What is the difference between actual overhead and applied overhead?

Definition of Actual Overhead

In the context of actual and applied overhead, actual overhead refers to a manufacturer's indirect manufacturing costs. (Costs that are outside of the manufacturing operations, such as marketing and general management, are expenses of the accounting period and are not applied or assigned to products.)

Actual overhead are the manufacturing costs other than direct materials and direct labor. Since the overhead costs are not directly traceable to products, the overhead costs must be allocated, assigned, or applied to goods produced.

Examples of Actual Overhead

A few of the many overhead costs are:

  • Electricity used to power the production equipment
  • Natural gas to heat the production facilities
  • Depreciation of the production equipment and facilities
  • Normal repairs and maintenance of the production equipment
  • Salaries and benefits for production supervisors

These actual costs will be recorded in general ledger accounts as the costs are incurred.

Definition of Applied Overhead

Applied overhead is the amount of the manufacturing overhead that is assigned to the goods produced. This is usually done by using a predetermined annual overhead rate.

Example of Applied Overhead

Let's assume that a company expects to have $800,000 of overhead costs in the upcoming year. It also expects that it will have its normal 16,000 of production machine hours during the upcoming year. As a result, the company will apply, allocate, or assign overhead to the goods manufactured using a predetermined overhead rate of $50 ($800,000 divided by 16,000) for every production machine hour used.

Since the future overhead costs and future number of machine hours were not known with certainty, and since the actual machine hours will not occur uniformly throughout the year, there will always be a difference between the actual overhead costs incurred and the amount of overhead applied to the manufactured goods. Hopefully, the differences will be not be significant at the end of the accounting year.