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Chapter 5

FACTORY OVERHEAD ACCOUNTING

Cost Savings in Business Outsourcing

Why is business process outsourcing industry booming in the Philippines? Outsourcing

happens when a company provides services to another company that could have been done by
the in-house employees of the latter. Outsourcing provides financial advantage that is why
many international companies nowadays outsource services. Examples of business process
outsourcing in the Philippines are, call center services, e-mail services, and payroll services.

These services are done by business process outsourcing (BPO) companies here in the
Philippines in behalf of those companies outside the country. Costs that could be eliminated if
services are outsourced are, additional rent for office space to accommodate many employees,
wages of employees, buying and maintaining computers and equipment, etc. Most of these
costs happen to be overhead costs. There can also be tax advantages if the country to which
the work is being outsourced has a more favorable tax environment. 

Also, aside from cost savings, outsourcing services provides companies the opportunity to
focus on other company business issues while having other details taken care of outside
experts. Furthermore, if a company has plans to expand worldwide, outsourcing is one of the
cost-effective ways to start building foundations in various countries like the Philippines.
-O-

Definition of Factory Overhead

Factory Overhead are all other manufacturing costs aside from direct materials and direct
labor. These costs are not conveniently traced to specific jobs. Other terms for Factory
Overhead are factory burden, manufacturing overhead, factory expenses, indirect
manufacturing costs, and manufacturing expenses.

Factory overhead refers to the cost pool used to accumulate all indirect manufacturing
costs. Examples of factory overhead are indirect materials, indirect labor, rent of factory
building, and depreciation and maintenance of factory building and factory equipment.
Factory overhead can be classified based on their behavior in relation to production. It can
be classified as variable factory overhead, fixed factory overhead, and mixed factory
overhead.

Variable factory overhead costs vary in direct proportion to the level of production within
the relevant range. As production increases or decreases, variable cost per unit remains
constant while total variable cost varies. The more units are produced, the higher the total
variable cost.

On the other hand, fixed factory overhead costs remains constant within the relevant range.
As production increases or decreases, total fixed cost remains constant while fixed cost per
unit varies inversely with production. The more units are produced, the lower the fixed cost
per unit. This shows an advantage of mass production wherein the more units are produced,
the lesser is the factory overhead cost per unit.
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Lastly, mixed factory overhead costs are neither totally fixed nor totally variable but have
characteristics of both. Taken for example, a factory building is rented for P1,500 per day
for only 8 hours of operation, P300 per extended hour. There is a rush order of products
from a valued customer that lead to extending operation hours for 2 more hours just to
finish the order. The total factory rent for that day would be P2,100 with P1,500 fixed and
P600 variable. Mixed factory overhead costs must be separated as to fixed or variable for
planning and controlling purposes.

Actual Costing with Actual FOH vs Normal Costing with Applied FOH

The allocation of factory overhead is done either through actual costing or normal costing.
Under actual costing, actual factory overhead incurred are accumulated in Factory Overhead
Control and then transferred to Work-in-Process at the end of the period. However, this
costing system is inconvenient since the complete costing of the jobs finished is yet to be
deferred until the end of the period.

For example, the factory expenses such as lighting power for the products finished before
the end of July are yet to be identified until the end of July or until the bill arrives. On the
other hand, normal costing uses a predetermined overhead rate to facilitate allocation of the
factory overhead cost to various jobs.

Predetermined Factory Overhead

To compute, predetermined factory overhead rate, it may be computed on three levels:

1. Plantwide overhead rate – the computed overhead rate is used for the entire
plant in the computation of the applied overhead rate. This is the most simple way of
computing the rate but its accuracy may be put into question if the manufacturing
company undertakes several activities to produce the finished output. Simply put,
this method of computing the rate is useful when majority if not all of the overhead
costs can be attributed to a common activity.

2. Departmentalized overhead rate- this type of computation for the overhead rate
is useful if the company is composed of several departments each having its own
activities. In the computation of the department overhead rate, the main objective is
to allocate and include in the computation of the overhead rate the costs incurred by
service departments who renders service indirectly to the producing departments.

3. Activity based overhead rate- this type of computation is useful in activity based
costing (ABC). The rate is based on the activities undertaken by the company. This is
useful if the company has several identifiable activities. This will be discussed in
detail under Chapter 6.

This chapter will focus on the plantwide and departmentalized overhead rate computation.

Management should know the total manufacturing cost of every job completed so as to
facilitate effectiveness and efficiency in the company. Information about these costs can
also aid management in decision-making. Materials and labor can easily be identified when
the job is finished while factory overhead is not that readily available. Predetermined
overhead rates also adjust for variations in actual overhead costs that are unrelated to the

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activity and overcome the problem of changes in activity levels that have no impact on
actual fixed factory overhead costs.

