Estimate your Overhead

by Anthony Williams | on May 28, 2013  

Reason to Estimate Factory Overhead

Why would a company estimate the amount of factory overhead assigned to individual jobs or job lots? Well, we could sum it up in one word, accountability. When work is being done at a factory, at times, there may be different production sites within that factory. Now, managers are inclined to estimate overhead for individual jobs. By estimating the amount of factory overhead to be assigned to each job, managers may gain insight. Managers gain insight as to what price to tag on to finish goods (products). As well as, whether the company will make a profit, and if a certain project should be pursued (Wild, Shaw & Chiappetta, 2009).

For example, if one had a shoe factory and were approached by a customer with a shoe design for a certain amount of shoes. Before one would take on the job to produce these special designed shoes, an estimated cost should be assigned. Once the cost has been assigned to the production of said shoes, a price may be then given to the customer. If the customer agrees to the price production may begin. Now, say the production cost is $15,000.00 but the customer is not willing to pay more than $15,000.00, it would not be in the factory’s best interest to procure this contract (Wild, et al.).

Overhead and Total Cost

Moreover, getting back to the specifics of estimated factory overhead assigned to individual jobs, which in fact should be included in total cost. Since it (overhead) is part of the expense incurred during production. If said expense (overhead) is not allocated to specific jobs in a reasonable manner, the factory financial records will be inaccurate. Thus, a good reason for estimating the amount of factory overhead to assigned to individual jobs or job lots. For instance, if the customer for the shoes contract in the second paragraph above agrees to producer’s sale price. And, the factory’s managers produce and sold the shoes. Let us also say, that the managers failed to include factory overhead in total cost, and thus the price. This is known as underapplied overhead, and will reflect an overstatement in net income, if remained unadjusted (Wild, et al.).

Activity Base for Overhead

So, how would one identify what should be used as his or her activity base for the overhead rate? Simply by first identifying all activities involved in the production process, keeping in mind that an activity is a task, operation, or procedure that resulted in cost incurring. One will then match these activities with the cost they incurred; it may be easier to group like activities together. Then rates from each pooled base are summed up to find the total rate that is then allocated to the overhead for products yielded from that activity base (Wild, Shaw & Chiappetta, 2009).  See you at the bank. Go ahead and be part of our team; opt-in, and come aboard now.

Reference

Wild, J. J., Shaw, K. W., & Chiappetta, B. (2009). Financial and Managerial Accounting:Information for Decisions (3^rd ed.). McGraw-Hill/Irwin, Inc.,