Factory Overhead

Applied & Actual

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 = factory overhead/unit

 Estimated units of production

 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 = Rate per direct labor hour
 Estimated Direct labor hours

 Machine hours
 Estimated factory overhead = Rate per machine hour
 Estimated machine hours
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 120,000 120,000

Variable expense:
150,000 hrs*0.50 75,000
120,000 hrs*0.50 60,000
______ ______
Total estimated overhead 195,000 180,000
Estimated DLHs 150,000 120,000
Factory overhead/hr $1.30 $1.50
Fixed overhead/ hr $0.80 $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 = Rate per direct labor hour
 Estimated Direct labor hours

 Factory overhead can be broken down into its fixed

and variable components:
 Estimated fixed factory overhead = fixed portion of factory overhead rate
 Estimated Direct labor hours

 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
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
Spending variance 750 unfavorable
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 $291,250

Idle Capacity Variance 6,250 unfavorable

 Applied Factory overhead(190,000 hrs*1.50) $285,000

 Factory overhead –underapplied _______

 (292,000-$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