Introduction to Management Accounting
Chapter 13
Accounting for
Overhead Costs
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 1
Learning
Objective 1
Accounting for Factory Overhead
Methods for assigning overhead costs
to the products is an important part of
accurately measuring product costs.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 2
Budgeted Overhead Application Rates
1.
2.
3.
4.
5.
Select one or more cost drivers.
Prepare a factory overhead budget.
Compute the factory overhead rate.
Obtain actual cost-driver data.
Apply the budgeted overhead
to the products.
6. Account for any differences between the
amount of actual and applied overhead.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 3
Budgeted Overhead Application Rates
Overhead rates are budgeted; they are
estimates. The budgeted rates are used
to apply overhead based on actual events.
Budgeted overhead application rate
= Total budgeted factory overhead
÷ Total budgeted amount of cost driver
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 4
Illustration of Overhead Application
Enriquez Machine Parts Company selects a single costallocation in each department for applying overhead,
machine hours in machining and direct-labor in assembly.
The company’s budgeted manufacturing overhead
for the machining department is $277,800.
Budgeted machine hours are 69,450.
The budgeted overhead application rate is:
$277,800 ÷ 69,450 = $4 per machine hour
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 5
Illustration of Overhead Application
Suppose that at the end of the year Enriquez
had used 70,000 hours in Machining.
How much overhead was applied to Machining?
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 6
Learning
Objective 2
Choice of Cost-Allocation Bases
No one cost –allocation base is right for all situations.
The accountant’s goal is to find the costallocation base that best links cause and effect.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 7
Choice of Cost-Allocation Bases
A separate cost pool should be
Identified for each cost-allocation base.
Base 1
Pool 1
Base 2
Pool 2
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 8
Learning
Objective 3
Normalized Overhead Rates
“Normal” product costs include
an average or normalized
chunk of overhead.
Actual direct material
+ Actual direct labor
+ Normal applied overhead
= Cost of manufactured product
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 9
Disposing of Underapplied
or Overapplied Overhead
Suppose that Enriquez applied
$375,000 to its products.
Also, suppose that Enriquez actually incurred $392,000
of actual manufacturing overhead during the year.
$392,000 actual
–375,000 applied
$ 17,000 Underapplied
The $375,000 becomes part of Cost of Goods Sold when the
product is sold. The $17,000 must also become an expense.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 10
Disposing of Underapplied
or Overapplied Overhead
The applied overhead is $17,000
less than the amount incurred. It is:
Overapplied overhead occurs when the
amount applied exceeds the amount incurred.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 11
Immediate Write-Off
This method regards the $17,000 as a reduction in
current income and adds it to Cost of Goods Sold.
Manufacturing Overhead
375,000
392,000
17,000
0
Applied Overhead
(Budgeted)
Cost of Goods Sold
Incurred Overhead
(Actual)
17,000
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 12
Prorating Among Inventories
This method prorates the $17,000 of
underapplied overhead to Work-In Process (WIP),
Finished Goods, and Cost of Goods Sold accounts
assuming the following ending account balances:
Work-in-Process Inventory
Finished Goods Inventory
Cost of Goods Sold
Total
$ 155,000
32,000
2,480,000
$2,667,000
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 13
Prorating Among Inventories
$17,000 × 155/2,667
= 988 to Work-in-Process Inventory
$17,000 × 32/2,667
= $204 to Finished Goods Inventory
$17,000 × 2,480/2,667
= $15,808 to Cost of Goods Sold
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 14
Variable and Fixed Application Rates
The presence of fixed costs is a
major reason of costing difficulties.
Some companies distinguish between
variable overhead and fixed
overhead for product costing.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 15
Variable Versus Absorption Costing
Variable costing excludes fixed manufacturing
overhead from the cost of products.
Variable
costing
Absorption
costing
Absorption costing includes fixed manufacturing
overhead in the cost of products.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 16
Facts and Illustration
Basic Production Data at Standard Cost
Direct material
Direct labor
Variable manufacturing overhead
Standard variable costs per unit
$205
75
20
$300
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 17
Facts and Illustration
The annual budget for fixed
manufacturing overhead is $1,500,000
Budgeted production is 15,000 computers.
Sales price = $500 per unit
$20 per computer is variable overhead.
