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CHAPTER 12
DISCUSSION QUESTIONS
Q12-1. Supervisors’ salaries, indirect labor, overtime
premium, supplies, indirect materials, payroll
tax, factory insurance, and depreciation.
Q12-2. The most important reason for variation in fac-
tory 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.
Q12-3. Predetermined rates are used when it
becomes obvious that any other method of
charging overhead results in inequitable cost-
ing 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 underapplied fac-
tory overhead.
Q12-4. Six bases used for applying factory overhead
are units produced, direct materials cost,
direct labor cost, direct labor hours, machine
hours, and transactions. Important considera-
tions 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.
Q12-5. Predetermined rates are used to charge over-
head and become the basis for determining
the cost of a job or product. Therefore, the rea-
sonableness of such costs is to a large extent
determined by the reasonableness of the
rates. Since these costs are used for costing
inventories and play an important role in estab-
lishing sales prices, the selection of proper pre-
determined rates can be appreciated.
Q12-6. An objective in selecting the base for a prede-
termined factory overhead rate is to ensure
the application of factory overhead in reason-
able proportion to a beneficial or causal rela-
tionship to jobs, products, or work performed
12-1
or to be performed, i.e., for estimating pur-
poses. Ordinarily, the base selected should be
closely related to functions represented by
the applied overhead cost. If factory overhead
costs are predominantly labor oriented, such
as supervision and indirect labor, the proper
base would probably be direct labor hours. If
factory overhead costs are predominantly
related to the cost incurred in the ownership
and operation of the machinery, the proper
base would probably be machine hours.
Another objective in selecting the base is
to minimize clerical cost and effort relative to
the benefits attained. When two or more
bases provide approximately the same
applied overhead cost to specific units of pro-
duction, the simplest base should be used.
Q12-7. (a) Theoretical capacity is actually the maxi-
mum production possible from a given
plant with no allowance made for cessation
of operations for holidays, weekends, mate-
rials shortages, or machine breakdowns.
(b) Practical capacity is theoretical capacity
less an allowance for interruptions such
as breakdowns, delays in receiving sup-
plies, 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 budg-
ets when expected capacity differs sub-
stantially 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 over-
head rates.
Q12-8. The underapplied overhead will be higher If
maximum capacity is used and lower if nor-
mal is used. If this cost is charged to the
12-2
current period, then maximum capacity will
produce a lower, and normal capacity a
higher, operating profit.
Q12-9. (a) Idle capacity costs arise from idle employ-
ees 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, mainte-
nance, repairs, shelter, and protection of
valuables such as insurance.
(b) 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 work-
ers or facilities in excess of a reasonable
budgeted amount might be in some kind
of overhead account to be treated sepa-
rately as a “management by exception”
factor. Idle capacity costs should be
accounted for separately for these rea-
sons: (1) to prevent distortion and confu-
sion in the analysis of production costs;
(2) to facilitate income determination; (3)
to control operations; and (4) to plan next
year’s budget adequately.
(c) Excess capacity cost has been identified
with those capacity costs that result from
greater production capacity than the com-
pany could ever hope to use, or from
unbalanced equipment or machinery
within departments. In creating the fore-
cast budget, it is important to isolate the
excess capacity cost so that manage-
ment can be made aware of its responsi-
bility regarding the excess investment in
labor and machines.
12-2
Chapter 12
Q12-10. (a) Analyze and identify the overhead trans-
actions.
(b) Journalize the transactions.
(c) Enter transactions in general and sub-
sidiary ledgers.
Q12-11. Overhead applied to production is entered
as a credit in the factory overhead control
account. Actual overhead is debited to the
same account. Therefore, overhead has
been overapplied when the account has a
credit balance.
Q12-12. Overhead can be overapplied because (a)
actual overhead was less than budgeted; (b)
capacity utilized was greater than that esti-
mated in computing overhead rates; (c) the
overhead estimate was too high (a mistake);
(d) the production estimate was too low (a
mistake); (e) combinations of the above.
Q12-13. Over- or underapplied factory overhead may
be prorated among work in process, finished
goods, and cost of goods sold, or it may be
treated entirely as a period cost. The first
method would have a smaller effect on cost
of goods sold and therefore on the net
income for the period.
Q12-14. The existence of large underabsorbed vari-
ances does not necessarily mean that unit
costs are incorrect. An analysis of the under-
absorbed figures will indicate (a) whether
actual overhead is too high or whether
expenses have been incorrectly estimated;
and (b) what part of the underabsorption is
caused by unused capacity. If actual over-
head is considered to be too high and there
is idle capacity, unit costs computed are
more reasonable than they would be if over-
head rates were computed to absorb all of
the actual overhead.
Chapter 12 12-3

