Factory Overhead

Planned, Applied & Actual

Chapter 9

This chapter
Discusses the methods, procedures and

bases available for applying factory overhead Describes methods and procedures for classifying and accumulating actual factory overhead Shows computations for over or underapplied factory overhead Analyzes the total net variance

Factory Overhead
Factory overhead is generally defined as:

Indirect materials Indirect labor All other factory expenses that cannot conveniently be identified with specific jobs or products.

Factory Overhead
Also known as:

Factory burden Manufacturing expense Manufacturing overhead Factory expense Indirect manufacturing cost

 Factory Overhead possesses two

characteristics:

Relationship with product

Difficult to trace factory overheads to certain jobs or products. A predetermined overhead rate permits an equitable and logical allocation , therewith abandoning the use of actual cost for costing purposes.

Relationship with volume

Fixed and variable expenses (Total & per unit)

Predetermined Factory Overhead Rate

Job Order Costing Total overhead cost are estimated Total estimated overhead cost are related to direct labor dollars, direct labor hours, etc to express it as a rate Process Costing Can produce product cost without the use of overhead rates Applying predetermined rates are recommended as they speed up unit product cost calculations

Factors to be considered in Selection of Overhead rates

Base to be used

Physical output
Estimated factory overhead Estimated units of production = factory overhead/unit

Direct materials cost

Estimated factory overhead *100 = % of overhead/direct material cost Estimated material cost

Factors to be considered in Selection of Overhead rates

Direct labor cost

Estimated factory overhead *100 = % of overhead/direct labor cost Estimated Direct labor cost

Direct labor costs = Direct labor hours* hourly wage rate

Direct labor hours

Estimated factory overhead Estimated Direct labor hours

= Rate per direct labor hour

Machine hours

Estimated factory overhead Estimated machine hours

= Rate per machine hour

Factors to be considered in Selection of Overhead rates

Activity level selection Normal capacity long-term approach

An overhead rate in which expenses and production are based on average utilization of the physical plant over a time period long enough to level out the highs and lows that occur in every business venture The rate does not change because of changes in actual production

Factors to be considered in Selection of Overhead rates

Expected actual capacity short-term
approach
A rate in which overhead and production are

based on the expected actual output for the next production period. The use of predetermined rate based on expected actual production is often due to the difficulty of judging current performance on a long range or normal capacity.

Example
Normal capacity= 150,000 DLH

Actual capacity= 116,000 hours

Expected actual capacity= 120,000DLH Fixed expense= $120,000 Variable expense= $0.50/ DLH

Solution
Fixed expense Variable expense: 150,000 hrs*0.50 120,000 hrs*0.50
Total estimated overhead Estimated DLHs Factory overhead/hr Fixed overhead/ hr

120,000
75,000

120,000

______ 195,000 150,000 $1.30 $0.80

60,000 ______ 180,000 120,000 $1.50 $1.00

Factors to be considered in Selection of Overhead rates

Including or excluding of fixed overhead

Absorption costing Fixed and variable expenses both are included in overhead rates.
Direct costing Only variable overhead is included in overhead rates. The fixed expense does not become a product cost but is treated as a period cost.

Calculation of Factory Overhead Rate

Identifying the base to be used Estimating the Activity level & Expenses Classifying Expenses as Fixed or Variable Establishing the Factory Overhead Rate

Calculation of Factory Overhead Rate

Estimated factory overhead Estimated Direct labor hours

= Rate per direct labor hour

Factory overhead can be broken down into its fixed

and variable components:

Estimated fixed factory overhead Estimated Direct labor hours

= fixed portion of factory overhead rate

Estimated variable factory overhead = variable portion of factory overhead rate Estimated Direct labor hours

Factory Overhead Actual

Accumulation of Actual Factory Overhead The basic purpose for accumulating factory overhead is the gathering of information for purposes of control.
Control in turn requires :
Reporting costs to the individual department heads

responsible for them And making comparisons with the amount budgeted for the level of operations achieved.

Accounting for Actual Factory Overhead

Steps involved in the accounting for factory

overhead transactions are: Analysis Journalizing Posting the factory overhead subsidiary ledger and the factory overhead general ledger control account.

 The principal source documents for recording

overhead in the journal are: Purchase vouchers Materials requisitions Labor time tickets General journal voucher.

The mechanics of applying Factory overhead

Factory overhead is applied after direct

materials and direct labor costs is available

Work in process Applied Factory Overhead Applied Factory Overhead Factory Overhead Control

The mechanics of applying Factory overhead

A debit balance indicates that overhead has been underapplied
A credit balance indicates that overhead has been

over applied
These over- and under applied must be analyzed

carefully; as they are the source of much information needed by management for controlling and judging the efficiency of operations and the use of available capacity during the particular period.

Disposition of Over or Under applied Factory Overhead

If underapplied (Actual > Applied)

COGS Factory Overhead

If overapplied (Actual < Applied)

Factory Overhead COGS

Assignment
The Carrcroft Company estimates its factory overhead for the

next period at $54,000. it is estimated that 36,000 units will be produced at a material cost of $45,000. Production will require 24,000 direct labor hours at an estimated cost of $120,000. The machines will run about 1,600 hours. Required: the predetermined factory overhead rate based on : Material cost Units of production Machine hours Direct labor cost direct labor hours.

Name five bases used for applying factory overhead. What

factors must be considered in selecting a particular basis?

Variance Analysis
Spending Variance-a variance due to budget

or expense factors Idle capacity Variance- a variance due to volume or activity levels

 Actual factory overhead Spending variance Budget allowance-based on capacity utilized Fixed factory overheads budgeted (in total)$125,000 Variable factory overheads

$292,000
750 unfavorable

(190,000 actual hours* 0.875)

166,250

$291,250
6,250 unfavorable

Idle Capacity Variance Applied Factory overhead(190,000 hrs*1.50) Factory overhead underapplied (292,000-$285,000)

$285,000 _______ $7,000

Spending Variance
The $ 750 is the difference between the actual

factory overhead incurred and the budget allowance estimated for the capacity utilized i.e 190,000 direct labor hours.
The budget figures represents the budget for the

level of the activity attained.

Favorable spending variance- when the actual

overhead is less than the budgeted overhead.

Unfavorable spending variance- when the actual

overhead is more than the budgeted overhead.

Idle Capacity Variance

This occurs when the actual activity is below the

normal capacity.
This should not increase the factory overhead costs

but should be recorded separately and be considered a part of total manufacturing costs.
The idle capacity can be computed by multiplying the

idle hours by the fixed rate per unit.

It can also be computed by multiplying the total

budgeted fixed expense by the idle capacity percentage.

Disposition of Over-or Underapplied Factory Overhead

At the end of the fiscal year , overhead

variances may be:

Treated as a period cost

Or divided between inventories and cost of

goods sold.

Journal Entries
Cost of goods sold

Factory overhead
Or Income Summary Factory overhead