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Accounting for Overhead Costs

Accurate overhead allocations are essential to understanding financial performance and making informed pricing decisions. Here’s guidance on how to estimate overhead rates to allocate these indirect costs to your products and how to adjust for variances that may occur.

What’s included in overhead?

Overhead costs are a part of every business. These accounts frequently serve as catch-alls for any expense that can’t be directly allocated to production, including:

  • Equipment maintenance and depreciation,
  • Factory and warehouse rent,
  • Building maintenance,
  • Administrative and executive salaries,
  • Taxes,
  • Insurance, and
  • Utilities.

Generally, such indirect costs of production are fixed, meaning they won’t change appreciably whether production increases or diminishes.

How are overhead rates calculated?

The challenge comes in deciding how to allocate these costs to products using an overhead rate. The rate is typically determined by dividing estimated overhead expenses by estimated totals in the allocation base (for example, direct labor hours) for a future period of time. Then you multiply the rate by the actual number of direct labor hours for each product (or batch of products) to establish the amount of overhead that should be applied.

In some organizations, the rate is applied companywide, across all products. This is particularly appropriate for organizations that make single, standard products — such as bricks — over long periods of time. If your product mix is more complex and customized, you may use multiple overhead rates to allocate costs more accurately. If one department is machine-intensive and another is labor-intensive, for example, multiple rates may be appropriate.

How do you handle variances from actual costs?

There’s one problem with accounting for overhead costs: Variances are almost certain. There are likely to be more variances if you use a simple companywide overhead rate, but even the most carefully thought-out multiple rates won’t always be 100% accurate.

The result? Large accounts that many managers don’t understand and that require constant adjustment. This situation creates opportunities for errors — and for dishonest people to commit fraud. Fortunately, you can reduce the chance of overhead anomalies with strong internal control procedures, such as:

  • Conducting independent reviews of all adjustments to overhead and inventory accounts,
  • Studying significant overhead adjustments over different periods of time to spot anomalies,
  • Discussing complaints about high product costs with nonaccounting managers, and
  • Evaluating your existing overhead allocation and making adjustments as necessary.

Allocating costs more accurately won’t guarantee that you make a profit. To do that, you have to make prudent pricing decisions — based on the production costs and market conditions — and then sell what you produce.

Need help?

Cost accounting can be complex, and indirect overhead costs can be difficult to trace. Here, at Patrick & Raines CPAs, we can help you understand how to minimize the guesswork in accounting for overhead and identify when it’s time to adjust your allocation rates. Our accounting pros can also suggest ways to monitor cost allocations to prevent errors and mismanagement.

904.396.5400 | office@CPAsite.com

A Recipe for Success: Quality Food + Financial Planning

Jumpin’ Jax – Atlantic Beach

1021 Atlantic Blvd.

Atlantic Beach, Florida 32233

T: 904-595-5272

​Hours: Monday – Saturday 11:00am – 9:00pm
Sunday 11:00am – 2:00pm



 

 

 

 

 

Earlier this year, Howdy Russell opened his second restaurant location in Atlantic Beach. Jumpin’ Jax House of Food is known for quality food in a friendly, fun environment! From sandwiches and wraps to pizza and milkshakes, Jumpin’ Jax is a fast casual restaurant that has everything you’ll crave for your next meal. Russell opened the first Jumpin’ Jax House of food in Mandarin in June 2017. With its growing success, Russell knew he wanted to open a second location at the Beaches. He turned to Patrick and Raines, CPAs (P&R) to help make his dream a reality. As a longtime P&R client, Russell knew he could turn to the team for financial and tax planning advice to fit his needs. Patrick & Raines is dedicated to giving close, personal attention that prepares you fully for the future. It’s the type of personal service that would be expected from a trusted advisor, customized to their client’s needs to help reach tomorrow’s goals. Tomorrow’s goals were met for Howdy Russell; in just two short years, Jumpin’ Jax House of Food opened its second location in Atlantic Beach.

Hard work and planning made this dream into a reality. If you have goals and aspirations for your business, let the CPA team at Patrick and Raines help you achieve them! We are more than just tax planning and preparation. Contact us for all your business strategy needs: 904.396.5400 | office@CPAsite.com

Or we can discuss your business needs over the famous Duval Burger!

 

 

 

 

 

 

 

 

 

Your sales are up, so why is cash flow low?

Business owners sometimes mistakenly equate profits with cash flow. Here’s how this can lead to surprises when managing day-to-day operations — and why many profitable companies experience cash shortages.

Working capital

Profits are closely related to taxable income. Reported at the bottom of your company’s income statement, they’re essentially the result of revenue less the cost of goods sold and other operating expenses incurred in the accounting period.

