ACCOUNTING FOR

FACTORY OVERHEAD
 I. Opening Prayer
 II. Announcements
 III. Overview of the topic
 IV. Discussion
LEARNING OUTCOMES:
1) Compute a factory overhead rate using the different bases
2) Apply the concept of actual factory overhead and applied factory overhead
3) Identify and compute the different methods of allocating budgeted service
departments to producing departments
FACTORY OVERHEAD:
Three Categories in the Basis of Behavior
1) Variable factory overhead costs
2) Fixed factory overhead costs
3) Mixed factory overhead costs
FACTORY OVERHEAD:
Bases to be Used
1) Direct labor hours
 the most used base or denominator in the computation of the predetermined
overhead rate.
FACTORY OVERHEAD:
Bases to be Used
2) Direct labor cost
 this method is recommended if it can be established that there is a direct
relationship between labor cost and factory overhead.
FACTORY OVERHEAD:
Bases to be Used
3) Machine hours
 this is appropriate when a direct relationship exist between factory overhead
cost and machine hours.
FACTORY OVERHEAD:
Bases to be Used
4) Direct material cost
 this method is appropriate if it can be inferred that factory overhead costs are
directly related to direct material cost as in cases where direct materials are a
very large part of total cost.
FACTORY OVERHEAD:
Bases to be Used
5) Units of Production
 this method is appropriate when a company or department manufactures only
one product.
MATERIALS:
Bases to be Used
Papa Bear Company estimates factory overhead Direct material cost
at P450,000 for the next fiscal year. It is
estimated that 90,000 units will be produced at a
material cost of P600,000. Conversion will require
an estimated 90,000 direct labor hours at a cost
of P3.00 per hour, with 45,000 machine hours.

Required: Compute the predetermined factory

rate based on:
a. Material cost
b. Units of production
c. Machine hours
d. Direct labor cost
e. Direct labor hours
FACTORY OVERHEAD:
Bases to be Used
Papa Bear Company estimates factory overhead Units of production
at P450,000 for the next fiscal year. It is
estimated that 90,000 units will be produced at a
material cost of P600,000. Conversion will require
an estimated 90,000 direct labor hours at a cost
of P3.00 per hour, with 45,000 machine hours.
units
Required: Compute the predetermined factory
rate based on:
a. Material cost
b. Units of production
c. Machine hours
d. Direct labor cost
e. Direct labor hours
FACTORY OVERHEAD:
Bases to be Used
Papa Bear Company estimates factory overhead Machine hours
at P450,000 for the next fiscal year. It is
estimated that 90,000 units will be produced at a
material cost of P600,000. Conversion will require
an estimated 90,000 direct labor hours at a cost
of P3.00 per hour, with 45,000 machine hours.

Required: Compute the predetermined factory

rate based on:
a. Material cost
b. Units of production
c. Machine hours
d. Direct labor cost
e. Direct labor hours
FACTORY OVERHEAD:
Bases to be Used
Papa Bear Company estimates factory overhead Direct labor cost
at P450,000 for the next fiscal year. It is
estimated that 90,000 units will be produced at a
material cost of P600,000. Conversion will require
an estimated 90,000 direct labor hours at a cost
of P3.00 per hour, with 45,000 machine hours.

Required: Compute the predetermined factory

rate based on:
a. Material cost
b. Units of production
c. Machine hours
d. Direct labor cost
e. Direct labor hours
FACTORY OVERHEAD:
Bases to be Used
Papa Bear Company estimates factory overhead Direct labor hours
at P450,000 for the next fiscal year. It is
estimated that 90,000 units will be produced at a
material cost of P600,000. Conversion will require
an estimated 90,000 direct labor hours at a cost
of P3.00 per hour, with 45,000 machine hours.

Required: Compute the predetermined factory

rate based on:
a. Material cost
b. Units of production
c. Machine hours
d. Direct labor cost
e. Direct labor hours
FACTORY OVERHEAD:
Bases to be Used
Papa Bear Company estimates factory overhead Direct labor hours
at P450,000 for the next fiscal year. It is
estimated that 90,000 units will be produced at a
material cost of P600,000. Conversion will require
an estimated 90,000 direct labor hours at a cost
of P3.00 per hour, with 45,000 machine hours.

