Introduction to Overhead Cost Accounting

Introduction to Management Accounting
008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 1
2008
Introduction to Management Accounting
Chapter 13
Accounting for
Overhead Costs
2008
Pioneered the “direct business model “ of
selling computers
Many orders are taken over the internet
Need to know product cost
Chapter focuses on applying overhead to
products
2008
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
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.
2008
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
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 $277,800.
Budgeted machine hours are 69,450.
The budgeted overhead application rate is:

$277,800 ÷ 69,450 = $4 per machine hour
2008
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
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 cost-

allocation base that best links cause and effect.
2008
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
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
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
2008 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.
2008
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)
2008
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
2008
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
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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.
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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
2008
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
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.
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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.
2008
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.
Do 13-61 Parts 1, 2,3

2008

Introduction to Overhead Cost Accounting

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Introduction to Management Accounting

Methods for assigning overhead costs

1. Select one or more cost drivers.

Overhead rates are budgeted; they

Budgeted overhead application rate

Enriquez Machine Parts Company selects a single cost-

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-

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

Basic Production Data at Standard Cost

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

All variances other than the

All other variances

Flexible-budget variances measure components of

Flexible budgets are

Do 13-61 Parts 1, 2,3

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