You are on page 1of 40

Chapter 12

Factory Overhead: Planned, Actual, and Applied

Prepared by Dewi Kartika for D3 Akuntansi FEUI

Chapter 12 Learning Objectives:

1. Define factory overhead and its 2. 3. 4.


components Define and calculate overhead rates Accumulate actual factory overhead costs Apply factory overhead using predetermined rates Dispose of over or underapplied factory overhead

The Nature of Factory Overhead

Factory Overhead is generally defined as indirect material, indirect labor and other that cannot be conveniently identified with or charged directly to specific jobs, products, or other final cost objects.

The Nature of Factory Overhead

The characteristics of Factory overhead:
1. Related to the product
Unlike direct materials and direct labor, overhead is an invisible part of the finished product. Yet overhead is as much a part of a products manufacturing cost as direct materials and direct labor.

2. Related to the volume of production

Overhead can be fixed, variable, or semivariable. As volume changes, the different overhead cost behavior patterns cause per-unit manufacturing cost to fluctuate considerably. As a result, some method is needed to determine an amount of overhead charged to the units produced

Use of a Predetermined Overhead Rate

Because of the impossibility of tracing overhead to specific jobs or specific products, overhead cost is allocated across jobs and units. A predetermined overhead rate permits a consistent and logical allocation to each unit of output. It serves managements needs for product cost information, to identify inefficiencies, and to smooth out the illogical month-to-month fluctuations that would otherwise appear in reported unit costs.

Factor considered in Selecting overhead Rates

1. Base to Be Used Physical Output Direct Material Cost Direct Labor Cost Direct Labor Hours Machine Hours Transactions or activities

Factor considered in Selecting overhead Rates

2. Activity Level Selection
Theoretical capacity Practical capacity Expected actual capacity Normal capacity Effect of capacity on overhead rates Idle capacity versus excess capacity

Factor considered in Selecting overhead Rates

3. Including or Excluding Fixed Overhead
Absorption Costing Direct Costing

4. Use of a Single Rate or Several Rates

Plantwide or blanket rate Department rates Subdepartmental and activity rates

5. Use of Separate Rates for Service Activities


Base to Be Used
Ordinarily the base should be closely related to functions represented by the overhead cost being applied.
If overhead is mostly labor oriented (costs of supervision and fringe benefits), then the proper base is probably direct labor cost or direct labor hours.

When two or more bases result in approximately the same applied factory overhead costs for each job or product, the simplest, most easily measured base should be used.

Physical Output
Physical output or units of production is the simplest base for applying factory overhead
Estimated Factory Overhead = Factory Overhead per unit Estimated units of production
Example: If Estimated Factory overhead is $300,000 and the company intends to produce 250,000 units during the next period, then the FOH per unit is charged $1.2 ( $ 300.000 : 250.000 units). Then an order with 1,000 completed units, is charged 1,000 x $1.2 = $1,200 of Factory Overhead

The physical output base is satisfactory when a company manufactures only one product, or if the products are alike or closely related; otherwise, the method is generally unsatisfactory.

Direct Materials Cost Base

In some companies, a study of past costs reveals a high correlation between direct materials cost and overhead
Estimated Factory Overhead x 100 = Factory Overhead as a percentage Estimated material cost of direct materials cost

If Estimated Factory overhead totals $300,000 and est. materials cost $250.000, then the FOH rate is $300,000 : $250,000 = 1.2 or 120 % of its direct materials cost. So, if the materials cost for an order is $5,000, Factory Overhead charged to the order would be $5.000 x 1.2 = $6,000

The material cost base is of limited use, because in most cases no logical relationship exists between the direct materials cost of a product and the use or creation of factory overhead in its production

Direct Labor Cost Base

This methods use is logical when a strong relationship between direct labor cost and factory overhead exists and hourly rates of pay are similar for similar work.
Estimated Factory Overhead x 100 = Factory Overhead as a percentage Estimated direct labor cost of direct labor cost

If Estimated Factory overhead is $300,000 and total direct labor cost is estimated at $500,000, then FOH rate is $300,000 : $500,000 = 0.6 or 60 %. So, a job or product with a direct labor cost $12,000 is charged $12.000 x 60% = $7,200 for Factory Overhead.

Direct Labor Hour Base

The use of the direct labor hour base is justified if there is a strong relationship between direct labor hours and factory overhead
Estimated Factory Overhead = Factory Overhead per direct labor hour Estimated direct labor hours

If estimated Factory overhead totals $300,000 and direct labor hours are est. 60,000, then factory overhead rate is ($300.000 : 60,000) = $5 per direct labor hour A job with 800 DLH, is charged 800 x $5 = $4,000 for factory overhead

Recent years have seen a shift away from direct labor usage and toward increasing levels of automation. As a result, a direct labor hours base for overhead application has become less appropriate, often giving way to machine hours as the preferred base.

Machine Hour Base

When machines are used extensively, machine hours may be the most appropriate basis for applying overhead.
Estimated Factory Overhead = Factory Overhead per machine hour Estimated machine hours

If estimated factory overhead totals $300,000 and a total of 20,000 machine hours are estimated, the FOH rate is $300,000 : 20,000 machine hours (MH) = $15 per MH So, a job or product that requires 120 machine hours is charged 120 x $15 = $1,800 for Factory Overhead

Transaction Base
The transaction-base approach to overhead allocation is popularly referred to as activity-based costing (ABC) and is discussed in detail in Chapter 14.