Required: Compute the predetermined factory

rate based on:
a. Material cost
b. Units of production
c. Machine hours
d. Direct labor cost
e. Direct labor hours
FACTORY OVERHEAD:
Steps in Computation of Departmentalized Overhead Rate
1. Divide the company into segments, called departments, cost centers, to which
expenses are charged.
2. Estimate the factory overhead for each department (direct departmental charges plus
indirect departmental charges).
3. Select and estimate the base to be used by each department.
4. Allocate the service department costs to the producing / operating departments.
5. Compute the factory overhead rate (similar to computation using blanket rate).
FACTORY OVERHEAD:
Typical Allocation Bases for Common Costs
1. Labor-related common costs
2. Machine-related common costs
3. Space-related common costs
4. Service-related common costs
FACTORY OVERHEAD:
Typical Allocation Bases for Common Costs
COMMON COST TYPICAL ALLOCATION BASE
Labor-related
1. Supervision No. of employees, payroll amount of DLHrs.
2. Personnel services Number of employees

Machine-related
3. Insurance on equipment Value of equipment
4. Taxes on equipment Value of equipment
5. Equipment depreciation Machine hours, equipment value
6. Equipment maintenance Number of machines, machine hours
FACTORY OVERHEAD:
Typical Allocation Bases for Common Costs
COMMON COST TYPICAL ALLOCATION BASE
Space-related
7. Building rental Space occupied
8. Building insurance Space occupied
9. Heat & air-conditioning Space occupied, volume occupied
10. Concession rental Space occupied & desirability of location
11. Interior building Space occupied
maintenance
FACTORY OVERHEAD:
Typical Allocation Bases for Common Costs
COMMON COST TYPICAL ALLOCATION BASE
Service-related
12. Materials handling Quantity or value of materials
13. Billing and accounting Number of documents
14. Indirect materials Value of direct materials
FACTORY OVERHEAD:
Allocation of Service Department Costs
Need for Allocation
 The costs of service departments are allocated to the operating departments because
they exist to support the operating departments.
Examples of service departments are maintenance, administration, cafeterias, laundries,
and receiving. 

  It is crucial that these service department costs be allocated to the operating
departments so that the costs of conducting business in the operating departments
are clearly and accurately reflected.
 For the computation of accurate FOH rate.
FACTORY OVERHEAD:
Allocation of Service Department Costs
Methods of Allocation:
1) Direct Method
2) Step Method / Sequential Method
3) Algebraic / Reciprocal Method
FACTORY OVERHEAD:
Allocation of Service Department Costs
Direct Method
 the most widely used method. This method ignores any service rendered by one
service department to another, it allocates each service department’s total cost directly
to the producing departments.
FACTORY OVERHEAD:
Allocation of Service Department Costs
Step / Sequential method
 this method recognizes services rendered by service departments to other service
departments and is more complicated because it requires a sequence of allocation.
 the sequence typically starts with the department that renders service to the greatest
number of other service departments and ends with the department that renders
service to the least number of other departments. Once a service department’s costs
are allocated, no subsequent service department costs are allocated to it. (not
allocated back.
FACTORY OVERHEAD:
Allocation of Service Department Costs
Algebraic / Reciprocal method
 this method allocates costs by explicitly including the mutual services rendered among
all departments.
 Under the reciprocal cost, the relationship between service departments is
recognized and cost is allocated to and from each service department for services
provided.
 Building & Grounds – SQ Feet
Factory Administration – DLH
FACTORY OVERHEAD: Molding – MH
Decorating – DLH
Allocation of Service Department Costs
Mama Bear Company’s factory is divided into four departments – producing departments; Molding
and Decorating, serviced by the Buildings and Grounds and the Factory Administration
departments. Buildings and Grounds cost will be allocated using square feet (floor area) and Factory
Administration cost will be allocated using direct labor hours. In computing predetermined overhead
rates, machine hours are used as the base in Molding and direct labor hours as the base in
Decorating.

Buildings and Factory

Molding Decorating
Grounds Administration
Budgeted FO P400,000 P600,000 P80,000 120,000
Direct labor hours 200,000 100,000
Floor area 100,000 60,000 2,000 4,000
Machine hours 200,000 100,000
 Buildings and Factory
Molding Decorating
Grounds Administration

Budgeted FO P400,000 P600,000 P80,000 120,000

FACTORY OVERHEAD:Direct labor hours 200,000 100,000
Floor area 100,000 60,000 2,000 4,000
Machine hours 200,000 100,000
Direct Method

Building & Grounds – SQ Feet

Factory Administration – DLH
Molding – MH
Decorating – DLH
 Buildings and Factory
Molding Decorating
Grounds Administration

Budgeted FO P400,000 P600,000 P80,000 120,000

FACTORY OVERHEAD:Direct labor hours 200,000 100,000
Floor area 100,000 60,000 2,000 4,000
Machine hours 200,000 100,000

Step Method

Building & Grounds – SQ Feet

Factory Administration – DLH
Molding – MH
Decorating – DLH
 Buildings and Factory
Molding Decorating
Grounds Administration

FACTORY OVERHEAD:
Budgeted FO
Direct labor hours
P400,000
200,000
P600,000
100,000
P80,000 120,000

Floor area 100,000 60,000 2,000 4,000

Machine hours 200,000 100,000
Algebraic Method

Building & Grounds – SQ Feet

Factory Administration – DLH
Molding – MH
Decorating – DLH
 Buildings and Factory
Molding Decorating
Grounds Administration

FACTORY OVERHEAD:
Budgeted FO
Direct labor hours
P400,000
200,000
P600,000
100,000
P80,000 120,000

