Administrative Overhead

Definition

Administrative overhead refers to the indirect costs associated with the overall management and administration of a business, rather than the direct costs of producing a product or providing a service. It encompasses the expenses incurred for the general operations and support functions that are necessary to sustain the organization's activities.

5 Must Know Facts For Your Next Test

1. Administrative overhead costs are necessary for the overall management and support of a business, but are not directly related to the production of specific goods or services.
2. Accurately estimating and allocating administrative overhead costs is crucial for determining the true cost of a product or service and ensuring appropriate pricing and profitability.
3. Predetermined overhead rates are used to apply administrative overhead costs to products or services based on expected activity levels, rather than actual costs incurred.
4. Applying overhead costs using the predetermined rate allows for a more consistent and predictable allocation of these indirect expenses, which can be beneficial for budgeting and decision-making purposes.
5. Variances between the predetermined overhead rate and the actual overhead costs incurred can provide insights into the efficiency of the organization's operations and the accuracy of the cost estimation process.

Review Questions

• Explain how administrative overhead costs differ from direct costs and their importance in managerial accounting.
  • Administrative overhead costs are indirect expenses that are necessary for the overall management and support of a business, but are not directly related to the production of specific goods or services. Unlike direct costs, which can be easily traced to a particular product or service, administrative overhead costs must be allocated using predetermined rates or other methods. Accurately estimating and allocating these indirect costs is crucial for determining the true cost of a product or service, ensuring appropriate pricing, and maintaining profitability. Managerial accountants must carefully consider administrative overhead costs when making decisions about resource allocation, budgeting, and pricing strategies.
• Describe the purpose and process of using a predetermined overhead rate to apply administrative overhead costs to products or services.
  • The predetermined overhead rate is an estimated rate used to allocate administrative overhead costs to products or services. This rate is calculated by dividing the estimated total overhead costs by the expected activity level, such as direct labor hours or machine hours. By using a predetermined rate, rather than applying actual overhead costs, the organization can achieve a more consistent and predictable allocation of these indirect expenses. The applied overhead, which is the amount of overhead costs assigned to a product or service based on the predetermined rate and the actual activity level, can then be used for various managerial accounting purposes, such as cost analysis, pricing decisions, and performance evaluation. The variance between the predetermined and actual overhead costs can provide valuable insights into the efficiency of the organization's operations and the accuracy of the cost estimation process.
• Analyze the role of administrative overhead costs in the context of computing a predetermined overhead rate and applying overhead to production, and explain how this information can be used to improve the organization's overall performance.
  • Administrative overhead costs play a crucial role in the computation of a predetermined overhead rate and the application of overhead to production. These indirect costs, which are necessary for the general management and support of the business, must be carefully estimated and allocated to ensure the accurate determination of the true cost of a product or service. The predetermined overhead rate, which is calculated by dividing the estimated total overhead costs by the expected activity level, allows for a more consistent and predictable application of these indirect expenses to the production process. The applied overhead, based on the predetermined rate and the actual activity level, can then be used for various managerial accounting purposes, such as cost analysis, pricing decisions, and performance evaluation. By analyzing the variances between the predetermined and actual overhead costs, the organization can gain valuable insights into the efficiency of its operations and the accuracy of the cost estimation process. This information can be used to identify areas for improvement, optimize resource allocation, and make more informed strategic decisions that enhance the organization's overall performance and profitability.

Related terms

Indirect Costs: Indirect costs are expenses that cannot be directly attributed to the production of a specific product or service, but are necessary for the overall operation of the business.

Predetermined Overhead Rate: The predetermined overhead rate is an estimated rate used to allocate overhead costs to products or services, calculated by dividing the estimated total overhead costs by the expected activity level.

Applied Overhead: Applied overhead is the amount of overhead costs that are assigned to a product or service based on the predetermined overhead rate and the actual activity level.