Selection of Activity Level

Theoretical Capacity
It is achieved if the plant or department producs at 100% of its rated capacity (produce at full speed without interruptions) Operating at theoretical capacity is unattainable goal for periods (month, quarter or year). Still, some managers use it, because it focuses attention on opportunities for improvement.

Practical Capacity
It is improbable that any company can operate at theoretical capacity. Allowances must be made for unavoidable interruptions (maintenance, material delays, holidays, etc). Those factors reduce theoretical capacity to the practical capacity.


Selection of Activity Level

Expected Actual Capacity
It corresponds to the amount of output expected to be produced during the period

Normal Capacity
It corresponds to the average activity over a time period long enough to level out the highs and lows


Selection of Activity Level

Effect of Capacity on Factory Overhead Rates
At higher capacity levels, the rate is lower because the fixed factory overhead is spread over more allocation base (machine hour). See Exh. 12-1.

Idle capacity Versus Excess Capacity

Idle capacity results from a temporary lack of sales. Excess capacity results either from greater productive capacity than a company can expect to use, or from an imbalance in equipment or machinery.

Including or Excluding Fixed Overhead

Absorption Costing
Both fixed and variable costs are included in factory overhead rates.

Direct Costing
Only variable factory overhead is included in overhead rates.


Calculation of an Overhead Rate

1. Determined the activity level to be used

for the base selected. 2. Estimated or budgeted each individual overhead cost item at that activity level
total estimated factory overhead.
Factory Overhead rate = Estimated Factory Overhead cost Estimated activity level base


Calculation of an Overhead Rate

Example: DeWitt Products has an expected capacity level of 20,000 machine hours. At that activity level, factory overhead is estimated to total $300,000 (consist of fixed factory overhead amounted $125,000 and variable factory overhead amounted $175,000) FOH rate = Estimated Factory Overhead = $300,000 = $15/MH Estimated Machine hours 20.000 $125,000 est. Fixed FOH 20,000 est. machine hours = $6.25 Fixed portion of FOH

$175,000 est. variable FOH = $8.75 Variable portion of FOH 20,000 est. machine hours Total FOH Rate = $15.00 per machine hours


Actual Factory Overhead

Some actual factory overhead costs are recorded when incurred, as transactions are journalized and posted to general and subsidiary ledgers. A basic objectives of accumulating factory overhead is to provide information for control (compare the budgeted amount with the actual incurred). Source documents used for recording overhead are:
Purchase vouchers Materials requisitions - general journal voucher - labor time tickets

Applied Factory Overhead and the Over- or Underapplied Amount

At the end of the month or year, applied factory overhead and actual factory overhead are compared.
Actual factory overhead:
The amount of indirect cost incurred.

Applied factory overhead:

The amount of cost allocated to output.

Applied Factory Overhead and the Over- or Underapplied Amount

Applying Factory Overhead
DeWitt Products predetermined factory overhead rate is $15 per machine hour, its actual machine hours totaled 18,900 and actual factory overhead totaled $292,000.

The factory overhead applied:

18,900 MH x $15 = $283,500

The general journal entry:

Work in Process Applied Factory Overhead 283,500 283,500 283,500 283,500

The closing entry:

Applied Factory Overhead Factory Overhead Control


Applied Factory Overhead and the Over- or Underapplied Amount

Factory Overhead Control Dec 31 $292.000 Dec 31 $283.500

Total actual overhead Incurred during period

Overhead applied


Over- or Underapplied Factory Overhead

FOH applied < FOH Control
(FOH Control has debit balance)

FOH applied > FOH Control
(FOH Control has credit balance)

For DeWitt Products,

FOH applied < FOH control $283,000 < $292.000 difference: $ 8.500 Underapplied

Disposition of Over or Underapplied FOH

The amount is material?



Close To COGS

Allocate to Inventories and COGS


Disposition of Over- or Underapplied Amount

If the amount of over- or underapplied factory overhead is insignificant:
Income Summary Factory Overhead Control Or COGS Factory Overhead Control 8,500 8,500 8,500


Disposition of Over- or Underapplied Amount

DeWitt Products Income Statement For Year Ending December 31, 20Sales Less: COGS Underapplied FOH COGS Adjusted Gross Profit $1,600,000 1,193,000 8,500 1,202,000 398.000

Allocation of Over or Underapplied FOH to Inventories and COGS

Spander Company had $4,000 of underapplied FOH, and the balances in inventories and COGS were: Work in Process Direct material $15.000 Finished Goods $7.000

COGS $28.000

Direct Labor
Applied FOH Year end Balance

5.000 $25.000

19.000 $45.000

76.000 $180.000

Allocation of Over- and Underapplied FOH to Inventories and COGS

The over- or underapplied factory overhead usually is allocated to the three accounts in proportion to their balances: Account Percentage Balance Of Total Work in process Finished goods COGS Total The journal entry: WIP (10% of $4,000) FG (18% of $4,000) COGS (72% of $4,000) Factory Overhead Control $ 25,000 45,000 180,000 $250,000 10% 18 72 100%

400 720 2,880 4,000

If factory overhead had been overapplied, the two inventories and COGS would be credited and Factory Overhead Control would be debited.


Changing Overhead Rates

Overhead rates usually are reviewed periodically. Changes in production methods, prices, efficiencies, and sales forecasts make review and possible revision of overhead rates necessary at least annually.


- Finish Any Question?


Exercise 12-1


Exercise 12-1


Exercise 12-4


Exercise 12-7


Exercise 12-11


Exercise 12-13


- The End -