What is Overhead Application?

Overhead application is the assignment of factory overhead costs to the units produced in a reporting period. The assignment is based on either a standard overhead rate that is used for multiple time periods, or a calculation that is specific to each reporting period. Overhead application is conducted in order to capitalize certain overhead costs into inventory. If the number of units on hand increases by the end of a reporting period, this means that a portion of factory overhead will be carried forward into the next period as an asset.

Example of Overhead Application

Tertiary Corporation produces orange widgets. In its most recent reporting period, it incurred $100,000 of factory overhead costs and produced 20,000 orange widgets. Based on this information, Tertiary’s accountant applies overhead to the widgets at the rate of $5 per widget (calculated as $100,000 factory overhead ÷ 20,000 widgets). Tertiary then sells 15,000 widgets, which means that $75,000 of the factory overhead has now been recognized as an expense through the cost of goods sold account, while the remaining $25,000 of overhead resides in the firm’s finished goods inventory.