EXERCISES
E12-1

(1) $1,750,000 fixed overhead and $720 variable overhead per ton, calculated as
follows:

For both the normal capacity and expected actual capacity, the problem states
the total budgeted overhead cost and the number of tons of activity. The high-
low method of estimating cost behavior can be used to determine the over-
head budget, using those two points:

Budgeted
Activity Level Tons Overhead
Normal capacity 6,000 $6,070,000
Expected actual 5,000 5,350,000
Difference 1,000 $ 720,000

$720, 000
Variable = = $720 va riable overhead per ton
overhead rate 1, 000 tons

Budgeted fixed overhead = $5,350,000 total overhead

– ($720 × 5,000) variable overhead
= $5,350,000 – $3,600,000 = $1,750,000

or, budgeted
fixed overhead = $6,070,000 total overhead
– ($720 × 6,000) variable overhead
= $6,070,000 – $4,320,000 = $1,750,000
12-4 Chapter 12

E12-1 (Concluded)
(2) The predetermined rate at practical capacity would be $938.75 per ton. Using
the budget for fixed and variable overhead, a predetermined overhead rate can
be calculated at any level of activity within the relevant range. Assuming prac-
tical capacity is within that range, the calculation is:

Predetermined
overhead rate at Budgeted total overhead at practical capacity
=
practical capacity Pr actical capacity in tons
(8,000 tons)

Budgeted fixed overhead

+ Budgeted variable
overhead at 8, 000 tons $1, 750, 000 + ($720 × 8, 000)
= =
8, 000 tons 8, 000 tons

$1, 750, 000 + $5, 760, 000) $7, 510, 000

= = =$938.75 per ton
8, 000 tons 8, 000 tons

or, $720 variable overhead per ton + ($1,750,000/8,000 tons)

= $720 per ton + $218.75 per ton = $938.75 per ton.

E12-2
Work in process balance, September 30.................... $12,200
Less materials still in process .................................... 5,560
Factory overhead and direct labor still in process ... $ 6,640

Charged to
Work in Process
Amount %
Factory overhead............... $15,840 44%* × $6,640 = $2,921.60
Direct labor ....................... 20,160 56 × 6,640 = 3,718.40
$36,000 100% $6,640.00
*$15,840 ÷ $36,000 = 44%
(or)

$15,840 (factory overhead) ÷ $20,160 (direct labor) = .7857

Let X = direct labor still in process
Then, X + .7857X = $6,640
1.7857X = $6,640
X = $3,718.4297 direct labor still in process
.7857X = $2,921.5702 factory overhead still in process
$6,639.9999
Chapter 12 12-5

E12-3
(1) 150 people × 8 hrs. per day × 5 days per week × 48 weeks =
288,000 direct labor hrs.
(2) 150 people × 10 hrs. per day × 4 days per week × 48 weeks =
288,000 direct labor hrs.

