Module No.

7 – Manufacturing Overhead Accounting (Actual and Applied)

Learning Outcome/s:
 Define and identify different examples of manufacturing overhead
 Properly classify manufacturing overhead costs
 Acquire skills to appropriately charge the overhead to production using different bases
 Determine the overapplied and underapplied overhead and prepare journal entries

Core Values/Biblical Principles:

“Have I not commanded you? Be strong and courageous. Do not be frightened, and do not be dismayed,
for the Lord your God is with you wherever you go.” – Joshua 1:9 (ESV)

Introduction:
The third type of production cost, the manufacturing overhead, will be discussed below. This module
will discuss the procedures in applying manufacturing overhead using a single predetermined overhead
rate and the procedures in recording manufacturing overhead.

Body:
Manufacturing overhead costs – costs that are not conveniently identified with particular units of
products. These include all factory costs other than direct materials and direct labor. These are
sometimes called manufacturing expenses, factory burden, factory overhead, factory expenses and
indirect manufacturing costs.

Types of Manufacturing Overhead Costs

1. Indirect materials – factory supplies, cleaning supplies, small tools, packaging materials, etc.
2. Indirect labor – receiving clerks, storeroom clerks, supervisors, etc.
3. Other manufacturing overhead – employee fringe benefits, factory utilities, rent of factory
building and warehouse, depreciation of factory building and equipment, property taxes, repairs
and maintenance, spoiled goods, shortage, etc.

Charging Manufacturing Overhead to Production

1. Actual costing – manufacturing overhead costs are charged to production at an arbitrary
manufacturing overhead costs using an arbitrary overhead application rate determined at the
end of the period.
2. Normal costing – uses predetermined overhead rate to allocate manufacturing overhead costs
to jobs.

Predetermined overhead rate – rate calculated at the beginning of a period. Its primary purpose is to
charge a fair share of overhead costs to each job. A number of bases for determining overhead rates
may be used to compute an overhead application rate:

1. Direct labor costs – this method is widely used because it is simple and easy to use.
Predetermined overhead rate is calculated by dividing the estimated manufacturing overhead
costs by the estimated direct labor costs.

Estimated manufacturing overhead costs

Percentage of direct labor costs =
Estimated direct labor costs

2. Direct labor hours – this method assumes that overhead costs tend to vary with the number of
hours of direct labor used.

Estimated manufacturing overhead costs

Rate per direct labor hour =
Estimated direct labor hours
 3. Direct material costs – the estimated manufacturing overhead costs are divided by the
estimated direct materials costs to compute the percentage of materials costs to be applied as
overhead.

Estimated manufacturing overhead costs

Percentage of materials costs =
Estimated direct materials costs

4. Machine hours – overhead may be applied as a rate for each machine hour when work is
performed principally by machines.

Estimated manufacturing overhead costs

Rate per machine hour =
Estimated machine hours

5. Units of production – this is used only if the manufacturing process is a simple one and only if
one type, or a few similar types, of products are produced.

Estimated manufacturing overhead costs

Overhead cost per unit of production =
Estimated units of production

Illustration
Assume the following budgeted data for the year:
Manufacturing overhead costs Php 96,000
Number of units of production 24,000 units
Direct material costs Php 480,000
Machine hours 12,000 hours
Direct labor hours 40,000 hours
Direct labor costs Php 200,000

1. Direct labor costs basis

96,000
= 48% of direct labor costs
200,000

2. Direct labor hour basis

96,000
= Php 2.4 per direct labor hour
40,000

3. Direct material costs basis

96,000
= 20% of materials costs
480,000

4. Machine hours basis

96,000
= Php 8 per machine hour
12,000

5. Units of production basis

96,000
= Php 4 per unit
24,000

Recording Applied Manufacturing Overhead Costs

Work in process xxx
Manufacturing overhead control xxx

Recording Actual Manufacturing Overhead Costs

Manufacturing overhead control xxx
Accounts payable and other accounts xxx
Overapplied or Underapplied Overhead
1. Overapplied overhead – results when product costs are overstated because the actual overhead
costs were lower than expected (applied overhead). This will show as a credit balance in the
manufacturing overhead control account.

2. Underapplied overhead – results when product costs are understated because the actual
overhead costs were higher than expected (applied overhead). This will show as a debit balance
in the manufacturing overhead control account.

Illustration
Assume that the applied manufacturing overhead of ABC Company is Php 500,000. However, the actual
manufacturing overhead costs incurred totaled Php 600,000. Further, the year-end balances of the
company are as follows:
Work in process Php 40,000
Finished goods 80,000
Cost of goods sold 280,000

Work in process 500,000

Manufacturing overhead control 500,000

Manufacturing overhead control 600,000

Accounts payable and other accounts 600,000

a. Assuming the amount is material:

Account balances % Allocated amount
Work in process Php 40,000 10% Php 10,000
Finished goods 80,000 20% 20,000
Cost of goods sold 280,000 70% 70,000
Total Php 400,000 100% Php 100,000

Work in process 10,000

Finished goods 20,000
Cost of goods sold 70,000
Manufacturing overhead control 100,000

b. Assuming the amount is immaterial:

Cost of goods sold 100,000
Manufacturing overhead control 100,000

Summary:
There are different bases that the company may use for the computation of the predetermined
manufacturing overhead rate. Company shall select the base to used according to some factors such as
the type of goods produced, amount of machinery employed, type of labor used, wage rates paid, etc.

References:
Cost Accounting Principles and Procedural Applications by Pedro P. Guerrero, 2014-2015 edition