Definition:
Applied overhead is the estimated amount of overhead costs assigned to products or services. It’s calculated using a predetermined overhead rate and a predetermined allocation base, such as direct labor hours or machine hours.
Key points about applied overhead:
- Overhead costs: Overhead costs are indirect costs that cannot be directly traced to specific products or services.
- Predetermined overhead rate: The predetermined overhead rate is calculated by dividing estimated total overhead costs by the estimated total allocation base.
- Allocation base: The allocation base is a measure of the activity that drives overhead costs.
- Underapplied or overapplied overhead: If the applied overhead is different from the actual overhead costs, it can result in underapplied or overapplied overhead.
Why is applied overhead important?
- Product costing: Applied overhead is used to determine the total cost of products or services, which is important for pricing, inventory valuation, and profitability analysis.
- Performance evaluation: Applied overhead can be used to evaluate the performance of different departments or products.
- Cost control: Understanding applied overhead can help businesses identify areas where costs can be reduced.
In essence, applied overhead is a crucial component of product costing and provides valuable information for decision-making.
