Pages: 7 (2267 words) Published: April 18, 2013

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The typical procedure for allocating overhead is to accumulate all manufacturing overhead costs into one or more cost pools, and to then use an activity measure to apportion the overhead costs in the cost pools to inventory. Thus, the overhead allocation formula is: Cost pool / Total activity measure = Overhead allocation per unit You can allocate overhead costs by any reasonable measure, as long as it is consistently applied across reporting periods. Common bases of allocation are direct labor hours charged against a product, or the amount of machine hours used during the production of a product. The amount of allocation charged per unit is known as the overhead rate. The overhead rate can be expressed as a proportion, if both the numerator and denominator are in dollars. For example, ABC Company has total indirect costs of \$100,000 and it decides to use the cost of its direct labor as the allocation measure. ABC incurs \$50,000 of direct labor costs, so the overhead rate is calculated as: \$100,000 Indirect costs

\$50,000 Direct labor
The result is an overhead rate of 2.0.
Alternatively, if the denominator is not in dollars, then the overhead rate is expressed as a cost per allocation unit. For example, ABC Company decides to change its allocation measure to hours of machine time used. ABC has 10,000 hours of machine time usage, so the overhead rate is now calculated as: \$100,000 Indirect costs

10,000 Machine hours
The result is an overhead rate of \$10.00 per machine hour.
If the basis of allocation does not appear correct for certain types of overhead costs, it may make more sense to split the overhead into two or more overhead cost pools, and allocate each cost pool using a different basis of allocation. For example, if warehouse costs are more appropriately allocated based on the square footage consumed by various products, then store warehouse costs in a warehouse overhead cost pool, and allocate these costs based on square footage used. Thus, far we...