Factory Overhead Allocation Method

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  • Topic: Inventory, Cost of goods sold
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  • Published : April 21, 2013
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Overhead Allocation
Overhead Allocation Overview
In many businesses, the cost of overhead is substantially greater than direct costs, so the cost accountant must expend considerable attention on the proper method of allocating overhead to inventory. There are two types of overhead, which are administrative overhead and manufacturing overhead. Administrative overhead includes those costs not involved in the development or production of goods or services, such as the costs of front office administration and sales; this is essentially all overhead that is not included in manufacturing overhead. Manufacturing overhead is all of the costs that a factory incurs, other than direct costs. You need to allocate the costs of manufacturing overhead to any inventory items that are classified as work-in-process or finished goods. Overhead is not allocated to raw materials inventory, since the operations giving rise to overhead costs only impact work-in-process and finished goods inventory. The following items are usually included in manufacturing overhead: |Depreciation of factory equipment |Quality control and inspection | |Factory administration expenses |Rent, facility and equipment | |Indirect labor and production supervisory wages |Repair expenses | |Indirect materials and supplies |Rework labor, scrap and spoilage | |Maintenance, factory and production equipment |Taxes related to production assets | |Officer salaries related to production |Uncapitalized tools and equipment | |Production employees’ benefits |Utilities |

Definition of 'Applied Overhead'

A type of overhead that is recorded under the cost-accounting method. Applied overhead is a fixed charged to a specific production job or department within a company. Applied overhead stands in contrast to general overhead, such as utilities or rent. Other forms of applied overhead include depreciation and insurance

Definition of Actual Overhead:
The actual overhead refers to the indirect manufacturing costs actually occurring and recorded. These include the manufacturing costs of electricity, gas, water, rent, property tax, production supervisors, depreciation, repairs, maintenance, and more. The applied overhead refers to the indirect manufacturing costs that have been assigned to the goods manufactured. Manufacturing overhead is usually applied, assigned, or allocated by using a predetermined annual overhead rate. For example, a manufacturer might estimate that in its upcoming accounting year there will be $2,000,000 of manufacturing overhead and 40,000 machine hours. As a result, this manufacturer sets its predetermined annual overhead rate at $50 per machine hour. Since the future overhead costs and future number of machine hours were not known with certainty, and since the actual machine hours will not occur uniformly throughout the year, there will always be a difference between the actual overhead costs incurred and the amount of overhead applied to the manufactured goods. Hopefully, the differences will be minimal at the end of the accounting year. APPLIED Overhead is computed using the predetermined overhead rate and is the amount of costs applied (or estimated) to be allocated (needed) for specific jobs. ACTUAL Overhead is found after the manufacturing process is complete which gives the actual amount of used/consumed resources (or total costs) that it needed to complete the job. The two amounts can then be compared afterward which is known as Under- or Overapplied Manufacturing Overhead. When...
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