Since unit fixed costs vary with activity level changes, a uniform annual predetermined
overhead rate for all units produced during the year is needed to avoid significant variations
in unit costs during the period.

Applying the predetermined overhead rates also assists the managers to be more aware of
product line profitability as well as the profitability of doing business with a certain customer
or vendor. These are the reasons why predetermined factory overhead rate is used in
estimating factory overhead cost.

Predetermined factory overhead rate is computed by dividing total budgeted factory

overhead at a specified activity level by the volume or quantity of specific activity level. This
activity level can be direct labor hours, machine hours, or any other basis.

Predetermined overhead rate = Budgeted factory overhead @ specific activity level

Budgeted Activity Base or Cost Driver

In selecting the overhead rate, two factors should be considered (1) base to be used; (2)
activity level to be used. In choosing the base, it should be observed that the objective is to
have the most accurate application of overhead cost to the various finished jobs. If factory
overhead pertains to procurement of materials, materials costs can be considered as a base.

Likewise, if factory overhead is labor-related, labor costs or labor hours may be considered
as a base. The common bases are:
(1) Units of Production;
(2) Direct Labor Hours;
(3) Machine Hours;
(4) Direct Labor Cost; and
(5) Direct Material Cost.

Given the budgeted data at the beginning of the year:

Direct Materials P350,000

Direct Labor 280,000
Factory Overhead 135,000
Labor Hours 35,000 hours
Machine Hours 18,000 hours
Units of Production 27,000 units

1. Units of Production – the most direct method of applying factory overhead and may
only be used if the company produces only one kind of product.

Budgeted factory overhead = Overhead per unit

Budgeted units of production

P135,000 = P5 per unit

27,000
For example, given that on January, 5,500 units are produced, the applied overhead for
the job will be P27,500 (5,500 x P5 ).

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2. Direct Labor Hours – this method is best used if the factory overhead costs vary
generally with the number of direct labor hours consumed.

Budgeted factory overhead = Overhead per unit

Budgeted direct labor hours

P135,000 = P3.86 per direct labor hour

35,000

For example, given that a product requires 3,380 direct labor hours, factory overhead
would be applied at P13,046.80 (3,380 x P3.86).

3. Machine Hours – if operations and production are done by the use of machine, this
method is to compute the overhead rate.

Budgeted factory overhead = Overhead per unit

Budgeted machine hours

P135,000 = P7.5 per unit

18,000

For example, given that a product requires 1,200 machine hours, factory overhead
would be applied at P9,000 (1,200 x P7.5).

4. Direct Labor Cost – the most widely used method in computing overhead rate
specifically for labor intensive production.
Budgeted factory overhead = Overhead per unit
Budgeted direct labor cost

P135,000 = 48.21 % of direct labor cost

P280,000

For example, given that P260,000 of direct labor costs was incurred for a product,
factory overhead would be applied at P125,346 (P260,000 x 48.21%).

5. Direct Materials Cost – this method may be used only when the each product in the
production uses more or less the same quantity of materials.

Budgeted factory overhead = Overhead per unit

Budgeted direct labor cost

P135,000 = 38.57% of direct materials cost

P350,000

For example, given that P460,000 of direct materials cost was incurred for a product,
factory overhead would be applied at P177,422 (P460,000 x 38.57%).

Production Capacities

Aside from choosing on which base to use in computing the overhead rate, activity level
selection may also be considered. These activity levels are called the production capacities

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namely theoretical or ideal capacity, practical capacity, expected actual capacity, and
normal capacity.

a. Theoretical or ideal capacity – this can also be called as maximum capacity. This
assumes 100% effectiveness and efficiency in the production. Losses or other events
that may disrupt production are disregarded though they may really actually happen.
This theoretical capacity is seldom achieved and thus not usually used.

b. Practical capacity – this is theoretical capacity less the unavoidable production

interruptions, lost time for machine breakdowns, normal delays, repairs, and also
rest days and holidays. However, this does not consider the external factors such as
those delays or interruptions caused by customers.

c. Expected Actual Capacity – this capacity is based generally on increases and

decreases in factory overhead and on the quantity of production output for the next
accounting period. This is determined during the budgeting process of the company.

d. Normal Capacity - this is basically the long term average capacity. This measures
the activity levels that satisfy average customer demand over a certain period of
time. This alsoconstantly averages over seasonal or cyclical fluctuations in demand.
This capacity is commonly used in computing overhead rates.

Idle Capacity vs. Excess Capacity

Idle capacity is caused by decrease in demand for the product that leads to less production
for the period. This idle capacity is restored when sales demand will increase. Budgeted idle
capacity is only included in the product cost if the overhead rate is computed using the
expected actual capacity as the denominator. When idle capacity exists, a firm can take on
an incremental order without increasing the fixed costs. Idle capacity is actually the capacity
available but is not being used. On the other hand, excess capacity is caused by excessive
production capacity compared to the company’s expected operations. Also, this can be
caused by imbalance in machinery used.

