Many costs are involved with running a business. Whether you are delivering a service or creating a product, you incur direct costs for supplies and labor. However, not all costs can be directly connected to your product or service. Indirect costs for insurance and administrative support are more easily associated with running the business overall. Applied overhead calculates the indirect costs for a particular business component, such as a product, service or department.
Choose a Cost Object
Applied overhead is allocated to a specific cost object. The cost object is the particular business component that you are calculating costs for such as a product or department. If your company manufactures multiple products, you can calculate the applied overhead for each, or you can calculate the costs of operating a department, like sales or marketing.
General overhead includes costs like rent and utilities. These expenses must be paid to stay in business, but they are not directly involved in delivering a service or producing a product. Applied overhead covers indirect costs such as printing or office supplies for a specific department or costs for operating a machine for a particular product. Applied overhead also can include depreciation and insurance.
Determine Total Overhead
Add up all general business costs that are not directly tied to your cost object. If you are calculating applied overhead for a product, your indirect overhead costs may include materials you need that are not used in the product. For example, assume a manufacturer has $200,000 in total overhead after accounting for all indirect costs.
Compute the Overhead Allocation Rate
Applied overhead requires an activity level that is associated with the cost object. Common activity levels include labor hours or machine hours. Divide the total overhead by the activity level to get the allocation rate. For example, dividing the $200,000 in total overhead by 2,000 machine-use hours will gives you an overhead allocation rate of $100 per machine hour.
Multiply the overhead allocation rate by the actual activity level to get the applied overhead for your cost object. If your overhead allocation rate is $100 per machine hour, then multiply $100 times the number of machine hours for a particular product to get its applied overhead. If one product takes 100 machine hours and another product requires 200 machine hours, then the applied overhead is $10,000 for the first product and $20,000 for the second product.