Allocated Overhead

Definition

Allocated overhead refers to the indirect costs associated with the production of goods or services that are distributed or assigned to individual jobs, products, or cost centers based on a predetermined allocation method. It is a crucial component in determining the full cost of a product or service within a job order costing system.

5 Must Know Facts For Your Next Test

1. Allocated overhead is used to assign indirect costs to individual jobs or products in a job order costing system.
2. The allocation of overhead costs is based on a predetermined allocation rate, which is calculated by dividing the total estimated overhead costs by the expected allocation base, such as direct labor hours or machine hours.
3. Accurate allocation of overhead costs is crucial for determining the full cost of a product or service, which is necessary for pricing decisions, profitability analysis, and inventory valuation.
4. Factors that influence the choice of allocation base include the nature of the indirect costs, the relationship between the indirect costs and the allocation base, and the availability and reliability of the allocation base data.
5. Underapplied or overapplied overhead can occur when the actual overhead costs differ from the estimated overhead costs used in the allocation rate, and these variances must be accounted for in the final cost of the job or product.

Review Questions

• Explain the purpose of allocating overhead costs in a job order costing system.
  • The purpose of allocating overhead costs in a job order costing system is to accurately determine the full cost of each individual job or product. Overhead costs, which are indirect costs that cannot be directly traced to a specific job, must be assigned to the jobs based on a predetermined allocation method. This allows for a more accurate representation of the total costs associated with each job, which is essential for pricing decisions, profitability analysis, and inventory valuation.
• Describe the process of calculating the overhead allocation rate and discuss the factors that influence the choice of the allocation base.
  • The overhead allocation rate is calculated by dividing the total estimated overhead costs by the expected allocation base, such as direct labor hours or machine hours. The choice of the allocation base is influenced by the nature of the indirect costs, the relationship between the indirect costs and the allocation base, and the availability and reliability of the allocation base data. For example, if the indirect costs are primarily related to machine usage, a machine hour allocation base may be more appropriate than a direct labor hour allocation base. The goal is to choose an allocation base that best reflects the relationship between the indirect costs and the production activity.
• Analyze the potential consequences of inaccurate overhead cost allocation in a job order costing system and discuss strategies for improving the accuracy of the allocated overhead.
  • Inaccurate overhead cost allocation in a job order costing system can lead to several consequences, including incorrect pricing decisions, distorted profitability analysis, and inaccurate inventory valuation. Strategies for improving the accuracy of allocated overhead include: 1) Conducting a thorough analysis of the indirect costs and their drivers to identify the most appropriate allocation base, 2) Regularly reviewing and updating the overhead allocation rate to reflect changes in the business, 3) Implementing more sophisticated cost allocation methods, such as activity-based costing, to better capture the relationship between indirect costs and the production process, and 4) Improving the accuracy and reliability of the data used to calculate the allocation base, such as tracking machine hours or direct labor hours more precisely.

Related terms

Indirect Costs: Indirect costs are expenses incurred in the production of goods or services that cannot be directly traced to a specific job or product, such as rent, utilities, and supervisory salaries.

Job Order Costing: Job order costing is a method of cost accounting where costs are accumulated for each separate job or batch of products, rather than for the entire production process.

Cost Allocation: Cost allocation is the process of assigning indirect costs to cost objects, such as jobs, products, or departments, based on a predetermined allocation base or cost driver.