In manufacturing, factory overhead costs are indirect costs that cannot be easily traced to a specific product or production process. Instead, they are incurred to support the production process as a whole. These costs include items such as rent, utilities, depreciation, and maintenance of factory equipment. Allocating these overhead costs to the products produced is important to ensure accurate product pricing and to track actual production costs.
To allocate factory overhead costs, a predetermined overhead rate is established at the beginning of the accounting period. This rate is determined by dividing the total expected overhead costs for the period by an allocation base, such as direct labor hours, machine hours, or direct material costs.
Once the predetermined overhead rate is established, the overhead cost for each unit of production can be calculated by multiplying the predetermined overhead rate by the actual amount of allocation base used in the production of that unit. For example, if the predetermined overhead rate is $10 per direct labor hour and a product requires 3 direct labor hours to produce, the overhead cost allocated to that product would be $30.
There are several methods of allocating factory overhead costs, including:
- Direct labor hours: This method allocates overhead costs based on the amount of direct labor hours required to produce a product.
- Machine hours: This method allocates overhead costs based on the amount of machine hours required to produce a product.
- Direct material costs: This method allocates overhead costs based on the direct material costs of a product.
- Activity-based costing: This method allocates overhead costs based on the activities required to produce a product, such as setup time, machine time, or material handling.
Allocating factory overhead costs is an important part of accurately determining the cost of production and ensuring that products are priced correctly. By using a predetermined overhead rate and an allocation base, factory overhead costs can be allocated to products in a consistent and accurate manner.