 In this presentation, we will allocate overhead to jobs using a predetermined overhead rate, which we will see how to calculate. First, we want to take a look at the overhead process, the procedures that the overhead will go through in order to record the overhead and then allocate the overhead. The first thing we're going to do at the beginning of a time period at the beginning of a month or period is to set the predetermined rate. Then we're going go ahead and record the actual overhead that we are going to incur and then we're going to apply estimated overhead to specific jobs. Now note that these two don't necessarily happen one after the other, but it's useful to think of them happening one after the other because it's useful and that's how we've presented it here. We've taken a look at the recording of actual overhead so far because we can think of that being the issue we're going to have. 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Now as we go through the month however remember that these two things are kind of happening at the same time meaning we're incurring overhead costs all the time anything that's a cost on the factory is a form of overhead costs and we're working on jobs and therefore applying the overhead all the time. So we first need to do at the beginning of the month is really set the predetermined overhead rate so we have it at any given time anytime we have a job we can't really wait to know what overhead is going to be at the end of the month that's not that's not something we can do. What we need to do is look at some type of estimate from the prior time period and estimates going forward so we're probably going to use information from the past and basically projections in the future to determine what the overhead will be and use some type of rate some type of estimate that we're then going to use to apply out the overhead as we go because we can't apply out the overhead on the actual numbers here because the month is an over yet and until the month is over we don't really know what overhead is going to be so we have to use this estimate so we need this estimate kind of at the beginning of the month we need to project the estimate and then we're going to record the actual overhead that we have within the overhead but we're also going to apply out as we go as we go through the month as we get new jobs we're going to apply overhead out as we go and then we're going to have the adjust the under overhead because this is an estimate because we're going to make here a predetermined overhead estimate and apply out the overhead two jobs based on that estimate then we're going to have an under over applied amount and we're going to have to deal with that in some way we'll have some type of adjusting entry here so at this point we're really looking to set the predetermined overhead rate so that we can apply out the estimated overhead now I wanted to put these two together because although this is done first typically I want to have these two together because they kind of apply to each other we want to set the rate in order to apply out the overhead two jobs so we're going to set the predetermined overhead rate so the predetermined overhead rate formula is simply going to be the estimated overhead cost divided by the estimated activity base so first what does that mean estimated overhead cost what we would like to do is have the actual overhead cost of course but if we're talking about this month of operations we don't know what the actual overhead cost is going to be and you know we might be able to say what it is up until this point it might include indirect materials indirect labor some of the stuff might be in there but it's not going to include those things like depreciation which we don't record until the end of the month it's not going to include like utilities on on the factory which isn't in there until the end of the month those things need to be allocated out as well so we can't really use the actual cost because we don't know what it is till the end and we have to start tracking costs because we need to keep the cost tracked as we go so then we need an estimate so what we're doing is basically saying what do you think total overhead will be as of the end of the month what will total overhead be as of the end of the month and we want to predict what it will be so that we can use that to allocate out uh usually we'll start with last month probably and then we'll try to project as to whether we're going to have an increase or decrease based on future events so anytime we have an estimate it's probably going to be starting with past data and then we're going to look at what's going to change in the future and we're going to come up with estimated overhead so we're probably going to add up all the stuff that went in the overhead last month you know all the indirect labor indirect materials all the other stuff and then try to adjust it to what we think will be adjusted for this month and come up with our estimated then we're going to divide by the estimated activity base and then what is that what's an estimated activity base now this is based on the idea that we need something to tell us how big one job is to another so in other words if if we had just you know if we if we think we're going to work on 10 jobs why can't we just take this number our estimated total overhead and divide it by 10 if we have 10 construction jobs we can just divide it by 10 and allocate that and it'll be an even allocation to how many jobs we think we're going to have but we can't really do that because even if we knew that we were only going to have 10 jobs the jobs are all going to be different in size that's the whole point of a job cost system they're all they're not the same size so how do I allocate more cost to a larger job and less cost to a smaller job and how are we going to do that so to do that we have to see some kind of factor that's going to tell us how big how relatively large one job is to another and that's going to be the activity base so typical activity bases for example it's going to be like a direct labor or possibly the amount of material we use so in other words if we think about how much labor was used in a job whether by cost of labor or by hours worked on the job those are going to mean that more labor is going to be worked on larger jobs and let's labor on smaller jobs to hopefully typically and therefore we can use that as some kind of ratio as a ratio to know how much of the overhead then we should allocate we should allocate more overhead to the job that has more labor cost to it because the job that has more labor cost is probably larger and therefore deserves more overhead which was probably actually used in the job if and we could have the same rationale for materials if this mature if this job used more materials then it's probably a bigger job and it probably has more overhead that should be allocated to it so what we're using is some type of activity base either