Page 181 - Accounting Best Practices

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Costing Best Practices
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problem—since the labor rate is frequently used as the primary basis upon which
overhead is allocated to products, a shift in the labor rate can result in a massive
change in the allocated overhead cost, which may be much larger than the under-
lying labor cost. Thus, an inaccurate labor routing can have a major impact on the
reported cost of a product.
The best practice that addresses this problem is auditing labor routings. By
doing so, one can gradually review all labor records and verify their accuracy,
thereby avoiding any miscosting of products. To do so, one must enlist the help of
the engineering manager, who must assign a staff person to review this informa-
tion on a regular basis and make changes as needed. The accounting department
can assist in the effort by comparing the labor routings of similar products to see
if there are any discrepancies and bring them to the attention of the engineering
department for resolution. Also, it can review computer records (if they exist) to
see when labor routings have been changed and verify the alterations with the
engineering staff. Finally, the accounting staff can work with the production plan-
ning department to see if the assumed production-run quantities noted in the
labor routings match actual production quantities. This last item is a critical one,
for the assumed per-unit labor quantity will go down as the run length increases,
due to the improved learning curve that comes with longer production runs, as
well as the larger number of production units over which the labor setup time can
be spread. Some unscrupulous businesspeople will assume very short production
runs in order to increase the assumed labor rates in their labor routings, resulting
in the capitalization of much higher labor and overhead costs in the inventory
records. Thus, a continual review and comparison of labor-routing records by the
accounting staff is a necessary component of this auditing process.
Cost: Installation time:

9–3 ELIMINATE HIGH-LEVERAGE OVERHEAD
ALLOCATION BASES

There is nothing more damaging to a company than to make a management deci-
sion based on inaccurate information. Though the accounting department is
devoted to presenting the best possible information to senior management at all
times, there is one area in which it continues to provide inaccurate data: overhead
costs. This is an increasingly large proportion of the costs of many companies,
and it is critical to allocate it to various activities and products properly. To be
blunt, most accountants do a very poor job of allocating these costs, resulting in
cost reports that show inordinately high or low overhead costs being assigned to
various items. When a manager acts upon this information, the decision may be a
wrong one because the overhead cost component of the information was wrong.
The reason why overhead costing information is incorrect in so many instances is
a faulty allocation base. For example, the most common allocation base is to