A normal cost system applies overhead to jobs _.
A) by multiplying a predetermined overhead rate by the estimated amount of the allocation base incurred by the job.
B) by multiplying a predetermined overhead rate by the actual amount of the allocation base incurred by the job.
C) using the actual amount of overhead caused by each job.
D) using the normal amount of overhead caused by each job.
The Correct Answer and Explanation is :
The correct answer is A) by multiplying a predetermined overhead rate by the estimated amount of the allocation base incurred by the job.
Explanation:
In a normal cost system, overhead is applied to jobs using a predetermined overhead rate. This rate is established at the beginning of the accounting period based on estimated costs and activity levels.
Calculation of Predetermined Overhead Rate:
The predetermined overhead rate is calculated by dividing the estimated total manufacturing overhead costs by the estimated total amount of the allocation base (such as direct labor hours, machine hours, or direct labor costs).
Predetermined Overhead Rate = Estimated Total Manufacturing Overhead / Estimated Total Allocation Base
For example, if a company estimates $500,000 in manufacturing overhead costs and expects 100,000 machine hours, the predetermined overhead rate would be:
$500,000 / 100,000 machine hours = $5 per machine hour
Applying Overhead to Jobs:
Once the predetermined overhead rate is established, it is used to apply overhead to individual jobs by multiplying the rate by the actual amount of the allocation base incurred by the job.
Applied Overhead = Predetermined Overhead Rate × Actual Allocation Base Incurred by the Job
Continuing with the previous example, if a job uses 50 machine hours, the applied overhead would be:
$5 per machine hour × 50 machine hours = $250 applied overhead
Purpose and Benefits:
The use of a predetermined overhead rate allows companies to allocate overhead costs to jobs promptly, facilitating timely job cost information. This approach helps in:
- Cost Control: By applying overhead based on estimated rates, companies can monitor and control overhead costs more effectively.
- Pricing Decisions: Accurate job costing, including applied overhead, assists in setting appropriate prices for products or services.
- Financial Reporting: Applying overhead using predetermined rates ensures consistency and comparability in financial statements.
It’s important to note that the actual overhead incurred may differ from the applied overhead, leading to over-applied or under-applied overhead. These variances are typically adjusted at the end of the accounting period to align the applied overhead with the actual costs incurred.
In summary, a normal cost system applies overhead to jobs by multiplying a predetermined overhead rate by the estimated amount of the allocation base incurred by the job, ensuring efficient and consistent cost allocation throughout the accounting period.