Actual and Applied Factory Overhead

Illustration:
Let us assume that the direct material cost and direct labor cost for the month are P
680,000 and P 720,000 respectively. Factory overhead is applied at 80% of direct labor. The
journal entry to record the applied factory overhead would be:

Work-in-Process (P720,000 x 0.80) 576,000

Applied Factory Overhead 576,000
Overhead applied to production
for the month

Assuming that the actual factory overhead costs incurred amounted to P446,000, this
amount is recorded as an aggregate debit to Factory Overhead Control taken from various
source documents about factory overhead incurred for the month.

Factory Overhead Control 446,000

Various Accounts 446,000
Actual overhead incurred for the month
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To close the actual and applied factory overhead, the variance (Over or Under-applied)
factory overhead will be recorded as:

Applied Factory Overhead 576,000

Factory Overhead Control 446,000
Over-applied Factory Overhead 130,000

The difference between applied and actual factory overhead is called either the over-applied
or under-applied overhead. When applied factory overhead is more than the actual, there is
over-applied factory overhead (there is credit balance) while if the actual factory overhead
is more than the applied, there is under-applied factory overhead (there is debit balance).
Over- or under-application of factory overhead is caused by two factors: cost differences
and utilization differences. These utilization differences are the spending and volume
variance. Spending variance is the difference between the actual factory overhead
estimated factory overhead based on the capacity utilized. It is the variance due to expense
factors. Volume variance is the difference between the estimated factory overhead based on
capacity utilized and the applied factory overhead. Volume variance is due to differences in
volume and activity factors.

Disposition of Factory Overhead Variance

The disposition of under-applied and over-applied overhead (overhead variance) is based on

the materiality of the amount. If the amount is immaterial, factory variance is directly
closed to Cost of Goods Sold. From the above illustration, the journal entry to close over-
applied factory overhead is:

Over-applied Factory Overhead 130,000

Cost of Goods Sold 130,000
To close over-applied
factory overhead for the month

However, if the amount is material, the overhead variance should be allocated pro rata to
Work-in-Process, Finished Goods, and Cost of Goods Sold.

Illustration:

Given that the actual factory overhead for the month is P550,000 and applied factory
overhead is P230,000. Allocation of the P320,000 under-applied factory overhead will be as
follows:

Fractio Allocated
Inventories Balances n Amount
Work-In-Process P 120000 120/960 P 40000
Finished Goods 240,000 240/960 80,000
Cost of Goods
Sold 600,000 600/960 200,000
Total P 960000   P 320,000

The journal entry to close under-applied factory overhead and adjust the inventory accounts
at the end of the month would be:

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Work-in-Process 40,000
Finished Goods 80,000
Cost of Goods Sold 200,000
Under-applied Factory Overhead 320,000
To close under-applied
factory overhead for the month

As shown in this illustration, when there is under-applied overhead, Cost of Goods Sold
(CGS) is increased in the closing process. This is because the amount that was applied to
the production for factory overhead during the period was understated. Consequently, when
there is over-applied overhead, Cost of Goods Sold (CGS) is decreased in the closing
process since it was initially overstated.

Departmentalization

Overhead rates used in computing applied factory overhead are usually plant-wide rates
wherein all the departments of the company use the same rate in purposes of computing
factory overhead. However, this can only be applicable to companies producing a single
product or if there are different products, these products pass through the same series of
departments in the production. Departmental rates are then used if a company produces
various products and these products pass through different departments in the production.

Producing vs. Service Departments

The operations of a manufacturing company are mostly made up of many departments. This
is to facilitate effectiveness and efficiency in the operations. This also helps in the costing of
the various jobs and products since dividing a manufacturing plant into separate
departments provides more accurate costing of the jobs and products. Several amounts of
factory overhead are assigned to each jobs and products as they move from one
department to another. Each department has its own predetermined factory overhead rate
that they charge to the jobs and products. The estimation of factory overhead is now done
by department instead of having it for the whole company. Actual factory overhead is still
recorded in Factory Overhead Control for each department. Factory overhead variances are
then analyzed by department.

There are two types of departments. These are the producing departments and the service
departments. Producing departments are those that are directly involved in the actual
manufacturing of the product while service departments are those that contribute indirectly
in the manufacturing process.

