Question

Cost Estimates:  Is that a good costing method?

Corbin Medical Group, Inc. is a manufacturer of small medical supplies, (e.g., medicine containers, plastic wash basins, etc.).      The company only makes the supplies when customers (e.g., hospital, doctor’s offices, clinics) order and provide specifics such as name, color, logos, sizes, etc.    For the past 2 years you have held an accounting manager position with the company and really enjoy the job.   Just about every job is different, not only in form and fashion, but also in the way you must account for the customers’ job.

Since you started with the company, you instituted some new procedures.    Corbin now uses a detailed job order cost sheet to aid in the accumulation of total cost figures that are sent to customers.   You are responsible for analyzing every order and preparing a cost sheet that includes details about the customers’ order including the materials and material cost, the labor cost, and overhead costs (based on a predetermined overhead rate).

A few days ago, you received an email from one of your newest account associates.    In the memo, the account associate, Frances Batson, noted that she was marketing Corbin to a prospective customer, a purchasing manager for a small  medical clinic.   She noted, also, that she had discussed and shared a copy of the documents Corbin’s customer received once a job is completed.  

Cherol had one question, however, to ask.    She wants to know more about HOW and WHY overhead costs is estimated.    Moreover, Cherol said that she would like to know what cost(s) are included in overhead.   She notes that she has her prospective customer 80% sold on using Corbin but feels that knowing more about overhead would be all that she would need to win the potential customer’s business.

Reading this memo from Frances Batson causes you to think that possibly other accounting associates might wanted to know the same information.    That is, why is the overhead cost estimated rather than reported as actual dollar amounts when completing a job order cost form.     Perhaps knowing more about overhead costs in general might be information you need to be sure your account associate has.

Write a memo to Frances Batson that will address her concerns and help her better market Corbin Medical Group, Inc. to potential customers.

Answer 1

MEMORANDUM

TO: Frances Baston

FROM: Accounting Manager

DATE: XX/XX/XXXX

SUBJECT: Information about Overhead costs

We received your request to explain the overhead costs. Regarding this I, am sending you a detailed memo to better understand overhead costs.

Overhead costs are those parts of cost which cannot be directly linked to a particular product but are required to run the business. These costs cannot be allocated directly which means that they are indirect costs of business. Overhead costs can be classified into three categories to estimate and allocate them.

First of all we have fixed overhead costs. They are called fixed because they are independent of any business activity, whether you generate revenue or not these overheads are always present and incurred. These include some utilities, depreciation, taxes for property, etc.

Second we have semi variable overhead costs. These cost have both fixed part and variable part. The best example is electricity charge. The business has to pay a base rate and extra amount is charged when production activity occurs.

Third we have fully variable overheads. As these overheads vary with production, they can have zero cost at zero production and rises with increase in output. They also decrease with a fall in output.

Knowledge of overhead costs is very useful to the business in determining the right cost to be allocated to goods produced. Overhead costs can be calculated for a specific period of time.  In case of our medical supplies we have different types of overhead which are allocated as predetermined rate. It makes our cost estimation better and helps us in determining profits. Overhead costs also helps us in controlling the cost of production. You will now find this information useful in explaining the costing of product to consumers.

Thanks