1. Factory overhead represents expenses that are incurred in the process of production, but that cannot be identified directly with the finished product. This distinguishes them from direct materials and direct labor which apply directly to the product being manufactured.
A variety of terms can be used to describe factory overhead, such asindirect expense, indirect manufacturing costs, and factory burden. For simplicity, factory overhead is often referred to merely as “overhead.”
2. The three categories of factory overhead expenses and examples of each are:
(1) Indirect materials. Examples: cleaning materials, lubricants, polishing compounds, glue and nails.
(2) Indirect labor. Examples: wages of supervisors, janitors,inspectors, forklift operators.
(3) Other indirect manufacturing expenses. Examples: factory rent, insurance, property taxes, depreciation, and power.
3. The distinguishing characteristic of a variable cost is that it tends to increase or decrease proportionately with production increases and decreases. Fixed costs will remain the same, in total, over a period of time, regardless of thechanges in production. Semivariable costs, although affected by production, contain both fixed and variable components.
4. When a product is composed of both fixed and variable costs, the total unit cost will decrease with volume increases and increase when volume goes down. The change in unit cost is caused by the spreading of the total fixed cost over the new level of volume. When volume goesup, the fixed cost assigned to each unit of product decreases, lowering the total unit cost. As volume decreases, more of the total fixed cost must be assigned to each unit produced; therefore, the total unit cost of the product increases. For example, assume $100,000 of fixed costs and production of 10,000 units. The fixed cost per unit would be $10. However, if production doubled to 20,000units, the new fixed cost per unit would only be $5 per unit.
5. Volume changes will affect cost patterns in the following ways:
(1) Total variable costs will vary proportionately with the volume change.
(2) Fixed costs will remain constant. In total, they are not affected by volume change (over a certain range of volume).
(3) Total semivariable costs will move in astair-step or continuous fashion when volume changes, but not in direct proportion to volume changes.
6. A step-variable cost, such as inspection and materials handling labor, will remain constant over a small range of production and then abruptly change. A step-fixed cost, such as factory supervision, will remain the same in total over a much wider range of activity before it changes.
7. The high-lowmethod assumes that a straight line can be drawn between the two extremes of the analyzed volume range and that all costs for volumes between the two points will fall along the straight line.
8. The scattergraph method is an improvement over the high-low method because it uses all of the available data points rather than just two of them. Also, visual inspection of the graph allowsnonrepresentative data points to be identified. The main disadvantage of the scattergraph method is that the cost line is drawn through the data points based on visual inspection rather than on utilization of mathematical techniques. Using visual inspection only, more than one line might be drawn to fit the data points.
9. The independent variable is the one whose change causes the variation in the dependentvariable. For example, the variation in electricity cost (dependent variable) from month-to-month can be explained by the variation in the number of units produced (independent variable)
10. R2 is a measure of the percentage of change in the dependent variable that can be explained by change in the independent variable. For example, an R2 of .95 means that 95% of the change in electricity cost...