Fixed overhead stays flat regardless of activity: rent, salaried supervisor pay, insurance, depreciation. Variable overhead moves with production volume: indirect materials, utilities tied to machine runtime, overtime supplies. Many cost systems split a single overhead rate into a fixed and a variable component so volume variances are visible separately from spending variances.

Pick the activity that best drives the indirect cost. Labor-intensive shops use direct labor hours or labor dollars; automated factories use machine hours; project-based services often use billable hours. The test is correlation: if doubling the base would roughly double overhead consumption, it is a defensible cost driver. Weak correlation distorts product costs and pricing.

GAAP (FASB ASC 330) requires manufacturing overhead to be capitalized into inventory and only expensed through cost of goods sold when units are sold. Selling and administrative overhead are period expenses. Internal job costing can include any overhead the manager wants for pricing decisions, but the books must still split product costs from period costs for financial reporting.

ABC traces overhead to multiple cost pools (setup, inspection, materials handling, engineering) and assigns each pool to products using its own driver (setups, inspections, moves, engineering hours). It is worth the effort when products differ significantly in complexity, batch size, or support needs and a single plantwide rate cross-subsidizes simple products at the expense of complex ones.

Lower the numerator or grow the denominator. Cut indirect spend through rent renegotiation, supervisor span-of-control reviews, energy efficiency, and shared services. On the denominator, raise utilization of labor hours or machine hours so the same fixed overhead spreads over more activity. Be careful not to cut indirect roles that protect quality, since rework spikes inflate overhead through scrap and warranty.

A rate calculated before the period starts using budgeted overhead and budgeted activity. It allows consistent cost allocation throughout the year without waiting for actual figures. Variances between applied and actual overhead are reconciled at period end, typically to COGS for small amounts or prorated across inventory and COGS for material amounts.

If applied overhead is less than actual, overhead is under-applied and COGS is understated; if applied exceeds actual, overhead is over-applied. Immaterial variances close directly to COGS. Material variances should be prorated among Work-in-Process, Finished Goods, and COGS based on the overhead already loaded in each account so financial statements reflect actual cost.