Chapter 5 Overhead
Direct labor hours - expressed as amount of peso per direct
Factory Overhead
All factory costs incurred in the manufacturing process other than
direct materials and direct labor. It is normally accumulated into
cost pools and allocated to units produced during the period and it
is charged to expense account when the units produced are later
sold as finished goods. Examples are:
a. Indirect materials
b. Indirect labor
c. Other manufacturing expenses
Classification of Factory Overhead according to Behavior
1. Variable factory overhead - these are cost that charges in direct
proportion to the level of production within the relevant range. The
total cost of variable overhead varies in direct proportion to the
level of activity, but remain constant per unit cost.
2. Fixed factory overhead - these are factory overhead costs that
do not change within the relevant range, regardless of the
changes in production activity. The total fixed overhead remains
constant but it varies inversely proportional to the level of
production activity.
3. Mixed factory overhead - these are factory overhead costs that
have the characteristics of both variable and fixed overhead
Approaches of Charging the FOH cost to Production
1. Actual costing, also known as historical costing system,
determined the factory overhead costs as they occur
simultaneously with the manufacturing operation but the total of
these costs is known only as the operation has been completed.
2. Normal costing system accumulates factory overhead costs
based on a predetermined overhead rate and direct materials and
direct labor are accumulated based on actual cost.
Determination of FOH Rates 1. Plant-wide or Blanket Rate - The
company uses a single overhead rate to allocate all of its factory
overhead costs to jobs, products sor departments. It is usually
used by small companies because it is simple to apply and
inexpensive to use. It is appropriate to allocate FOH costs using
plant-wide if:
a. the company manufactures similar products.
b. the services provided by various departments are relatively
similar.
c. the total amount of FOH to be allocated is too small that using
multiple allocation rates to achieve a higher level of accuracy is
unnecessary and too costly.
FOH Bases
1. Direct labor costs - expressed as percentage of direct labor
costs. Ex. 125% of direct labor cost.
2.
labor hour. Ex. P5 per direct labor hour.
3. Machine hours - expressed as amount of peso per machine
hour. Ex. P20 per machine hour.
4. Direct material costs - expressed as percentage of direct
materials costs. Ex. 50% of direct materials costs
. 5. Physical output or units produced - expressed as amount of
peso per unit produced. Ex. P10 per unit.
Capacity of Production
1. Theoretical (Maximum or Ideal) - It refers to plant or
departmental capability to produce without any interruption. It
assumes that nothing will go wrong in the production. It gives no
allowance for human and non-human errors. It is a production in
full efficiency.
2. Practical - It refers to plant or departmental capability to
produce with an allowance for internal factors such as shutdowns
for holidays, interruptions due to delays, machine breakdowns,
etc.
3. Expected - It refers to the level based on expected capacity
utilization for the budget period.
4. Normal - The most commonly used capacity. It is a capacity
driven by customers or business demand and not by maximum
capacity. It takes into consideration the seasonal and cyclical
demand cycle of the product and is usually estimated over the
number of periods or seasons, taking into account the loss
capacity resulting from planned maintenance. It is practical
capacity less loss of productive capacity due to external factors
Determination of FOH Rates
2. Departmental Overhead Rates - The company uses one
factory overhead rate for each department. This approach
provides more accurate product costing when a company
produces different products that require variety of processes
because factory overhead incurred includes various overhead
costs that vary greatly in their relationship to the production
process. This is appropriate to use if:
a. the company produces various products which require different
process in a department.
b. the company has a large amount of factory overhead to
allocate.
c. the services provided by several departments are highly
differentiated
Two (2) Types of Departments
a. Producing Department - This department is responsible in the
actual manufacture of products. Example: Cutting, Planning,
Assembly, Machining, Sewing, Mixing, Extracting, Refining,
Finishing, etc.
b. Servicing Department - This department is responsible in
assisting other departments by rendering service to production
departments and other service departments. Examples: Repairs
and Maintenance, Storage, Medical, Receiving, Purchasing,
Personnel, Security, Cafeteria, Inspection, etc.

1. Direct method

2. Step-up method

3. Algebraic method

Illustration #1 of Allocating Costs of Service Departments Addidas

Inc. is exploring ways to allocate the cost of service departments
such as Quality Control (1st) and Maintenance (2nd) in the
production departments such as Machining and Assembly. In
determining the factory overhead rate, the machine hours 30,000
is used for Machining Department and 60,000 direct labor hours is
used for Assembly Department. The controller of the company
provided the ff

Quali Maintena Machini Assem total

ty nce ng bly
Contr
ol
Budget 350k 200k 400k 300k 1,250,
ed OH 00
Budget 30k 30k
ed
mach.
hrs
Budget 60k 60k
ed
labor
hrs
Budget 7k 21k 7k 35k
ed hrs
QC
Budget 10k 18k 12k 40k
ed hrs
Maint.