Applied overhead refers to the amount of overhead costs that are allocated or assigned to products, services, or cost objects based on a predetermined rate or allocation method. It is the application of indirect manufacturing costs to the specific items or activities within an organization.
The applied overhead is calculated by multiplying the predetermined overhead rate (which is based on estimates) by the actual usage or consumption of the allocation base or cost driver for each cost object. The allocation base can be factors such as direct labor hours, machine hours, units produced, or any other measure that relates to the incurrence of overhead costs.
The purpose of applying overhead is to assign a fair share of indirect costs to the products or cost objects. Since indirect costs cannot be directly traced to specific items, they need to be allocated using a systematic method. By applying overhead, businesses can better determine the total cost of their products, services, or activities, and gain insights into the profitability and cost behavior.
It’s important to note that applied overhead is based on estimates and predetermined rates. The actual overhead costs may differ from the applied amount, leading to variances known as underapplied or overapplied overhead. These variances are adjusted at the end of the accounting period to reconcile the actual costs with the applied amounts.
Applied overhead is a key component in determining the full cost of products or services, supporting decision-making processes such as pricing, budgeting, and evaluating the profitability of different activities. It allows organizations to allocate their indirect costs in a systematic and reasonable manner, providing a more accurate representation of the costs associated with their operations.