Explain how manufacturing overhead rates are constructed in conventional cost accounting systems. Speak separately about fixed versus variable overhead application rates. What key choices must be made in establishing these rates? In answering this question, you might want to discuss differences (if any) between current IRS (income tax) requirements and internal reporting purposes, and between financial reporting requirements, i.e., applicable GAAP (FASB ASC 330-10-30, previously SFAS No. 151, available using the FASB link and internal reporting purposes.

Your company uses a standard cost system. As such, at the end of each period, it must "clean up" the accounts by disposing of any standard cost variances that occurred for the period. You need to educate members of the board about how the variances for fixed manufacturing overhead are disposed of at the end of the period. In your answer, pay particular attention to the following two financial-reporting issues: The requirements of FAS151

How, under absorption costing, reported earnings can be "managed" by choice of the denominator volume used to establish the fixed overhead application rate.

Search the Internet for the Institute of Management Accountant's Statement of Ethical Professional Practice. Which of the stated "standards" relate directly to the issue of setting (fixed) overhead application rates and the decision as to how any resulting production volume variances are disposed of for financial-reporting purposes? Be specific.