Chapter 12 Factory Overhead: Planned, Actual, and Applied Learning Objectives ‘After studying this chapter, you will be able to: 1. Define factory overhead and its components 2. Define and calculate overhead rates. ‘Accumulate actual factory overhead costs. Apply factory overhead using predetermined rates Dispose of over- or underapplied factory overhead. ‘The preceding chapters dealt with the planning and control of materials and labor costs. This chapter introduces the last of the three cost elements, factory ov erhead. “The use of predetermined overhead rates for charging overhead to products was intro- duced briefly in Chapters 5 and 6. This chapter discusses methods of applying overhead, describes the classification and accumulation of actual overhead costs, and shows the com- putation and disposition of over- or underapplied overhead The Nature of Factory Overhead Factory overhead is generally defined as indirect materials, indirect labor, and all other fac- tory costs that cannot be conveniently identified with or charged directly to specific jobs, lots, products, or other final cost objects. Other terms used for factory overhead are factory bur- den, production overhead, indirect production costs, manufacturing expense, manufac turing overhead, factory expense, and indirect manufacturing cost Factory overhead has two characteristics that require consideration if products are to be charged with a reasonable amount of this cost. The characteristics deal with overhead’s relationships to the product and to the volume of production. Unlike direct materials and race Tabor, overhead isan invisible part of the finished product. There is no materials req- si con or labor time ticket to indicate the amount of overhead that enters into a job oF product. Yet overhead is as much a part of a product's manufacturing COS direct mate- rinsed direct labor. Because automation has increased, overhead has become a larger percentage of total product cost, while direct labor's percentage has declined. “The vecond characteristic of overhead deals with how different items of overhead change in response to a change in production volume. Overhead can be fixed, variable, oF semivari- ae ar discussed in Chapter 3, fixed overhead remains relatively constant regardless of changes in the level of output, within the relevant range; another way of stating that relation- chip is that fixed overhead per unit of output varies inversely with production volume. Venable overhead changes proportionately with production volume, within the relevant 12-112.2 and Control of Costs Part 3. > Planning range; in other words, variable overhead per unit of output is constant. Semivariable over- head is neither fixed nor variable; its amount changes, but not in proportion to production volume. 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 deter- mine an amount of overhead charged to the units produced. Use of a Predetermined Overhead Rate Overhead costs are charged to all work done during any period. The problem is how to make such a charge. It is possible to allocate actual overhead to all work completed dur- ing the month. If production volume is steady from month to month and overhead costs are incurred in level monthly amounts, this method results in a reasonable charge to produc- tion each period. Typically. however, large variations do occur between months or between seasons of the year, which would cause work completed during different months to receive signifi- cantly different charges for overhead. For example, unreasonable product costs are caleu- lated if the actual costs of repairs are charged immediately and directly to jobs or products. Ordinarily repairs are necessary because of wear and tear over long periods. Further, dur- ing months when significant repair work is done, it is often necessary to slow or stop pro- duction temporarily while repairs are carried out. The resulting high repair cost and low production volume results in astronomical unit cost calculations if actual (high) overhead is charged to actual (low) production in those months, Because several components of overhead cost are incurred in the same pattern as that described for repairs, and because overhead cost needs to be assigned promptly to production, overhead generally is charged to production at predetermined amounts, not at actual amounts incurred, 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 consistent and logical allocation to each unit of output. In both job order and process cost accumulation, predetermined overhead rates provide the only feasible method of comput ing product overhead costs promptly enough to serve management's 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. In job order costing, actual costs of direct materials and direct labor used on a job are determined from materials requisitions and time cards and are entered on job order cost sheets. Overhead costs are estimated using a predetermined overhead rate. For example, overhead applicable to a job is calculated by multiplying actual machine hours used on the job by the predetermined overhead rate per machine hour. The result is entered on the job order cost sheet. The cost of a job is thus calculable at the time the job is completed, rather than being unavailable until month-end or year-end. In process costing, unit costs are computed by dividing total weekly or monthly costs for each process by the output of that process, Product costs can be determined in some process cost settings without the use of overhead rates, but predetermined overhead rates result in more uniform unit cost calculations each month even if there are large monthly fluctuations in overhead or production levels. Overhead rates used in process costing are calculated the same way as they are in job order costing.Chapter 12 > Factory Overhead: Planned, Actual, and Applied 123 Factors Considered in Selecting Overhead Rates ‘Types of overhead rates differ not only from one company to another, but also from one department, cost center, or cost pool to another within the same company, ‘At least five fac- tor influence the selection of overhead rates. The frst three are discussed in (his chapter; the last two are discussed in Chapter 13. The five factors are summarized as follows 1. Base to Be Used a. Physical output b. Direct materials cost c. Direct labor cost d._ Direct labor hours e. Machine hours {Transactions or activities 2. Activity Level Selection a. Theoretical capacity b. Practical capacity c. Expected actual capacity 4. Normal capacity e f 1 Effect of capacity on overhead rat Idle capacity versus excess capacity including or Excluding Fixed Overhead a. Absorption costing b. Direct costing 4. Use of a Single Rate or Several Rates a. Plamwide or blanket rate b. Department rates ¢. Subdepartmental and activity rates 5. Use of Separate Rates for Service Activities s Base to Be Used ‘The factor measured in the denominator of an overhead rate is called the overhead rate ase, the overhead allocation base, or simply the base, Selection of the base is important ita cost system is io provide meaningful cost data. The primary objective in selecting a base is to ensure the application of overhead in a reasonable proportion to the indirect fac- tory resources used by the jobs, products, or work performed, Ordinarily the base should be closely related to functions represented by the overhead cost being applied. If overhead is mostly labor oriented, dominated by costs such as SuPer vision and fringe benefits then the proper base is probably