The proper allocation of manufacturing overhead to products produced is required by generally accepted accounting principles and provides a sound basis for pricing products using a full cost approach. The three elements of cost are Direct Materials, Direct Labor and Manufacturing Overhead. All are important to the successful costing of inventories and cost of goods sold.
Let's suppose that you are making automobiles. In July there is a plant shutdown for two weeks and taking vacations by factory labor, both direct and indirect, is mandatory during those two weeks.
Please explain, the mechanics of calculating a predetermined overhead rate for this year and which allocation base or bases may be used to apply the predetermined rate to the automobiles produced. Should the cost of the factory labor vacations be spread to all autos produced from the first one in January to the last one in December?
Would the cost of the vacations for the sales and human resource departments also be allocated to the automobiles? If not, what type costs are these as compared to the inventoriable costs?, and how do they flow through the income statement?