Overheads in our company include all other expenses on labor, other materials and or services that the management cannot economically identify with any specific products or costs per unit. In this case, there are times when the company incurs expenses on indirect material, labor and there is not specific cost object to which it can be feasibly allocated. In manufacturing companies, these overheads mat vary from administration, sales as well as distribution (Woods & Sangster, 2005)
Description and treatment of some of the overhead costs
The factory overhead costs are incurred within the production units apart from the normal direct material and labor costs. This is an indirect cost and, Wood & Sangster, (2007) argues that according to the GAAP, these cost are not product cost and this can only be reported as expenses in the company’s income statements of the specific fiscal period in which they accrued/occurred. These may include depreciation, rents, and indirect materials (Coe, Schildhouse, Weygandt, Kimmel, & Kieso, 2010).
While overhead can be classified functionally in terms of the department such as manufacturing, or administration, they can also be classified based on the nature such as semi variable overhead, fixed overhands and the rest (Weygandt, Kieso, & Kimmel, 2002)
How the overhead is calculated
The company calculated its overheads as a portion or percentage of manufacturing cost. For example, it always consider its overheads to be the percentage of its direct labor cost
OH= x% of company’s direct labor cost. The percentage is calculated as a ration of the factory overheads to direct labors. In this case, FO/DR= OH ratio. The overhead ratio is a percentage used to determine final cost of the products.
The cost of the product = Direct Labor+ Direct Materials+ Factory OH
How I think they should be allocated.
Eisen, (2013) recommends that overhead should be allocated using the duirect method, which involves allocating each department’s total cost to the specific departments without considering the fact that these departments also produced intermediate goods for other departments. For example, in a company with a machining, and assembly department, the overhead is apportioned to each department in a predetermined ration due to the intensiveness of their operations. In this case, if the OH is $200,000. The allocation is as shown below
Machining department=60%of 200,000= $120,000
The assembly department = 40% of 200,000= $80,000
It is important tom note that the production costs can only be derived from the production budget to accurately calculate the overhead rates. Each company can model its own unique way of determining, allocating, and apportioning the overheads based on their operations (service/manufacturing), or prevailing accounting principles.
Coe, M., Schildhouse, R. A., Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2010).Peachtree complete accounting for Accounting principles. Hoboken, NJ: Wiley.
Eisen, P. J. (2013). Accounting. Barron’s Educational Series, Incorporated.
Weygandt, J. J., Kieso, D. E., & Kimmel, P. D. (2002). Accounting principles. New York: John Wiley & Sons.
Wood, F., & Sangster, A. (2005). Business accounting. Harlow, England: Financial Times Pitman Publishing.
Wood, F., & Sangster, A. (2007). Frank Wood’s business accounting. Harlow: FT Prentice Hall.