direct Tabor cost or direct labor hours. If overhead items are predominantly technology oriented, resulting from the own- ership and operation of machinery, then machine-hour base is probably most sppropr® ate. IFoverhead is mainly materials oriented, dominated by costs associated with procuring and handling materials, then materials cost may be suitable as the base. Correlation analy- sis, discussed in Chapter 3, is useful in selecting the base. ‘A second objective in selecting a base is minimization of clerical cost and effort. When two or more bases result in approximately the same applied factory overhead costs for each12-4 Part 3 > Planning and Control of Costs Job or product, the simplest, most easily measured base should be used. Although the cost of administering the various methods differs from one company to another, the direct labor Cost base and the direct materials cost base tend to cause the least clerical effort, because the data they require are accumulated for other reasons and thus are readily available. Labor hour and machine hour bases generally entail additional clerical work due to extra effort required to collect the data Physical Output. Physical output or units of production is the simplest base for applying factory overhead. Its use is illustrated as follows: Eslimated factory overhead . Estimated units of production ~ Faetory overhead per unt If estimated factory overhead is $300,000 and the company intends to produce 250,000 units during the next period, each completed unit is charged $1.20 ($300,000 250,000 units) as its share of factory overhead. An order with 1,000 completed units is charged 1,000 x $1.20 = $1,200 of factory overhead, ‘The physical output bas factory when a company manufactures only one prod- uct; otherwise, the method is generally unsatisfactory. If, however, a company's products are alike or closely related, their difference being merely one of weight or volume, appli- cation of factory overhead can be made on a weight, volume, or point base. Chapter 14 dis cusses additional problems to consider when products differ in terms of volume. The weight base applied factory overhead according to the weight of each product and is illustrated as follows: Product A B & Estimated number of units manufactured... 20,000 15,000 20,000 Unit weight of product 5 lbs. 2 Ibs, 1 Ibs. Estimated total weight produced 100,000 Ibs. 30,000 Ibs. 20,000 Ibs. Estimated factory overhead per pound ($300,000 = 150,000)... $2. $2 Estimated factory overhead for each product... $200,000 ‘$40,000 Estimated factory overhead per unit $10 $2 If the weight or volume base does not yield a reasonable apportionment of overhead, the method can be improved by assigning a certain number of points to each product to compensate for differences in the amounts of indirect resources they consume during pro- duction. For example, a company manufacturing Products L, $, M, and F computes an overhead rate per product as follows: Estimated Estimated Estimated Factory Factory Estimated Factory Overhead Overhead Estimated Points Total Overhead tor Each Cost Product Quantity Assigned Points. —_per point Product —_ per Unit E 2,000 5 40,000 $3 $ 30,000 $15 s 5,000 10 50,000 3 150,000 30 M 3,000 8 24,000 = 72,000 24 F 4,000 4 18,000 3 48,000 2 00,000 $200,00012-5 Chapter 12 > Factory Overhead: Planned, Actual. and Applied If products differ in any respect not considered in the allocation base, such as process: ing time required, number and complexity of machinery setups, or method of production, a uniform charge based on physical output can result in inappropriate costing. Tn such instances, other methods must be adopted. Direct Materials Cost Base. \n some companies, a study of pa reveals a high cor- relation between direct materials cost and overhead. This is plausible. for example, when much of the production work consists of receiving, inspecting, storing, reieVInEs and han- dling many lots of costly materials, In such cases. a rate based on materials cost may be appropriate. The rate is computed by dividing total estimated overhead by total estimated direct materials cost, as follows: Estimated factory overhead 44g, ead eee econ * 100 = as a percentage of direct materials cos STiEIGaT Amal exer, 7100 = FAO evernvediana Pi entage oF If estimated factory overhead totals $300,000 and estimated materials cost totals 0,000, each job or product is charged an amount of factory overhead equal to $300,000 $250,000 = 1.20, or 120 percent of its direct materials cost, For example, if the materi- n additional charge of $5,000 x 120% = als cost of an order is $5,000, the order receives # $6,000 for factory overhead. The material cost base is of limited use, because in most cases no logical relations exists between the direct materials cost of a product and the use or creation of factory Over head ints production. One product might be made from high-priced materials and another from less expensive materials, yet both products could use the same manufacturing process and consume the same materials-related overhead resources. If a direct materials cost base is used to apply factory overhead, the product using expensive materials will De charged more ovethead cost than it causes, and the product using less expensive materials will be charged less overhead cost than it causes. To overcome this discrepancy, two factory over head rates can be calculated. In one rate, a measure of usage such as material weight or the number of pieces used can be the base for applying materials-related costs such a8 pur. chasing, receiving, inspecting, handling, and storage costs. In the other rate, a measute of Some other relevant activity can be the base for applying the remaining factory overhead costs. The factory overhead cost of each job or product is then calculated in two parts using the two rates. Similarly, three or more rates might be used if appropriate Direct Labor Cost Base. Using a direct labor cost base for applying factory overhead to jobs or products entails dividing estimated overhead by estimated direct labor cost fo com- pute a percentage: Estimated factory overhead 4 eave Eaivaiedaveerensraner "100° Pasioay overhead as a percentage of direct labor cost Lfestimated factory overhead is $300,000 and total direct labor cost for the next period ig estimated at $500,000, the factory overhead rate is $300,000 + $500,000 = .60. oF 60 percent. A job or product with a direct labor cost of $12,000 is charged $12,000 60% = $7,200 for factory overhead The direct labor cost base is relatively easy to use, because the direct labor cost infor- mation needed is usually readily available. The weekly payroll provides the direct lubor12-6 Part 3 > Planning and Control of Costs cost without any additional record keeping. If economy in obtaining underlying informa- tion is a main prerequisite, the direct labor cost base can be accepted as the quickest of the available methods of applying factory overhead in labor-intensive manufacturing. This method’s 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. It is inappro- priate when: 1. Factory overhead includes depreciation of high-cost machinery, which bears no relationship to the direct labor payroll 2. Total direct labor cost represents the sum of wages paid to high- and low-wage production workers doing similar work. By applying factory overhead on the basis of direct labor cost, a job or product is charged with more overhead when a high- wage operator performs work. Such a method can lead to an incorrect distribution of