Examples of Producing and Service Departments:

Types of Examples
Department

PRODUCING Cutting, Assembly, Upholstery, Finishing, Plating, Knitting, Machining,

Mixing, Refining

SERVICE DEPT. Personnel, Maintenance, Purchasing, Receiving, Storage, Plant

Power Plant, Security, Shipping

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Direct and Indirect Departmental Costs in Producing and Service Departments

Direct departmental overhead costs are those that are readily identified with the originating
department, may it be producing or service department. Major classification of direct
departmental overhead cost are
(1) Indirect materials and factory supplies;
(2) indirect labor such as overtime;
(3) labor fringe benefits such as SSS, PhilHealth, and Pag-IBIG;
(4) repairs and maintenance; and
(5) depreciation of machinery and equipment.

Indirect departmental overhead costs are those that cannot be traced to a certain
department since these expenses are being shared by various departments. Examples of
these costs are electricity, rent, and depreciation of factory or manufacturing plant.

Estimation and allocation of indirect departmental overhead costs are difficult and at times,
done subjectively. A survey of factory facilities and resources to gather information for the
basis in allocating is being made.

Information as to the total square footage occupied, number of employees, number and
usage of machinery, estimates of total kilowatt hours or horsepower hours used for each
and every department are secured through the survey.

Indirect Departmental
Expense Distribution Basis
Factory Rent Square Footage
Property Tax Square Footage
Depreciation - Factory
Building Square Footage
Fire insurance (building) Square Footage
Repairs and Maintenance Square Footage
Superintendence No. of employees
No. of employees or
Telephone telephone
Employee's contributions Department Payroll
Power Horsepower hours
Freight – in Materials Used
Light Kilowatt hours

Allocation of Service Department Costs

Similar to indirect departmental factory overhead costs, costs charged to service

departments should be distributed equitably to producing and service departments, or just
to producing department depending on the decision of the management. There is a need for
allocation of these costs since same to indirect departmental costs, service department
costs cannot be directly identified to the products manufactured. The allocation may be
based on the horsepower or kilowatt-hour consumption, or the number of employees, floor
space consumed by the department, etc.

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Service Departments Allocation Basis

Personnel Number of employees or labor hours
Purchasing Number or cost of orders
Receiving Number or cost of orders
Cost of materials or number of
Storage requisitions
Factory Office Number of employees or labor hours
Building Maintenance Floor space
Power Plant Kilowatt hours

There are three (3) alternative methods of allocating Service Department Costs (SDC),
namely: Direct Method, Step or Sequential Method and Reciprocal or Simultaneous
Method.

1. Direct Method

Under this method, the Service Department Costs are directly allocated to producing
departments only. This is the method mostly used in practice because it’s simple and easy
to apply.

Consider the following data for a manufacturing plant:

Departments
Producing Servicing
Building
Cutting Assembly Machining Maintenance Personnel Procurement
P
Costs 13,890 P 32,500 P 23,780 P 1,500 P 8,400 P 5,600
Floor Space
(sq. ft) 672 224 448 130 210 150
Number of
Employees 45 15 30 20 9 10
Number of
Orders 154 308 308  220 10  -

Service Departments Costs are allocated pro rata to the producing departments through
following the allocation bases for each service departments.

Buildin Procuremen
Producing g Personnel t
floor no. of no. of
Departments space employees orders
Cutting 672 45 154
Assembly 224 15 308
Machining 448 30 308
Total 1344 90 770

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Allocation:

Cost
Allocated Cutting Assembly Machining Total
Building Maintenance P1500 672/1344 P750 224/1344 P250 448/1344 500 P1500
Personnel 8400 45/90 4200 15/90 1400 30/90 2800 8400
Procurement 5600 154/770 1120 308/770 2240 308/770 2240 5600
Total P15500   P6070   P3890   P5540 P15500

In this illustration, Cutting Department will be allocated for P6,070; Assembly Department
for P3,890; and Machining Department for P5,540.

2. Step Method or Sequential Method

The Service Department Costs are allocated to both producing and service departments.
The allocation of such costs are done through the predetermined sequence of the company,
or the service department with the higher cost would be the one to first allocate then
followed by the other service departments.

Service departments that have already allocated their costs can no longer be allocated with
the cost of the next service departments. This method disregards reciprocal services
provided among the service departments. Considering the previous illustration, the
allocation using the step method would be as follows:

Departments

Producing Servicing

Cutting Assembly Machining Building Main. Person. Procurement

Cost P13890   P32500   P23780   P 1,500 P 8,400   P 5,600

Allocation:                      
10/
Personnel 45/120 3150 15/120 1050 30/120 2100 20/120 1,400 (8,400) 120 700
220/
154/990 308/990 308/ 990
Procure. 980 1960 1960 990 1400     (6,300)

Building
Main. 672/
1344 2150 224/ 1344 716.7 448/1344 1433   (4300)      

Total Allocation 6280   3727   5493        

Total Cost   P20,170   P36,227   P29,273          

3. Reciprocal Method (Also known as Simultaneous or Algebraic Method)

The allocation of Service Department Costs is based on the reciprocal services provided by a
service department to the other departments.

