why is applied overhead rather than actual overhead used in determining the cost of the job? and what would be the problems associated with this approach of using applied overhead
Applied overhead is used in determining the cost of a job because it provides a more accurate representation of the actual costs incurred in the production process. Actual overhead refers to the actual costs incurred during a specific period for items such as utilities, rent, and repairs. However, actual overhead can vary from one period to another due to factors such as seasonal fluctuations or unexpected expenses.
On the other hand, applied overhead is the estimated portion of overhead costs that is allocated to each job based on a predetermined overhead rate. It is based on the assumption that overhead costs are incurred in proportion to the amount of labor, machine hours, or other relevant factors used in the production process. By using this approach, the actual costs of overhead are spread out evenly across the jobs, providing a more consistent and predictable measure of the cost of each job.
However, there are several problems associated with the use of applied overhead:
1. Variability: Applied overhead may not accurately reflect actual costs if there is significant fluctuation in the amount of overhead incurred. This can be due to changes in production volume, changes in overhead rates, or unexpected events.
2. Inaccuracy: The predetermined overhead rate is based on assumptions and estimates. If these assumptions are incorrect or if the estimates are not properly adjusted, it can result in an inaccurate allocation of overhead costs to jobs.
3. Distortion: Applied overhead can sometimes lead to distortion in cost calculations. For example, if a job requires significantly more overhead resources than initially estimated, the applied overhead may not capture the true cost of the job.
4. Difficulty in tracing costs: When using applied overhead, it becomes difficult to trace and identify the specific costs associated with each job. This can make it challenging to analyze and control costs effectively.
Overall, while applied overhead provides a more consistent and predictable measure of job costs, it is important to be aware of its limitations and potential problems. Regular monitoring, analysis, and adjustment of the predetermined overhead rate can help mitigate some of these issues.