overhead, particularly when operators with different hourly pay rates perform similar operations, Direct Labor Hour Base. The direct labor hour base is designed to overcome the sec- ond disadvantage of using the direct labor cost base. The factory overhead rate based on direct labor hours is computed as follows: Estimated factory overhead Estimated direct labor hours ~ Factory overhead per direct labor hour -ct labor hours are estimated to 60,000 = $5 per direct labor = $4,000 If estimated factory overhead totals $300,000 and total 60,000, then the factory overhead rate is $300,000 + hour. A job or product that requires 800 direct labor hours is charged 800 x $: for factory overhead. This method requires accumulating direct labor hours by job or product. Timekeeping records must be organized to provide the additional data. The use of the direct labor hour base is justified if there is a strong relationship between direct labor hours and factory over- head. As long as labor operations are the chief factor in production, the method is acceptable. However, if production uses machines extensively and overhead costs are caused primarily by machine usage, the direct labor hour base can iead to unreasonable costing. Recent years have seen a shift away from direct labor usage and toward increasing lev- els of automation. As a result, a direct labor cost or direct labor hour base for overhead appli- cation has become less appropriate, often giving way to machine hours as the preferred base. In highly automated manufacturing, direct labor may not only be an inappropriate base for overhead application, but it also may be a relatively small portion of total manufactur- ing cost. In this latter case, direct labor may be included with overhead in a single conver- sion cost classification and applied as a part of a conversion cost rate. Machine Hour Base. When machines are used extensively, machine hours may be the most appropriate basis for applying overhead. This method is based on time required to perform identical operations by a machine or group of machines, Total machine hours expected to be used are estimated, and a machine hour rate is determined as follows: Estimated factory overhead = Factory overhead per 1e hour Estimated machine hours POOL OEINEAG pet machinChapter 12 > Factory Overhead: Planned, Actual, and Applied 12-7 If total factory overhead is estimated to be $300,000 and a total of 20,000 machine 15 per n hours are estimated, the factory overhead rate is $300,000 + 20.000 = hour. A job of product that requires 120 machine hours is charged 120% $15 = $1,800 for factory overhead. If machines differ with respect to overhead casts per hour of usage, then a weighting system similar to that discussed for the physieal output base is required. An alternative is to use a separate factory overhead rate for each machine or machine group. ‘This requires segmenting the cost esti mulation, and application, following the procedures discussed in the next chapter. third alternative, increasingly popular in auto- rated settings, is use of process time as the base. Process time is the total time required to produce a unit of product. “The machine hour method entails additional clerical work, because a reporting system must be designed to assure correct accumulation of machine hour data. Unless the data are requited for costing, shop personnel, supervisors, or timekeepers normally do not collect the machine hour data nceded to charge factory overhead to jobs or products. In comput- rized plants. this data collection effort can be entirely electronic, Machine hours may be the most reasonable base if factory overhead costs are mainly technology related, such as depreciation, maintenance, and utilities. ation, ace Transactions Base. A group of costs may be associated with a particular activity in a man ner not adequately represented by any of the bases previously discussed. For example, Setup outs can be assigned more appropriately to products by a rate per setup. Each setup is thus Viewed as a transaction, with costs assigned to a product or batch of products based on the umber of transactions required. This transaction approach can also apply to activities such as scheduling, inspections, materials movements, and changes in products and processes "The greater the diversity and complexity in the product fine, the greater the number of transactions, Such transactions often are responsible for a large percentage of overhead costs, and the key to managing overhead is controlling the transactions that drive it. This requires thinking carefully about which transactions are necessary and which are not, and about how to-carry out the necessary ones most effectively. For example, adherence toa just-in-time phi- losophy of process design permits elimination or reduction of many transact ions. The transactions-base approach to overhead allocation is popularly referred to as activity-based costing (ABC) and is discussed in detail in Chapter 14, ABC recognizes that significant overhead costs may not be caused by volume of output, Rather, in modern mul- tiproduct s, overhead cost can be caused more by the complexity of the product line and by the handling required for special, low volume items than by the total volume of pro- duction, To the extent that overhead cost is driven by transactions that are not proportional to output volume, the use of a volume-of-output base tends to overcost the high-volume products and undercost the low-volume products. Use of the transactions base ean correct misallocation. ‘The central criteria in selecting an overhead base are reasonable correlation between the base and the overhead costs, practicality of clerical work, and costing accuracy. Increasingly, companies are selecting different bases for different categories of cost. One example of Jtttey G. Miller and Thomas E. Vollman, “The Hidden Factory” Harvard Business leview Vol. S. p. 146 Sere Siraniccnd Vijay Govindarajan, “The perils of Cost Alocation Based on Production Volumes’ Accounting Hontons Vol 2 No.4. 6.77, See Debbie Beriant, Reese Browning, and George Foster, “How Hewlat-Packar Cee thanbers I Can Trust” Harvard Business Review, Vol. 68, No. 1, pp. 178-183, for description of Hewlett Packard's experience with the transactions-base approach12-8 Part 3 > Planning and Control of Cos this approach is multiple production departments with one or more overhead rates caleu- lated for each department. This approach is discussed in detail in Chapters 13 and 14. Selection of Activity Level In calculating a predetermined overhead rate, a great deal depends on the activity level selected. The numerator of the overhead rate is an estimate of overhead at a certain activ: ity level, and the denominator is an estimate of the allocation base at that same level of activity. The greater the assumed activity level, the lower the predetermined overhead rate; this relationship exists because factory overhead consists of fixed and variable portions. The higher the activity level, the smaller the fixed portion of the factory overhead rate, because fixed factory overhead is being spread over a greater number of units of activity, The variable portion of the rate tends to remain constant at different activity levels within the relevant range. The different activity levels include theoretical capacity, practical capacity, expected actual capacity, and normal capacity. Current federal income tax regulations permit the use of expected actual capacity or normal capacity for assigning overhead costs to inventories> The