To illustrate, consider the following example:

DEPARTMENT Overhead Services Provided

S Costs
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Maintenanc Storag
PRODUCING e e
Machining P130,000 30% 50%
Assembly 220,000 20% 30%
SERVICING      
Maintenance P205,000  20%
Storage 100,000  50%
TOTAL P655,000 100% 100%

The costs of the service departments are calculated as follows:

Maintenance = P 205,000 + 0.20(Storage)

Storage = P 100,000 + 0.50(Maintenance)

Substitute to compute maintenance cost:

Maintenance = P 205,000 + 0.20 { P100,000 + 0.50(Maintenance)}

Maintenance = P 205,000 + 20,000 + 0.10(Maintenance)
Maintenance = P 225,000 + 0.10(Maintenance)
0.90 (Maintenance) = P 225,000
Maintenance = P 250,000

Substitute to compute storage cost:

Storage = P 100,000 + 0.50(P250,000)

Storage = P 100,000 + P 125,000
Storage = P 225,000

Allocation of the service department cost:

Producing Servicing
Machini Assemb Maintenan Storag
ng ly ce e
Cost 130,000 220,000 205,000 100,000
Allocation:        
Maintenan
ce 75,000 50,000 (250,000) 125,000
(225,00
Storage 112,500 67,500 45,000 0)
Total 317,500 337,500

Summary of procedures in determining factory overhead for departmentalization

1. Dividing the company into departments or cost centers where expenses are charged.
2. Estimating factory overhead cost for each department, this is composed of direct
departmental expense and indirect departmental expense.
3. Selecting the base to be used by each department.
4. Allocating the costs of servicing departments to the producing departments.
5. Computing the factory overhead.

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Disposition of Over or Under-applied Factory Overhead

At the end of the accounting period, the overhead variance can either be treated as period
cost or allocated between inventories and Cost of Goods Sold (CGS).

1. If the overhead variance is insignificant, it should be closed directly to Income Summary

or to CGS as a period cost.

Income Summary or Cost of Goods Sold …………..P xx

Factory Overhead Control ……………………………………P xx
Under-applied overhead for the year

Cost of Goods Sold (CGS) is ultimately closed to Income Summary account.

2. If the overhead variance is material, then it can be allocated to Work in Process, Finished
Goods and Cost of Goods Sold (CGS). This is an attempt to restate all applied overhead
at amounts approximating actual overhead. Expensing a large under-applied Factory
Overhead balance, generally overstates the CGS, understates income or profit and
understates inventory end on the statement of financial position.

Overhead rates are usually reviewed periodically. Changes in production methods, prices,
efficiencies, and sales forecasts make review and possible revision of overhead rates
necessary at least annually. The extent to which a company revises its overhead rates
depends on the frequency of changes, on factors that affect overhead rates and on
management’s need and desire for current cost data.

Factory Overhead in Non-Manufacturing Business and Not-for-Profit Organizations

 Financial Institutions – these are the savings and loans associations, brokerage
houses and banks. These institutions departmentalize their operations in order to
control expenses and monitor profitability in their operations. Expenses that are
charged directly to the departments are salaries, depreciation of equipment used,
supplies used while electricity and rental of office is still prorated to the department
using appropriate bases.

 Retail Stores – these organizations adapt departmentalization and divide their

operations as to procurement, marketing, sales, logistics, administration, building or
store maintenance, etc. Same as to manufacturing businesses, common costs are
allocated to revenue-producing sales department.

 Educational and service institutions – this includes schools, hotels, hospitals, and
nursing homes. These organizations need to departmentalize in order to control
expenses and be able to accurately charge the costs of their services rendered.

 National and local government – departmentalization in the government is an

important factor in achieving the goal of the government in providing quality services
to its citizens. Different agencies for different functions are utilized in order to
answer various concerns in the society. These agencies are responsible for ensuring
proper handling of funds given to them and to provide efficient and effective services
at the lowest costs.
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ooo0ooo
Terminologies

 Factory Overhead – costs of product or service other than direct labor and direct
materials.

 Actual Costing – costing method wherein actual factory overhead costs incurred are
recorded as product cost.

 Normal Costing – costing method wherein a predetermined factory overhead rate is

used in estimating factory overhead costs to be charged to jobs or services.

 Predetermined Factory Overhead Rate – rate established at the beginning of the

period to be used in estimating factory overhead cost, computed by dividing factory
overhead by the estimated base.

 Theoretical Capacity – production capacity that assumes 100% effectiveness and

efficiency in the production.

 Practical Capacity – production capacity that is theoretical capacity less the

unavoidable production interruptions, lost time for machine breakdowns.

