Factory Overhead

Accounting for Factory
Overhead Costs
Cost Accounting
©2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 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 company’s budgeted manufacturing overhead

for the machining department is P277,800.
Budgeted machine hours are 69,450.
The budgeted overhead application rate is:

P277,800 ÷ 69,450 = P4 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?
Choice of Cost-Allocation Bases
No one cost –allocation base is right for all situations.
The accountant’s goal is to find the cost-

allocation base that best links cause and effect.
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
P375,000 to its products.
Also, suppose that Enriquez actually incurred P392,000

of actual manufacturing overhead during the year.
392,000 actual
–375,000 applied
17,000 Underapplied
The P375,000 becomes part of Cost of Goods Sold when the
product is sold. The P17,000 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 P17,000 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 P17,000 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 P 155,000

Finished Goods Inventory 32,000
Cost of Goods Sold 2,480,000
Total P2,667,000
Prorating Among Inventories
P17,000 × 155/2,667
= 988 to Work-in-Process Inventory
P17,000 × 32/2,667
= P204 to Finished Goods Inventory
P17,000 × 2,480/2,667
= P15,808 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 P205
Direct labor 75
Variable manufacturing overhead 20
Standard variable costs per unit P300
The annual budget for fixed

manufacturing overhead is P1,500,000
Budgeted production is 15,000 computer parts.
Sales price = 500 per unit
20 per computer parts is variable overhead.
Fixed S&A expenses = 650,000
Sales commissions = 5% of sales

Units 2011 2012

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.
Variable- Costing Method
Cost of Goods Sold
(thousands of pesos) 2011 2012

Variable expenses:
Variable manufacturing cost
of goods sold
Opening inventory, at – P 900
standard costs of P300
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 P300 900¹ 300²
Variable manufacturing
cost of goods sold P4200 P4800
¹3,000 units × P300 = P900,000 ²1,000 units × P300 = P300,000
Variable-Costing Method
Comparative Income Statement
(thousands of pesos) 2011 2012
Sales, 14,000 and 16,000 units P7,000 P8,000
Variable expenses:
Variable manufacturing
cost of goods sold 42001 48001
Variable selling expenses,
at 5% of peso sales 350 400
Contribution margin P2,450 P2,800
Fixed expenses:
Fixed factory overhead P1,500 P 1,500
Fixed selling and admin. expenses 650 650
Operating income, variable costing P 300 P 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
P1,500,000 ÷ 15,000 = P100

Factory Overhead

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Accounting for Factory

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 company’s 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 accountant’s goal is to find the cost-

“Normal” product costs include

Actual direct material

Also, suppose that Enriquez actually incurred P392,000

The applied overhead is 17,000

Overapplied overhead occurs when the

This method regards the P17,000 as a reduction in

Cost of Goods Sold

This method prorates the P17,000 of

Work-in-Process Inventory P 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 computer parts.

Sales price = 500 per unit

20 per computer parts is variable overhead.

Fixed S&A expenses = 650,000

Sales commissions = 5% of sales

Units 2011 2012

There are no variances from the standard variable

(thousands of pesos) 2011 2012

The fixed-overhead rate is the

budgeted fixed manufacturing overhead

P1,500,000 ÷ 15,000 = P100

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