COLLEGE OF ACCOUNTANCY

C-AE22: Cost Accounting and Control

First Semester AY 2021-2022

A. Course Code – Title : C-AE22: Cost Accounting and Control

B. Module No – Title : M07 – Accounting for Factory Overhead
C. Time Frame : 1 week (Week 8) – 6 hrs

D. Overview
This learning material provides the learner about the third component of product
cost – manufacturing overhead. This module will discuss in detail the procedures in
recording manufacturing overhead and applying manufacturing overhead using a single
pre-determined rate.
.

E. Desired Learning Outcomes

At the end of the learning session, you should be able to:
1. Identify the nature of manufacturing overhead costs.
2. Account for actual manufacturing overhead costs.
3. Apply manufacturing overhead using pre-determined rates

F. Values Integration
In studying this module, it is hoped that you will be able to develop and manifest the
following UA Core Value/s:

✓ Integrity
✓ Service Orientation
✓ Teamwork
✓ Obedience
✓ Open Communication

G. Interaction/Collaboration
You will be engaging in activities that would make use of:

✓ Google Sheets
✓ Google Forms
✓ Quizizz

H. Content/Discussion

Lesson 1 – Nature of Manufacturing Overhead

All costs incurred in the factory that are NOT chargeable DIRECTLY to the finished
product are called manufacturing overhead. Simply stated, manufacturing overhead
includes all factory costs other that direct materials or direct labor.

Other business expenses that take place outside factory operations such as
administrative costs, sales, and marketing, are not included in manufacturing overhead.

Manufacturing costs should be considered in determining the cost of goods sold and
the inventory at hand, whether finished goods or still in process.

Faculty: Elizabeth B. Boneo 1 | Page

 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

Types of Manufacturing Overhead Costs

Indirect Materials Indirect Labor Other Manufacturing

Overhead
Factory supplies Factory payroll clerks Employee’s fringe benefits
Lubricants Receiving Clerk Employer’s contribution
Cleaning supplies Storeroom clerk Factory utilities
Packaging materials Storeroom supervisors Rental/depreciation of factory
building /equipment
Small tools Purchasing clerks Insurance and taxes

Can you name more factory cost not mentioned above which we can consider as
manufacturing overhead?

Lesson 2. Accounting for Actual Manufacturing Overhead Cost.

Cost accounting systems are designed to accumulate, classify and summarize the
factory overhead cost actually incurred. The specific procedures used to account for actual
factory overhead costs depend on the nature and organization of the manufacturing firm.

As the overhead costs are actually incurred, the Factory Overhead account is
debited, and logically offsetting accounts are credited. The table below provides examples
using some types of manufacturing overhead cost given above.

Example of Overhead Debit Credi

t
Indirect Materials
Factory supplies Manufacturing Overhead Inventory/Supplies
Lubricants Manufacturing Overhead Inventory/Supplies
Indirect Labor
Factory payroll Manufacturing Overhead Salary Payable
clerks
Receiving Clerk Manufacturing Overhead Salary Payable
Other Manufacturing
Overhead
Factory utilities Manufacturing Overhead Utilities Payable
Insurance Manufacturing Overhead Prepaid Insurance
Factory Depreciation Manufacturing Overhead Accumulated
Depreciation

If you notice, instead of debiting an expense account, we are debiting a

“Manufacturing Overhead”. This account is not a typical account, it doesn’t represent assets,
expense or any other elements of financial statements. Instead, it is a “suspense” or
“clearing” account. Amounts that go into the suspense account are then transferred out to
other accounts. Later I’ll show you how this account will be transferred out.

Please be reminded that what we are talking here are expenses incurred in the
factory. Selling and Administrative expenses not related to production are separately
expensed, using their corresponding expense accounts.

Faculty: Elizabeth B. Boneo 2 | Page

 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

In a small manufacturing industry that has only one production department, say a
bakeshop, may simply keep a general ledger account for each manufacturing overhead
costs.

A substantial modification must be made in the accounting system when the

number of overhead accounts become sizable. Simply stated, the organization incurs a lot of
items in overhead cost. To properly monitor these items for control purposes, a
manufacturing subsidiary ledger is being used to be able to further monitor and control the
manufacturing overhead account.

The manufacturing overhead subsidiary ledger works the same as the subsidiary
ledger of Accounts Receivable as discussed in basic accounting.