Generally Accepted Accounting Principles (GAAP) require companies to “match” costs and expenses to the period in which revenue is recognized. Under accrual-basis accounting, it doesn’t necessarily matter when you receive payments from customers or when you pay expenses.

For example, inventory sitting in a warehouse or retail store can’t be deducted — even though it may have been long paid for (or financed). The expense hits your income statement only when an item is sold or used. Your inventory account contains many cash outflows that are waiting to be expensed.

Other working capital accounts — such as accounts receivable, accrued expenses and trade payables — also represent a difference between the timing of cash flows. As your business grows and prepares for increasing future sales, you invest more in working capital, which temporarily depletes cash.

The reverse also may be true. That is, a mature business may be a “cash cow” that generates ample cash, despite reporting lackluster profits.

Capital expenditures, loan payments and more

Working capital tells only part of the story. Your income statement also includes depreciation and amortization, which are noncash expenses. And it excludes changes in fixed assets, bank financing and owners’ capital accounts, which affect cash that’s on hand.

To illustrate: Suppose your company uses tax depreciation schedules for book purposes. In 2018, you purchased new equipment to take advantage of the expanded Section 179 and bonus depreciation allowances. The entire purchase price of these items was deducted from profits in 2018. However, these purchases were financed with debt. So, actual cash outflows from the investments in 2018 were minimal.

In 2019, your business will make loan payments that will reduce the amount of cash in the company’s checking account. But your profits will be hit with only the interest expense (not the amount of principal that’s being repaid). Plus, there will be no “basis” left in the 2018 purchases to depreciate in 2019. These circumstances will artificially boost profits in 2019, without a proportionate increase in cash.

Look beyond profits

It’s imperative for business owners and management to understand why profits and cash flow may not sync. If your profitable business has insufficient cash on hand to pay employees, suppliers, lenders or even the IRS, contact Patrick & Raines CPAs to discuss ways to more effectively manage the cash flow cycle.

904.396.5400 | office@CPAsite.com

Tax Law Changes That May Affect Your Business’s 401(k) Plan

Think about recent tax law changes and your business: There’s the new 20% pass-through deduction for qualified business income (QBI) and the enhancements to depreciation-related breaks. There’s also the reduction or elimination of certain business expense deductions. However, if your business sponsors a 401(k) plan, then there are also a couple of recent tax law changes you need to be aware of.

    1.  Plan loan repayment extension:

A great way to get a low-interest loan would be to borrow from your 401(k). But what happens if you leave the company (voluntarily or otherwise)? I’ll tell you; you have 60 days to either roll over the 401(k) into another qualified account or repay the loan. If the loan is not repaid, it then goes into default and is reported to the IRS as taxable income (and be subject to a 10% early distribution penalty if the employee was under age 59½).

However, under The Tax Cuts and Jobs Act (TCJA), starting 2018 any loans taken from your 401(k) now allows more time for the borrower to repay. Instead of the 60-day window, borrows now have until their tax return filing due date — including extensions — to repay the loan (or contribute the outstanding balance to an IRA or qualified retirement plan) and avoid taxes and penalties. To sum up, if you borrowed from your 401(k) and leave your job in 2018, you now have until April 15, 2019 to repay the loan.

    2.  Hardship withdrawal limit increase:

Some 401(k) plans allow for hardship withdrawals. If the 401(k) plan does include Hardship, an employee is allowed to take the withdrawal if their hardship falls under it’s criteria: purchase of a new home, damage/repair expenses for your home, payment expenses to avoid evictions or foreclosure on your home, unexpected medical costs, tuition/educational fees, or burial/funeral expenses. Before, a person could only borrow what they contributed into their 401(k). Beginning in 2019, the Bipartisan Budget Act (BBA) eases restrictions on employee 401(k) hardship withdrawals. Now, a person can not only withdraw their own contribution, but they can also withdraw their employer matched contributions plus earnings on contributions. This deduction will be considered taxable income and subject to the 10% early distribution tax penalty.

While this may sound beneficial, many people do not save enough for retirement. In addition, it is taking Americans longer to pay back loans thus missing out on potential tax-deferred growth during that time. Hardship withdrawals can result in a smaller, perhaps much smaller, nest egg at retirement.

So consider educating your employees on the importance of letting their 401(k) accounts grow undisturbed and the potential negative tax consequences of loans and early withdrawals. The team at Patrick & Raines CPAs have many years of experience helping small business owners and financial planning.  Contact us at Office@CPAsite.com or 904-396-5400 if we can help you!

Thinking of selling your business…?

Mark Patrick, CPA was featured in the UNF Spotlight newsletter. If you are thinking of selling your business, here are 4 ways to yield a large tax savings and/or better proceeds at closing!

Tax Efficient Sale of Your Business

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