Factory Overhead Planned, Applied & Actual Chapter 9

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 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 variable factory overhead = variable portion of factory overhead rate

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 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)

Assignment The Carrcroft Company estimates its factory overhead for the next period at $54,000. it is estimated that 36,000 units will be produced at a material cost of $45,000. Production will require 24,000 direct labor hours at an estimated cost of $120,000. The machines will run about 1,600 hours. Required: the predetermined factory overhead rate based on : Material cost Units of production Machine hours Direct labor cost direct labor hours. Name five bases used for applying factory overhead. What factors must be considered in selecting a particular basis?

Variance Analysis Spending Variance-a variance due to budget or expense factors Idle capacity Variance- a variance due to volume or activity levels

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

Spending Variance The $ 750 is the difference between the actual factory overhead incurred and the budget allowance estimated for the capacity utilized i.e 190,000 direct labor hours. 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.

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.

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