Applied overhead

Applied overhead
See also

Applied overhead is the amount of manufacturing overhead allocated to products. In turn, the overhead is an indirect cost that cannot be physically or economically assigned to individual items. During in a production process some costs can’t be traced back to a product, but they should be included in the cost of goods produced for the units manufactured at a certain time[1].Calculation of what amount overhead cost should be applied to some product is much more difficult than determination of direct cost. In such cases costs are divided according to formulas created in the company.

Accounting for applied overhead[edit]

Discussing applied overhead, it should be mentioned that it’s one of two types of overhead. We distinguish also actual overhead, which are tracked throughout the year in the overhead account. In this case overhead applied to production is computed throughout the year and is added to actual direct materials and actual direct labor to get total product cost. They require to reconcile any difference between actual and applied overhead and also correct the cost of goods sold account to reflect actual overhead spending. It must be done at the end of the year[2].

Overhead is applied based on a predetermined formula. To put into the appropriate basis for making this allocation requires a considerable thought. The overhead account isn’t a typical account, because it doesn’t represent an asset, liability, expense and any other element of financial statement. Amounts go into this account, but then they are transferred out to the other accounts. Actual overhead goes in and then applied overhead goes out. When overhead is applied to production, they are booked on the debit side. In turn if the actual amounts being spent on overhead, they are presented on the debits[3].

Example of reconciliation applied overhead[edit]

At the beginning of the year some company estimated the following[4]:

  • Overhead: 360 000
  • Direct labor cost: 720 000

This company like most other firms use normal costing and applies overhead on the basis of direct labor cost. For the month of March, direct labor cost was 56 000 $.

Steps by calculate applied overhead[edit]

First step

  • Add up total overhead, which are estimated indirect materials, indirect labor and also other costs that are not in the direct materials and direct labor. Overhead includes fixed and variable overhead.In this example the company has determined its own overhead on 360 000.

Second step[5].

  • Compute the overhead allocation rate. This predetermined overhead rate must be used to assign overhead to units or services produced
  • Pretermined overhead rate = total overhead / direct labor cost
  • Pretermined overhead rate is: 360 000 / 720 000 = 0,50, or 50 percent of direct labor cost.

Third step

  • Apply overhead. Multiply the overhead allocation rate by the number of direct labor needed to make each goods.
  • Overhead applied = pretermined overhead rate x direct labor cost in the analyzed period
  • Applied overhead in the March is: 0,50 x 56 000 = 28 000.

Footnotes[edit]

  1. Davis C., Davis E. (2012), Managerial Acoounting, John Wiley and Sons
  2. Heitger D., Mowen M., Hansen D. (2008), Fundamental Cornerstones of Managerial Accounting
  3. Walther L., Skousen C. (2009), Managerial and Cost Accounting
  4. Heitger D., Mowen M., Hansen D. (2008), Fundamental Cornerstones of Managerial Accounting
  5. Heitger D., Mowen M., Hansen D. (2018), Managerial Accounting, the cornerstone of business decision making

References[edit]

Author: Sławomir Maciejowski