Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved.

May not be copied, scanned, or duplicated, in whole or in part, except for

use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Chapter 4
ACCOUNTING FOR
FACTORY OVERHEAD

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objectives
• Identify cost behavior patterns.
• Separate semivariable costs into variable
and fixed components.
• Prepare a budget for factory overhead
costs.
• Account for actual factory overhead.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Learning Objectives (cont.)
• Distribute service department factory
overhead costs to production
departments.
• Apply factory overhead using
predetermined rates.
• Account for actual and applied factory
overhead.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Factory Overhead
• Overhead costs are a very big deal costing
companies, large and small, thousands of
dollars each year.
• It must be allocated in a rational way to all
jobs produced during the period.
• All costs incurred in the factory that are
not chargeable directly to the finished
product are called factory overhead.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Factory Overhead
• Factory Overhead includes:
• Indirect materials consumed in the factory,
such as glue and nails in the production of
wooden furniture and oil used for maintaining
factory equipment.
• Indirect factory labor, such as wages of janitors,
forklift operators and supervisors, and overtime
premiums paid to all factory workers.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Factory Overhead (cont.)
• All other indirect manufacturing expenses, such
as insurance, property taxes, and depreciation
on the factory building and equipment.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Cost Behavior Patterns
• Variable costs are costs that vary in direct
proportion to volume changes.
• Fixed costs are costs that remain the same
in total, when production levels increase
or decrease.
• Semivariable costs have characteristics of
both variable and fixed costs.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Cost Behavior Patterns

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Analyzing Semivariable
Factory Overhead Costs
• Observation Method relies heavily on the
ability of an observer to detect a pattern
of cost behavior by reviewing past cost
and volume data.
• High-Low Method compares a high
production volume and its related cost to a
low production volume with its related
cost.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Analyzing Semivariable
Factory Overhead Costs
• Scattergraph method estimates a straight
line along which the semivariable costs
will fall.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Analyzing Semivariable
Factory Overhead Costs
• The high-low and statistical scattergraph
methods use historical cost patterns to
predict future costs and are, therefore
subject to limitations that apply to all
forecasting techniques.
• Statistical software packages are often
used to analyze semivariable factory
overhead.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Analyzing Semivariable
Factory Overhead Costs
• Least-squares regression method uses all
of the data to separate a semivariable cost
into its fixed and variable elements based
on the equation for a straight line:
Y = a + bX, where:
• X = activity level
• Y = the total semivarible cost
• a = the total fixed cost
• b = the variable cost per unit
Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Analyzing Semivariable Factory
Overhead Costs

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Budgeting Factory Overhead
Costs
• Budgets are management’s operating
plans expressed in quantitative terms,
such as units of production and related
costs.
• The segregation of fixed and variable cost
components permits the company to
prepare a flexible budget. A flexible
budget is a budget that shows estimated
costs at different production volumes.
Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Accounting for Actual Factory
Overhead
• Cost accounting systems are designed to
accumulate, classify, and summarize the
factory overhead costs actually incurred.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Schedule of Fixed Costs

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Summary of Factory
Overhead
Figure 4-9 Summary of Factory Overhead

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Distributing Service
Department Expenses
• Departments are divided into two classes:
service departments and production
departments.
• A service department is an essential part
of the organization, but it does not work
directly on the product.
• A production department performs the
actual manufacturing operations that
physically change the units being
processed.
Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Distributing Service
Department Expenses
• Direct Distribution Method
• Sequential Distribution or Step-Down
Method
• Reciprocal Method

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Direct Distribution Method
Figure 4-10 Method 1-Spreadsheet for Direct Distribution of Service Department Costs to Production Departments

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Sequential Distribution
Method
Figure 4-11 Method 2-Spreadsheet for Sequential Distribution of Service Department Costs Based on Magnitude of Total
Costs in Service Departments

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Applying Factory Overhead
to Production
• Predetermined factory overhead rates are
computed by dividing the budgeted
factory overhead cost by the budgeted
production.
• The budgeted production may be
expressed in such terms as machine hours,
direct labor hours, direct labor cost, and
units produced.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Applying Factory Overhead
to Production
• Management should give a high priority to
attaining the most accurate
predetermined factory overhead rate.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Applying Factory Overhead to
Production
• Direct Labor Cost Method
• Direct Labor Hour Method
• Machine Hour Method
• Activity-based Costing Method

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Accounting for Actual and
Applied Factory Overhead
• Entry to apply estimated FOH to production:

Work in Process XXX

Applied Factory Overhead XXX

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Accounting for Actual and
Applied Factory Overhead
• At the end of the period, the applied
factory overhead account is closed to the
FOH control account:

Applied Factory Overhead XXX

Factory Overhead XXX

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Under and Over applied
Factory Overhead
• The debit balance indicates that the
factory overhead costs were underapplied
or underabsorbed.
• The credit balance indicated that the
factory overhead costs were overapplied
or overabsorbed.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Under and Over applied
Factory Overhead
• At the end of the year, the balance of the
under and overapplied account will be
closed to Cost of Goods Sold, or allocated
on a pro rata basis to Work in Process,
Finished Goods, and Cost of Goods Sold.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Period and Product Cost
• Period cost
• Costs that directly reduce net income for the
current period.
• Product Cost
• Costs that are included as part of the
inventories and expensed when the goods are
sold.

Principles of Cost Accounting, 17th Edition, Edward J. VanDerbeck, ©2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.