E12-4

Factory overhead rates:

(1) Units of production: $225,000 ÷ 25,000 units = $9

(2) Materials cost: $225,000 ÷ $500,000 = .45 = 45%

(3) Direct labor hours: $225,000 ÷ 56,250 DLH = $4

(4) Direct labor cost: $225,000 ÷ (56,250 DLH × $8) = .50 = 50%

(5) Machine hours: $225,000 ÷ 75,000 machine hours = $3

E12-5

(1) Assuming normal capacity:

(a) The factory overhead rate: ($400,000 ÷ 50,000) + $6.69 = $14.69
(b) The fixed part of the factory overhead rate: $400,000 ÷ 50,000 = $8
(2) Assuming expected actual capacity:
(a) The factory overhead rate: ($400,000 ÷ 40,000) + $6.69 = $16.69
(b) The fixed part of the factory overhead rate: $400,000 ÷ 40,000 = $10

E12-6

Actual factory overhead ........................................................... $281,000

Applied factory overhead (52,500 machine hours × $5.10*) . 267,750
Underapplied factory overhead for the period....................... $ 13,250

*$255,000 ÷ 50,000 budgeted machine hours = $5.10

12-6 Chapter 12

E12-7
(1) Work in Process............................................................ 1,450,000
Materials ............................................................... 1,450,000
Work in Process............................................................ 928,000
Payroll ................................................................... 928,000
Factory Overhead Control ........................................... 561,600
Materials, Payroll, Accruals, and Various Credits 561,600
Work in Process............................................................ 551,000
Applied Factory Overhead.................................. 551,000
Applied Factory Overhead........................................... 551,000
Factory Overhead Control .................................. 551,000
Estimated factory overhead $570, 000
Overhead rate : = = $19 per drill
Estimated production 30, 000

(2) Underapplied factory overhead: $561,600 – $551,000 = $10,600

E12-8
Actual factory overhead............................................... $ 9,000
Applied factory overhead (4,100 units × $2.46)* ....... 10,086
Overapplied overhead.................................................. $(1,086)
*Variable factory overhead rate ................................... $2.10
Fixed factory overhead rate ($1,440 ÷ 4,000 units) ... .36
Total factory overhead rate ........................................ $2.46
E12-9
(1) Applied factory overhead:
$16, 920
= $ .47 fixed portion of rate
36, 000 machine hours
2.10 variable portion of rate
$2.57 total rate

$2.57 × 2,700 machine hours = $6,939 applied factory overhead

(2) Actual factory overhead............................................... $7,400

Applied factory overhead ............................................ 6,939
Underapplied overhead................................................ $ 461
Chapter 12 12-7

E12-10

Actual factory overhead ........................................................... $832,000

Applied factory overhead (210,000 machine hours × $4) ..... 840,000
Overapplied factory overhead ................................................. $ (8,000)

E12-11

(1) Fixed portion of the factory overhead application rate:

$150, 000
= $1.50 per machine hour
100, 000 machine hours

(2) Variable portion of the factory overhead application rate:

$250, 000
= $2.50 per machine hour
100, 000 machine hours

(3) Actual factory overhead............................................... $411,000

Applied factory overhead (105,000 × $4.00)............... 420,000
Overapplied factory overhead..................................... $ (9,000)

E12-12

Actual factory overhead ........................................................... $ 14,134

Applied factory overhead (200% of $8,117)............................ 16,234
Overapplied overhead .............................................................. $ (2,100)
12-8 Chapter 12

E12-13

Requirements (1) & (2) Requirement (3)

Account Percentage Applied Percentage
Balance of Total Overhead of Total
Work in process .............................. $ 6,000 5 % $ 2,000 4%
Finished goods ............................... 38,000 31 2/3% 16,000 32%
Cost of goods sold ......................... 76,000 63 1/3% 32,000 64%
Total........................................... $120,000 100 % $50,000 100%

(1) Work in Process (5% of $6,000) .................................. 300

Finished Goods (31 2/3% of $6,000) ........................... 1,900
Cost of Goods Sold (63 1/3% of $6,000) .................... 3,800
Factory Overhead Control .................................. 6,000

(2) Factory Overhead Control ........................................... 6,000

Work in Process (5% of $6,000) ......................... 300
Finished Goods (31 2/3% of $6,000) .................. 1,900
Cost of Goods Sold (63 1/3% of $6,000) ........... 3,800

