Bernson Corporation Is Using A Predetermined

Bernson Corporation's Use of a Predetermined Overhead Rate: A Deep Dive

Bernson Corporation, like many manufacturing companies, likely employs a predetermined overhead rate to allocate manufacturing overhead costs to its products. This crucial accounting practice ensures accurate product costing, facilitates better budgeting, and simplifies the management of overhead expenses. Understanding how Bernson Corporation, or any similar entity, uses this system is vital for both internal management and external stakeholders. This article will explore the intricacies of predetermined overhead rates, focusing on their application within a hypothetical scenario mirroring Bernson Corporation's potential operations.

What is a Predetermined Overhead Rate?

A predetermined overhead rate is a rate calculated before the beginning of an accounting period. It's an estimate, designed to allocate overhead costs to products or services more efficiently than assigning costs retrospectively. This is crucial because manufacturing overhead costs – encompassing indirect expenses like rent, utilities, and depreciation – are difficult to directly trace to specific products.

The formula for calculating a predetermined overhead rate is straightforward:

Predetermined Overhead Rate = Estimated Total Manufacturing Overhead Costs / Estimated Total Allocation Base

The allocation base is a measure of activity that drives overhead costs. Common allocation bases include:

• Direct labor hours: The total number of hours worked by direct labor employees.
• Machine hours: The total time machinery is used in production.
• Direct labor costs: The total wages paid to direct labor employees.

Why Use a Predetermined Overhead Rate?

Employing a predetermined overhead rate offers several advantages:

• Accurate Product Costing: It provides a more timely and reliable estimate of product costs than waiting until the end of the period to determine actual overhead costs. This is especially beneficial for pricing decisions and inventory valuation.
• Simplified Budgeting: It allows for better budgeting and cost control by establishing a planned overhead rate at the beginning of the accounting period. This provides a benchmark against which actual performance can be measured.
• Facilitates Decision-Making: Managers can use the predetermined overhead rate to make informed decisions regarding pricing, production volume, and product mix.
• Streamlined Accounting Processes: Calculating the rate in advance simplifies the year-end closing process and reduces the time needed for final cost allocations.

Applying the Predetermined Overhead Rate at Bernson Corporation (Hypothetical Scenario)

Let's imagine Bernson Corporation manufactures two products: Product A and Product B. For the upcoming year, Bernson estimates the following:

Estimated Total Manufacturing Overhead Costs: $500,000 Estimated Direct Labor Hours (Allocation Base): 100,000 hours

Using the formula above, Bernson's predetermined overhead rate would be:

$500,000 / 100,000 hours = $5 per direct labor hour

Now, let's say Bernson produced the following during the year:

Product A:

• Direct Labor Hours: 60,000 hours
• Direct Materials Cost: $200,000
• Direct Labor Cost: $300,000

Product B:

• Direct Labor Hours: 40,000 hours
• Direct Materials Cost: $150,000
• Direct Labor Cost: $200,000

Allocating Overhead Costs:

Using the predetermined overhead rate of $5 per direct labor hour, Bernson would allocate overhead costs as follows:

Product A: 60,000 hours * $5/hour = $300,000

Product B: 40,000 hours * $5/hour = $200,000

Calculating Total Product Costs:

To determine the total cost of each product, Bernson would add the direct materials cost, direct labor cost, and allocated overhead cost:

Product A: $200,000 (Direct Materials) + $300,000 (Direct Labor) + $300,000 (Overhead) = $800,000

Product B: $150,000 (Direct Materials) + $200,000 (Direct Labor) + $200,000 (Overhead) = $550,000

Variations and Considerations

Several factors influence the selection of the allocation base and the accuracy of the predetermined overhead rate:

Choosing the Right Allocation Base:

The choice of allocation base is critical. A well-chosen base should have a strong correlation with the incurrence of overhead costs. If the relationship is weak, the cost allocation may be inaccurate. For example, if Bernson's overhead costs are heavily driven by machine usage, using direct labor hours as the allocation base might lead to misallocation. In this case, machine hours would be a more appropriate choice.

Dealing with Over- or Under-applied Overhead:

The predetermined overhead rate is an estimate; therefore, actual overhead costs will likely differ from the applied overhead costs. This difference is called over-applied or under-applied overhead.

• Over-applied overhead: Occurs when the actual overhead costs are less than the applied overhead costs.
• Under-applied overhead: Occurs when the actual overhead costs are greater than the applied overhead costs.

Bernson Corporation would need to adjust for this difference at the end of the accounting period. Common methods include prorating the difference across work-in-process (WIP), finished goods, and cost of goods sold (COGS).

Multiple Predetermined Overhead Rates:

For companies with diverse manufacturing processes or products, using a single predetermined overhead rate may not be accurate. Bernson Corporation might consider using multiple predetermined overhead rates, each tailored to a specific department or product line, to improve the accuracy of cost allocation. This is particularly useful when different departments have vastly different overhead cost drivers.

Impact on Decision-Making:

Accurate product costing using a well-calculated predetermined overhead rate is vital for making informed decisions. Pricing decisions, especially, rely heavily on an accurate understanding of product costs. Bernson Corporation can leverage this information to establish competitive prices and maximize profitability. Production volume decisions can also be guided by understanding the impact of overhead costs on each product.

External Reporting Requirements:

External financial reporting standards may require adjustments to the overhead allocation method. While the predetermined overhead rate is used for internal management, Bernson Corporation must comply with Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) when presenting its financial statements to external parties.

Conclusion

The use of a predetermined overhead rate is an essential aspect of cost accounting for manufacturing companies like Bernson Corporation. By carefully estimating overhead costs and selecting an appropriate allocation base, Bernson can achieve accurate product costing, facilitate effective budgeting, and enhance decision-making processes. However, it's crucial to understand the limitations of the system, address potential over- or under-applied overhead, and consider the use of multiple rates if necessary to ensure the greatest accuracy and effectiveness. Continuous monitoring and refinement of the predetermined overhead rate are critical for maintaining its accuracy and relevance over time. Regular review of the assumptions used to calculate the rate should be undertaken to ensure it continues to reflect the realities of Bernson Corporation’s operations and cost structure.