BUSMGT713 Chap.6 Overhead application rates and job costing
Overhead application rates and job costing
Week 3 of the course covers overhead allocation, relevant costs and job costing, and this chapter takes the first of those. A laboratory cannot trace the cost of an analytical instrument or a preparation room to a single test, so it budgets each cost pool, divides it by a budgeted allocation base and charges every job at the resulting rate.
The Week 3 workshop contrasts one combined rate over estimated hours with several rates, each pool divided by its own driver, and finds that an average rate ignores how differently jobs use resources.
This chapter applies the contrast to departments in a food-testing laboratory: one plant-wide overhead rate on labour hours against a departmental rate for an instrument bench charged per instrument hour and a sample-preparation rate charged per labour hour. When the lab bills a flat fee per test, the costing choice decides which tests look profitable, so it changes what the lab should promote and how it should set fees.
The practice mid-term asks for rates on different bases, costs per project and reasons to allocate with care, and the chapter rehearses each.
What this chapter covers
- 01
Cost pools, allocation bases and predetermined overhead rates
- 02
One plant-wide overhead rate on labour hours
- 03
Departmental rates for an instrument bench and a preparation room
- 04
Building a job cost sheet line by line
- 05
Profit per test under a flat fee
- 06
Reasons to allocate overhead with care: pricing, profitability and control
Worked example · free
Kauri Coast Food Lab: is the Manual test really a loss-maker?
- +2Plant-wide: $20 consumables + 3 x $35 labour + 3 x $33 overhead = $20 + $105 + $99 = $224.
- +2Departmental: $20 + $105 + 3 x $15 preparation + 0.5 x $20 instrument = $20 + $105 + $45 + $10 = $180.
- +2Profit at $200: a $24 loss under the plant-wide rate but a $20 profit under departmental rates, because the plant-wide rate charges instrument overhead on labour hours, which the Manual test has plenty of.
Key terms
- Plant-wide overhead rate
- One rate for the whole organisation, total budgeted overhead divided by a single base such as labour hours.
- Departmental overhead rate
- A rate calculated separately for each department from its own overhead and its own activity base.
- Allocation base
- The activity measure, for example instrument hours or labour hours, used to share a cost pool among jobs.
- Job cost sheet
- A record that accumulates the consumables, labour and every overhead charge for one job or test.
- Cost pool
- A grouping of overhead costs with a common cause, such as an instrument bench, that is charged out through a single rate.
Overhead application rates and job costing FAQ
What is an overhead application rate?
It is a budgeted cost pool divided by the budgeted quantity of the activity chosen to share it out, such as hours or projects. Each job is then charged that rate times its own use of the activity. The practice mid-term asks for three such rates, each on a different base, before costing two kinds of project.
When does a plant-wide overhead rate distort job costs?
It distorts them when jobs use departments in different proportions. A rate on labour hours loads machine overhead onto labour-heavy work, so a hand-prepared test is charged for instruments it hardly touches, while a machine-heavy test escapes most of that cost. Departmental rates follow each department's own driver and remove the distortion.
How do I choose an allocation base for a cost pool?
Choose the activity that causes the cost to be incurred. Instrument cost follows instrument hours, preparation overhead follows labour hours, and costs incurred once per client follow the number of jobs. Where nothing drives a cost, pick a broad measurable base and say plainly that it is an approximation rather than a cause.
Why does a flat fee make overhead allocation matter more?
With a fixed price per job, revenue does not rise with cost, so any error in the cost lands directly in reported profit. A test can look loss-making under a plant-wide rate and profitable under departmental rates, which changes which services the business should promote, drop or reprice.
Does a departmental costing system change total overhead?
No. Total budgeted overhead stays the same; only its spread across jobs changes. That is a useful check in an answer: after costing with departmental rates, the overhead charged across the whole budget should add back to the department totals you started with, give or take rounding.
Assessment move
Begin by listing every cost pool with its budgeted cost, its base and the base quantity, and compute each rate on its own line with its unit. Next, for each job, write how much it uses of every base; this stops you charging a labour-hour rate where instrument hours drive the cost. Build the job cost sheet line by line, consumables first, then labour, then each department's overhead.
Repeat the job under the plant-wide rate and record the difference. Compare the cost with the price, especially when the price is a flat fee, and finish with one sentence on what the gap means for pricing or for which service to promote. Rework the routine on a second set of numbers under time pressure.
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