How should indirect costs (overhead) be allocated to jobs?

How should indirect costs (overhead) be allocated to jobs?

• A. Allocate overhead by applying a single fixed rate to all jobs without a base.
• B. Choose a base (e.g., direct labor hours, direct costs, machine hours) and apply an overhead rate to allocate indirect costs to each job.
• C. Ignore overhead in job costing.
• D. Allocate overhead only to the largest job.

Answer: (B)

Indirect costs must be allocated to jobs using an overhead rate tied to a base that reflects how those costs are incurred. The idea is to choose an activity base—such as direct labor hours, direct costs, or machine hours—that drives overhead consumption, then compute an overhead rate by dividing estimated overhead by the estimated total amount of that base. Apply that rate to each job by multiplying the base actually used by the job. This distributes overhead in proportion to the work a job requires and keeps costs aligned with actual activity, which supports accurate costing and pricing. Using a single fixed rate with no base ignores differences in activity between jobs and can over- or under-absorb overhead. Ignoring overhead altogether leaves a gap in total cost. Allocating overhead only to the largest job distortively skews costs away from other jobs.

Indirect costs must be allocated to jobs using an overhead rate tied to a base that reflects how those costs are incurred. The idea is to choose an activity base—such as direct labor hours, direct costs, or machine hours—that drives overhead consumption, then compute an overhead rate by dividing estimated overhead by the estimated total amount of that base. Apply that rate to each job by multiplying the base actually used by the job. This distributes overhead in proportion to the work a job requires and keeps costs aligned with actual activity, which supports accurate costing and pricing.

Using a single fixed rate with no base ignores differences in activity between jobs and can over- or under-absorb overhead. Ignoring overhead altogether leaves a gap in total cost. Allocating overhead only to the largest job distortively skews costs away from other jobs.