1. Step 5: PREPARE THE MANUFACTURING OVERHEAD COSTS BUDGET. Stylistic’s managers next budget for manufacturing overhead costs such as supervision, depreciation, maintenance, supplies, and power. To manage overhead costs, managers need to understand the various activities needed to manufacture products and the cost drivers of those activities. As described on page 201, Stylistic’s managers identify two activities for manufacturing overhead costs in its activity-based costing system: manufacturing operations and machine setups. The following table presents the activities and their cost drivers.
Cost Driver of VariableCost Driver of Fixed
ManufacturingComponent of OverheadComponent of OverheadManufacturing and
Overhead CostsCostsCostsSetup Capacity in 2020
ManufacturingDirect manufacturingManufacturing capacity300,000 direct
     operations     labor-hours     manufacturing
     overhead costs     labor-hours
Machine setupSetup labor-hoursSetup capacity15,000 setup labor-hours
     overhead costs
  1. The use of activity-based cost drivers gives rise to activity-based budgeting (ABB), a budgeting method that focuses on the budgeted cost of the activities necessary to produce and sell products and services.
  2. In its activity-based costing system, Stylistic’s manufacturing managers estimate various line items of overhead costs that comprise manufacturing operations overhead (that is, all costs for which direct manufacturing labor-hours is the cost driver). Managers identify opportunities for process and efficiency improvements, such as reducing defect rates and the time to manufacture a table, and then calculate budgeted manufacturing operations overhead costs in the operating department. They also determine the resources that they will need from the two support departments—kilowatt-hours of energy from the power department and hours of maintenance service from the maintenance department. The support department managers, in turn, plan the costs of personnel and supplies that they will need in order to provide the operating department with the support services it requires. The costs of the support departments are then allocated (first-stage cost allocation) as part of manufacturing operations overhead. Chapter 15 describes the allocation of support department costs to operating departments when support departments provide services to each other and to operating departments. The first half of Schedule 5 shows the various line items of costs that constitute manufacturing operations overhead costs—that is, all variable and fixed overhead costs (in the operating and support departments) that are caused by the 300,000 direct manufacturing labor-hours (the cost driver).
  1. Stylistic budgets costs differently for variable and fixed overhead costs. Consider variable overhead costs of supplies: Stylistic’s managers use past historical data and their knowledge of operations to estimate the cost of supplies per direct manufacturing labor-hour of $5. The total budgeted cost of supplies for 2020 is $5 multiplied by 300,000 budgeted direct manufacturing labor-hours, equal to $1,500,000. The total variable manufacturing operations overhead cost equals $21.60 ($5+$5.60  + $7+$4) per direct manufacturing labor-hour multiplied by 300,000 budgeted direct manufacturing labor-hours, equal to $6,480,000.
  2. Stylistic measures manufacturing operations capacity in terms of the direct manufacturing labor-hours that the facility is configured to support. It currently has a capacity of 300,000 direct manufacturing labor-hours. To support this level of capacity, and taking into account potential cost improvements, managers estimate total fixed manufacturing operations overhead costs of $2,520,000. (Note that, unlike 2020, Stylistic may not operate at full capacity each year, but fixed manufacturing operations costs will still be $2,520,000.) Fixed manufacturing overhead cost is $2,520,000  ÷  300,000=$8.40 per direct manufacturing labor-hour (regardless of the budgeted direct manufacturing labor-hours, which may be less than 300,000 in a particular year). That is, each direct manufacturing labor-hour will absorb $21.60 of variable manufacturing operations overhead plus $8.40 of fixed manufacturing operations overhead for a total of $30 of manufacturing operations overhead cost per direct manufacturing labor-hour.
  3. Next, Stylistic’s managers determine how setups will be done for the Casual and Deluxe line of tables, taking into account past experiences and potential improvements in setup efficiency.
  4. For example, managers consider the following:
    1. • Increasing the number of tables produced per batch so fewer batches (and therefore fewer setups) are needed for the budgeted production of tables
    2. • Decreasing the setup time per batch
    3. • Reducing the supervisory time needed, for example by increasing the skill base of workers
  5. Stylistic’s managers forecast the following setup information for the Casual and Deluxe tables:
<p>A table shows setup information for Casual and Deluxe tables</p>

The table depicts quantity of tables to be produced, number of tables to be produced per batch, number of batches (which is quantity of tables to be produced divided by number of tables to be produced per batch), setup time per batch, total setup-hours (which is number of batches times setup time per batch), and setup-hours per table (which is total setup-hours divided by quantity of tables to be produced). The details of the table are as follows:

