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:
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Indirect materials
Indirect labor
All other factory expenses that cannot
conveniently be identified with specific jobs or
products.
Factory Overhead
 Also known as:
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Factory burden
Manufacturing expense
Manufacturing overhead
Factory expense
Indirect manufacturing cost
 Factory Overhead possesses two
characteristics:
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Relationship with product
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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.
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Relationship with volume
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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
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Physical output
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Estimated factory overhead
Estimated units of production
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Direct materials cost
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Estimated factory overhead *100 = % of overhead/direct material cost
Estimated material cost
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= factory overhead/unit
Factors to be considered in
Selection of Overhead rates
 Direct labor cost
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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
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Estimated factory overhead
Estimated Direct labor hours
= Rate per direct labor hour
 Machine hours
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Estimated factory overhead
Estimated machine hours
= Rate per machine hour
Factors to be considered in Selection
of Overhead rates
 Activity level selection
 Normal capacity – long-term approach
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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
Variable expense:
150,000 hrs*0.50
120,000 hrs*0.50
Total estimated overhead
Estimated DLHs
Factory overhead/hr
Fixed overhead/ hr
120,000
120,000
75,000
______
195,000
150,000
$1.30
$0.80
60,000
______
180,000
120,000
$1.50
$1.00
Factors to be considered in Selection
of Overhead rates
 Including or excluding of fixed overhead
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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
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Estimated factory overhead
Estimated Direct labor hours
= Rate per direct labor hour
 Factory overhead can be broken down into its fixed
and variable components:
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Estimated fixed factory overhead
Estimated Direct labor hours
= fixed portion of factory overhead rate
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
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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
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(190,000 actual hours* 0.875)
166,250
$291,250
 Idle Capacity Variance
 Applied Factory overhead(190,000 hrs*1.50)
 Factory overhead –underapplied
 (292,000-$285,000)
6,250 unfavorable
$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
Factory overhead