Chapter 8

ACCOUNTING FOR FACTORY OVERHEAD

Accounting for Factory Overhead
1. Review on cost behavior patterns.
2. Budget factory overhead costs.
3. Accumulate actual overhead costs.
4. Apply factory overhead estimates to production.
5. Calculate and analyze differences between actual and applied factory overhead.
Cost Behavior Patterns
Variable costs are costs that vary in proportion to volume changes.
Fixed costs remain constant.
Semivariable costs have characteristics of both fixed and variable costs.
◦ Type A – remain constant over a range of production, then change abruptly.
◦ Type B – vary continuously but not in direct proportion to volume changes.
Cost Behavior Patterns
Cost

Volume

Variable Fixed

Cost Cost

Volume Volume

Semivariable Type A Semivariable Type B

Techniques for Analyzing Semivariable
Costs
Observation Method (Account Classification Method)
High-Low Method
Scattergraph Method
Method of Least Squares
Budgeting Factory Overhead Costs
Budgets are management’s operating plans expressed in quantitative terms.
Costs are segregated into fixed and variable components.
Budgets can be prepared for different levels of production (flexible budget).
Valuable management tool for planning and controlling costs.
Accounting for Factory Overhead
Entries are made in the general journal for indirect materials and indirect labor from the
summary of materials issued and the labor cost summary.
Other factory overhead expenses are recorded in the general ledger from the invoices and
schedules for fixed costs.
A factory overhead subsidiary ledger may be used if the number of factory overhead accounts
becomes too large.
Examples of Factory Overhead Accounts
Defective Work Overtime Premium
Depreciation Plant Security
Employee Fringe Benefits Power
Fuel Property Tax
Heat and Light Rent
Indirect Labor Repairs
Indirect Materials Small Tools
Insurance Spoilage
Janitorial Service Supplies
Lubricants Telephone/Fax
Maintenance Water
Materials Handling Workers’ Compensation Insurance
Factors to be considered in the computation
of Factory Overhead Rate
1. Based to be used
◦ Physical Output
◦ Direct Materials Cost
◦ Direct Labor Cost
◦ Direct Labor Hours
◦ Machine Hours

2. Activity Level to Use

◦ Normal Capacity
◦ Expected Actual Capacity

3. Inclusion or exclusion of Fixed Factory Overhead

◦ Absorption costing
◦ Direct Costing

4. Use of Single or Multiple Rates

◦ Plant-wide or Blanket Rate
◦ Departmentalized Rate
◦ Activity Based Costing (ABC) System
Distributing Service Department
Expenses
Service departments are an essential part of the organization, but they do not work directly on
the product.
Production departments perform the actual manufacturing operations that physically change
the units being processed.
The costs of the service departments must be apportioned to the production departments.
An analysis of the service department’s relationship to other departments must be done.
Plant-Wide
Factory Overhead Rate Formula

Total Budgeted or Estimated Factory Overhead

Factory Overhead Rate = ------------------------------------------------------------
Total Budgeted or Estimated Base
Departmentalize Factory Overhead Rate
Common Bases for Distributing Service Department Costs
Service Departments Basis for Distribution
Building Maintenance Floor space occupied by other departments

Inspection and Packing Production volume

Machine Shop Value of machinery and equipment

Human Resources Number of workers in departments served

Purchasing Number of purchase orders

Shipping Quantity and weight of items shipped

Stores Units of materials requisitioned

Tool Room Total direct labor hours in departments served

Methods of Distributing Costs
1. Direct Distribution Method
◦ Service department costs are allocated only to production departments.
2. Sequential Distribution or Step Method
◦ Distributes service department costs regressively to other service departments and then to
production departments.
3. Algebraic Distribution Method
◦ Distributes costs by simultaneous equations recognizing the relationship of services rendered by
departments to each other.
Applying Factory Overhead to
Production
Factory overhead costs may not be known until the end of the accounting period.
The cost of a job is needed soon after completion, so a method to estimate the amount of
factory overhead applied must be established.
This enables companies to bill customers on a more timely basis and to prepare bids for new
contracts more accurately.
Accounting for Actual and Applied
Factory Overhead
Entry to apply estimated factory overhead to production
Work in Process XX
Factory Overhead Applied XX

At the end of the period, the applied factory overhead

account is closed to factory overhead.
Factory Overhead Applied XX
Factory Overhead Control XX
Under- and Overapplied Factory Overhead
After the applied factory overhead account is closed, the underapplied (debit) or overapplied (credit)
balance in the factory overhead account is moved to work in process.

Under- and Overapplied Factory Overhead XX

Factory Overhead XX

Assuming the under or overapplied overhead is immaterial

Cost of Goods Sold XX
Under- and Overapplied Factory Overhead XX
Plant-wide
Problem 1
Determining Overhead Rate; Expected Actual Capacity Method. Desmond Corp. estimates that its
production for the coming year will be 10,000 widgets, which is 80% of normal capacity, with the
following unit costs: materials, P40; direct labor, P60. Direct labor is paid at the rate of P24 per hour.
The widget shaper, the most expensive piece of machinery, must be run for 20 minutes to produce one
widget. Total estimated overhead is expected to consist of P400,000 for variable overhead and
P400,000 for fixed overhead.
 
