Principles of Cost Accounting, 16th Edition, Edward J. VanDerbeck, ©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
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Chapter 4
Accounting for Factory
Overhead
Learning Objectives
Identify cost behavior patterns.
Separate semivariable costs into variable
and fixed components.
Prepare a budget for factory overhead
costs.
Account for actual factory overhead.
Learning Objectives (cont.)
Distribute service department factory
overhead costs to production departments.
Apply factory overhead using predetermined
rates.
Account for actual and applied factory
overhead.
Factory Overhead
• Overhead costs are a very big deal costing
companies, large and small, thousands of
dollars each year.
• It must be allocated in a rational way to all
jobs produced during the period.
• All costs incurred in the factory that are not
chargeable directly to the finished product
are called factory overhead.
Factory Overhead
• Factory Overhead includes:
(1) indirect materials consumed in the
factory, such as glue and nails in the
production of wooden furniture and oil
used for maintaining factory equipment.
(2) indirect factory labor, such as
wages of janitors, forklift operators and
supervisors, and overtime premiums
paid to all factory workers.
Factory Overhead (cont.)
(3) all other indirect manufacturing
expenses, such as insurance, property
taxes, and depreciation on the factory
building and equipment.
Cost Behavior Patterns
• Variable costs are costs that vary in direct
proportion to volume changes.
• Fixed costs are costs that remain the
same in total, when production levels
increase or decrease.
• Semivariable costs have characteristics of
both variable and fixed costs.
Cost Behavior Patterns
Analyzing Semivariable
Factory Overhead Costs
• Observation Method relies heavily on the
ability of an observer to detect a pattern of
cost behavior by reviewing past cost and
volume data.
• High-Low Method compares a high
production volume and its related cost to a
low production volume with its related
cost.
Analyzing Semivariable
Factory Overhead Costs
• Scattergraph method estimates a straight
line along which the semivariable costs will
fall.
Analyzing Semivariable
Factory Overhead Costs
• The high-low and statistical scattergraph
methods use historical cost patterns to
predict future costs and are, therefore
subject to limitations that apply to all
forecasting techniques.
• Statistical software packages are often
used to analyze semivariable factory
overhead.
Analyzing Semivariable
Factory Overhead Costs
• Least-squares regression method uses all
of the data to separate a semivariable cost
into its fixed and variable elements based
on the equation for a straight line:
Y = a + bX, where:
X = activity level
Y = the total semivarible cost
a = the total fixed cost
b = the variable cost per unit
Analyzing Semivariable
Factory Overhead Costs
Budgeting Factory Overhead
Costs
• Budgets are management’s operating
plans expressed in quantitative terms,
such as units of production and related
costs.
• The segregation of fixed and variable cost
components permits the company to
prepare a flexible budget. A flexible budget
is a budget that shows estimated costs at
different production volumes.
Accounting for Actual Factory
Overhead
• Cost accounting systems are designed to
accumulate, classify, and summarize the
factory overhead costs actually incurred.
Schedule of Fixed Costs
Summary of Factory
Overhead
Distributing Service
Department Expenses
• Departments are divided into two classes:
service departments and production
departments.
• A service department is an essential part of
the organization, but it does not work directly
on the product.
• A production department performs the actual
manufacturing operations that physically
change the units being processed.
Distributing Service
Department Expenses
• Direct Distribution Method
• Sequential Distribution or Step-Down
Method
• Reciprocal Method
Direct Distribution Method
Sequential Distribution
Method
Applying Factory Overhead
to Production
• Predetermined factory overhead rates are
computed by dividing the budgeted factory
overhead cost by the budgeted production.
• The budgeted production may be expressed
in such terms as machine hours, direct labor
hours, direct labor cost, and units produced.
• Management should give a high priority to
attaining the most accurate predetermined
factory overhead rate.
Applying Factory Overhead to
Production
• Direct Labor Cost Method
• Direct Labor Hour Method
• Machine Hour Method
• Activity-based Costing Method
Accounting for Actual and
Applied Factory Overhead
• Entry to apply estimated FOH to
production:
Work in Process XXX
Applied Factory Overhead XXX
Accounting for Actual and
Applied Factory Overhead
• At the end of the period, the applied
factory overhead account is closed to the
FOH control account:
Applied Factory Overhead
Factory Overhead
XXX
XXX
Under and Over applied
Factory Overhead
• The debit balance indicates that the
factory overhead costs were underapplied
or underabsorbed.
• The credit balance indicated that the
factory overhead costs were overapplied
or overabsorbed.
Under and Over applied
Factory Overhead
• At the end of the year, the balance of the
under and overapplied account will be
closed to Cost of Goods Sold, or allocated
on a pro rata basis to Work in Process,
Finished Goods, and Cost of Goods Sold.
Period and Product Cost
• Period cost
Costs that directly reduce net income for
the current period.
• Product Cost
Costs that are included as part of the
inventories and expensed when the
goods are sold.