Overhead Application Rate

Definition

The overhead application rate is a predetermined rate used to allocate overhead costs to production. It is calculated by dividing the estimated total overhead costs by the expected activity or volume measure, such as direct labor hours or machine hours. This rate is then used to apply overhead to individual jobs or products in a job order cost system.

5 Must Know Facts For Your Next Test

1. The overhead application rate is used to apply overhead costs to individual jobs or products in a job order cost system.
2. Calculating the overhead application rate involves dividing the estimated total overhead costs by the expected activity or volume measure, such as direct labor hours or machine hours.
3. Using a predetermined overhead rate allows companies to apply overhead costs to production in a timely and consistent manner, rather than waiting until the end of the accounting period.
4. Applying overhead using the overhead application rate helps to ensure that overhead costs are allocated to products or jobs in proportion to the resources they consume.
5. Accurately estimating the overhead application rate is crucial for ensuring that overhead costs are properly allocated and that product or job costs are accurately reported.

Review Questions

• Explain how the overhead application rate is used to apply overhead costs to production in a job order cost system.
  • In a job order cost system, the overhead application rate is used to apply overhead costs to individual jobs or products. The overhead application rate is calculated by dividing the estimated total overhead costs by the expected activity or volume measure, such as direct labor hours or machine hours. This predetermined rate is then used to apply overhead to each job or product based on the amount of the activity measure consumed by that job or product. Using the overhead application rate allows for a timely and consistent allocation of overhead costs to production, rather than waiting until the end of the accounting period.
• Describe the importance of accurately estimating the overhead application rate in a job order cost system.
  • Accurately estimating the overhead application rate is crucial in a job order cost system because it directly affects the allocation of overhead costs to individual jobs or products. If the overhead application rate is set too high, it will result in an over-application of overhead, leading to inflated product or job costs. Conversely, if the rate is set too low, it will result in an under-application of overhead, leading to understated product or job costs. Accurate estimation of the overhead application rate is essential for ensuring that overhead costs are properly allocated and that product or job costs are reported accurately, which is crucial for making informed pricing and profitability decisions.
• Analyze how the use of a predetermined overhead application rate in a job order cost system differs from the allocation of overhead costs in a process cost system.
  • In a job order cost system, a predetermined overhead application rate is used to apply overhead costs to individual jobs or products, whereas in a process cost system, overhead costs are typically allocated based on the actual costs incurred during the accounting period. The use of a predetermined overhead application rate in a job order cost system allows for a more timely and consistent allocation of overhead, as the rate is calculated before the accounting period begins. This contrasts with the process cost system, where overhead costs are allocated based on the actual costs incurred, which may vary throughout the period. The predetermined overhead application rate in a job order cost system also helps to ensure that overhead costs are allocated to products or jobs in proportion to the resources they consume, whereas in a process cost system, overhead costs are often allocated based on a single volume measure, such as units produced. The choice between a job order cost system and a process cost system depends on the nature of the production process and the desired level of cost information for decision-making purposes.

Related terms

Predetermined Overhead Rate: A predetermined overhead rate is an estimated overhead rate that is calculated before the accounting period begins. It is used to apply overhead costs to production.

Job Order Cost System: A job order cost system is an accounting system that accumulates costs by individual jobs or batches of products, rather than by the entire production process.

Overhead Costs: Overhead costs are indirect costs that cannot be easily traced to a specific product or job, such as rent, utilities, and supervisory salaries.