Kindly refer to the following illustration.

In manufacturing companies with several departments, the accounting system is

designed to accumulate costs by department. Instead of expanding the Manufacturing
Overhead Subsidiary Ledger to include the separate account of each department’s share in
such item cost, Manufacturing Overhead Analysis may be used. This analysis will further be
used by the management for their decision making.

For illustration purposes, I will use the item Depreciation. This depreciation is for
the factory building, where 3 departments are located namely: Cutting, Assembling and
Finishing Departments.

The table above was used to identify further how the P65,000 depreciation which
was part of the factory overhead was distributed. Manner of distributing the overhead cost
will be further discussed in the next module.

Lesson 3 – Apply manufacturing overhead using pre-determined rates

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 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

Under actual costing, manufacturing overhead costs is charged to the production at

the end of the period, where actual cost incurred for the period have been fully recognized.
These procedures were used to emphasize the flow of costs and the basic cost accounting
techniques without unduly complicating the fundamentals. However, factory overhead
includes many different costs which will not be known until the end of the period and some
goods are completed during the period. Do we have to defer the costing of goods that were
finished and sold during the period until the end of the period?

Management wants to know the particular cost of the job or good. Such information
enables management to assess efficiency and to aid in determining the selling prices. The
direct labor and direct material can easily be determined as soon as the job is done but for
the overhead costs, it will take a while to complete the costs information. Thus, some
method must be established for estimating the amount of overhead that should be applied
to finished product. Accordingly, predetermined overhead rate are used to estimate the
overhead cost to estimate the cost of the finished product. At the end of the accounting
period, the actual overhead cost can be compared to the estimated overhead costs applied
to production. Any difference will be subject to analysis for decision making.

How to determine the overhead rate?

A predetermined overhead rate is simply a rate calculated at the beginning of a

period, usually a year which was based on the manufacturing overhead budget on a certain
activity level. This budgeted overhead rate is then divided by the estimated allocation
base. The common allocation bases are as follows:

 Direct labor costs

 Direct labor hours
 Direct Material costs
 Machine hours
 Units of production

For illustration purposes for each allocation basis, we will use the following budgeted data
for the year:

Direct labor cost method

This method is widely used because of its simplicity. Data concerning direct labor
costs of each job is available from payroll records and time tickets/timesheets.

Using the data given, the rate is:

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 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

Hence if the actual labor cost incurred on a particular job is P60,000, the applied
overhead rate would be P9,600 (P60,000*16%).

This method is widely used where manufacturing overhead costs vary with direct
labor costs.

Direct labor hour method

This method assumes that overhead costs tend to vary with the number of hours of
direct labor used.

Using the data given, the rate is:

Hence if the actual labor hour incurred on a particular job is 6,000 hours, the
applied overhead rate would be P49,980 (P6,000*8.33).

The direct labor hour basis is appropriate when there is a correlation between total
manufacturing overhead costs and the number of direct labor hours.

Direct material cost method

This method assumes that overhead costs tend to vary with the use of materials.
Each product manufactured must require approximately the same amount of materials, or
materials usage must be uniformly throughout the manufacturing process.

Using the data given, the rate is:

Hence if the direct material costs used on a specific job is P80,000, the applied
overhead rate would be P41,600 (P80,000*52%).

Machine hour method

This method is used when work is performed principally by machines. However, a
machine hour basis is not appropriate if different kinds of machine are used for various
products.

Using the data given, the rate is:

Faculty: Elizabeth B. Boneo 5 | Page

 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

Hence if the actual machine hour incurred on a particular job is 500 hours, the
applied overhead rate would be P10,415 (500*P20.83).

Units of Production method

This method is used when manufacturing process is a simple one and only if one
type or a few similar types of products are produced. Thus, if Product A will require more
number of hours to produce than Product B, applying overhead using units of production
will give the same amount of overhead charged to Product A and B. Product A is obviously
going to require more overhead because it takes more time to produce it.

Using the data given, the rate is:

Hence if there are 800 units produced on a particular job, the applied overhead rate
would be P5,000 (800*P6.25).

To summarize the illustration above:

Selecting the Overhead Basis

The overhead rate basis selected by a company will depend on many factors, such as
type of goods produced, the machinery employed, type of labor used, wages rates paid, and
cost and time involved in collecting necessary data. The following principles should be
observed in selecting a basis.
 The rate can be easily computed
 The factor choses as the basis must be one that can easily be measured on
each job
 The mount of overhead cost incurred must have some direct relationship
with the base selected.

