A large part of managerial accounting is the allocation of overhead costs and expenses to produced goods. Many different methods exist for overhead expense allocation. While new systems may come along in managerial accounting, tried-and-true allocation methods are still common among businesses. Companies will often select an overhead expense allocation method based on the goods they produce.
A standard allocation method uses a predetermined rate to allocate overhead expenses. Accountants and operational managers will create a production budgets to outline how much each overhead expense should be during a specific period. Dividing the budgeted amounts by a cost driver will represent how much budgeted overhead to allocate for produced goods. A cost driver may be machine hours or labor hours, for example. Actual overhead costs and standard overhead cost comparisons help determine why and where variances occurred.
Process allocation allocates overhead expenses by the number and types of processes necessary to produce goods. Processes may be refining, finishing and packaging of goods during production. Managerial accountants allocate overhead based on the amount spent for each production process. This increases the cost for a batch of goods produced through a company’s manufacturing system.
Activity-based allocations focus on the selection of any activity that can increase costs or expenses of produced goods. Each activity will result in a specific amount of overhead expense. Managerial accountants allocate these expenses based on how much of the activity a good or service requires. For example, a product may use 2 machine hours for production. The utilities expense for the machine is $1,000 for 500 hours. Producing 100 units results in $200 of utilities expense allocated to these goods.
Hybrid methods may exist between these traditional expense allocation methods. Managerial accounting tools do not fall under any national accounting standard or requirements. Companies can allocate costs and expenses in a manner that works best for their operations. The only caveat with creating an expense allocation is to include all production expenses and avoid the inclusion of any period expenses. The latter expenses go on the income statement and are not production costs.