Overhead Application

Definition

Overhead application refers to the process of assigning indirect costs, or overhead, to individual products or jobs within a manufacturing or service environment. This term is crucial in the context of job order costing, journal entries for a job order cost system, and calculating predetermined overhead and total cost under the traditional allocation method.

5 Must Know Facts For Your Next Test

1. Overhead application is used to assign indirect costs to individual jobs or products in a job order costing system.
2. The predetermined overhead rate is calculated by dividing the estimated total overhead costs by the expected activity level, such as machine hours or direct labor hours.
3. Applying overhead to jobs or products is crucial for accurately determining the full cost of each unit, which is important for pricing decisions and inventory valuation.
4. Overhead application is recorded through journal entries that debit Work in Process Inventory and credit Manufacturing Overhead for the applied overhead amounts.
5. Comparing the applied overhead to the actual overhead incurred during the period is important for evaluating the accuracy of the predetermined overhead rate and making adjustments as needed.

Review Questions

• Explain how overhead application is used in a job order costing system to compute the cost of a job.
  • In a job order costing system, overhead application is used to assign indirect costs, or overhead, to individual jobs or batches of products. This is done by calculating a predetermined overhead rate, typically based on a measure of activity such as machine hours or direct labor hours. The predetermined overhead rate is then applied to each job or product by multiplying the rate by the actual activity level for that job or product. This allows the full cost of each job, including both direct and indirect costs, to be accurately determined.
• Describe the journal entries required to record overhead application in a job order cost system.
  • The journal entries to record overhead application in a job order cost system involve debiting the Work in Process Inventory account and crediting the Manufacturing Overhead account. This records the overhead costs that have been applied to the jobs or products currently in production. At the end of the accounting period, the balance in the Manufacturing Overhead account represents the total overhead that has been applied to jobs or products, which is then compared to the actual overhead incurred to evaluate the accuracy of the predetermined overhead rate.
• Analyze how overhead application impacts the calculation of predetermined overhead and total cost under the traditional allocation method.
  • Under the traditional allocation method, overhead application is a critical component in calculating both the predetermined overhead rate and the total cost of a job or product. The predetermined overhead rate is calculated by dividing the estimated total overhead costs by the expected activity level, such as machine hours or direct labor hours. This rate is then applied to each job or product based on its actual activity level to determine the amount of overhead to be assigned. The total cost of a job or product is then calculated by adding the applied overhead to the direct materials and direct labor costs. Accurate overhead application is essential for ensuring the predetermined overhead rate and total cost calculations are reliable and meaningful for decision-making purposes.

Related terms

Overhead: Indirect costs that cannot be directly traced to a specific product or job, such as factory rent, utilities, and administrative salaries.

Predetermined Overhead Rate: A rate calculated at the beginning of a period to allocate overhead costs to products or jobs, based on an estimated activity level.

Job Order Costing: A costing system that accumulates costs by individual jobs or batches of products, rather than by the entire production process.