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 utilizes a predetermined overhead rate to allocate manufacturing overhead costs to its products. This method offers a practical approach to cost accounting, providing a more accurate representation of product costs than simply assigning direct costs. However, understanding the implications and limitations of using a predetermined overhead rate is crucial for effective cost management and accurate financial reporting. This article delves into the mechanics of a predetermined overhead rate, explores its application within Bernson Corporation (hypothetically, as specific internal data is not publicly available), examines its advantages and disadvantages, and analyzes potential improvements for enhanced accuracy.

Understanding Predetermined Overhead Rates

A predetermined overhead rate is a calculated rate used to allocate manufacturing overhead costs to products or services. Unlike direct costs, which are directly traceable to a specific product (like raw materials or direct labor), manufacturing overhead costs are indirect and include items such as factory rent, utilities, depreciation of machinery, and supervisory salaries. Because these costs are not easily traceable to individual products, a predetermined rate provides a systematic method for their allocation.

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 labor hours worked on production.
• Machine Hours: The total number of machine hours used in production.
• Direct Labor Costs: The total amount paid for direct labor.
• Units Produced: The total number of units manufactured.

Bernson Corporation would choose the allocation base that best reflects the relationship between overhead costs and production activity. For example, if overhead costs are heavily influenced by machine usage, machine hours would be a more appropriate allocation base than direct labor hours.

Estimating Overhead Costs and the Allocation Base

The accuracy of the predetermined overhead rate hinges critically on the accuracy of the estimated overhead costs and the estimated allocation base. Bernson Corporation would typically base these estimations on:

• Past Data: Analyzing historical overhead costs and activity levels can provide a valuable starting point. However, past performance is not always indicative of future results, particularly in environments with significant changes in production volume or technology.
• Industry Benchmarks: Comparing Bernson's overhead costs to those of similar companies within the same industry can provide insights and help refine estimations.
• Budgeted Information: Bernson's budgeting process should include detailed projections of overhead costs and activity levels for the upcoming period. This provides a forward-looking perspective, incorporating planned changes and anticipated growth.
• Management Expertise: The experience and judgment of Bernson's management team are invaluable in making realistic and informed estimations. They should consider factors like planned capital expenditures, technological upgrades, and anticipated changes in production processes.

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

Let's consider a hypothetical scenario for Bernson Corporation:

Assume Bernson estimates its total manufacturing overhead costs for the next year at $500,000 and estimates its total direct labor hours at 25,000. Using direct labor hours as the allocation base, Bernson would calculate its predetermined overhead rate as follows:

Predetermined Overhead Rate = $500,000 / 25,000 hours = $20 per direct labor hour

This means that for every direct labor hour worked on a particular product, $20 of overhead costs will be allocated to that product. If a product requires 10 direct labor hours, the allocated overhead cost would be $200 (10 hours * $20/hour).

Advantages of Using a Predetermined Overhead Rate

The use of a predetermined overhead rate offers several key advantages for Bernson Corporation:

• Cost Estimation During Production: The predetermined rate allows Bernson to estimate product costs early in the production process, facilitating accurate pricing decisions and informed bidding for contracts. This is crucial for maintaining profitability and competitiveness.
• Simplified Cost Accounting: The process simplifies cost accounting by providing a readily available and consistent method for allocating overhead costs. This avoids the complexities and potential inaccuracies of assigning overhead costs retrospectively.
• Timely Financial Reporting: By using a predetermined rate, Bernson can produce timely financial reports without waiting for the actual overhead costs to be incurred and recorded at the end of the accounting period. This allows for faster decision-making based on up-to-date financial information.
• Better Cost Control: By comparing actual overhead costs to the budgeted amounts used to calculate the predetermined rate, Bernson can identify areas of potential cost savings and improve efficiency in the manufacturing process. This enhances cost control and reduces waste.

Disadvantages and Limitations of a Predetermined Overhead Rate

While offering significant benefits, the predetermined overhead rate also has limitations:

• Inaccuracy Due to Estimation Errors: The accuracy of the predetermined rate depends entirely on the accuracy of the estimations of both overhead costs and the allocation base. Significant deviations between estimated and actual figures can lead to inaccurate product costing and distort financial reporting.
• Over- or Under-Allocation of Overhead: If the actual overhead costs differ substantially from the estimated overhead costs, this can lead to an over- or under-allocation of overhead to products. This can affect the profitability of individual products and make it difficult to accurately assess product performance.
• Arbitrary Allocation Base: The choice of allocation base is somewhat arbitrary, and different bases can lead to different product cost figures. Bernson must carefully consider which base most accurately reflects the relationship between overhead costs and production activity.
• Inappropriateness for Diverse Product Lines: For companies with diverse product lines requiring significantly different amounts of overhead resources, a single predetermined overhead rate may not accurately reflect the true overhead costs associated with each product.

Improving Accuracy and Addressing Limitations

Bernson Corporation can implement several strategies to improve the accuracy of its predetermined overhead rate and address its limitations:

• Refine Estimation Techniques: Employ more sophisticated forecasting methods to improve the accuracy of estimations of both overhead costs and the allocation base. This might involve using statistical techniques or incorporating input from various departments.
• Use Multiple Overhead Rates: For companies with diverse product lines, using multiple overhead rates, each based on a different allocation base appropriate for a specific product group, can improve accuracy. This allows for a more nuanced allocation of overhead costs.
• Implement Activity-Based Costing (ABC): ABC is a more sophisticated costing method that assigns overhead costs based on the specific activities that consume those costs. It offers greater accuracy than traditional methods, but is also more complex and resource-intensive.
• Regularly Review and Adjust the Rate: Bernson should periodically review and adjust the predetermined overhead rate to reflect changes in the manufacturing environment, production volumes, and cost structures. This ensures that the rate remains relevant and accurate over time.
• Variance Analysis: Regularly perform variance analysis, comparing actual overhead costs to budgeted overhead costs. This helps identify discrepancies and provides valuable insights into the accuracy of the predetermined rate and the efficiency of the manufacturing process.

Conclusion: Optimizing Overhead Cost Allocation at Bernson Corporation

Using a predetermined overhead rate is a common and often effective method for allocating manufacturing overhead costs. However, Bernson Corporation must carefully consider the advantages and limitations of this approach. By refining its estimation techniques, potentially adopting multiple rates or ABC, and regularly reviewing and adjusting its rate, Bernson can significantly improve the accuracy of its product costing, enhance its cost control efforts, and ultimately make more informed business decisions. The ultimate goal is to achieve a balance between simplicity and accuracy in its cost accounting practices, leading to improved profitability and competitive advantage. Continuous monitoring and improvement are key to optimizing overhead cost allocation and maximizing operational efficiency at Bernson Corporation.