  1. Quantity of tables to be produced:
    • Casual tables: 60,000 tables
    • Deluxe tables: 10,000 tables
  2. Number of tables to be produced per batch:
    • Casual tables: 50 tables per batch
    • Deluxe tables: 40 tables per batch
  3. Number of batches (quantity of tables to be produced divided by number of tables to be produced per batch):
    • Casual tables: 1,200 batches
    • Deluxe tables: 250 batches
  4. Setup time per batch:
    • Casual tables: 10 hours per batch
    • Deluxe tables: 12 hours per batch
  5. Total setup-hours (number of batches times setup time per batch):
    • Casual tables: 12,000 hours
    • Deluxe tables: 3,000 hours
    • Total: 15,000 hours
  6. Setup-hours per table (total setup-hours divided by quantity of tables to be produced):
    • Casual tables: 0.2 hour
    • Deluxe tables: 0.3 hour
  1. Using an approach similar to the one described for manufacturing operations overhead costs, Stylistic’s managers estimate various line items of costs that comprise variable machine setup overhead costs (supplies, indirect manufacturing labor, and power)—that is, all costs caused by the 15,000 setup labor-hours (the cost driver) and fixed machine setup overhead costs such as depreciation and supervision. The bottom half of Schedule 5 summarizes (1) total variable machine setup overhead costs per setup labor‐hour  =  $88   ($26 +$56+ $6)   × the budgeted 15,000 set up labor‐hours = $1,320,000and (2) fixed machine setup overhead costs of $1,680,000 needed to support the planned 15,000 setup labor-hours of capacity. (Stylistic may not operate at full capacity each year but fixed machine setup costs will still be $1,680,000.) The fixed machine setup cost is $1,680,000   ÷  15,000=$112 per setup labor-hour (regardless of the budgeted setup labor-hours, which may be less than 15,000 in a particular year). That is, each setup labor-hour will absorb $88 of variable machine setup overhead cost plus $112 of fixed machine setup overhead cost for a total of $200 of machine setup overhead cost per setup labor-hour.
<p>A table shows manufacturing overhead costs budget</p>

Schedule 5: Manufacturing Overhead Costs Budget for the Year Ending December 31, 2020 shows two tables.

The first table depicts manufacturing operations overhead costs. Details are as follows:

  1. Variable costs for 300,000 direct manufacturing labor-hours
    • Supplies, 5 dollars per direct manufacturing labor-hour: 1,500,000 dollars
    • Indirect manufacturing labor, 5.60 dollars per direct manufacturing labor-hour: 1,680,000 dollars
    • Power (support department costs), 7 dollars per direct manufacturing labor-hour: 2,100,000 dollars
    • Maintenance (support department costs), 4 dollars per direct manufacturing labor-hour: 1,200,000 dollars
    • Total for variable costs: 6,480,000 dollars
  2. Fixed costs to support capacity of 300,000 direct manufacturing labor-hours
    • Depreciation: 1,020,000 dollars
    • Supervision: 390,000 dollars
    • Power (support department costs): 630,000 dollars
    • Maintenance (support department costs): 480,000 dollars
    • Total for fixed costs: 2,520,000 dollars
  3. Total manufacturing operations overhead costs: 9,000,000 dollars

The second table depicts machine setup overhead costs. Details are as follows:

  1. Variable costs for 15,000 setup labor-hours
    • Supplies, 26 dollars per setup labor-hour: 390,000 dollars
    • Indirect manufacturing labor, 56 dollars per setup labor-hour: 840,000 dollars
    • Power (support department costs), 6 dollars per setup labor-hour: 90,000 dollars
    • Total for variable costs: 1,320,000 dollars
  2. Fixed costs to support capacity of 15,000 direct setup labor-hours
    • Depreciation: 603,000 dollars
    • Supervision: 1,050,000 dollars
    • Power (support department costs): 27,000 dollars
    • Total for fixed costs: 1,680,000 dollars
  3. Total machine setup overhead costs: 3,000,000
  4. Total manufacturing overhead costs: 12,000,000 dollars
  1. Note how using activity-based cost drivers provides additional and detailed information that improves decision making compared with budgeting based solely on output-based cost drivers. Of course, managers must always evaluate whether the expected benefit of adding more cost drivers exceeds the expected cost.*
  1. Note that Stylistic is scheduled to operate at capacity. Therefore, the budgeted quantity of the cost allocation base/cost driver is the same for variable overhead costs and fixed overhead costs—300,000 direct manufacturing labor-hours for manufacturing operations overhead costs and 15,000 setup labor-hours for machine setup overhead costs. In this case, the budgeted rate for the manufacturing operations overhead cost does not have to be calculated separately for variable costs and for fixed costs as we did earlier. Instead, it can be calculated directly by estimating total budgeted manufacturing operations overhead: $9,000,000  ÷  300,000 direct manufacturing labor‐hours =  $  30 per direct manufacturing labor-hour. Similarly, the budgeted rate for machine setup overhead cost can be calculated as total budgeted machine setup overhead: $3,000,000  ÷  15,000 budgeted setup hours =  $200 per setup-hour.

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