Overview
This lecture explains why manufacturing overhead is sometimes over- or under-allocated and how better estimation of allocation bases improves accuracy.
Overhead Allocation Concepts
- Manufacturing overhead is allocated to jobs at the start of the year using estimated data.
- A predetermined overhead allocation rate is used, often based on expected costs and allocation bases like direct labor hours.
- Actual outcomes can differ from estimates, causing over- or under-allocation.
Examples of Over/Under Allocation
- An under-costed job (skinny widget) results when overhead is underestimated.
- An over-costed job (fat widget) occurs when overhead is overestimated.
Improving Allocation Accuracy
- Analyzing main cost drivers, such as labor hours, machine hours, or a combination, can improve overhead estimates.
- Selecting the most relevant allocation base helps the cost accountant match overhead costs more closely to actual production.
Key Terms & Definitions
- Manufacturing Overhead — Indirect production costs not directly traceable to a specific product.
- Allocation Base — A measure (e.g., direct labor hours, machine hours) used to assign overhead costs to products or jobs.
- Predetermined Overhead Rate — Estimated overhead cost divided by estimated allocation base at the year's start.
- Over-allocated Overhead — When assigned overhead exceeds actual overhead incurred.
- Under-allocated Overhead — When assigned overhead is less than actual overhead incurred.
Action Items / Next Steps
- Review the methods for selecting allocation bases in your textbook.
- Practice problems on calculating and adjusting for over- and under-allocated overhead.