Factory OverheadPlanned, 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/ 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

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?

Preparing the Master Budget

Master or static budget is prepared for a single level of volume based on best estimate of the level of production and sales for the coming period.

The sales budget is the starting point. From the sales budget, production

requirements are determined.

Budgeted Income Statement

Sales budget Cost of goods sold budget

Production budget Direct materials budget Direct labor budget Factory overhead budget

Selling and administrative expenses budget

Sales Budget

This is the basis for preparing all other budgets.

Projects the volume of sales both in units and dollars.

Production Budget

After the sales forecast and inventory levels have been determined, management can determine production requirements.

Units to be soldUnits to be sold 100,000100,000

Ending inventory requiredEnding inventory required 4,5004,500

TotalTotal 104,500104,500

Beginning inventoryBeginning inventory 2,5002,500

Units to be manufacturedUnits to be manufactured 102,000102,000

Units per month (102,000/12)Units per month (102,000/12) 8,5008,500

Direct Materials Budget

The direct materials budget is prepared once the production requirements have been determined.

The desired ending inventory for each material is added to the quantity needed to meet production needs, and that total is reduced by the estimated beginning inventory to determine the amount of materials to be purchased.

Direct Labor Budget

The production requirements are used to prepare the direct labor budget.

Standard labor time allowed per unit is multiplied by the number of required units to obtain the total direct manufacturing labor hours.

Factory Overhead Budget

Consists of the estimated individual factory overhead items needed to meet production requirements.

Factory Overhead BudgetFactory Overhead Budget

Indirect materialsIndirect materials $225,000$225,000

Indirect laborIndirect labor 375,250375,250

Depreciation of buildingDepreciation of building 85,00085,000

Depreciation of machinery and Depreciation of machinery and equipmentequipment

67,50067,500

Total factory overhead costTotal factory overhead cost $$752,750752,750

Cost of Goods Sold Budget

Budget is prepared once the direct material, direct labor, and factory overhead budgets have been completed.

The estimated beginning inventories and the desired ending inventories of WIP and Finished Goods are included to compute the cost of goods sold.

Selling & Administrative Expenses Budget

The selling and administrative expenses budget may be prepared once the sales forecast has been made.

This budget has separate sections for selling and administrative expenses.

Budgeted Income Statement

Once the preceding budgets have been completed, the budgeted income statement may be prepared.

If the budgeted profit does not meet expectation, management may wish to reevaluate their original expectations.

Budgeted Balance Sheet

Cash budget Shows the anticipated cash flow and the timing of cash

receipts and disbursements. Accounts receivable budget

Based on anticipated sales, credit terms, the economy, and other relevant factors.

Liabilities budget Reflects how the company’s cash position will be affected by

paying their liabilities. Capital expenditures budget

A plan for the timing of acquisitions of buildings, equipment, or other significant assets during the period.

Flexible Budgeting

A plan of what will happen to a company under varying sets of conditions.

The company plans in advance what the effect will be on revenue, expense, and profit if sales or production differ from the budget.

Standard production is determined and the initial calculation of variable and fixed costs is based on this level of production.

Preparing the Flexible Budget

28,000 units28,000 units 30,000 30,000 unitsunits

32,000 units32,000 units

Sales ($150/unitSales ($150/unit $4,200,000$4,200,000 $4,500,000$4,500,000 $4,800,000$4,800,000

Direct materials:Direct materials:

Lumber ($20/unit)Lumber ($20/unit) 560,000560,000 600,000600,000 640,000640,000

Paint ($4/unit)Paint ($4/unit) 112,000112,000 120,000120,000 128,000128,000

Direct labor:Direct labor:

Cutting ($3.75/unit)Cutting ($3.75/unit) 105,000105,000 112,500112,500 120,000120,000

Assembly ($2.40/unit)Assembly ($2.40/unit) 67,20067,200 72,00072,000 76,80076,800

Variable FOH ($6.93/unit)Variable FOH ($6.93/unit) 194,040194,040 207,90207,9000 221,760221,760

Contribution MarginContribution Margin $3,161,760$3,161,760 $3,387,600$3,387,600 $3,613,440$3,613,440

Fixed FOH and S & A Fixed FOH and S & A expenseexpense

773,825773,825 773,825773,825 773,825773,825

Operating incomeOperating income $$2,387,9352,387,935 $$2,613,7752,613,775 $$2,839,6152,839,615

Performance Report Based on Flexible Budgeting

Budget Budget

(28,000 units)(28,000 units)Actual Actual

(28,000 units)(28,000 units)VarianceVariance

Sales ($150/unit)Sales ($150/unit) $4,200,000$4,200,000 $4,250,000$4,250,000 $50,000 F$50,000 F

Direct materials:Direct materials:

Lumber ($20/unit)Lumber ($20/unit) 560,000560,000 585,000585,000 25,000 U25,000 U

Paint ($4/unit)Paint ($4/unit) 112,000112,000 108,000108,000 4,000 F4,000 F

Direct labor:Direct labor:

Cutting ($3.75/unit)Cutting ($3.75/unit) 105,000105,000 120,000120,000 15,000 U15,000 U

Assembly ($2.40/unit)Assembly ($2.40/unit) 67,20067,200 72,00072,000 4,800 U4,800 U

Variable FOH ($6.93/unit)Variable FOH ($6.93/unit) 194,040194,040 206,823206,823 12,763 U12,763 U

Contribution MarginContribution Margin $3,161,760$3,161,760 $3,158,177$3,158,177 $3,583 u$3,583 u

Fixed FOH and S & A expenseFixed FOH and S & A expense 773,825773,825 770,550770,550 3,275 F3,275 F

Operating incomeOperating income $$2,387,9352,387,935 $$2,387,6272,387,627 $$308 u308 u

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