 x 60000/100000 = 12000_
*13. Machining Dept OH = $80,000. Budgeted MH = 10,000. Job used 500 MH. OH Applied = ?*
A. $4,000 B. $8,000 C. $40,000 D. $400
*Ans: A* _Rate = 8. 500 x 8 = 4000_
*14. Main reason to switch from Plantwide to ABC:*
A. Reduce Total OH B. Improve Accuracy + Reduce Overcosting C. GAAP Requirement D. Easier
*Ans: B*
*15. Non-Manufacturing OH is treated as:*
A. Product Cost B. Inventoriable Cost C. Period Cost D. Direct Cost
*Ans: C*
*16. Reciprocal Method is:*
A. Simplest B. Most Accurate C. Not allowed D. Only for Service Companies
*Ans: B*
*17. If Applied OH > Actual OH, COGS will be:*
A. Overstated B. Understated C. Correct D. Zero
*Ans: B* _Because we applied too much, need to reduce COGS_
*18. Step 1 in Dept allocation is:*
A. Calculate Rate B. Allocate Service Dept to Production Dept C. Apply to Job D. Close Variance
*Ans: B*
*19. Cost Pool in ABC is:*
A. Total OH B. Group of OH caused by same activity C. Direct Cost D. Period Cost
*Ans: B*
*20. Objective of OH Allocation is:*
A. Reduce OH B. Assign indirect cost to cost objects C. Increase Sales D. Avoid Taxes
*Ans: B*
*EXAM HACK*:
In CMA, if they ask "Which product is undercosted under plantwide?" → Answer: *Complex, low-volume product*
*All the Best for CMA 🍀*
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