Overhead Allocation
Module 4:
Inventory & Costing
Duration:
45-60 minutes
Level:
Beginner to Diploma-Level
Lesson Objectives
➛ Define overhead allocation
➛ Distinguish between direct and indirect costs
➛ Identify bases used for overhead allocation
➛ Calculate predetermined overhead rates
➛ Apply overhead to production
➛ Understand over- and under-applied overhead
Key Vocabulary
➛ Overhead
➛ Overhead Allocation
➛ Allocation Base
➛ Predetermined Overhead Rate
➛ Applied Overhead
➛ Actual Overhead
➛ Overapplied Overhead
➛ Underapplied Overhead
What Is Overhead Allocation?
Overhead allocation is
➛ The process of assigning indirect costs to products or jobs
Common Allocation Bases
➛ Direct labor hours
➛ Machine hours
➛ Units produced
➛ Direct labor cost
Choice depends on what best reflects resource usage.
Predetermined Overhead Rate
POHR = Estimated Overhead ÷ Estimated Activity Level
Used to apply overhead before the period begins.
Applying Overhead
Applied Overhead = POHR × Actual Activity
Example Calculation
Given
Estimated overhead =
Estimated machine hours =
Estimated machine hours =
$120,000
60,000
60,000
Step 1
POHR
120,000 ÷ 60,000 = 2
$2 per machine hour
Step 2
Apply Overhead
If actual machine hours = 10,000
10,000 × 2 = 20,000
Applied overhead = $20,000
Overapplied vs Underapplied Overhead
Type
Overapplied
Underapplied
Overapplied
Underapplied
Meaning
Applied > Actual | overestimated
Applied < Actual | underestimated
Applied > Actual | overestimated
Applied < Actual | underestimated
Adjustment Entry
➛ If underapplied
Cost of Goods Sold
Manufacturing Overhead
Manufacturing Overhead
Dr
Cr
Cr
➛ If overapplied
Manufacturing Overhead
Cost of Goods Sold
Cost of Goods Sold
Dr
Cr
Cr
True or False
➛ Overhead costs are directly traceable
➛ POHR is calculated using estimates
➛ Applied overhead uses actual activity
➛ Overapplied overhead means too much cost was assigned
Fill in the Blanks
1. Overhead refers to __________ costs
2. POHR = __________ ÷ estimated activity
3. Applied overhead = POHR × __________
4. If applied > actual, overhead is __________
Calculation Practice
A company reports
Estimated overhead =
Estimated labor hours =
Actual labor hours =
Estimated labor hours =
Actual labor hours =
$90,000
30,000
8,000
30,000
8,000
➛ Calculate POHR
➛ Calculate applied overhead
Over/Under Application
Actual overhead =
Applied overhead =
Applied overhead =
$25,000
$28,000
$28,000
➛ Is overhead overapplied or underapplied?
➛ By how much?
➛ What is the adjustment entry?
Mini Case Study
A manufacturing company uses machine hours to allocate overhead. At year-end, actual overhead differs from applied overhead.
Questions
➛ Why is overhead allocated using estimates?
➛ What causes over/under-applied overhead?
➛ How should the difference be treated?
➛ Why is accurate allocation important?
Quick Quiz
➛ What is overhead allocation?
➛ What is a POHR?
➛ How is applied overhead calculated?
➛ What is overapplied overhead?
➛ Name one allocation base
Answers ➧ Here
Cost-Volume-Profit Analysis ➧ Here