Basis For Allocating Overhead Costs To Products

Basis for Allocating Overhead Costs: The primary objective in selecting a base is to insure the most accurate application of overhead cost to the work performed. Ordinarily, the base selected should be closely related to functions represented by the overhead cost being applied.

If, for example, factory overhead is predominately labor oriented, such as supervision and indirect labor, the proper base is probably direct labor cost or direct labor hours. If overhead items are predominately investment-oriented, related to the ownership and operation of machinery, then a machine-hour basis is probably most appropriate. If overhead relates mainly to materials oriented overhead such as the purchasing and handling of materials, then the materials cost might be considered as the base. Basis for Allocating Overhead Costs  to Products is depending on the circumstances and vary from industry to industry.

A secondary objective in selecting a base is to minimize clerical costs and effort. When two or more bases provide approximately the same applied overhead cost to specific units of production, the simplest base should be used. Although the cost of administering the various methods differs from one company to another, the direct labor cost basis or the materials cost basis seems to cause the least clerical effort and  cost. The labor and machine hour bases generally require additional clerical work and expense.

Factory overhead rates are stated as percentages or as an amount per hour, unit, pound, product, etc. The following bases are used for applying factory overhead: Basis for Allocating Overhead Costs to Products which is otherwise know as Applying Factory Overhead generally are:

(1) units of production,

(2) materials cost,

(3) direct labor cost,

(4) direct labor hours, and

(5) machine hours.

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