regulations do not permit use of practical capacity nor theoretical capacity, arguing that it is an “exception to the general rules of “full absorption’ accounting that apply to the determination of inventoriable costs Theoretical Capacity. The theoretical capacity of a department, plant, or other facility is its capacity to produce at full speed without interruptions. It is achieved if the plant or department produces at 100% of its rated capacity. Operating at theoretical capacity is an unattainable goal for periods as long as a month, quarter, or year. Still, some mangers feel the concept is useful because it focuses attention on opportunities for improvement, For example, if actual activity is only 60% of theoretical capacity, an analysis of the other 40% can be enlightening: if much of it is due to shortages of materials, managers may investi- gate how much improvement could be gained by relocating nearer to suppliers or by pur- chasing a supplier outright; if much of the unused capacity is due to machine breakdowns, managers may investigate how much improvement could be gained by a program of pre- ventive maintenance. Practical Capacity. It is highly improbable that any company can operate at theoretical capacity for more than a few minutes or hours at a time, Allowances must be made for unavoidable interruptions, such as crew changes, preventive maintenance, repairs, setups, failures, unsatisfactory materials, delay in delivery of materials, labor shortages and absences, Sundays, holidays, vacations, inventory counting, and pattern and model changes. The number of daily shifts must also be considered; it is very rare to find three shifts per day and production maintained around the clock. These factors reduce theoret cal capacity to the practical capacity level. This reduction is caused by internal influences and does not consider the chief external influence—lack of customer orders. The reduction from theoretical to practical capacity typically ranges from 15% to 25%, resulting in a practical capacity level of 75% to 85% of theoretical capacity. 3Reguiations, Section 1.471-11 ‘Regulations, Section 1 2634-12)Chapter 12 > Factory Overhead: Planned, Actual, and Applied 129 Expected Actual Capacity. Expected actual capacity corresponds o the amount of output expected to be produced during the period. This activity level usually results in a different pre- determined rate for each period, because of increases or decreases in planned production Normal Capacity. Normal capacity corresponds to the average activity over a Tine period long enough to level out the highs and lows. The normal capacity concept secks to epbilize an overhead rate that otherwise would fluctuate as facilities are used to different degrees in different periods. A jab or product should not cost more to produce in any one accounting period just because production was lower andl fixed costs were spread over fower units. The rate is changed, however, when prices of overhead items change. Using normal capacity as the assumed activity level usually means applied factory overhead will differ from factory overhead incurred. Effect of Capacity on Factory Overhead Rates. The effect of the various capacity lev- els on predetermined overhead rates is illustrated in Exhibit 12-1. Ifthe 75% capacity level (normal capacity) is selected, the factory overhead rate is $2.40 per machine hour At higher capacity levels, the rate is lower because the fixed factory overhead is spread over more machine hours. Idle Capacity Versus Excess Capacity. 1dle capacity results from a temporary lack of sales, When sales demand increases, the idle production workers and facilities are restored to use. When idle capacity is budgeted for the period, its cost is included in the overhead rate only when expected actual capacity is used as the denominator. In that event, the cost Of idle capacity becomes a part of the product cost; this is achieved by setting the denom- jnator of the overhead rate at a lower level that reflects the idleness expected. If idle capac- ity exists but was not budgeted, there is a resulting variance related to idle facilites Factory overhead variances are discussed in Chapters 17 and 18. Effect of Various Capacity Levels on | Predetermined Factory Overhead Rates | Expected Normal ‘Actual _-Practical_-—-‘Theoretical tem Capacity Capacity Capacity Capacity Percentage of theoretical capacity 75% 80% 85% 100% Machine hours 7.500 vs. 8,000hrs. —8,500hrs. 10,000 hrs. Budgeted factory overhead: Fed _ $12,000 12,000 «$12,000 $12,000 Variable ncn 6,000 6,400 6,800 8,000 Total rer $ia000 «S4adog «$18,800 $20,000 Fixed factory overhoad rate per machine hour s 16 $150 $§ 1 $ 120 Variable factory overhead rate per machine hour : 80 so 20 Total factory overhead rate per machine hour $2.40 $2.21 s 2.00 | L . — | EXHIBIT 12-112-10 Part 3 > Planning and Control of Costs Excess capacity, in contrast, results either from greater productive capacity than a Company can expect to use, or from an imbalance in equipment or machinery. This imbal- ance occurs when the capacity of one machine does not match the capacity of other machines with which it must be synchronized. Including or Excluding Fixed Factory Overhead Ordinarily cost accounting applies all factory costs to the output of a period. Under this approach, called absorption costing, conventional costing, or full costing, both fixed and variable costs are included in factory overhead rates. Another method of costing, termed direct costing or variable costing, is not allowed for external reporting but is sometimes used for internal management purposes. Under this method, only variable factory overhead is included in overhead rates, The fixed portion of factory overhead cost does not become 8 product cost. It is instead treated as a period cost, meaning that itis charged off in total cach period, as are marketing and administrative expenses. Itis not included in either work in process or finished goods inventories. Direct costing is discussed in detail in Chapter 20. Absorption costing and direct costing are the results of two entirely different cost con. cepis with respect to product cost, period cost, gross profit, and operating income. Although the two methods result in different inventory costs and different period profits, cach of the various bases discussed for applying factory overhead can be used with absorp. tion costing or direct costing, Factory overhead variances due to idle capacity do not arice under direct costing, however. Calculation of an Overhead Rate The first step in calculating the overhead rate is determining the activity level to be used for the base selected. Then each individual overhead cost item is estimated or budgeted at that activity level, artiving at the total estimated factory overhead. For example, assume that DeWitt Products has an expected capacity level of 20,000 machine hours. At that activity level, factory overhead is estimated to total $300,000, This amount of overhead is classified into fixed and variable categories, as shown in Exhibit 12-2. Total variable costs are a function of volume: that is, the amount of variable cost per unit is constant within the relevant range, Fixed costs have a constant total amount within the relevant range, so their cost per unit is different for each production level. Increased Production causes a decrease in fixed cost per unit. Knowledge of the effect of fixed and Variable costs on unit cost is important in any study of overhead, A knowledge of the behavior of all