Accounting For Overhead Costs

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.
Budgeted Overhead Application Rates
1. Select one or more cost drivers.

2. Prepare a factory overhead budget.
3. Compute the factory overhead rate.
4. Obtain actual cost-driver data.
5. Apply the budgeted overhead
to the products.
6. Account for any differences between the
amount of actual and applied overhead.
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
Illustration of Overhead Application
Enriquez Machine Parts Company selects a single cost-

allocation in each department for applying overhead,
machine hours in machining and direct-labor in assembly.
The companys 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
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?
Learning
Objective 2 Choice of Cost-Allocation Bases
No one cost allocation base is right for all situations.
The accountants goal is to find the cost-

allocation base that best links cause and effect.
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
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
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.
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.
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
Applied Overhead
375,000
392,000 (Budgeted)
17,000
0
Cost of Goods Sold

17,000
Incurred Overhead
(Actual)
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 $ 155,000

Finished Goods Inventory 32,000
Cost of Goods Sold 2,480,000
Total $2,667,000
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
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.
Variable Versus Absorption Costing
Variable costing excludes fixed manufacturing

overhead from the cost of products.
Variable Absorption
costing costing
Absorption costing includes fixed manufacturing

overhead in the cost of products.
Facts and Illustration
Basic Production Data at Standard Cost

Direct material $205
Direct labor 75
Variable manufacturing overhead 20
Standard variable costs per unit $300
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

Units 20X7 20X8

Opening inventory 3,000
Production 17,000 14,000
Sales 14,000 16,000
Ending inventory 3,000 1,000
There are no variances from the standard variable

manufacturing costs, and the actual fixed manufacturing
overhead incurred is exactly $1,500,000.
Learning Variable- Costing Method
Objective 4 Cost of Goods Sold
(thousands of dollars) 20X7 20X8

Variable expenses:
Variable manufacturing cost
of goods sold
Opening inventory, at $ 900
standard costs of $300
Add: variable cost of goods
manufactured at standard,
17,000 and 14,000 units 5100 4200
Available for sale, 17,000 units 5100 5100
Ending inventory, at $300 900 300
Variable manufacturing
cost of goods sold $4200 $4800
3,000 units $300 = $900,000 1,000 units $300 = $300,000
Variable-Costing Method
Comparative Income Statement
Sales, 14,000 and 16,000 units $7,000 $8,000
Variable expenses:
Variable manufacturing
cost of goods sold 42001 48001
Variable selling expenses,
at 5% of dollar sales 350 400
Contribution margin $2,450 $2,800
Fixed expenses:
Fixed factory overhead $1,500 $1,500
Fixed selling and admin. expenses 650 650
Operating income, variable costing $ 300 $ 650
1 from Cost of Goods Sold previous calculation
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
Learning Absorption-Costing Method
Objective 5 Cost of Goods Sold

Beginning inventory $ $1,200
Add: Cost of goods manufactured
at standard, of $400* 6,800 5,600
Available for sale $6,800 $6,800
Deduct: Ending inventory 1,200 400
Cost of goods sold, at standard $5,600 $6,400
*Variable cost $300
Fixed cost 100
Standard absorption cost $400
Absorption-Costing Method
Comparative Income Statement
Sales $7,000 $8,000
Cost of goods sold, at standard 5,6001 6,4001
Gross profit at standard $1,400 $1,600
Production-volume variance* 200 F 100 U
Gross margin or gross profit actual $1,600 $1,500
Selling and administrative expenses 1,000 1,050
Operating income, variable costing $ 600 $ 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
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.
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.
Variable Costing and Absorption Costing
The difference between income reported

under these two methods is entirely due to
the treatment of fixed manufacturing costs.
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.
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.
Flexible-Budget Variances
All variances other than the

production-volume variance are
essentially flexible-budget variances.
All other variances

appear on both variable-
and absorption-costing
income statements.
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.
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.
The End
End of Chapter 13

Accounting For Overhead Costs

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Accounting For Overhead Costs

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Accounting for

Methods for assigning overhead costs

1. Select one or more cost drivers.

Overhead rates are budgeted; they are

Budgeted overhead application rate

Enriquez Machine Parts Company selects a single cost-

The companys budgeted manufacturing overhead

Budgeted machine hours are 69,450.

The budgeted overhead application rate is:

Suppose that at the end of the year Enriquez

How much overhead was applied to Machining?

No one cost allocation base is right for all situations.

The accountants goal is to find the cost-

A separate cost pool should be

Normal product costs include

Actual direct material

Also, suppose that Enriquez actually incurred $392,000

The applied overhead is $17,000

Overapplied overhead occurs when the

This method regards the $17,000 as a reduction in

Cost of Goods Sold

This method prorates the $17,000 of

Work-in-Process Inventory $ 155,000

The presence of fixed costs is a

Some companies distinguish between

Variable costing excludes fixed manufacturing

Absorption costing includes fixed manufacturing

Basic Production Data at Standard Cost

The annual budget for fixed

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

Units 20X7 20X8

There are no variances from the standard variable

(thousands of dollars) 20X7 20X8

The fixed-overhead rate is the

budgeted fixed manufacturing overhead

$1,500,000 15,000 = $100

(thousands of dollars) 20X7 20X8

A production-volume variance appears when actual

In practice, the production-volume variance

There is no production-volume variance for variable overhead.

A flexible budget for fixed overhead is a lump-sum

The difference between income reported

On a variable-costing income statement, costs are

On an absorption-costing income statement, costs

One reason is that absorption-costing

Another reason is based on which

All variances other than the

All other variances

Flexible-budget variances measure components of

Flexible budgets are

Production > Sales

Production < Sales

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