Algebraic Method Floor area 100,000 60,000 2,000 4,000

Machine hours 200,000 100,000

Building & Grounds – SQ Feet

BG = 93,878 Factory Administration – DLH
FA = 138,776 Molding – MH
Decorating – DLH

50% 30% 20%

40% 50% 10%
FACTORY OVERHEAD:
Capacity Production
 In the estimation of manufacturing overhead, as well as the estimation of the base to
be used for allocation, it is important to determine what capacity of production should
be adopted.
 FOH / Activity  Activity is based on what capacity?
FACTORY OVERHEAD:
Capacity Production
Theoretical, maximum or ideal capacity
 a capacity to produce at full speed without interruptions. It gives no allowance for
human capacity to achieve the maximum nor due allowance for any circumstances
that might result to a stoppage of production within or not within the control of
management. At this capacity level, the plant is assumed to function 24 hours a day,
7 days a week, and 52 weeks a year without any interruptions in order to yield the
highest physical output possible.
FACTORY OVERHEAD:
Capacity Production
Practical capacity
 a capacity of production that provides allowance for circumstances that might result
to stoppage of production.
FACTORY OVERHEAD:
Capacity Production
Expected actual capacity
 a capacity concept based on a short-range outlook which is feasible only for firms
whose products are seasonal or where the market and style changes allow price
adjustments according to competitive conditions and customer demands.
FACTORY OVERHEAD:
Capacity Production
Normal capacity
 a capacity of production taking into consideration the utilization of the plant facilities
to meet commercial demands served over a period long enough to level out the
peaks and valleys which come with seasonal and cyclical variations.
 This capacity is commonly used in the computations of overhead rates. (normal
costing)
FACTORY OVERHEAD:
Method of Accumulation of Factory Overhead Costs
1) Non-controlling account system
 an account for each kind of overhead expense according to their nature is opened in
the ledger and charges to such account are made upon incurrence of the expense.

2) Controlling account system

 an Overhead Control account is opened in the general ledger wherein the overhead
incurred are charged and a subsidiary ledger is maintained to show in detail the
nature and account of the expense.
FACTORY OVERHEAD:
Computation of Overhead Chargeable to Individual Cost Sheets
(FOH Applied)

 After factory overhead application rate has been determined, it is used to apply (or
match) estimated factory overhead costs production. The estimated factory overhead
costs are applied to production on an on-going basis as goods are manufactured,
according to the base used (i,e., as a percentage of direct material costs or direct
labor cost or on the basis of direct labor hours, machine hours, or units produced).
 Applied factory overhead can be computed by multiplying the actual factor incurred
per cost sheet x predetermined overhead rate. (Activity x POHR)
 Entry to charge production with applied overhead:
(Dr) Work-in-Process Inventory xxx
(Cr) Factory overhead applied xxx
FACTORY OVERHEAD:
FOH Variance (Actual FOH vs Applied FOH)
 the difference between the actual factory overhead as shown by factory overhead
control account and the overhead charged to production as shown by the factory
overhead applied account.

Classification of manufacturing overhead variance

a. Underapplied overhead - the difference between actual overhead and applied overhead
when the actual is more than the applied. (Applied<Actual)

b. Overapplied overhead - the difference between actual overhead and applied overhead
when the actual is less than the applied. (Applied>Actual)
FACTORY OVERHEAD:
Causes of the manufacturing overhead variance:
1) Spending variance - the variance due to expense factors.

2) Idle capacity or volume variance - the variance due to difference in volume and activity factors.
FACTORY OVERHEAD:
FOH Variances:

1) Compute for the spending variance

2) Compute for the volume variance
FACTORY OVERHEAD:
FOH Variances:

BFOH = 300,000
BA = 100,000

(2 x 100,000)
(1 x 110,000) POHR = 300,000
100,000

POHR = 3

VFOH = 1 FFOH = 2
100,000 200,000
FACTORY OVERHEAD:
3-way variance:
Spending Efficiency Volume

AFOH BAAH BASH SHSR

Budget Allowed Based Budget Allowed Based Standard Hours x
Actual FOH
on Actual Hours on Standard Hours Standard Rate

Use Cost Formula: Use Cost Formula:

y = a + bx y = a + bx
y = fixed + variable/unit x activity y = fixed + variable/unit x activity
y = BFFOH + (VC/u x AH) y = BFFOH + (VC/u x SH)
FACTORY OVERHEAD:
2-way variance: (if SH = AH)
Spending + Efficiency (0) Volume

AFOH BASH SHSR

Budget Allowed Based Standard Hours x
Actual FOH Standard Rate
on Standard Hours

Use Cost Formula:

y = a + bx
y = fixed + variable/unit x activity
y = BFFOH + (VC/u x SH)
FACTORY OVERHEAD:
FOH Variances:
Spending variance Volume

AFOH BASH SHSR

350,000 y = a + bx y = SR x SH
y = 200,000 + 1 (110,000) y =3 x 110,000
y = 310,000 y = 330,000

40,000 Unfavorable 20,000 favorable