Why Allocate Overhead Costs?

Read the Chapter 3 introduction, and then click "Next Section" to read section 3.1. Like Custom Furniture Company, SailRite Company, a maker of fine sail boats, is earning less profit than expected. Because SailRite makes many boats but only two models, job costing is not an appropriate costing system. Activity-based costing (ABC) is another method to allocate costs.

Direct labor and direct materials are allocated the same regardless of which system is used. Manufacturing overhead, however, which is an indirect manufacturing cost, can be allocated a number of different ways. Each way results in different total cost for the same product. the goal is to find a system of allocation that best approximates the amount of overhead costs required for each product.

ABC allocates overhead based on the activities that are driving the costs. The four steps to apply ABC are relatively straightforward. The key is to determine the appropriate cost driver for each activity. Note that job costing, process costing, and ABC use the same pool of costs. They are just three different ways of analyzing and allocating the cost pool. 

At the end of "3.3: Using Activity-Based Costing to Allocate Overhead Costs", which you'll read soon, be sure to find out what is going wrong at SailRite and what two management actions or decisions could remedy the lower-than-expected profit.