 Expected Actual Capacity – production capacity that is based generally on

increases and decreases in factory overhead and on the quantity of production
output for the next accounting period.

 Normal Capacity – production capacity that is basically the long term average
capacity.

 Idle Capacity – caused by decrease in demand for the product that leads to less
production for the period.

 Excess Capacity - caused by excessive production capacity compared to the

company’s expected operations.

 Over-applied Factory Overhead – results when applied factory overhead is

greater thanactual factory overhead.

 Under-applied Factory Overhead – results when actual factory overhead is

greater than applied factory overhead.

 Producing Department - those that are directly involved in the actual

manufacturing of the product.

 Servicing Department - those that contribute indirectly in the manufacturing

process.

 Direct Departmental Expense - those that are readily identified with the
originatingdepartment, may it be producing or service department.

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 Indirect Departmental Expense - those that cannot be traced to a certain

department since these expenses are being shared by various departments.

Name: _________________________________________________ Score: ___________

Class Schedule: ________________________________________ Date: ___________

Exercise 5-1

Supply the table with the necessary data.

Applied Actual
Factory Factory Under- Over-
Overhead Overhead applied applied

Example 130,000 120,000 - 10,000

1. 135,000 123,000    

2. 23,600 34,500    

3. 43,500 116,268    

4. 132,623 113,998    

5. 33,200 85,410    

6. 15,966 60,218    

7. 31,128 15,657    

8. 56,199 77,735    

9. 127,696 127,102    

10. . 144,027 140,717    

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Name: _________________________________________________ Score: ___________

Class Schedule: ________________________________________ Date: ___________

Exercise 5-2 (Departmental Classification)

Identify the following items given below as either Producing Dept (PD) or Service Dept.
(SD):
1. Receiving Dept. _____ 6. Security _____ 11. Shipping _____
2. Brewing _____ 7. Purchasing_____ 12. Personnel _____
3. Mixing _____ 8. Assembly _____ 13. Maintenance _____
4. Refining _____ 9. Bottling _____ 14. Fabricating _____
5. Storage _____ 10. Canning _____ 15. Utilities _____

Exercise 5-3 (Over/Under Applied FOH Computation)

The following information is available concerning the inventory and Cost of Goods Sold
accounts of N-Sure Co. at the end of the most recent year:

Work in Process Finished Goods Cost of Goods Sold

Direct Materials…………… P 2,000 P 6,000 P 12,000
Direct Labor ..……………… 2,000 16,000 32,000
Applied factory overhead … 4,000 16,000 30,000
Year-end balance ………… P 8,000 P 38,000 P 74,000
====== ======= ========

Applied Factory Overhead has already been closed to Factory Overhead Control account. In
all previous years, the overhead variance was treated as an adjustment to income or
expense. Beginning inventories of the most recent year were insignificant.

REQUIRED: Give the journal entry to close Factory Overhead Control, assuming:

a) Under-applied Overhead of P 12,000 is to be allocated to inventories and CGS in

proportion to the balances in those accounts.

b) Over-applied Overhead of P 12,000 is to be allocated to inventories and CGS in

proportion to the balances in those accounts.

c) Under-applied Overhead of P 12,000 is to be allocated to WIP, FGI and CGS in

proportion to the amount of overhead applied to those accounts.

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Name: _________________________________________________ Score: ___________

Class Schedule: ________________________________________ Date: ___________

Problem 5-1 (Short Computations)

Compute for what are being asked in the following numbers:

1. Given the cost data of a manufacturing company:

Depreciation of sales office P2,000
Depreciation of factory machine 1,500
Shipping costs 700
Salary of production workers 2,300
Salary of security guards 1,300
Raw materials used 6,500
Rent of factory 700
Salary of sales personnel 4,000
Factory Insurance 2,000

How much is factory overhead and total manufacturing cost?

2. A company applies a predetermined overhead application rate of P0.50 per direct

labor hour. During the year, it incurred actual overhead of P250,000, but it
estimated to incur only P180,000. The company applied P230,000 of factory
overhead during the year. How many direct labor hours did the company estimated
to incur?

3. A manufacturer of bags estimates its production for the next year at 15,000 units
which is 75% of normal capacity. Material and Labor costs are P75 and P30
respectively per unit. Budgeted factory overhead costs is P630,000. Direct labor rate
per hour is P20.

What is the predetermined or standard factory overhead rate based on:

a. direct labor hours
b. direct labor cost
c. units of production
d. material costs
e. units of production using the normal capacity as its activity level

4. Given the following data for the current year.

Work in Process P 37,510

Finished Goods 72,300
Cost of Goods Sold 83,600
Direct Labor 98,000
Direct Material 56,020

Actual factory overhead incurred is P82,700 and applied factory overhead is P72,660.
Factoy overhead is under- or over-applied? At what amount?

