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/ variable 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?

Preparing the Master Budget

Master or static budget is prepared for a

single level of volume based on best estimate of the level of production and sales for the coming period. The sales budget is the starting point. From the sales budget, production requirements are determined.

Budgeted Income Statement

Sales budget Cost of goods sold budget Production budget Direct materials budget Direct labor budget Factory overhead budget Selling and administrative expenses budget

Sales Budget
This is the basis for

preparing all other budgets. Projects the volume of sales both in units and dollars.

Production Budget
After the sales forecast and inventory levels

have been determined, management can determine production requirements.

Units to be sold
Ending inventory required Total Beginning inventory Units to be manufactured Units per month (102,000/12)

100,000
4,500 104,500 2,500 102,000 8,500

Direct Materials Budget

The direct materials budget is prepared

once the production requirements have been determined. The desired ending inventory for each material is added to the quantity needed to meet production needs, and that total is reduced by the estimated beginning inventory to determine the amount of materials to be purchased.

Direct Labor Budget

The production

requirements are used to prepare the direct labor budget. Standard labor time allowed per unit is multiplied by the number of required units to obtain the total direct manufacturing labor hours.

Factory Overhead Budget

Consists of the estimated individual factory

overhead items needed to meet production requirements.

Factory Overhead Budget

Indirect materials
Indirect labor Depreciation of building Depreciation of machinery and equipment Total factory overhead cost

$225,000
375,250 85,000 67,500 $752,750

Cost of Goods Sold Budget

Budget is prepared once the direct material,

direct labor, and factory overhead budgets have been completed. The estimated beginning inventories and the desired ending inventories of WIP and Finished Goods are included to compute the cost of goods sold.

Selling & Administrative Expenses Budget

The selling and

administrative expenses budget may be prepared once the sales forecast has been made. This budget has separate sections for selling and administrative expenses.

Budgeted Income Statement

Once the preceding budgets have been

completed, the budgeted income statement may be prepared. If the budgeted profit does not meet expectation, management may wish to reevaluate their original expectations.

Budgeted Balance Sheet

Cash budget

Shows the anticipated cash flow and the timing of cash receipts and disbursements.
Based on anticipated sales, credit terms, the economy, and other relevant factors. Reflects how the companys cash position will be affected by paying their liabilities.

Accounts receivable budget

Liabilities budget

Capital expenditures budget

A plan for the timing of acquisitions of buildings, equipment, or other significant assets during the period.

Flexible Budgeting
A plan of what will happen to a company

under varying sets of conditions. The company plans in advance what the effect will be on revenue, expense, and profit if sales or production differ from the budget. Standard production is determined and the initial calculation of variable and fixed costs is based on this level of production.

Preparing the Flexible Budget

28,000 units Sales ($150/unit Direct materials: Lumber ($20/unit) Paint ($4/unit) 560,000 112,000 105,000 67,200 194,040 $3,161,760 773,825 $2,387,935 600,000 120,000 112,500 72,000 207,900 $3,387,600 773,825 $2,613,775 640,000 128,000 120,000 76,800 221,760 $3,613,440 773,825 $2,839,615 $4,200,000 30,000 units $4,500,000 32,000 units $4,800,000

Direct labor:
Cutting ($3.75/unit) Assembly ($2.40/unit) Variable FOH ($6.93/unit) Contribution Margin Fixed FOH and S & A expense Operating income

Performance Report Based on Flexible Budgeting

Budget (28,000 units) Sales ($150/unit) Direct materials: Lumber ($20/unit) Paint ($4/unit) Direct labor: Cutting ($3.75/unit) Assembly ($2.40/unit) 105,000 67,200 120,000 72,000 15,000 U 4,800 U 560,000 112,000 585,000 108,000 25,000 U 4,000 F $4,200,000 Actual (28,000 units) $4,250,000 Variance $50,000 F

Variable FOH ($6.93/unit)

Contribution Margin Fixed FOH and S & A expense Operating income

194,040
$3,161,760 773,825 $2,387,935

206,823
$3,158,177 770,550 $2,387,627

12,763 U
$3,583 u 3,275 F $308 u

Variance Analysis
Spending Variance-a variance due to budget

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

Spending Variance
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.

Spending variance = budgeted allowance- actual FOH

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.

Idle Capacity Variance

Idle variance= applied FOH budget allowance Budget allowance is based on actual capacity
= fixed cost +(variable cost per unit*actual activity)

Applied = actual activity * POHR

 Actual factory overhead

$292,000
750 unfavorable

Spending variance Budget allowance-based on capacity utilized Fixed factory overheads budgeted (in total)$125,000 Variable factory overheads (190,000 actual hours* 0.875) 166,250 Idle Capacity Variance Applied Factory overhead(190,000 hrs*1.50)
Factory overhead underapplied (292,000-$285,000)

$291,250
6,250 unfavorable

$285,000 _______ $7,000

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