Recording Applied Manufacturing Overhead Cost

Faculty: Elizabeth B. Boneo 6 | Page

 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

At the end of the month, entries are made to record the estimated manufacturing
overhead to be charged to production. Remember that the Manufacturing Overhead Control
is a suspense account that is debited for actual manufacturing overhead costs that
should be transferred out. Journal entry to transfer out or apply overhead to production
will be:

Work in Process xx
Manufacturing Overhead Control xx

Is actual manufacturing overhead account equals to applied manufacturing

overhead? The answer is No. It is very rare that estimates will equal actual figure. Take note
that applied overhead is based on estimates.

If actual and applied overhead are not equal, how to dispose such difference?

Overapplied or Underapplied Overhead

 Overapplied overhead results when product costs are overstated because

actual overhead cost were lower. The suspense account for the actual
manufacturing overhead has a credit balance.
 Underapplied overhead results when product costs are understated
because actual overhead cost were higher. The suspense account for the
actual manufacturing overhead has a debit balance, (not yet transferred out
in full).
To illustrate let us assume the following figure

 Actual overhead incurred is P600,000

Manufacturing Overhead Control 600,000
Various Accounts 600,000

 Applied Overhead is P540,000

Work in Process 540,000
Manufacturing Overhead Control 540,000

Is the illustration above shows overapplied or underapplied overhead? Its

underapplied, because after posting the manufacturing overhead control account it still has
a P40,000 debit balance.

Disposition of Overapplied or Underapplied Manufacturing Overhead

At the end of the year, the Manufacturing Overhead Control account must be closed
to another suspense account “Underapplied/Overapplied Mfg Overhead.” This suspense
account should be closed also depending on the materiality of the amount.

Using the example above, to close the Manufacturing Overhead Control account:

Underapplied Manufacturing Overhead 60,000

Manufacturing Overhead Control 60,000

To close the Underapplied Manufacturing Overhead:

 If the amount is immaterial – the underapplied or overapplied overhead costs is

directly closed to Cost of Goods Sold:
Cost of Goods Sold 60,000
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 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

Underapplied Manufacturing Overhead 60,000

 If the amount is Material - the underapplied or overapplied overhead costs is

allocated proportionately to three accounts: Work In Process, Finished Goods and
Cost of Goods Sold

Assuming the P60,000 underapplied of overhead is material in amount and the

balances of inventories and cost of goods sods were as follows:

The underapplied or overapplied account will be meaningful when analyze. This

analysis will be discussed in your strategic cost management.

I. Assessment of Learning/ Progress Check

Play Station Manufacturing Inc., is studying the results of applying factory overhead
to production. The following data have been used: estimated manufacturing overhead,
P100,000; estimated material costs, P60,000; estimated direct labor cost, P80,000;
estimated direct labor hours, 10,000; estimated machine hours, 20,000.

The actual factory overhead incurred was P130,000. The production statistics are as
follows:

Faculty: Elizabeth B. Boneo 8 | Page

 COLLEGE OF ACCOUNTANCY
C-AE22: Cost Accounting and Control
First Semester AY 2021-2022

Required:
a) Compute the predetermined overhead rate, based on the following:
o Material Cost
o Direct labor cost
o Direct labor hours
o Machine hours
b) Using each of the methods, compute the estimated total costs of each product.
c) Determine the total under or overapplied of manufacturing overhead under
each of the methods.
Which method would you recommend in applying for overhead costs? Why?

J. References
Guerrero, Pedro P., (2018) Cost Accounting: Principles and Procedural Application,
2018 Edition, Manila, Philippines: GIC Enterprises & Co., Inc.

De Leon, Norma D., De Leon, Ellery D., & De Leon, Guillermo M, Jr., (2019) Cost
Accounting and Control 2019 Edition, Manila, Philippines: GIC Enterprises & Co., Inc.

Vanderbeck, Edward J. & Mitchell, Maria R., Principles of Cost Accounting 17 th Edition,
Taguig City, Philippines: Cengage Learning Asia Pte Ltd (Philippine Branch).

Modules prepared by : Elizabeth B. Boneo

Reviewed/updated by : Elizabeth B. Boneo

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