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Name: _________________________________________________ Score: ___________

Class Schedule: ________________________________________ Date: ___________

5. The normal capacity of a manufacturing company is 27,000 machine hours,

budgeted variable factory overhead at P3.50 per hour, and budgeted fixed factory
overhead at P15,430. In the month of March, actual production required 3,500
hours, with an actual overhead of P8,500. How much is applied manufacturing
overhead? What is the over- or under-applied factory overhead?

Problem 5-2 (Short Computations)

1. Mocha Company manufactures an electric chocolate fountain that has a direct

materials cost of P340 and labor of P290. Estimated factory overhead for the next
year for the production of 50,000 chocolate fountains are as indirect materials
P3,500,000; indirect labor P3,100,000; depreciation of factory P660,000; factory
electricity P2,800,000; insurance P240,000; miscellaneous P2,000,000. During the
year, 64,000 electric chocolate fountain were manufactured with actual factory over
head of P13,890,000. What is the over- or under-applied factory overhead? Prepare
the necessary journal entries.

2. Gel Corporation applies factory overhead at 80% of direct labor. It incurred direct
labor cost of P330,000 during the current year; actual factory overhead incurred was
at P250,000. What is the amount of under- or over-applied factory overhead for the
current year? Prepare the necessary journal entry in disposition of the factory
variance, assuming that the amount is immaterial.

3. Given the following data of Nopia Corporation for the current year:

Direct Labor P340,000

Direct Material 204,000
Actual Overhead 260,000
Applied Overhead 295,000
Raw Material 43,500
Work in Process 75,000
Finished Goods 150,000
Cost of Goods Sold 300,000

What is the amount of under- or over-applied overhead? Prepare the necessary

journal entry to dispose of under- or over-applied overhead, assuming the amount is
material.

4. Sondra Company uses direct method in allocating service department costs to

producing departments. Costs of department S1 and S2 are distributed on the basis
of number of employees and machine hours respectively, while the allocation bases
for predetermined factory overhead in department P1 and P2 are machine hours and
direct labor hours, respectively.

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Name: _________________________________________________ Score: ___________

Class Schedule: ________________________________________ Date: ___________

Producing Departments Service Departments

  P1 P2 S1 S2
Budgeted
Overhead P 410,000 P 304,000 P 100,000 P 50,000
No. of employees 90 210 20 28
Machine hours 64,000 16,000  
Direct Labor hours 35,000 100,000  

What are the predetermined overhead rates in producing department P1 and P2?
Given the data for Job 620, what is the amount of overhead cost of the job if
predetermined overhead rates are calculated for the producing departments? If
plant-wide overhead rate is used based on direct labor hours, what is the amount of
factory overhead applied to Job 640?

5. JRT Company has Service Departments A and B and Production Departments X and Y
with the following data:

Production
Service Departments Departments
  A B X Y
Direct Costs P 150 P 300 P 5,000 P 6,000
Services performed by
Dept. A   40% 40% 20%
Services performed by
Dept. B 20%   70% 10%

What is the total cost of Department A, B, X and Y?

D E P A R T M E N T______
A B X Y____

a. Using direct method __________ __________ __________ __________

b. Using step-down method __________ __________ __________ __________

c. Using reciprocal method __________ __________ __________ __________

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Name: _________________________________________________ Score: ___________

Class Schedule: ________________________________________ Date: ___________

Problem 5-3(Allocation of Service Dept. Cost)

Rapunzel Company produces various products. These products pass through different
departments in the manufacturing process. The companies’ two (2) Producing Departments
are Departments A, where operations are mostly done by workers, and Department B,
where mostly machines run the production. It has also two (2) Service Departments, X and
Y, in which costs are allocated to producing departments using the direct method. Cost of
Department X is distributed on the basis of number of employees while Department Y is
based on machine hours.

The company uses a uniform base in computing predetermined overhead rate for both
Producing Departments, which is based on direct labor hours (DLHs).