costs is fundamental to planning, decision making, and cost control. An examination of fixed and variable costs reveals the difficulty of categorizing all items as either fixed or variable. Some cost items are partly fixed and parily variable; some are fixed to a certain production level and then increase as production increases. Also, costs can change in step-like fashion at various production levels. Such items are called semi- Variable. Because costs must be classified as either fixed or variable, the fixed portion of any semivariable cost and the degree of change in the variable portion must be determined. Chapter 3 presented the methods available for finding a cost’s fixed portion and the degree of variability in its variable portion. These methods determine the relationship between increases in production and increases in expected costs. For example, when pro- duction is expected to increase 10 percent, it is possible to determine the correspondingChapter 12. > Factory Overhead: Planned, Actual, and Applied 12-11 DeWitt Products Estimated Factory Overhead for 20— | Expense Yariable Supervisors Indirect labor 2 $ 66,000 Ovartime prer 9,000 Factory supplies. 19,000 Repairs and maintenance. 9,000 Electric power 18,000 5,000 500 48,500 Depreciation—equipment... Property tax... Insurance (lire). — Total estimated factory overhead ...n. 125,000 $175,000 EXHIBIT 12-2 increase in total cost as well as the increase in individual cost items such as supplies, power, or indirect labor. ‘Afier the activity level and the overhead cost have been estimated, overhead rates can be computed. Assuming the machine hour base is used and machine hours for the coming year are expected to be 20,000 for DeWitt Products, the factory overhead rate at this selected activity level i Estimated factory overhead _ $800,000 _ 515.09 per machine hour Estimated machine hours 20,000 Factory overhead rate = This rate is used to charge factory overhead to jobs, produets or work performed. Amounts applied are first entered in subsidiary ledgers such as job order cost sheets or cost of production reports, Hy used will determine the amount of fac- tory overhead chargeable to each job, product, or department. “The factory overhead rate can be divided into fixed and variable components as follows $128,000 estimated fixed factory overhead So gam 7 €25toed poten oie fadny overeat $175,000 estimated variable factory overhead _ 720,000 estimated machine hours ~ Total factory overhead rate = $15. 8.75 variable portion of the factory overhead rate | 8 per machine hour | Actual Factory Overhead Determining the base and the activity level. estimating total overhead, and ealculating the overhead rate take place prior to incurring or recording actual costs. Factory overhead may be applied each week or month, as soon as the necessary data—such as the prede- termined rate and the actual machine hours—are available. Each day, however, some actual factory overhead costs are recorded when incurred, as transactions are journalized1212 Part 3 > Planning and Control of Costs and posted to general and subsidiary ledgers; this recording is independent of the appli- cation of factory overhead, A basic objective of accumulating factory overhead is to provide information for con- trol, Control requires first reporting costs to the individual department heads responsible for them, and then making comparisons with amounts that would be budgeted for the level of activity actually achieved. Collecting overhead cost data relies on the chart of accounts, Which indicates the accounts to which various overhead transactions ate to be charged. The principal source documents used for recording overhead in the journals are pur- chase vouchers, materials requisitions, labor time tickets, and general journal vouchers. These documents provide a record of information to be analyzed and recorded in the accounts. To obtain accurate and useful information, each wansaction must be properly classified. Those responsible for this classification must be familiar with each cost account's name, account numbers, and purpose. Factory overhead includes numerous items that can be classified in many different ways. Every firm has its own peculiarities and must devise its own accounts and methods of classifying them. Regardless of the possible variations, overhead costs incurred are sum- marized in a factory overhead control account in the general ledger. Details of this general ledger account are kept in a subsidiary overhead ledger. This subsidiary ledger also can take many forms and may be difficult to recognize, particularly when electronic data processing equipment is used. A subsidiary ledger groups various overhead cost items together under meaningful, significant categories. The subsidiary ledger also can detail the costs charge- able to individual departments, as discussed in Chapter 13. Departmental details of over- head incurred provide for stricter control over overhead, as discussed in Chapter 17. Applied Factory Overhead and the Over- or Underapplied Amount Atthe end of the month or year, applied factory overhead and actual factory overhead are compared. Actual factory overhead is the amount of indirect cost incurred, while applied factory overhead is the amount of cost allocated to output. This section illustrates the mechanics of applying factory overhead and determining the over- or underapplied amount. Applying Factory Overhead A predetermined factory overhead rate of $15 per machine hour was calculated previously for DeWitt Products, using estimated factory overhead and estimated machine hours. To Continue that illustration, assume DeWitt Products’ actual machine hours totaled 18,900 and actual factory overhead totaled $292,000. The factory overhead applied during the period is 18,900 x $15 = $283,500. The general journal entry summarizing factory over- head applied is: Work in Process... sn 28 283,500 Applied Factory Overhead. icone 283,500 The debit to the work in process control account brings into the general ledger the total applied factory overhead for the period, usually a month. Charges to subsidiary records (job order cost sheets or departmental cost of production reports) list details of the applied factory overhead charged to each job or department,Chapter 12 > Factory Overhead: Planned, Actual, and Applied 12-13 “The applied factory overhead account subsequently is closed 19 the factory overhead control account at the end of the year by the following entry Applied Factory Overhead 283,500 Factory Overhead Control 283,500 I is common practice to use an applied factory overhead account because iT keeps applied costs and actual costs separate. This separation facilitates monthly comparison with budgeted factory overhead. These comparisons are necessary to evaluate the appropriate ness of the predetermined overhead rate. Factual experier .s substantially from the budget, and if the reasons for the divergence are not expected to be offset later the period, then the overhead rate should be adjusted to avoid misstating product costs during: the year tind to avoid a large over- or underapplied factory overhead! amount at year-encl. For examples of a divergence between actual and budgeted overhead that would not be expected to be offset later in the period, consider the occasional, presumably permanent changes in costs of items of overhead, These changes include cost of iving increases in ‘ndirect laborers’ hourly pay rates, changes in property taxes and insurance premiuts related to plant assets, and changes