Allocating Manufacturing Overhead: Videos & Practice Problems
Allocating Manufacturing Overhead assigns indirect manufacturing costs to jobs based on their activity base and each job’s activity use, rather than splitting overhead evenly. An activity base is a measurable driver of production, such as machine hours, labor hours, production cycles, ride cycles, operating room hours, or procedure count. The key is choosing a base that reasonably reflects the work performed over time for the company and for each specific job.
A central tool is the predetermined overhead rate, an estimated rate calculated before production begins: \( \text{Predetermined overhead rate} = \frac{\text{Estimated total overhead costs}}{\text{Estimated total activity base}} \) . This rate is then used for applied overhead: \( \text{Applied overhead} = \text{Predetermined overhead rate} \times \text{Activity used by the job} \) .
Once overhead is applied, total job cost includes applied overhead plus direct materials and direct labor, and unit cost is found by dividing total job cost by units produced. This process improves product costing and supports pricing decisions by linking indirect costs to the jobs that actually consume resources.
Activity Base & Activity Use
Activity Base & Activity Use
Oak-ay Furniture Company uses a job order costing system to track the cost of each piece of furniture it builds. To fully understand its costs, the company wants to use an activity base that reflects the work required for each job.
Which of the following would be the most appropriate activity base?
Number of employees in the company.
Direct labor hours spent on each job.
The color of the wood stain used.
The number of furniture stores in the city.
Allocating Overhead & Predetermined Overhead Rate
Allocating Overhead & Predetermined Overhead Rate
Prisca’s Print Shop plans to calculate a predetermined overhead rate using machine hours as the activity base.
Managers estimate the following manufacturing overhead costs for the month:
The printing facility lease will cost \$48,000, utilities for the presses are expected to be \$12,000, maintenance for the printing equipment will cost \$9,000, and the factory supervisor’s salary will be \$21,000. The company expects its printing machines to operate 4,500 machine hours during the month.
What is the predetermined overhead rate per machine hour?
\$10 per machine hour.
\$15 per machine hour.
\$20 per machine hour.
\$30 per machine hour.
Applying Overhead & Calculating Total Job Cost & Unit Cost
Applying Overhead & Calculating Total Job Cost & Unit Cost
Prisca’s Print Shop applies manufacturing overhead using a predetermined overhead rate of \(20 per machine hour.
The company is currently calculating the unit cost for Job #204, which involves printing 500 custom event posters for a local business. Job #204 will require 120 machine hours. It will also incur the cost of specialty paper of \)1,200, as well as ink and printing plates of \$300. Direct labor on this job is estimated to cost \$2,000.
Using the company’s predetermined overhead rate, what is the unit cost to produce one poster in Job #204?
\$6.40 per poster.
\$11.80 per poster.
\$13.00 per poster.
\$14.80 per poster.
Here's what students ask on this topic:
An activity base is a measurable factor used to allocate manufacturing overhead costs to products or jobs. It represents the type of activity that drives overhead costs, such as machine hours, labor hours, production cycles, or other relevant measures depending on the company. For example, a vehicle manufacturer might use machine hours, while a hospital might use operating room hours. The key is that the activity base should reflect the production process over a period, allowing overhead costs to be distributed fairly based on how much each job uses that activity. This helps in accurately assigning indirect costs rather than splitting them evenly.
The predetermined overhead rate is calculated before production begins to estimate how much overhead cost will be assigned per unit of the activity base. The formula is: . For example, if estimated overhead is \$120,000 and estimated machine hours are 6,000, the predetermined overhead rate is \$20 per machine hour. This rate is then used to apply overhead costs to jobs based on their actual activity use.
To apply overhead to a job, multiply the predetermined overhead rate by the actual amount of the activity base used by that job. The formula is: . For example, if the predetermined overhead rate is \$20 per machine hour and a job uses 50 machine hours, the applied overhead is \$1,000. This method ensures overhead costs are assigned based on the job's consumption of resources.
First, calculate the total job cost by adding applied overhead to direct materials and direct labor costs: . Then, find the unit cost by dividing the total job cost by the number of units produced: . For example, if total job cost is \$4,500 and 500 units are produced, the unit cost is \$9 per unit. This helps in pricing and cost control.
Allocating overhead evenly ignores the actual consumption of resources by each job. Different jobs use different amounts of activities like machine hours or labor hours, so overhead should be assigned based on each job's activity use. For example, a small job using 10% of labor hours should not be charged the same overhead as a large job using 60%. Using activity-based allocation ensures more accurate product costing and fair pricing by linking overhead costs to the jobs that actually incur them.
