We have actually previously discussed cost objects and assigning costs to expense objects. One object that is used frequently by project costing.

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Job costingis a price allocation an approach used by suppliers that make custom products. Imagine a cabinet maker who renders custom cabinets for homes. Each cabinet is custom built based upon measurements made within the customer’s home. All work require different amounts of material, labor, and also overhead. Therefore, every job has actually a unique complete cost.

Direct costs are simple to entrust to jobs. It is basic to calculate the total cost of straight materials based on the products used in the job. Companies usejob cost sheets to document the price of materials used ~ above the job.

Direct labor is easy to calculate as we know exactly how much every of the employee earns per hour and also how plenty of hours the employees functioned on the job. Employees monitor which work they space working on transparent the week so that direct labor prices can be added to the job expense sheets.

Overhead can cause problems for institutions that use project costing. There is no allocating overhead to jobs, we carry out not have specific idea that the price of the job. Because overhead is together a huge part the the cost of operation a business, us cannot ignore it. So just how do us allocate it?

We could wait until the end of the year, once we understand actual numbers but that go not help us determine if our work are rewarding when they room completed. If we waited till we had actually all the overhead security calculated because that the year, it would be January of 2017 before we recognize if work completed in 2016 were profitable or not. We can’t wait that lengthy if we want to determine if we room making profit on our jobs.

We could use overhead prices for the existing or ahead month and apply those costs to the job, yet what if our overhead prices vary greatly from month to month. For example, what if we gain the yearly renewal because that our insurance plans in March. Those insurance allowance policies expense $100,000. Is it honest to allocate that $100,000 just to the jobs that space completed in in march or April? No, those prices should be allocated come all jobs completed transparent the year, not just those unlucky customers who occurred to ar in order with our agency in in march or April.

If we don’t know the actual costs, how deserve to we allocate overhead reasonably to all of our jobs? We are going to use estimates.

Most businesses finish budgets before the beginning of every year. These budgets incorporate estimated overhead and estimated activity. We deserve to use those estimates to calculated a rate that us can apply to ours jobs. We contact this price thepredetermined overhead rate.

Predetermined overhead rate = estimated Overhead / approximated Activity

The firm can pick any activity it trust will many accurately use the overhead costs. Many companies use straight labor hours or device hours come allocate overhead costs.

Example #1

K’s Premier Cabinets uses job costing to calculation the expense of jobs as they are completed. The company estimates the it will have actually $1,250,000 in overhead costs in 2015. The company believes that employees will work 200,000 hours and also that 150,000 device hours will be used during 2015. Calculate the predetermined overhead rate assuming that the company uses straight labor hrs to point out overhead to jobs.

Predetermined overhead price is estimated overhead split by estimated activity. The example states that estimated activity is 200,000 direct labor hours.

$1,250,000 / 200,000 straight labor hours = $6.25 per straight labor hour (don’t forget to brand your numbers)

Applying the predetermined overhead rate to jobs

Alright, therefore we have a rate. Currently what?

We must use the price to our jobs. The rate from our example over is $6.25 per straight labor hour. How do we use this to our jobs? based on the direct labor hours worked on the job. Because that each straight labor hour worked, us will include $6.25 the overhead to the job.

Applied overhead is overhead added to a project by acquisition the predetermined overhead rate multiplied by theactual activity. Applied overhead is included to straight materials and also direct labor to calculate full job cost.

Total Job cost = straight Materials + direct Labor + applied Overhead

Every time a project is completed, overhead is applied to the job. The total cost of all the tasks completed over the food of the year is cost of goods sold.

Example #2

K’s Premier cabinet completes project #322 top top July 7. The job provided 45 straight labor hours and also 30 an equipment hours. The project consumed $1,800 worth of materials. The average direct labor price is $18.00 per hour and the firm uses the predetermined overhead price calculated in instance #1. Calculation the complete cost of project #322.

There room three materials of job cost: straight materials, straight labor and also applied overhead.

We are told that direct materials space $1,800.

We have to calculate total direct labor cost. Straight labor is a variable cost. Our price is $18.00 per direct labor hour. Ours driver is 45 hours. If us calculate price x activity, our complete direct labor cost for task #322 is:

$18.00 per straight labor hour X 45 straight labor hours = $810

Lastly, we just apply overhead to the job. Overhead is used by taking our predetermined overhead rate and multiplying it by activity. We are given task for straight labor hours and for device hours. I m sorry one carry out we use? Remember when I claimed to label your answer? This is exactly why it is so vital to label your rate! so what was our rate?

$6.25 per straight labor hour

Therefore, we room going to apply the rate based upon direct labor hours.

$6.25 per direct labor hour X 45 straight labor hrs = $281.25

We now have the components of job cost. Now to add them up and see what the complete cost the the task is.

Direct materials = $1,800 straight labor = $810 applied overhead = $281.25 Total job price = $2,891.25

Final Thoughts

One of the most essential pieces that advice ns can give you about allocating overhead utilizing a predetermined overhead price is maintaining the terminology straight in your mind.

Estimated overhead is calculated in ~ the start of the year before any kind of work begins. Applied overhead is calculated throughout the year as jobs are perfect and included to the expense of the jobs.

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First calculate your predetermined overhead rate using estimates and also LABEL your ANSWER! Then use overhead to work by utilizing the predetermined overhead rate and actual activity.