Companies incur overhead costs as a part of operating in the business world. Overhead costs include labor expenses for employees not working on the production line, property taxes and supplies. These costs do not apply directly to a product. Without any direct method of assigning these costs, the company develops several programs to allocate these costs to individual products. These programs spread a percentage of the overhead costs to each product offered to customers. This allows the company to price its products high enough to recoup both the direct costs of the product and the overhead assigned to the product.
Identify different overhead programs. Review the production process. Make a list of measurable activities that occur during this process. Examples of measurable activities include machine hours, direct labor hours and production quantity. Each measurable activity represents a separate overhead program.
Classify all overhead expenses within individual overhead programs. Review the expenses listed in the overhead budget. Match each expense with an overhead program. The expense should relate to the measurable activity of that program. For example, repairs and maintenance expense increases as the number of machine hours increases.
Estimate the annual quantity for each activity associated with an overhead program. For example, review the production budget to estimate the production quantity for the year.
Segregate the total annual quantity for each activity from Step 3 between each product line. For example, separate the total production quantity among each machine that runs that product.
Calculate the overhead percentage to assign to each product for each program. For example, divide the estimated production quantity from machine #1 by the total production quantity for that item. Multiply this number by 100 to determine the percentage.
- The overhead percentage allows you to calculate the overhead dollars assigned to each product. Multiply the total overhead expenses within each program by the percentage assigned to each product.
- Calculating the overhead percentage does not provide the total overhead dollar amount assigned to each unit. The percentage tells you how much overhead to assign to the entire product line. In order to determine the overhead assigned to each unit, divide the total overhead dollars by the number of units produced annually.
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