Chapter 12 : Factory Overhead: Planned, Actual, and Applied; Variance Analysis

 FOH: Supervisors’ salaries, indirect labor, overtime premium, supplies, indirect

materials, payroll tax, factory insurance, and depreciation.
Why FOH Changes?
 The most important reason for variation in factory overhead is the presence of fixed and
variable expenses. Therefore, as production volume changes from month to month, the
costs will do likewise. However, overhead also will change because of improved or
decreased efficiencies and changes in prices paid for overhead items such as supplies and
repairs.
Pre Determined Overhead
 Predetermined rates are used when it becomes obvious that any other method of charging
overhead results in inequitable costing and delays the reporting of financial results.
Charging actual overhead to jobs and products can result in charging unreasonable
amounts of overhead to various periods and in delayed reporting of cost data. The use of
predetermined rates also enhances control through analysis of over- or under applied
factory overhead.
 Five bases used for applying factory overhead are;
1. units produced,
2. direct materials cost,
3. direct labor cost,
4. direct labor hours and
5. machine hours.
Important considerations in selecting a base are the relationship (correlation) of the base
used and the use of overhead items in manufacturing operations, as well as the clerical
practicability of using a particular base
 Predetermined rates are used when it becomes obvious that any other method of charging
overhead results in inequitable costing and delays the reporting of financial results.
Charging actual overhead to jobs and products can result in charging unreasonable
amounts of overhead to various periods and in delayed reporting of cost data. The use of
predetermined rates also enhances control through analysis of over- or under applied
factory overhead.
Activity Level Selection
(a) Theoretical capacity is actually the maximum production possible from a given plant
with no allowance made for cessation of operations for holidays, weekends, materials
shortages, or machine breakdowns.
(b) Practical capacity is theoretical capacity less an allowance for interruptions such as
breakdowns, delays in receiving supplies, and worker absences. Practical capacity is
usually 75 to 85 percent of theoretical capacity.
(c) Expected actual capacity is practical capacity adjusted for the lack of sufficient
demand in a single operating period and may be used in building operating budgets when
expected capacity differs substantially from normal capacity.
(d) Normal capacity is practical capacity adjusted to give consideration to the lack of
sufficient demand over a period long enough to include cyclical and seasonal
fluctuations. This is usually the basis for long-range planning, standards, and preferably
for the determination of overhead rates.
 Idle capacity costs arise from idle employees and idle facilities. Idle employees give rise
to costs such as base wages paid, employer’s share of payroll taxes, and other fringe
benefit costs. Idle facilities cause capacity costs due to deterioration with time,
approaching obsolescence, costs for upkeep, readiness, maintenance, repairs, shelter, and
protection of valuables such as insurance. When idle capacity is present, an attempt
should be made to segregate idle employees and idle facilities through proper
reclassification. The accumulation of the cost attributable to these idle workers or
facilities in excess of a reasonable budgeted amount might be in some kind of overhead
account to be treated separately as a “management by exception” factor. Idle capacity
costs should be accounted for separately for these reasons: (1) to prevent distortion and
confusion in the analysis of production costs; (2) to facilitate income determination; (3)
to control operations; and (4) to plan next year’s budget adequately.
b) Excess capacity cost has been identified with those capacity costs that result from
greater production capacity than the company could ever hope to use, or from unbalanced
equipment or machinery within departments. In creating the forecast budget, it is
important to isolate the excess capacity cost so that management can be made aware of its
responsibility regarding the excess investment in labor and machines.

 The spending and idle capacity variances are usually computed each period by
analyzing any over or under applied overhead. The spending variance is so titled because
it is computed by comparing actual overhead with estimated overhead. And idle capacity
variance is computed by comparing applied overhead with estimated overhead.