Required: Compute the overhead rate for each of the following bases, using the expected actual
capacity activity level:
 
(1) physical output
(2) materials cost
(3) direct labor cost
(4) direct labor hours
(5) machine hours
Plant-wide
Problem 1 - solution
  Physical Output Materials Cost Direct Labor Cost Direct Labor Hours Machine Hours

Estimated Factory Overhead 800,000.00 800,000.00 800,000.00 800,000.00 800,000.00

Divide by Expected actual capacity 10,000 widgets (40 X 10,000) (60 X 10,000) (60/24 X 10,000) (20/60 X 10,000)

80.00 200% 133.33% 32.00 240.00

Factory Overhead Rate

/Widget of Material Cost of Direct labor cost /Direct Labor Hour /Machine Hour
Plant-wide
Using Problem 1 and instead of using expected actual
capacity the company uses the normal capacity…
  Physical Output Materials Cost Direct Labor Cost Direct Labor Hours Machine Hours

Estimated Factory Overhead 800,000.00 800,000.00 800,000.00 800,000.00 800,000.00

Divide by Expected actual capacity 12,500 widgets (40 X 12,500) (60 X 12,500) (60/24 X 12,500) (20/60 X 12,500)

64.00 160% 106.67% 25.60 192.00

Factory Overhead Rate

/Widget of Material Cost of Direct labor cost /Direct Labor Hour /Machine Hour

Normal capacity = 10,000 / 80% 12,500.00

Plant-wide
Problem 2
Overhead Analysis. Data for the past two years for J&J Corp. are:
20A 20B
Overhead applied per unit P 15 P 18
Actual overhead:
Fixed 50,000 55,000
Variable 95,000 150,000
Estimated overhead:
Fixed 50,000 56,000
Variable 130,000 142,000
The company determines overhead rates based on estimated units to be produced.
Required:
(1) Determine the estimated units of production used to obtain the overhead allocation rates in 20A and 20B.
(2) Determine the over- or underapplied factory overhead for each of the two years.
Plant-wide
Problem 2 solution…
20A 20B
Estimated Factory Overhead 180,000.00 198,000.00
Factory Overhead Rate 15.00 18.00
Estimated Units of Production 12,000.00 11,000.00

20A:
Actual Factory Overhead 145,000
Applied Factory Overhead (10,000 x P15) 150,000
Overapplied Factory Overhead   -5,000

20B:
Actual Factory Overhead 205,000
Applied Factory Overhead (11,000 x P18) 198,000
Underapplied Factory Overhead   7,000
Discussion Problem
Departmentalize Factory Overhead Rates
Ferry Company has three service departments, Purchasing, Bldg Maintenance and Human Resources, and two producing departments, Machining and Assembly. The following data have been
estimated for next year’s operations:

Department: Total OH Charges Square Footage Machine Hours Estimated Labor Hours No. of Employees
Acquisitions
Purchasing 85,000 200 -- 50,000 -- 3
Human Resources 135,000 300 -- 75,000 -- 5
Bldg Maintenance 100,000 100 -- 35,000 5,000 2
Machining 275,000 1,800 25,000 1,785,000 20,000 15
Assembly 225,000 2,700 1,000 2,105,000 25,000 30

Ferry’s applies overhead to the production using machine hours for Machining and labor hours for assembly.

Required:
Compute for the Factory Overhead Rate, assuming the company allocates service department costs using:
1.  Direct Method
2.  Step Method
3. Algebraic Method
Practice problem...
Departmentalize Factory Overhead Rate Direct Method
Chaing Chemical Co. operates with three producing departments Blending, Testing, and Terminal. The overhead items and
amounts for the period, along with the bases for their allocation, are listed below.
Item Amount Allocation Basis
Building depreciation P 24,000 Square footage
Janitorial cost 33,000 Square footage
Materials receiving cost 48,000 Materials usage
Payroll Department cost 126,000 Number of employees
Power 75,000 Horsepower of equipment
Other relevant data are:
Blending Testing Terminal
Department Department Department Total
Number of employees 25 40 19 84
Direct labor hours 62,000 104,000 54,000 220,000
Horsepower of equipment 60,000 15,000 5,000 80,000
Kilowatt-hours 4,000 1,000 6,000 11,000
Square footage 2,000 2,000 2,000 6,000
Directly chargeable overhead cost P 125,000 P 75,000 P 87,500 P 287,500
Direct materials P 75,000 P 25,000 P 100,000
Practice problem...
Departmentalize Factory Overhead Rate Step Method
Granny's Nut Co. operates with three producing departments (Cutting, Dividing, and Shelling that are serviced by two service
departments Equipment Maintenance and General Plant). Costs are allocated using the step method with the service
department servicing the greatest number of other departments allocated first. General Plant is allocated on the basis of
square footage and Equipment Maintenance is allocated on the basis of direct labor hours. Relevant May data are:

Producing Departments
Service Departments
Equipment
General
Cutting Dividing Shelling Maintenance
Plant
Overhead before allocation of service
department costs P105,000 P93,000 P87,000 P56,000 P30,000
Square footage 8,000 12,000 6,000 4,000 -
Machine hours used 6,000 2,000 7,000 - -
Direct labor used 5,000 6,000 9,000 - -

Required: Prepare a schedule indicating the allocation of service department costs to producing departments and the rate per
machine hour for applying overhead in each producing department.
Practice problem...
Departmentalize Factory Overhead Rate Algebraic Method
Orleans Corp. operates two producing departments, C and D, and two service departments, E and F. The
overhead before allocation of service department costs, together with the usage of services from the service
departments, is:
 
Overhead Before
Allocation of Service Services Provided by
Department Department Costs E F
Producing:
C P18,000 30% ‑-
D 29,000 30% 80%
Service:
E 8,000 -‑ 20%
F 1,400 40% ‑-
P56,400
 
Required: Prepare the overhead distribution, using the simultaneous method to allocate the service departments'
costs to the producing departments.