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Matthew 11:28
Come to me,
all of you who are weary
and loaded down with burdens,
and I will give you rest.
Learning Objectives
Why and how are overhead costs allocated to products and services?
What causes underapplied or overapplied overhead, and how is it
treated at the end of a period?
What impact do different capacity measures have on setting
predetermined overhead rates?
How is the high-low method used in analyzing mixed costs?
How do managers use flexible budgets to set predetermined overhead
rates?
How do absorption and variable costing differ?
How do changes in sales or production levels affect net income
computed under absorption and variable costing?
How is the least squares regression used in analyzing mixed costs?
(Appendix)
CostMethods
Costing allocation methods
Actual Costing
Normal Costing
Standard Costing
Actual vs Normal vs Standard
Product Cost
Direct Materials
Direct Labor
Overhead
What is Overhead?
Definition
What are other names of overhead?
Give 5 examples of overhead.
Examples
Indirect labor, indirect materials
Total budgeted
Predetermined overhead
Overhead = Activity level
Rate (Volume)
1. Based to be used
2. Activity level selection
3. Including or excluding fixed overhead
4. Use of single rate or several rates
5. Use of separate rates for service
activities
Based to be used cost driver
a. Physical output
b. Direct materials cost
c. Direct labor cost
d. Direct labor hours
e. Machine hours
f. Transactions or activities (ABC)
Desmond Corp. estimates that its production
for the coming year will be 10,000 widgets,
which is 80% of normal capacity, with the
following unit costs: materials, $40; direct
labor, $60. Direct labor is paid at the rate of
$24 per hour. The widget shaper, the most
expensive piece of machinery, must be run for
20 minutes to produce one widget. Total
estimated overhead is expected to be
$800,000.
Required
Compute the overhead rate for each of the following bases, using the
expected actual capacity activity level:
(1) physical output
(2) materials cost
(3) direct labor cost
(4) direct labor hours
(5) machine hours
o SOLUTION
Assignment please answer
exercises 13 & 14
Enumerate the
four capacity levels.
Activity level selection
a. Theoretical capacity
b. Practical Capacity
c. Expected Actual Capacity
d. Normal Capacity
Theoretical capacity
Required:
Compute the overhead application rate for fixed, variable, and total overhead per
direct labor hour, using both the normal capacity and the expected actual
capacity activity levels.
OH Application
Applied overhead is the amount of overhead
assigned to Work in Process Inventory using
the activity that was employed to develop the
application rate.
Overhead Account
(Combined Fixed/Variable)
Actual Overhead Applied Overhead
Variable xxx
Variable xxx
Fixed xxx
Fixed xxx
differences
Actual OH > Applied OH
underapplied
Manufacturing OH xxx
COGS xxx
To close overapplied OH
COGS xxx
Manufacturing OH xxx
To close underapplied OH
If overhead is underapplied
Cost of Goods Sold increases
Income decreases
If overhead is overapplied
Cost of Goods Sold decreases
Income increases
Entries - material
Manufacturing OH xxx
WIP xxx
FGI xxx
COGS xxx
To close overapplied OH
WIP xxx
FGI xxx
COGS xxx
Manufacturing OH xxx
To close underapplied OH
Assignment
Group Exercise/Problem
1 11
2 12
3 13
4 14
5 15
6 16
7 17
8 18
9 19
10 20
A mixed cost contains both
a variable and fixed component
variable
Mixed Cost $
fixed
# of Units
Separating Mixed Costs
To determine variable and fixed predetermined overhead
rates, separate mixed costs into variable and fixed
components
Use formula for a straight line:
y = a + bX
y = total cost
a = fixed portion of total cost
b = variable cost
X = activity base to which y is related
Methods for Separating Mixed Costs
High-Low Method Least Squares Regression
Actual cost observations Analysis
Considers only two data
Statistical technique that
points
analyzes the relationship
Highest and lowest levels of
between dependent and
activity
independent variables
Disregard outliers when
Dependent variableCost
analyzing mixed costs
Independent variables
Activities
Regression line provides line
of best fit for the data
Using the HighLow Method ex. 3-6
Machine
Hours Cost
High 9,000 $3,500
Low 4,600 2,180
Difference 4,400 $1,320
$1,320
= $0.30/unit Variable cost per unit
4,400
3,500 = a + ($0.30)(9,000)
a = 800 Fixed cost
Y = $800 + $0.30X (X = machine hours)
Please answer
exercises 3-21 to 3-23
Regression Analysis Assumptions
More data
points
mean a
better
estimate of
total costs
(X = machine hours)
Please answer exercises 34-35
Flexible Budgets
Flexible Budgets
Separate overhead costs into fixed and variable components
in order to estimate the amount of overhead at various levels
of the denominator activity
Shows manufacturing overhead costs and cost behavior
Separates costs into fixed and variable elements
Provides budgeted costs at various activity levels
Shows impact of a change in the denominator level of activity
Preparing a Flexible Budget
1. Separate mixed costs into variable and fixed elements
2. Determine the a + bX cost formula
3. Select several potential levels of activity within the
relevant range
4. Determine total cost expected at each of the activity levels
Flexible Budgets
Absorption or Full Costing Variable or Direct Costing
External use Internal use
GAAP Not GAAP
Classify by Function Classify by Behavior
Cost of goods sold Variable
Selling expense Fixed
Administrative expense
Absorption vs. Variable Costing
Absorption or Full Variable or Direct
Product costs Product costs
Selling Selling
General General
Administrative Administrative
Absorption Costing Variable Costing
Fixed manufacturing Fixed manufacturing
overhead is a product cost overhead is a period cost
Variable operating expenses
are subtracted from product
contribution margin to equal
contribution margin
Income Statement
Absorption Costing
Product Costs
Sales Direct Material
Less: Cost of Goods Sold Direct Labor
Gross Profit Fixed and Variable
Less: Operating Expenses Mfg. Overhead
Net Income
Period Costs
Selling, General,
Administrative
Sales Direct Material
Less: Variable Cost of Goods Sold Direct Labor
Product Contribution Margin Variable Mfg.
Overhead
Less: Variable Operating Expenses
Contribution Margin Selling,
Selling
General,
General
Less: Fixed Mfg. Overhead Administration
Administrative
Less: Fixed Operating Expenses
Net Income
Illustration
Given:
2010 2011 2012
Production (units) 1,000 1,000 1,000
Sales (units) 1,000 800 1,200