What is manufacturing overhead and how is it useful? How do you calculate applied manufacturing overhead?
Manufacturing overhead refers to indirect costs incurred during the production process that cannot be directly traced to a specific product. These costs include expenses such as rent, utilities, insurance, property taxes, depreciation of manufacturing equipment, maintenance, and indirect labor.
Manufacturing overhead is useful because it allows companies to allocate indirect costs to individual products. By including manufacturing overhead, a company can have a more accurate understanding of the total cost of producing a specific product, which is crucial for pricing decisions, profitability analysis, and performance evaluation.
To calculate applied manufacturing overhead, you need to determine the predetermined overhead rate and apply it to the actual level of activity (usually measured in direct labor hours, machine hours, or direct labor cost).
The formula to calculate applied manufacturing overhead is:
Applied Manufacturing Overhead = Predetermined Overhead Rate x Actual Level of Activity
To compute the predetermined overhead rate, you need to estimate the total manufacturing overhead costs for a specific period and select an appropriate cost driver. The cost driver is a measurement that best represents the level of activity that causes overhead costs to be incurred. Once you have estimated the total overhead costs and determined the cost driver, divide the estimated overhead costs by the estimated level of activity to obtain the predetermined overhead rate.
The formula to calculate the predetermined overhead rate is:
Predetermined Overhead Rate = Estimated Overhead Costs / Estimated Level of Activity
By applying the predetermined overhead rate to the actual level of activity, you can determine the amount of manufacturing overhead that should be allocated to a particular job, unit, or product. This helps in evaluating the cost effectiveness of production processes and in making informed decisions regarding pricing, cost control, and resource allocation.