direct labor or or direct or direct materials typically and we're going to use a ratio to help us allocate this so we're going to say this is the estimated overhead divided by whatever activity base and then we'll use that to allocate so let's see what that looks like we're going to say that our predetermined overhead rate is going to be 1.6 so let's see what that means here now we're going to take the direct labor that we had calculated by job this is the direct labor that we have applied directly to each of these jobs and we're going to use that to apply out the overhead using the estimated overhead or the predetermined overhead rate we determined to be 1.6 so note that this predetermined overhead rate can be given to the total here meaning if we look at the direct labor for all of the jobs we've got we've got the 4200 summing up all the jobs we can take that of course and multiply it times the 1.6 so we can take the 4200 times 1.6 and that'll give us the 6020 and we can multiply each one of these jobs to give us a total for each job that's going to total up to that 607.20 and so that's going to be the total now it's important this number here is all we need to make the journal entry because the journal entry what we're going to do is we're going to be moving this from the overhead account to the work in process account but we need this worksheet in order to tell us how much of that overhead should be applied to each job so remember every time we transfer something to work in process it needs to be supported by the jobs and this will be the worksheet to do that also remember that although we're using direct labor the overhead has nothing to do with direct labor the overhead is just using direct labor as a means to tell us how big one job is in relationship to another job it's just basically a ratio analysis that we can we can think of basically we're basically saying you know this this particular job is 1200 of the total divided by the total for two zero zero it's that percentage if we take that percentage times the overhead we would take this times the 6720 this number here that's going to give us the 1920 so we're just using the relative ratios in essence here that's what the predetermined overhead rate is based on in order to allocate in the proper amounts to these based on relative size of the job relative size being determined by the direct labor that's being applied to each of them now note that we could see this actually on the job sheet as well so this is job number 15 this is just an example job sheet so but just note that we could see in the overhead section every job sheet is going to be allocating the cost the cost being direct materials labor and overhead and we could note on the overhead here that it's going to be 160 or 1.6 of the direct labor and so these numbers on this particular job cost sheet are just taking this number times 160 percent or 1.6 and we could sum those up as well also note again this looks like an invoice it's not really an invoice here but it an invoice could use this as a basis to it meaning this would be the cost this is the actual cost to us of the production of the inventory we might use this and say well we we mark it up 30 or 40 percent and that's how we come up to the the cost so if we had a job cost in terms of construction that would be a fairly transparent way to do this we'd say hey this is how much direct material this is how much direct labor this is our overhead this is the total cost we're going to mark it up you know 30 or 40 percent or whatever our markup is that's the revenue we get that's one way that we could construct an invoice and that would be based on this information note that the overhead no matter how you look at it is going to be the most difficult thing to explain because people are going to say well you know you took the direct labor and multiplied it times 160 and charged me for direct labor twice it seems like it seems like you charged me three times you know two and a half times for direct labor or something like that and it's like and and the response to that of course is no the overhead is not anything to do with the direct labor where the direct labor again is just used as a ratio it's an estimate for us to allocate out the overhead to jobs based on relative size based on how much labor is being used in them okay so if we take a look at the journal entry then we're going to say that the work in process is going to be debited increasing the work in process we're basically moving this information from the factory overhead to the work in process so work in process has a debit balance we're going to increase it with a debit because the inventory is increasing note that the debit is not for 7100 and the and might ask well why isn't it for the amount that's in factory overhead and the the reason for that is one we wouldn't know this number again until the end of the month and so as we as we do this allocation we may do this allocation multiple times for each job and so we wouldn't know exactly what's in factory overhead therefore we had to make an estimate the estimate is never going to match what actual factory overhead is it can only be close unless we were perfect which is unlikely so that would be so it's always going to be somewhat off here so we're going to we're going to put it into work in process and we're going to take it out of of factory overhead this being an inventory type account an asset account has a debit balance we're going to decrease it doing the opposite thing to it a credit so we're moving it from here to here from one inventory account in essence to another whenever we move something to the work in process account it needs to be able to be supported by the jobs if we post the journal entry then we're going to say that the work in process account here is going to be debited in the gl so the gl for the work in process was at 6,430 it's going to increase by that 6,722 13,150 so that's what we have here and then the factory overhead is going to be credited decreasing it it was at 7,100 it's going to go down by 6,722 380 that's what's left in factory overhead now we're going to say that for this particular month this is all the activity in factory overhead so we've done all the we've allocated all the cost the actual cost to the factory overhead and or we've actually incurred the actual cost and recorded them and then we've allocated those costs out to work in process and to the related jobs in order to allow us to allocate to the to the to the work in process remember that the work in process account needs to be supported not only by a gl account but actually by the jobs as well and that's why we couldn't post directly to work in process when we incurred these costs but had to put them into the factory overhead and then use this allocation method to know which jobs we can apply to so that we can do this kind of lump sum journal entry this lump sum journal entry is going to be supported by backed up by job cost sheets