(3) Work in Process (4% of $6,000) .................................. 240

Finished Goods (32% of $6,000) ................................. 1,920
Cost of Goods Sold (64% of $6,000) .......................... 3,840
Factory Overhead Control .................................. 6,000
Chapter 12 12-9

PROBLEMS
P12-1
(1) Actual overhead incurred ............................................ $3,470,000
Applied overhead* ........................................................ 3,325,000
Underapplied overhead................................................ $ 145,000

*actual MH × predetermined rate based on expected actual capacity

= 9,500 MH × ($3,500,000/10,000 MH)
= 9,500 MH × $350 per MH = $3,325,000

(2) The predetermined rate at practical capacity would be $316.67 per machine
hour (MH), calculated as follows:

First, find the budgeted total fixed overhead and the budgeted variable over-
head rate per MH. The problem states both the total budgeted overhead cost
and the number of MH of activity, at both the normal capacity and expected
actual capacity levels, so the high-low method of estimating cost behavior can
be used:

Machine Budgeted
Activity Level Hours Overhead
Expected actual 10,000 $3,500,000
Normal capacity 8,000 3,000,000
Difference 2,000 $ 500,000

Variable $500, 000

= = $250 var iable overhead per MH
overhead rate 2, 000 MH

Budgeted fixed overhead = $3,500,000 total overhead

– ($250 × 10,000) variable overhead
= $3,500,000 – $2,500,000 = $1,000,000

or, budgeted
fixed overhead = $3,000,000 total overhead
– ($250 × 8,000) variable overhead
= $3,000,000 – $2,000,000 = $1,000,000

Then, using the budget for fixed and variable overhead, a predetermined overhead rate
can be calculated at any level of activity within the relevant range. Assuming practical
capacity is within that range, the calculation is:
12-10 Chapter 12

P12-1 (Concluded)

Predetermined
overhead rate at Budgeted total overhead at practical capacity
=
practical capacity Practical capacity in MH
(15,000 MH )

Budgeted fixed overhead

+ Budgeted variable
Overhead at 15, 000 MH $1, 000, 000 + ($250 × 15, 000)
= =
15, 000 MH 15, 000 MH

$1, 000, 000 + $3, 750, 000 $4, 750, 000

= = = $316.67 per MH
15, 000 MH 15, 000 MH

or, $250 variable overhead per MH + ($1,000,000 ÷ 15,000 MH)

= $250 per MH + $66.67 per MH = $316.67 per MH.

(3) If the actual overhead of $3,470,000 were underapplied by $10,000, then Applied
Overhead would have a credit balance of $3,470,000 – $10,000, or $3,460,000.
The closing entries are:

Applied Overhead......................................................... 3,460,000

Factory Overhead Control .................................. 3,460,000

Cost of Goods Sold...................................................... 10,000

Factory Overhead Control .................................. 10,000

(4) Account Percentage

Balance of Total
Work in process............................................................ $ 200,000 2.5%
Finished goods ............................................................. 400,000 5.0%
Cost of goods sold....................................................... 7,400,000 92.5%
Total ...................................................................... $8,000,000 100.0%

Work in Process (2.5 % of $10,000) ............................ 250

Finished Goods ............................................................ 500
Cost of Goods Sold...................................................... 9,250
Factory Overhead Control .................................. 10,000
P12-2
Chapter 12

(1) (2)
Factory Variable
Overhead Overhead Fixed
Cost per Unit Overhead
Depreciation on
factory building
and equipment................................................. $14,500

Heat, light, and power .....................................

($ 8, 000 − $6, 000) = $ .40 $ 8,000 = a + $ .40 (15,000)
(15, 000 − 10, 000) a = 2,000

Supplies used ..................................................