in the prices of eleetricity, indirect materials and sup- plies. For an example of a divergence between actual and budgeted factory overhead that vould be expected to be offset later in the period, consider a monthly budget (6 factory ven head coms in a company that conducts machinery maintenance each quarter. If the First maintenance program is scheduled for the end of March, then the budgeted maintenance costa part of factory overhead—would be high for Mare and much lower for April Now suppose that because of large rush order in ‘March, the maintenance program is post poned by one week, thus falling in the first week to April, Actual factory overhead cost for the first quarter will be significantly lower than budgeted. Because the change is merely cone of timing and not amount, the divergence will be offset in the second quarter by the high acwal maintenance cost in the first week of April "After the preceding entries are recorded, the factory overhead control account for DeWitt Products appears as follows: Factory Overhead Control Dec. 31 292,000 | Deo.31 (18,900 x $15.00) _ 283,500 Total Actual Overhead Overhead Applied Incurred During Period =| During Period Factory overhead costs are normally charged to Work in Process, but in @ just-in-time environment, Factory overhead costs may be charged directly to Cost of Goods Sold. An end-of-period entry is then made, adjusting the inventory accounts for the portion of factory ashes and other manufacturing costs appropriate to the units in inventory. The offsetting entry is made to the cost of goods sold account, using backflush costing 3s discussed in Chapter 10. Over- or Underapplied Factory Overhead Debits to the factory overhead control account reflect actual factory overhead costs incurred during the period, white credits reflect applied amounts. There may also be credit adjustments (e.g. for the retum of supplies to the storeroom) that reduce the total actual factory overhead, Because the debits and eredits are seldom equal, there is usually a debit12-14 Part 3 > Planning and Control of Costs or credit balance in the account. A debit balance indicated that factory overhead has been underapplied; a credit balance means that factory overhead has been overapplied. These over- or underapplied balances are a source of much information needed by management for controlling and judging the efficiency of operations and the use of available capacity, and for calculating predetermined factory overhead rates in subsequent periods, For DeWitt Products, applied factory overhead for the period is $8,500 less than actual factory overhead incurred, so factory overhead for the period is $8,500 underapplied. This difference can be analyzed to determine the reasons for the underapplied factory overhead, as discussed in Chapter 17 and 18. Disposition of Over- or Underapplied Amount Disposition of the over- or underapplied factory overhead is usually quite simple. At the end of the accounting period, it can be either treated as a period cost or allocated between inventories and the cost of goods sold. If the amount of over- or underapplied factory overhead is insignificant, it should be closed directly to Income Summary or to Cost of Goods Sold as a period cost. Insignificance in this sense refers to an amount so small that the effect on income of expensing all of it, rather than allocating part to inventories, is immaterial; that is, it is so small that the difference is not expected to affect the decisions of a reader of the financial statements. In that case, the entry to dispose of underapplied factory overhead on the books of DeWitt Products is: Income Summary 8,500 Factory Overhead Control... 8,500 or Cost of Goods Sold nan 8,500 Factory Overhead Control 8,500 In the second entry, the $8,500 becomes a part of the cost of goods sold account bal- ance, which subsequently is closed into the summary account. In either event, the over- or underapplied factory overhead amount can be reported as an adjustment in the income statement as shown in Exhibit 12-3. DeWitt Products Income Statement For Year Ending December 31, 20— Sales. a: i $1,600,000 Less: Cost of goods sold... om $1,193,500 Underapplied factory overhead... 8500 _1,202,000 Gr088 PrOFlt esses $ 398,000 Less: Marketing expense... S 150,000 Administrative expense... 100,000 250,000 Operating income S_148,000 EXHIBIT 12-3Chapter 12 > Factory Overhead: Planned, Actual, and Applied 12-15 Alternatively, over- or underapplied factory overhead can be reported as an adjustment in the cost of goods sold statement. This statement and the income statement then appear fs shown in Exhibit 12-4. The treatment of the adjustment may be based on management responsibility for the over- or underapplied factory overhead: if @ respons! ‘lity of manu- facturing managers, itis reported in the cost of goods sold statement; if a responsibility of general management, itis reported in the income statement as illustrated previously. DeWitt Products Cost of Goods Sold Statement For Year Ending December 31, 20— Direct materials used.. $400,000 Direct labor used... ra 500,000 Applied factory overhead... 283,500 Total manufacturing COSt...-~- $1,183,500 Less inerease in work in process inventory. 20,000 Cost of goods manufactured : $1,163,500 Plus decrease in finished goods inventory 30,000 Cost of goods 501K... e-- $1,193,500 Plus underapplied factory overhead 8.500 Adjusted Cost of goods Sold... $1,202,000 DeWitt Products Income Statement For Year Ending December 31, 20— SAIS reer : $1,600,000 | Less cost of goods sold at actual.. 1,202,000 Gross profit rican $ 398,000 Less: Marketing @xpense ...rnmnnn $150,000 ‘Administrative €[email protected] 400,000 256,000 Operating income eo $148,000 EXHIBIT 12-4 Rather than treat the over- or underapplied factory overhead as an adjustment to income or expense, it can be allocated to inventories and the cost of goods sold. This allo; cation is an attempt to restate all applied factory overhead at amounts approximating actual factory overhead. It is required for financial reporting purposes if its effect on the financial statements are material. Expensing a large underapplied factory overhead balance, for example, generally overstates the cost of goods sold, understates income, and understates inventory on the balance sheet. “To illustrate the allocation of over- or underapplied factory overhead between invento- ries and cost of goods sold, suppose Spander Company in all previous years had treated Over. or underapplied factory overhead as an adjustment to income or expense, At the end of the current year the company had $4,000 of underapplied factory overhead, and the bal- ances in inventories and cost of goods sold were:1216 Part 3 > Planning and Control of Costs Work in Finished —_Cost of Process Goods Goods Sold Direct material aeeeeeten $15,000 § 7,000 § 28,000 Direct lab0F nnn = : 5,000 19,000 76,000 Applied factory overhead... oe 5,000 _149.000 76,000 Year-end balance... $25,000 $45,000 $180,000 The purpose of allocating the underapplied factory overhead is to revise all the amounts of factory overhead that were applied during the year. The revision is achieved by adjusting the three accounts shown, because all applied factory overhead amounts are con- tained in the year-end balances of those three accounts. The materials inventory account is not involved, because it contains no applied factory overhead. (This illustration also assumes that the beginning balances of Work in Process and Finished Goods were very small compared to Cost of Goods Sold. When beginning inventories are significant, the appropriate disposition of over- or underapplied factory overhead parallels the disposition of factory overhead standard cost variances, discussed in Chapter 19.) ‘The over- or underapplied factory overhead usually is allocated to the three accounts in proportion to their balances. The calculation is as follows: Account —_ Percentage Balance of Total. Work in process $ 25,000 10% Finished goods... 