Manufacturing overheads are the indirect cost of production. Examples of these costs are depreciation of plant and machinery, electricity bills, and purchase of factory equipment, among others. It is difficult to trace the production overheads to the units of output produced. However, it is important that they be allocated to the units produced. Thus, cost accountants of a company need to come up with absorption rates for allocating the manufacturing overheads to the number of units produced. Allocation of overheads plays a significant role in determining accurately and with completeness the total cost of production. It is because not only variable costs can bring good to their useable state.
Further, the allocation of overheads aids management in setting the price of goods and services because the selling price will be computed as a mark-up of the per-unit cost of production. Therefore, the allocation of overheads is significant in making a pricing decision. Finally, the allocation of overheads to various cost centers is an important management control tool since various heads of cost centers are responsible for managing the costs of their departments. An important consideration that one needs to make when allocating overheads to various cost centers is the consumption of the various overheads by the cost centers. A cost center that consumes more should be allocated more overhead than other centers. For instance, a center that consumes a lot of electricity should be allocated more electricity bills. Therefore, the allocation of overheads should ensure fairness in the distribution of the overheads to the various cost centers.