Definition
Percentage on Direct Material Cost is a method utilized in absorption costing to allocate manufacturing overheads based on the cost of direct materials. The typical formula used is:
\[ Manufacturing Overhead Allocation = (Direct Material Cost) × (Prescribed Percentage) \]
This approach ties the overhead costs directly to the amount of material used, positing that more material-intensive products consume more resources, and hence, should bear a greater portion of overheads.
Application and Importance
In practical terms, businesses apply a predetermined percentage rate to the direct costs of materials to find the portion of manufacturing overheads to be allocated to each unit produced. This method is particularly popular in industries where material costs are a significant driver of product costs, such as manufacturing and construction.
Here’s a catchy mnemonic for remembering this principle: “More Material, More Money,” suggesting that larger material costs incur larger overhead allocations. This can be a critical factor in industries where material costs fluctuate significantly.
Related Terms
- Absorption Costing: A costing method that includes all manufacturing costs, both fixed and variable, in the cost of a product.
- Manufacturing Overhead: Indirect factory-related costs that cannot be directly traced to a specific product but are necessary for the manufacturing process.
- Direct Material Cost: The total cost of raw materials directly involved in the manufacturing of a product.
Further Reading
To dive deeper into the world of absorption costing and overhead management, consider the following books:
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren - A comprehensive guide that covers a variety of costing methods, including detailed sections on absorption costing.
- “Manufacturing Cost Policy Deployment (MCPD)” by Alin Posteuca and Shigeo Shingo - A look into strategic cost management in manufacturing environments, focusing on efficiency and overhead reduction.
Absorbing this knowledge not only counts; it calculates!
