Describe the conflict between the need for cost information to make managerial decisions and the timing of the availability of actual cost data. How do companies resolve this conflict?

Question

What will be an ideal response?

Answer 1

Answers will vary.

There are two kinds of costs involved in producing a product: direct costs (direct materials and direct labor) and indirect costs (i.e., overhead). The direct costs are easily identified and can be traced to actual production. Thus, their amounts will be known immediately upon completion of production. However, the indirect costs (rent, utilities, indirect materials, indirect labor, depreciation, etc.) associated with a particular unit of product cannot be determined at the time production is completed. Many overhead costs occur sporadically. Unfortunately, the total amount of actual overhead cannot be determined until the end of the period. Therein lies the conflict: managers need to cost a product upon its completion but the total actual costs cannot be determined until year- end. To resolve the conflict, companies cost their products and services using actual direct material and labor costs and estimated overhead costs. The estimated overhead cost is determined by multiplying a predetermined overhead rate by the actual volume used of the overhead allocation base.