45,000 18 Cost of goods sold... 180,000 72 Total $250,000 100% The $4,000 of underapplied factory overhead is then allocated to the three accounts based on the three percentages calculated, The journal entry to dispose of Spander Company's underapplied factory overhead is as follows: Work in Process (10% of $4,000). 400 Finished Goods (18% of $4,000)..... 720 Cost of Goods Sold (72% of $4,000) 2,880 aa 4,000 Factory Overhead Conttol «nn If factory overhead had been overapplied, the two inventories and Cost of Goods Sold would be credited and Factory Overhead Control would be debited Often the work in process inventory consists mostly of direct material cost and rela- tively little overhead, so the approach just illustrated attributes too much of the adjustment to Work in Process. Because only the overhead components of the three accounts need to be restated, the allocation should be in proportion to the amounts of applied factory over- head contained in three accounts. Using this approach, the calculation and the journal entry to dispose of the underapplied factory overhead are as follows: Applied Percentage Overhead —of Total Work in process... S 5,000 5% Finished goods ... 19,000 19% Cost of goods sold... 76,000 78% Total an $100,000 Work in Process (5% of $4,000)... coe 200 Finished Goods (19% of $4,000)... nnsennnnoe 760 Cost of Goods Sold (76% of $4,000) wn. 3,040 Factory Overhead Control ar 4,000Chapter 12 > Factory Overhead: Planned, Actual, and Applied 12-17 Under ether approach, the inventories are reported on the balance sheet at their adjusted amounts, ‘and Cost of Goods Sold is adjusted on either Cost of Goods Sold Statement or the Income Statement, as illustrated previously. At the beginning of the next year, the portions of the journal entry that involve inventories are reversed. Income tax regulations require that inventories include an allocated portion of signifi- cant annual overhead varianees. When the amount involved is not significant in relation to Tora actual overhead, an allocation is not required unless such allocation is made for finan- cial reporting purposes. Also, the taxpayer must treat both over- and underapplied factory overhead consistently. Further discussion of the analysis and disposition of under- or over- applied factory overhead is reserved for Chapter 19. Changing Overhead Rates Summary Key Terms Overhead rates usually are reviewed periodically. Changes in production methods, prices, ‘efficiencies, and sales forecasts make review and possible revision of overhead rates nec- essary at least annually. The extent to which a company revises its overhead rates depends on the frequency of changes, on factors that affect overhead rates, and on management’s need and desire for current cost data ‘An overhead rate can be incorrect because of misjudgments regarding estimated over- head or anticipated activity. A large over- or underapplied factory overhead figure does not necessarily mean that the overhead rate was wrong. When the overhead rate is based on expected actual conditions, seasonal variations can result in a large interim amount of over. or underabsorbed overhead that will even itself out during a full year. All production costs not traced directly to output are collectively referred to as factory overhead and generally are allocated to output by use of predetermined rates. The denom- jnator of the predetermined rate calculation can be set at the level of theoretical, practical, expected actual, or normal capacity. Capacity can be expressed in machine hours, labor toons, material cost, of a variety of other measures. The numerator of the predetermined rare calculation is the amount of factory overhead estimated to be incurred at the Tevel of activity used in the denominator This chapter's discussion of estimating and accounting for factory overhead is dia- grammed in Figure 12-1 factory overhead (12-1) factory burden (12-1) production overhead (12-1) indirect production costs (12-1) manufacturing expense (12-1) manufacturing overhead (12-1) factory expense (12-1) indirect manufacturing cost (12-1)1218 Part 3 > Planning and Control of Costs ESTIMATING FACTORY OVERHEAD Estimated total factory overhead Estimated activity Factory overhead (e.9., machine hours) application rate ACCOUNTING Factory Overhead Applied Factory Work in Process— FOR Control ‘Overhead Factory Overhead __ Finished Goods FACTORY acigal charges: ‘Applied Goods ‘Completed OVERHEAD indirect factory completed, ‘goods materials overhead ———> | with tactory —> | transtorred Indirect labor (rate x overhead to cost of Uiities capacity based on ‘goods sold Maintenance uilized, Le. Predetermined Depreciation actual rate Property tax activity) etc. | Over-/Underapplied Factory Overhead FIGURE 12-1 Factory Overhead predetermined overhead rate (12-2) overhead rate base (12-3) overhead allocation base (12-3) base (12-3) process time (12-7) transactions-base approach (12-7) theoretical capacity (12-8) practical capacity (12-8) expected actual capacity (12-9) normal capacity (12-9) idle capacity (12-9) excess capacity (12-10) absorption costing (12-10) conventional costing (12-10) full costing (12-10) direct costing (12-10) variable costing (12-10) actual factory overhead (12-12) applied factory overhead (12-12) underapplied (12-14) overapplied (12-14)Chapter 12 > Factory Overhead: Planned, Actual, and Applied 12-19 Discussion Questions Q12-1 Qi2-2 Q12-3 Qi2-4 Q12-5 Q12-6 Q12-7 Q12-8 Q12-9 Q12-10 Q12-11 Q12-12 Q12-13 Q12-14 included in factory overhead. List some of the c Why does factory overhead vary from month to month? When and why must predetermined factory overhead rates be used? Indicate the impracti- ‘es of charging actual overhead to jobs and products. calities and inaccura (AICPA adapted) Name six bases used for applying factory overhead. What factors must be considered in the selection of a particular base? Why is the sclection of a proper predetermined rate essential 10 reasonable costin Explain, Discuss the objectives and criteria that should be used in deciding whether to use direct labor hours or machine hours as the overhead allocation base. (AICPA adapted) Differentiate among (a) theoretical capacity, (b) practical capacity, (c) expected actual capacity, and (d) normal capacity. How does the selection of normal or maximum capacity affect operating profit in setting the overhead rate? (a) What situations give rise to idle capacity costs? (b) How are such costs accounted for, and why? (©) What is excess capacity cost? ‘What are the steps involved in accounting for actual factory overhead? “The factory overhead control account has a credit balance at the end of the period. Was fac tory overhead over- or underapplied? A. company applies factory overhead to production on the basis of direct labor dollars. At the end of the year, factory overhead has been overapplied to the extent of $60,000. What factors can cause this situation? Describe two methods for disposing of over- or underapplied factory overhead and explain how the decision to use one of these methods rather than the other