GAAP dictates a particular manner in which manufacturing overhead is reported on all financial statements obtained through financial accounts. However, in order to truly assess costs associated with production managerial accountants must utilize different techniques. Managerial accounting utilizes various costing methods in order to allocate manufacturing overhead charges with production. These techniques better equip decision-makers within firms with appropriate information needed to make the best decisions possible.
Williams, Haka, and Bettner (2015), describe these reasons as to why overhead costs are allocated to certain products or services using an application rate rather than dividing total overhead cost by units produced. The first reason is that units and costs produced are not compiled until the end of the year. This leaves management devoid of essential information needed to make important decisions throughout the year. The second reason is that not all services or produced consume an equal amount of overhead. Finally, anticipating overhead per product is helpful in making decisions regarding the use of overhead in production processes. Improper pricing is one of the most devastating results to occur if overhead is improperly applied to products or services.
An appropriate overhead application rate is determined through expressing a relationship between some activity base and relating to the production process and overhead costs (Williams et al.,2015). Firms must ensure that an activity base is selected that best matches individual capabilities and needs. Additionally, firms must ensure wise estimates are made regarding overhead costs. “For overhead application rates to provide reliable results, any activity base chosen to compute an application rate must be a significant “driver” of overhead costs” (Williams et al.,2015, pg.764). It is important to choose a base that is a prime driver, or directly related to, overhead costs.
For calculation purposes using one cost driver for all calculations may seem simplest. However, it is important to understand that this technique is likely to yield just that, “simple” results. In order for a firm to remain competitive and make well informed decisions, using multiple cost drivers is recommended. The objective of this type of cost allocation is to align overhead costs with the product, activity, job, or process generating such costs. This method is more likely to result in more accurate information pertaining to the allocation of overhead costs.



Reference
Williams, J. R., Haka, S. F., Bettner, M. S., & Carcello, J. V. (2015). Financial & managerial accounting: The basis for business decisions (17th ed.). New York, NY: McGraw-Hill Companies.