Fixed S&A expenses = $650,000
Sales commissions = 5% of dollar sales
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 18
Facts and Illustration
Units
Opening inventory
Production
Sales
Ending inventory
20X7
20X8
–
17,000
14,000
3,000
3,000
14,000
16,000
1,000
There are no variances from the standard variable
manufacturing costs, and the actual fixed manufacturing
overhead incurred is exactly $1,500,000.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 19
Learning
Objective 4
Variable- Costing Method
Cost of Goods Sold
(thousands of dollars)
Variable expenses:
Variable manufacturing cost
of goods sold
Opening inventory, at
standard costs of $300
Add: variable cost of goods
manufactured at standard,
17,000 and 14,000 units
Available for sale, 17,000 units
Ending inventory, at $300
Variable manufacturing
cost of goods sold
20X7
–
20X8
$ 900
5100
5100
900¹
$4200
4200
5100
300²
$4800
¹3,000 units × $300 = $900,000 ²1,000 units × $300 = $300,000
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 20
Variable-Costing Method
Comparative Income Statement
(thousands of dollars)
Sales, 14,000 and 16,000 units
Variable expenses:
Variable manufacturing
cost of goods sold
Variable selling expenses,
at 5% of dollar sales
Contribution margin
Fixed expenses:
Fixed factory overhead
Fixed selling and admin. expenses
Operating income, variable costing
1
20X7
$7,000
42001
20X8
$8,000
48001
350
$2,450
400
$2,800
$1,500
650
$ 300
$1,500
650
$ 650
from Cost of Goods Sold previous calculation
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 21
Fixed-Overhead Rate
The fixed-overhead rate is the
amount of fixed manufacturing
overhead applied to each
unit of production.
budgeted fixed manufacturing overhead
Fixed overhead rate =
expected volume of production
$1,500,000 ÷ 15,000 = $100
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 22
Learning
Objective 5
Absorption-Costing Method
Cost of Goods Sold
(thousands of dollars)
20X7
Beginning inventory
Add: Cost of goods manufactured
at standard, of $400*
Available for sale
Deduct: Ending inventory
Cost of goods sold, at standard
*Variable cost
Fixed cost
Standard absorption cost
20X8
$ –
$1,200
6,800
$6,800
1,200
$5,600
5,600
$6,800
400
$6,400
$300
100
$400
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 23
Absorption-Costing Method
Comparative Income Statement
(thousands of dollars)
Sales
Cost of goods sold, at standard
Gross profit at standard
Production-volume variance*
Gross margin or gross profit “actual”
Selling and administrative expenses
Operating income, variable costing
20X7
$7,000
5,6001
$1,400
200 F
$1,600
1,000
$ 600
20X8
$8,000
6,4001
$1,600
100 U
$1,500
1,050
$ 450
*Based on expected volume of production of 15,000 units:
20X7: (17,000 – 15,000) × $100 = $200,000 F
20X8: (14,000 – 15,000) × $100 = $100,000 U
1From Cost of Goods Sold previous calculation
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 24
Learning
Objective 6
Production-Volume Variance
A production-volume variance appears when actual
production deviates from the expected volume of production
used in computing the fixed overhead rate.
Production-volume variance =
(actual volume – expected volume) X fixed overhead rate
In practice, the production-volume variance
is usually called simply the volume variance.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 25
Production-Volume Variance
There is no production-volume variance for variable overhead.
The production-volume variance for fixed overhead arises because
of the conflict between accounting for control (flexible budgets)
and accounting for product costing (applied rates).
A flexible budget for fixed overhead is a lump-sum
budgeted amount; volume does not affect it. However,
applied fixed cost depends on actual volume.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 26
Variable Costing and Absorption Costing
The difference between income reported
under these two methods is entirely due to
the treatment of fixed manufacturing costs.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 27
Variable Costing and Absorption Costing
On a variable-costing income statement, costs are
separated into the major categories of fixed and variable.
Revenue less all variable costs (both manufacturing
and non-manufacturing) is the contribution margin.
On an absorption-costing income statement, costs
are separated into the major categories of
manufacturing and non-manufacturing. Revenue
less manufacturing costs (both fixed and variable)
is gross profit or gross margin.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 28
Learning
Objective 7
Why Use Variable Costing?
One reason is that absorption-costing
income is affected by production
volume while variable-costing
income is not.
Another reason is based on which
system the company believes
gives a better signal about
performance.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 29
Flexible-Budget Variances
All variances other than the
production-volume variance are
essentially flexible-budget variances.
All other variances
appear on both variableand absorption-costing
income statements.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 30
Flexible-Budget Variances
Flexible-budget variances measure components of
the differences between actual amounts and the
flexible-budget amounts for the output achieved.
Flexible budgets are
primarily designed to
assist planning and
control rather
than product costing.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 31
Effects of Sales and Production
on Reported Income
Production > Sales
Variable costing income is lower
than absorption income.
Production < Sales
Variable costing income is higher
than absorption income.
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 32
The End
End of Chapter 13
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 33