Chapter 19 Manufacturing Overhead Standard Costs: Completing the Accounting Cycle for Standards costs

Introduction Manufacturing overhead costs consist of numerous costs items Few are directly related to individual products The standard for manufacturing overhead per completed unit of product is largely the result of an allocation process

Standard Manufacturing Overhead Costs Determined at the start of the year Based on budgeted overhead allowed for the volume of activity chosen Expected actual production Normal capacity for a period Represents the average expected utilization of plant and labor for a year in order to even out variations

Setting up a Standard Cost System Establish standard overhead costs per unit Record actual costs incurred Determine standard costs for units produced Compute variances by comparison of costs Break down variances into component parts Record standard costs and variances Transfer standard cost of units produced to Finished Goods Inventory

Illustration of Terminology Total budgeted hours Estimated work hours for the period - budgeted output of units x standard hours Total standard hours Number of hours it should take to produce actual output - actual output of units x standard hours Total actual hours Number of hours it did take to produce actual output - actual output of units x actual hour

Establishing Standard Overhead Costs Per Unit of Product Established by using estimated costs and selected basis for application Standard hours per unit X Rate per hour Overhead rate per unit of product

Recording Actual Costs Actual manufacturing overhead costs are accounted for in two steps Record in the Manufacturing Overhead Control account the actual costs incurred Allocate the service department costs to the producing departments Manufacturing Overhead Control dr. Various Payables (Prepaid Expenses, etc) cr.

Determining Standard Costs for Period Usually direct labor hours are used to apply manufacturing overhead to production Standard cost applied = standard hours allowed x standard overhead rate per hour

Measuring and Analyzing the Total Overhead Variance Variance analyses Analyzes total variance in each department and divides it into its component parts

Two-Variance Analysis Method Total variance is separated into: Budget variance - difference between actual cost incurred and the overhead in flexible budget for the standard hours allowed for units produced Relates to variable and fixed costs Volume variance – difference between the number of hours on which overhead was charged and the number of hours used by the original budget to compute standard overhead rate Relates to fixed costs

Three-Variance Analysis Method This method results in Volume variance Spending variance Compares what should have been spent with what was actually spent for the actual hours worked Efficiency variance Compares the standard hours worked with the actual hours worked for the actual level of output times the variable application rate

Four-Variance Analysis Method Volume variance Efficiency variance Variable overhead spending variance Difference between the actual variable overhead cost incurred and the budget allowance for variable overhead based on the actual hours worked Fixed overhead spending variance Difference between the actual fixed cost incurred and the budgeted fixed cost

Applying and Recording Overhead Variances Manufacturing overhead is applied on the basis of standard cost for the number of actual units produced Summaries of overhead variances provide information for recording journal entries

Recording Transfer of Finished Goods and Sale of Products Completed units are valued at their standard costs when transferred to Finished Goods Sold units are also priced at standard costs when transferred to Cost of Goods Sold

Disposition of Standard Cost Variance Variances are prorated among Cost of Goods Sold, Finished Goods, and Work in Process Variances are accumulate until the end of the year – either prorated or closed into Cost of Goods Sold Variances are accumulate until the end of the year closed into Cost of Goods Sold and adjusted in the income statement Variance accounts are closed into Cost of Goods Sold at the end of each month Variances are closed into the income and expense summary account and shown as income or other expenses in the income statement at the end of each month

Disposition of Standard Cost Variance (cont’d) Showing variances in the income statement When variances are treated as adjustment to cost of goods sold in the income statement Individual variances may be shown All variances may be combined and shown as a single figure