($10, 500 − $7, 000) = .70 $10,500 = a + $ .70 (15,000)
(15, 000 − 10, 000) a = 0

Taxes on factory building ............................... 1,500

Indirect labor.................................................... ($70, 000 − $60, 000) = 2.00 $70,000 = a + $2.00 (15,000)
(15, 000 − 10, 000)
a = 40,000

($18, 000 − $12, 000)

Maintenance..................................................... = 1.20 $18,000 = a + $1.20 (15,000)
(15, 000 − 10, 000)
a = 0

Total .................................................................. $4.30 $58,000

. CGA-Canada (adapted). Reprint with permission.
12-11
12-12 Chapter 12

P12-3
(1) Total cost of Job 50:
Work in process, December 1 ............................................................ $ 54,000
December costs:
Materials ...................................................................................... 45,000
Direct labor (($102,000 ÷ 8,500) × 3,500) .................................. 42,000
Factory overhead ($4.50 × 3,500) .............................................. 15,750
$156,750

(2) Factory overhead costs applied to Job 52 during December:

$4.50 × 2,000 = $9,000

(3) Total factory overhead costs applied during December:

$4.50 × 8,500 = $38,250

(4) Actual December factory overhead incurred:

Supplies ................................................................................................ $ 3,500
Indirect labor wages ............................................................................ 15,000
Supervisory salaries............................................................................ 6,000
Building occupancy costs .................................................................. 3,500
Factory equipment costs .................................................................... 8,000
Other factory costs.............................................................................. 5,000
$39,000

(5) An insignificant amount of over- or underapplied factory overhead would be

treated as a period cost.

(6) Actual overhead ................................................................................... $39,000

Applied overhead................................................................................. 38,250
Underapplied overhead ....................................................................... $ 750
Chapter 12 12-13

P12-4
(1) Actual factory overhead:
Indirect materials and supplies .......................................................... $ 18,000
Indirect labor ........................................................................................ 53,000
Employee benefits ............................................................................... 23,000
Depreciation ......................................................................................... 12,000
Supervision .......................................................................................... 20,000
$126,000

(2) Over- or underapplied factory overhead:

Total direct labor, 20— $ 70,000
Factory overhead rate per direct labor dollar ................................... 160%
Applied factory overhead $112,000
Actual factory overhead ...................................................................... 126,000
Underapplied factory overhead $ 14,000

(3) Amount included in cost of goods sold for Job 1376:

Beginning balance $ 72,500
Materials and labor, 20—..................................................................... 8,000
Applied factory overhead, 20— ($7,000 × 160%) .............................. 11,200
$ 91,700

(4) Cost assigned to the work in process account at the end of 20—:
Beginning balance (Job 1376)..................................... $ 72,500
Cost charged to work in process, 20—:
Materials ............................................................... $ 43,000
Labor..................................................................... 70,000
Applied factory overhead ................................... 112,000 225,000
$297,500
Less cost of Job 1376, which was completed
and sold................................................................ 91,700
$205,800
12-14 Chapter 12

P12-5
(1) Predetermined factory overhead rate based on normal capacity:
$29, 250
= $.65 variable portion of rate for expected actual
45, 000 MH and normal capacity
$18, 000 = .30 fixed portion of rate based on normal capacity
60, 000 MH $.95 total rate based on normal capacity

(2) Predetermined factory overhead rate based on expected actual capacity:

$29, 250
= $ .65 variable portion of rate for expected actual and
45, 000 MH normal capacity
$18, 000
= .40 fixed portion of rate based on expected actual capacity
45, 000 MH
$1.05 total rate based on expected actual capacity

(3) Amount of factory overhead charged to production if the company used the
normal capacity rate:

47,000 MH × $.95 = $44,650

(4) Amount of factory overhead charged to production if the company used the
expected actual capacity rate:

47,000 MH × $1.05 = $49,350

(5) Actual factory overhead ...................................................................... $ 47,100

Applied overhead (from (3) normal capacity rate)............................ 44,650
Underapplied overhead ....................................................................... $ 2,450

(6) Actual factory overhead ...................................................................... $ 47,100

Applied overhead (from (4) expected actual capacity rate)............. 49,350
Overapplied overhead ......................................................................... $ (2,250)
Chapter 12 12-15