Producing Service
Departments Departments
  A B X Y
Estimated factory P150,00 P250,00
overhead P320,000 P540,000 0 0
Machine hours 6,000 44,000 - -
1 1
Number of employees 120 30 0 0
Direct labor hours 30,000 5,000    

Data for Job 507:

Departmen Department
  tA B
Materials P120 P100
Direct labor hours 30 10
Machine hours 12 35

REQUIRED: Answer the following questions:

A. What is the plant-wide predetermined factory overhead rate?

B. What is the factory overhead cost of job 507?

C. Is it appropriate to use a plant-wide factory overhead rate? Why or why not?

D. What is the departmentalized factory overhead rate of the two (2) Producing
Departments?

E. What is the factory overhead cost of Job 507 using the departmentalized factory
overhead rate?

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Name: _________________________________________________ Score: ___________

Class Schedule: ________________________________________ Date: ___________

Problem 5-4 (Allocation of Service Dept. Cost)

University of San Carlos offers only high-tech graduate-level programs. USC has two
principal operating departments, Engineering and Computer Sciences, and two support
departments, Facility and Technology Maintenance and Enrollment Services. The base used
to allocate facility and technology maintenance is budgeted total maintenance hours. The
base used to allocate enrollment services is number of credit hours for a department. The
Facility and Technology Maintenance budget is P350,000, while the Enrollment Services
budget is P950,000. The following chart summarizes budgeted amounts and allocation-base
amounts used by each department.

Services Provided: (Annually)

Computer F&T Enrollment
Budget Engineering Sciences Maintenance Service
F&T Maintenance
P350,000 2,000 5,000 Zero 1,000
(in hours)
Enrollment
Service P950,000 24,000 36,000 2,000 Zero
(in credit hrs)

Required:
Use the direct method to allocate support costs to each of the two principal operating
departments, Engineering and Computer Sciences. Prepare a schedule showing the
support costs allocated to each department.

Problem 5-5 (Allocation of Service Dept. Cost)

University of San Carlos offers only high-tech graduate-level programs. USC has two
principal operating departments, Engineering and Computer Sciences, and two support
departments, Facility and Technology Maintenance and Enrollment Services. The base used
to allocate facility and technology maintenance is budgeted total maintenance hours. The
base used to allocate enrollment services is number of credit hours for a department. The
Facility and Technology Maintenance budget is P350,000, while the Enrollment Services
budget is P950,000. The following chart summarizes budgeted amounts and allocation-base
amounts used by each department.

Services Provided: (Annually)

Computer F&T Enrollment
Budget Engineering Sciences Maintenance Service
F&T
Maintenance P350,000 1,000 2,000 Zero 5,000
(in hours)
Enrollment
Service P950,000 24,000 36,000 2,000 Zero
(in credit hrs)

Required:

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Prepare a schedule, which allocates service department costs using the step-down
method with the sequence of allocation based on the highest-percentage support
concept. Compute the total amount of support costs allocated to each of the two
principal operating departments, Engineering and Computer Sciences.

Name: _________________________________________________ Score: ___________

Class Schedule: ________________________________________ Date: ___________

Problem 5-6 (Allocation of Service Dept. Cost)

University of San Carlos offers only high-tech graduate-level programs. USC has two
principal operating departments, Engineering and Computer Sciences, and two support
departments, Facility and Technology Maintenance and Enrollment Services. The base used
to allocate facility and technology maintenance is budgeted total maintenance hours. The
base used to allocate enrollment services is number of credit hours for a department. The
Facility and Technology Maintenance budget is P350,000, while the Enrollment Services
budget is P950,000. The following chart summarizes budgeted amounts and allocation-base
amounts used by each department.

Services Provided: (Annually)

Computer F&T Enrollment
Budget Engineering Sciences Maintenance Service
Engineering P3,500,000
Computer
P1,400,000
Sciences
F&T
Maintenance P350,000 2,000 1,000 Zero 5,000
(in hours)
Enrollment
Service P950,000 24,000 36,000 2,000 Zero
(in credit hrs)

Required:
a. Set up algebraic equations in linear equation form for each activity.
b. Determine total costs for each department by solving the equations from part (a)
using the reciprocal method.
(Engineering= Eng; Computer Sciences = CS; Facility and Technical Maintenance
= FTM; Enrollment Service = ES)

Problem 5-7 (Allocation of Service Department Costs)

JR Co. has two service departments and two operating departments. Budgeted costs and
other data relating to these departments are presented below:

Building Operating Department

& Grounds Personnel A B
Departmental costs ..... P54,000 P200,000 P650,000 P800,000
Square feet occupied ... 1,000 3,000 12,000 15,000
Number of employees .... 10 5 45 55
Direct labor-hours .....76,000 92,000

The costs of Building & Grounds are allocated first on the basis of square feet of space
occupied. Personnel costs are allocated on the basis of number of employees. The

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departmental costs for the operating departments are overhead costs. Predetermined
overhead rates in the operating departments are computed on the basis of direct labor-
hours.

a. Assume that the company uses the direct method of allocating service
department costs to operating departments. How much Building & Grounds cost
would be allocated to Department A?

b. Assume that the company uses the direct method of allocating service
department costs. The predetermined overhead rate that would be used in
Department B would be closest to how much?

c. Assume that the company uses the step method of allocating service
department costs to operating departments and Building and Grounds costs are
allocated first. How much Personnel Department cost would be allocated to
Department B?

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