Please define each of the following terms, direct manufacturing item, indirect manufacturing item, variable manufacturing overhead, fixed manufacturing overhead, pre-determined manufacturing overhead, pre-determined manufacturing overhead rate, and the base for pre-determined manufacturing overhead rate. Then discuss if predetermined manufacturing overhead rate depends on production level. Provide examples to clarify and support your argument.
About direct & indirect manufacturing item, variable manufacturing overhead, fixed manufacturing overhead, pre-determined manufacturing overhead, pre-determined manufacturing overhead rate, and the base for pre-determined manufacturing overhead rate
Direct manufacturing item: Direct manufacturing item includes those materials which can be easily tracked as the component of the end product. Direct manufacturing items are directly and observably used in the end product so, an individual understand the Direct Manufacturing item as a component of that product. In accounting terms, direct manufacturing items are the items, the cost of which can be directly traced cost of any product. For Example, in a biscuit industry, the sugar and flour can be a direct manufacturing item.
Indirect manufacturing item: Indirect manufacturing items are the items that are not directly linked or observably used in production. Indirect Manufacturing items are the items the cost of which cannot be traced to a product.These type of items are generally of inexpensive type or sometimes difficult to measure. For example for a biscuit industry, machine cleaning chemicals, broom for cleaning etc can be indirect manufacturing items.
The cost incurred in production, beside Direct Material and Direct Labor, is called "Manufacturing Overhead" which can be divided into two parts:
Variable manufacturing overhead: Variable Manufacturing Overhead are the costs, which incurres in an organization and is directly proportional to the volume of production. Depending on Labor intensive or Machine intensive work nature of the product, it is calculated "Per Labor Hour" or "Per Machine Hour" respectively. For example, the A/C or Lights used in a plant is directly related to the hours the factory is functional. So, if the factory operates for more hours, cost becomes high and if it operates for fewer hours, the cost becomes less
Fixed Manufacturing Overhead: Fixed Manufacturing Overheads are the costs that incurs irrelevant to the volume of production or slight increment of volume of production. Mowen, Hansen and Heitger describes it as the "capacity costs acquired in advance of usage". Some of the cost like maintenance might depend upon the scale of production, i.e. most frequently maintenance when operated intensively, but might not be directly proportional functions of the scale of production. Some examples of Fixed Manufacturing Overhead are Rent, salary and maintenance cost.
Pre-determined manufacturing overhead: Predetermined manufacturing Overhead is an estimate of all costs beside direct material and direct labor, for another accounting year, based on present experience and target set for next year. They include estimate for indirect labor, Depreciation, indirect material, taxes, factory supplies, factory insurance, factory utilities etc.
Pre-determined manufacturing overhead rate: Predetermined overhead rate is the ratio of predetermined overhead to the activity level. The activity level can be either labor hour or machine hour, depending on the nature of factory (i.e. Labor intensive or machine intensive)
Pre-determined overhead rate are the pre-determined estimates of some any given year and are not dependent to the level of activity. One fixed estimated rate is used through the year and at the end of the year, it is undervalued or over-valued, which is adjusted at the end of the year. For example: The estimated overhead of a factory was $10,000 and the factory was estimated to run for 1000 Labour hour. Now,
Predetermined Overhead rate = 10,000/1,000
= $ 10 per labor hour
Now if end of the year, the real overhead fluctuates, say if it reaches to $ 8,000 or $12,000, the overhead doesn’t change. The same overhead rate is used while in accounting books it is adjusted as over-applied or under-applied