P12-6
(1) Work in Process: Finished Goods:

Direct materials ......... $ 9,000 Direct materials ................ $10,000

Direct labor ................ 16,000 Direct labor ....................... 40,000
Factory overhead Factory overhead
(2,000 × $3.60) ..... 7,200 (5,000 × $3.60) ............. 18,000
Total................ $32,200 Total ....................... $68,000

(2) Supervision .......................................................................................... $ 17,500

Indirect labor ........................................................................................ 29,050
Heat, light, and power.......................................................................... 23,800
Depreciation—factory buildings......................................................... 7,500
Property tax—factory facilities........................................................... 4,000
Insurance on factory buildings .......................................................... 3,000
Transportation in.................................................................................. 6,500
Repairs and maintenance ................................................................... 8,250
Depreciation—factory equipment ...................................................... 7,500
Miscellaneous factory overhead ........................................................ 9,900
Total actual factory overhead .................................................... $117,000

(3) Actual overhead ................................................................................... $117,000

Applied overhead................................................................................. 115,200
Underapplied overhead ....................................................................... $ 1,800
12-16 Chapter 12

P12-6 (Concluded)
(4) COLUMBUS COMPANY
Cost of Goods Sold Statement
For January
Materials:
Inventory, January 1 .......................................... $ 21,000
Purchases........................................................... $108,000
Less returns to suppliers.................................. 5,050 102,950
Materials available ............................................. $123,950
Inventory January 31......................................... 9,000 $114,950
Direct labor ..................................................................... 256,000
Applied factory overhead .............................................. 115,200
January manufacturing cost ......................................... $486,150
Add work in process, January 1 ................................... 32,500
$518,650
Less work in process, January 31 ................................ 32,200
Cost of goods manufactured ........................................ $486,450
Add finished goods, January 1 ..................................... 18,000
Cost of goods available for sale ................................... $504,450
Less finished goods, January 31.................................. 68,000
Cost of goods sold at normal ....................................... $436,450
Add underapplied factory overhead............................. 1,800
Cost of goods sold at actual......................................... $438,250
Chapter 12 12-17

CASES
C12-1
(1) Direct Labor Factory
Hours Overhead Costs
High ............................................................ 2,760,000 hours $34,500,000
Low ............................................................ 2,160,000 29,880,000
Difference ................................................... 600,000 hours $ 4,620,000

Variable rate = $4,620,000 ÷ 600,000 hours = $7.70 per direct labor hour

High Low
Total cost ....................................................... $34,500,000 $29,880,000
Variable cost ($7.70 per direct labor hour) . 21,252,000 16,632,000
Fixed element................................................. $13,248,000 $13,248,000

Estimated total factory overhead for next year.

Total variable factory overhead (2,300,000 × $7.70)..................... $17,710,000
Total fixed factory overhead........................................................... 13,248,000
Total factory overhead .................................................................... $30,958,000

(2) Utility of cost behavior information:

(a) Evaluation of product pricing decisions—The calculation of the factory
overhead rate required the company to estimate the variable factory over-
head cost. In short-term price-cutting situations, the price set should cover
at least the variable materials, labor, factory overhead, and nonmanufactur-
ing costs. For the longer term, the total cost assigned to the various prod-
ucts may provide some basis for price differentials among the items.
(b) Cost control evaluation—The calculation of the factory overhead rate
required the company to estimate the fixed factory overhead cost and the
variable factory overhead cost per direct labor hour. The amounts are esti-
mates of what the cost should or will be during the next year. The amounts
can be used as the basis for preparation of a budget allowance for actual
activity to be compared to actual cost incurred. Any difference between the
budget amounts and actual cost would be a measure of the effectiveness
of factory overhead cost control.
(c) Development of budgets—The estimates of fixed factory overhead cost and
the variable factory overhead cost per direct labor hour are useful in
budget development. They permit the company to calculate the estimated
factory overhead cost for different activity levels that are being considered
as the budget is developed.