How many predetermined overhead rates can be used by a job order costing system?
Application of Manufacturing Overhead Cost in Job Order Costing:Learning objective of this article:
Predetermined Overhead Rate:Manufacturing overhead must be included with direct labor on the job cost sheet since manufacturing overhead is also a product cost. However, assigning manufacturing overhead to units of product can be a difficult task. There are three reasons for this: Show
Given these problems, about the only way to assign overhead costs to production is to use an allocation process. This allocation of overhead cost is accomplished by selecting an allocation basethat is common to all of the company’s products and services. An allocation base is a measure such as direct labor hours or machine hours that is used to assign overhead costs to products and services. The most widely used allocation bases are direct labor hours, and direct labor cost, with machine hours and even units of product (where a company has only a single product) also used to some extent. The allocation base is used to compute “predetermined overhead rate“ in the following formula or equation. Formula and Calculation of Predetermined Overhead Rate:Predetermined Overhead Rate = Estimated total manufacturing overhead cost / Estimated total units in the allocation base Example:If a company has estimated that its total manufacturing overhead cost will be $320,000 for the year and its total direct labor hour will be 40,000. Its predetermined overhead rate for the year will be $8 per direct labor hour, as calculated below: $320,000 / 40,000 predetermined overhead rate is based on estimates rather than actual results. This is because the predetermined overhead rate is computed before the period begins and is used to apply overhead cost throughout the period. The process of assigning overhead cost to jobs is calledoverhead application.The formula for determining the amount of overhead cost to apply to a particular job is: Overhead applied to a particular job = Predetermined overhead rate × Amount of allocation incurred by the job Note that the job cost sheet in the example below indicates that 27 labor hours have been worked. Therefore a total of $216 of manufacturing overhead cost would be applied to the job. See the following calculation: Overhead applied to job 2B47 = Predetermined overhead rate × Actual direct labor hours charged to job 2B47 = $8 per DLH × 27 DLHs = $216 of overhead applied to job 2B47 Example of Job Cost Sheet
The amount of overhead has been entered on the job cost sheet above. Note that this is not the actual amount of overhead caused by the job. There is no attempt to trace actual overhead costs to jobs–if that could be done, the costs would be direct costs, not overhead costs. Overhead assigned to the job is simply a share of the total overhead that was estimated at the beginning of the year. When a company applies overhead cost to jobs as we have done–it is called normal cost system. The overhead may be applied as direct labor-hours are charged to jobs, or all of the overhead can be applied at once when the job is completed. The choice is up to the company. If a job is not completed at the year-end, however, overhead should be applied to value the work in process inventory. The Need for Predetermined Overhead Rate:Instead of using a predetermined overhead rate, a company could wait until the end of the accounting period to compute an actual over head rate based on actual total manufacturing costs and the actual total units in the allocation base for the period. However, managers cite several reasons for using predetermined over head rates instead of actual overhead rates:
The Flow of Documents in a Job Order Costing System
How is predetermined overhead rate used in Job Order costing?Factory overhead costs are allocated to jobs in process using a predetermined overhead rate. The predetermined overhead rate is determined by estimating (during the budget process) total factory overhead costs and dividing these total costs by direct labor hours or direct labor dollars.
Why are multiple predetermined overhead rates used?Larger organizations may employ a different predetermined overhead rate in each production department, which tends to improve the accuracy of overhead application by employing a higher level of precision. However, the use of multiple predetermined overhead rates also increases the amount of required accounting labor.
How the predetermined factory overhead rate can be used in job order cost accounting to assist managers in pricing jobs?Using a predetermined factory overhead rate ensures that the same amount of indirect cost is applied to each unit produced. This prevents your production costs from being skewed due to seasonal fluctuations or unusual changes in demand.
Why does Job Order cost accounting require a predetermined overhead rate?A predetermined overhead rate makes reconciling the overhead account much easier. Most often, the overhead account will reflect a credit balance or a debit balance. A credit balance indicates predetermined overhead was over-applied and a debit balance indicates predetermined overhead was under-applied.
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