Question

Manufacturer of custom hot tubs and spas. What factors should be considered in selecting an allocation base to be used in computing a predetermined overhead rate. Would you expect the amount of applied overhead for a period to equal the actual overhead cost of the period? Why or Why not? Provide two reasons why overhead might be underapplied in a given period.

Answer 1

Answer:

1. Factors to be considered in selecting an allocation base to be used in computing a predetermined overhead rate are:

the cost drivers.

2. The amount of applied overhead for a period does not necessarily have to equal the actual overhead cost of the same period.  The reason for the difference is that the applied overhead is based on a predetermined rate(s) and a level or volume of activities, whereas the actual overhead cost is not based on a predetermined rate and a level of activities.

3. Overhead might be underapplied in a given period when the volume of activity between the budgeted and the actual are not equal and when the spending rates differ.

Explanation:

The cost driver is the factor that creates or drives an activity and its associated costs. It is, therefore, the root cause why a particular cost occurs during the activity.   This shows that activities consume resources, whereas products and customers consume activities.  Examples of cost drivers include the direct labor hours, the direct machine hours, and the number of machine set-ups.