In calculating product costs, actual direct materials and actual direct labor are charged to the Work in Process account; however, an estimated amount of overhead is charged to the account. Why is overhead accounted for differently than the other costs of production?

Question

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Answer 1

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Direct material and direct labor costs are incurred as production takes place; therefore, they present no particular challenge to the product costing system. Using appropriate source documents, management can easily identify the amount of material and labor costs incurred in producing any product or service at the time production is completed. However, actual overhead costs may be incurred at a different time than the time when goods are being made. For example, production takes place throughout the year, but factory depreciation is recorded only once each year in December. Assigning all of the depreciation expense to December alone would overstate the cost of December production and understate the cost of production during the other months. Because of this timing problem, companies use a predetermined overhead rate to assign an estimated amount of overhead to production throughout the year; this reduces the distortions that will occur if actual costs are used.