MSE608C – Engineering and Financial
Cost Analysis
Calculating and Accounting for
Overhead
Overhead Costs
•
•
Overhead manufacturing costs are expenses that
are difficult or too costly to assign directly to
product.
The method for allocating Overhead must be:
– Rational
– Able to identify a cause/effect relationship between costs and
products
– Applied consistently
– Fair to responsible managers
– Based on timely cost data
– Based on accepted cost accounting rules and procedures.
Calculating the Overhead Rate
• When measuring and allocating Overhead
there are three decisions that must be made
by the Cost Accountant.
1. What costs become Overhead?
2. What will be the Cost-allocation base?
3. What will be the Overhead Rate?
• Different choices will result in different
costs.
Calculating the Overhead Rate
1. What items become Overhead?
– Identify the Prime Costs (Direct Labor and Direct Material);
– all other Manufacturing costs will become Overhead.
– Apply the Materiality concept.
2. What will be the Cost-allocation base?
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–
–
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Direct-labor hours
Direct-labor dollars
Material-dollars
Machine-hours
Units of Production
Calculating the Overhead Rate
3. What will be the Overhead (Burden) Rate?
Step 1. Budget Overhead for the next accounting period
Step 2. Budget cost-allocation base for the accounting
period.
Step 3. Calculate the applied Overhead Rate.
Total Overhead Costs
Overhead Rate =
Total Cost-allocation base
Over-absorbed and Underabsorbed Overhead
• There is little chance the actual amount of
Overhead incurred will equal the amount
applied!
– Applied Overhead was based on both budgeted overhead costs and
budgeted utilization of the cost-allocation base.
• Under-absorbed Overhead
– The amount applied is less than the actual amount spent on
Overhead during the accounting period.
• Over-absorbed Overhead
– The amount applied is more than the actual amount spent on
Overhead during the accounting period.
The Overhead Variance Account
• In the Journal there is a special account called
Overhead Variance.
Overhead Variance
Actual Overhead Expenses
(Debit)
Applied Overhead
(Credit)
• A credit variance = Over-absorbed Overhead
• A debit variance = Under-absorbed Overhead
Journal Entries for Incurring
Overhead
Indirect Wages Payable
$100
Allowance for
Depreciation
$200
In-Process
Inventory
Overhead Variance
$100
Production Supplies
$50
$200
$50
$150
Factory Utilities
$150
Cost-of-Goods-Sold
Finished Goods
Inventory
Allocating Overhead
Wages Payable
$$$$$
Indirect Wages
Payable
$100
Allowance for
Depreciation
$200
Direct Labor
$$$$$
$75
Overhead Variance
$100
$75
$225
$50
$200
Production Supplies
$50
$50
$150
$$$$$
$350
Cost-of-Goods-Sold
$350
$225
Raw Material Inv.
Factory Utilities
In-Process
Inventory
$50
$150
Finished Goods
Inventory
$350
Accounts Payable
$$$$$
$350
Overhead Allocation Methods
Full-absorption Costing
– Allocates VARIABLE and FIXED Overhead costs.
• Variable Costing
– Allocates only VARIABLE Overhead costs.
• Activity Based Costing (ABC)
– Allocates overhead costs to the products that use them.
Only useful when multiple products are manufactured
in the same facility.
Assessment
• What is Overhead and why do we have to
allocate it?
• Define Under-absorbed Overhead? Define
Over-absorbed Overhead?
• Which is the only allowable method for
reporting Overhead on financial reports,
Full or Variable Absorption?