Allocating overhead costs is an essential part of running a business and accurately determining the cost of production. Traditional overhead allocation methods have been used by companies for many years to allocate indirect costs to products or services. In this blog post, we will explore some common traditional overhead allocation methods and how they work.

Category : Overheads allocation methods | Sub Category : Traditional overhead allocation methods Posted on 2024-02-07 21:24:53

Allocating overhead costs is an essential part of running a business and accurately determining the cost of production. Traditional overhead allocation methods have been used by companies for many years to allocate indirect costs to products or services. In this blog post, we will explore some common traditional overhead allocation methods and how they work.

One of the most common traditional overhead allocation methods is the single overhead rate method. This method involves calculating one predetermined overhead rate based on total estimated overhead costs and a chosen cost driver, such as direct labor hours or machine hours. The overhead costs are then allocated to products based on the actual amount of the chosen cost driver used by each product.

Another traditional method is the departmental overhead rate method. With this approach, overhead costs are allocated to different departments within a company based on the specific overhead activities and resources used by each department. Each department is assigned its own overhead rate, which is then applied to the products or services produced by that department.

A third traditional overhead allocation method is the plant-wide overhead rate method. In this method, all overhead costs are combined and allocated to all products or services using a single predetermined overhead rate. This rate is typically based on the total estimated overhead costs and a broad cost driver, such as direct labor hours or machine hours.

While traditional overhead allocation methods have been widely used by companies for many years, they do have some limitations. One of the primary drawbacks is that these methods rely on predetermined rates, which can sometimes lead to inaccurate allocations if the actual overhead costs differ significantly from the estimates. Additionally, traditional methods may not account for the varying complexity of different products or services, leading to distortions in cost allocations.

In conclusion, traditional overhead allocation methods play a crucial role in helping companies determine the true cost of production. While they have been used successfully by many organizations, it's important to be aware of their limitations and consider alternative methods for more accurate cost allocations. By understanding the different traditional overhead allocation methods available, businesses can make more informed decisions and better manage their overhead costs.