Allocation of Overheads
Overhead costs are the indirect costs that are incurred in the production of a product or service. Overhead costs are typically allocated to products or services based on a predetermined overhead rate. The predetermined overhead rate is calculated by dividing the estimated overhead costs by the estimated number of units that will be produced.
There are a number of different methods that can be used to allocate overhead costs. Some of the most common methods include:
- Direct labor hours: This method allocates overhead costs based on the number of direct labor hours that are used to produce a product or service.
- Machine hours: This method allocates overhead costs based on the number of machine hours that are used to produce a product or service.
- Direct materials cost: This method allocates overhead costs based on the cost of direct materials that are used to produce a product or service.
- Sales value: This method allocates overhead costs based on the sales value of a product or service.
The best method to use for allocating overhead costs depends on the specific needs of the business. If the business produces products or services that are labor-intensive, then the direct labor hours method is the best method to use. If the business produces products or services that are machine-intensive, then the machine hours method is the best method to use.
Applications of Allocation of Overheads
The allocation of overhead costs is used in a variety of applications, including:
- Job costing: Job costing is a method of costing that is used to determine the cost of a specific job or order. Overhead costs are typically allocated to jobs based on a predetermined overhead rate.
- Process costing: Process costing is a method of costing that is used to determine the cost of a product or service that is produced in a continuous process. Overhead costs are typically allocated to products or services based on the direct labor hours or machine hours that are used to produce them.
- Budgeting: Budgeting is the process of planning and forecasting future financial performance. Overhead costs are typically included in budgets to ensure that the business has enough money to cover its overhead costs.
- Pricing: Pricing is the process of setting prices for products or services. Overhead costs are typically considered when setting prices to ensure that the business can cover its costs and make a profit.