affects net income. Comment on the following statement: If large amounts of underapplied factory overhead occur month after month, the overhead rate should be revised to make unit costs more accurate.12.20 Exercises El2-1 E12-2 E12-3 E12-4 Part 3 > Planning and Control of Costs Predetermined Overhead Rates; Activity Levels. Stevens Fabricators (SF) is a maker of small steel machine parts, The company’s total factory overhead costs are a linear function of the number of tons of steel processed. The company’s theoretical capacity is 15,000 tons per year, practical capacity is 8,000 tons per year, normal capacity is 6,000 tons per year; 5,000 tons was the budgeted amount to be processed in the year just ended. At the beginning of each year, the company budgets the expected actual factory over- head costs for the coming year and divides by the budgeted (expected actual) activity for the coming year. The result is the predetermined overhead rate. Actual activity in the year just ended was 5,500 tons, and budgeted factory overhead costs were $5,350,000. The factory overhead budget would be $6,070,000 at normal capacity. Actual factory overhead costs in the year just ended were $5,340,500. Required: (2) Use the high and low points method (Chapter 3) to calculate the budgeted fixed fac- tory overhead and the budgeted variable factory overhead rate per ton for the year just ended, assuming the practical capacity level of activity is within the relevant range. (2) If the company had used practical capacity as the activity level in its predetermined overhead rate calculation for the year just ended, what would have been the predeter- mined overhead rate per ton? (Calculate to two decimal places.) Overhead Application. The work in process account of Cumberland Inc. showed the fol- Towing at the end of September: Work in Process Materials 24,800 | Finished goods “48,600 Direct tabor 20,160 Factory overhead Materials charged to the work still in process amounted to $5,560. Factory overhead is applied as a percentage of direct labor cost. Required: Compute the individual amounts of factory overhead and direct labor charged to work still in process. (Round all amounts to four decimal places.) Calculation of Estimated Labor Base. The direct labor work force of Edwin Inc. con- sists of 150 employees working full time, 8 hours, 5 days a week. Normal capacity assumes that the equivalent of 48 weeks of work can be expected from a full-time employee. Required: Calculate the following: (1) The number of direct labor hours to be used in calculating the factory overhead rate based on normal capacity, (2) The number of direct labor hours if management and workers agree on a 10-hour, 4- day workweek Various Overhead Rates. Nazareth Company estimates overhead of $225,000 for the next year. An estimated 25,000 units will be produced, with materials cost of $500,000.Chapter 12 > Factory Overhead: Planned, Actual and Applied E12-5 E12-6 E12-7 12-21 Conversion will require an estimated 56,250 direct labor hours at a cost of $8 per hour, and ‘an estimated 75,000 machine hours. Required: Compute the predetermined overhead rate to be used in applying factory over head to production on each of the following bases: (1) Units of production 2) Materials cost (3) Direct labor hours (4) Direct labor cost (5) Machine hours Normal and Expeeted Actual Capacity. Theoretical capacity for Cybertech Company is 80.000 direct labor hours, and normal capacity is 50,000 direct labor hours. The actual capacity attained for the fiscal year ended June 30, 204, was 43,000 hours. It is estimated that 40,000 hours will be worked in 20B. Fixed factory overhead is $400,000, and variable factory overhead is $6.69 per direct labor hour. Required: (a) Using the normal capacity, compute (a) the factory overhead rate, and (b) the fixed part of the factory overhead rate. (b) Using expected actual capacity for 20B, compute (a) the factory overhead rate, and (b) the fixed part of the factory overhead rate, Over- or Underapplied Factory overhead, Nelsonville Inc. budgeted factory overhead at $255,000 for the period for Department A, based on a budgeted volume of 30,000 machine Fore. At the end of the period, the actual factory overhead was $281,000 and actual machine hours were 52.500. Required: Calculate the applied factory overhead and the over- or underapplied amount for the period. Entries for Factory Overhead. Millerby Inc. assembles and sells hand drils. All parts 2fe purchased, and the cost of the parts per drill totals $50. Labor is paid on the basis of $32 per drill assembled. Because the company handles only this one product, the unit cost base te used for applying factory overhead at a predetermined rate, Estimated factory overhead for the coming period, based on a production of 30,000 drills, is as follows: Indirect materials. $220,000 Indirect 1abOr 240,000 Light and power 30,000 Depreciation... 25,000 55,000 Miscellaneous During the period, actual factory overhead was $561,600 and 29,000 drills were asséan- bled, These units were completed but not yet transferred to the finished goods storeroom- Required: (1) Prepare the journal entries to record the preceding information (2) Determine the amount of over- or underapplied factory overhead.12-22 E12-8 E12-9 E12-10 E12-11 E12-12 Part 3 > Planning and Control of Costs Over. or Underapplied Factory overhead. Normal annual capacity for Irving Company is 48,000 units, with production rates being level throughout the year. The October budget shows fixed factory overhead of $1,440 and an estimated variable factory overhead rate of $2.10 per unit, During October, actual output was 4,100 units, with a total actual factory overhead of $9,000. Required: Calculate the over- or underapplied factory overhead for October. Applied Factory Overhead; Over- or Underapplied Amount, Normal annual capacity for Smythe Company is 36,000 machine hours, with fixed factory overhead budgeted as $16,920 and an estimated variable factory overhead rate of $2.10 per hour, During Qctober, actual production required 2,700 machine hours, with a total factory overhead of $7,400. Required: Compute (1) the applied factory overhead and (2) the over- or underapplied amount for October. Over- or Underapplied Factory Overhead. Kipper Company made the following data available from its accounting records and reports: (a) $800,000 estimated factory overhead = $4 predetermined factory overhead rate 200,000 estimated machine hours Lie (©) During the year, the company used 210,000 machine hours. Actual factory overhead was $832,000. Required: Compute the over- or underapplied factory overhead amount for the year. Fixed and Variable Factory Overhead Rates; Over- or Underapplied Amount. Normal operating capacity of Robertson Inc. is 100,000 machine hours per month, the level used {0 compute the predetermined factory overhead application rate. At this level of activity, fixed factory overhead is estimated to be $150,000, and variable factory overhead is esti. mated to be $250,000. During March, actual production required 105,000 machine hours and actual factory overhead totaled $411,000. Required: (1) Determine the fixed portion of the factory overhead application rate. (2) Determine the variable portion of the factory overhead application rate. (3) Is factory overhead for March over- or underapplied, and by how much? Over- or Underapplied Factory overhead. Thomas Company was totally destroyed by fire during June. However, the following cost data were recovered: actual direct labor cost, $8,117; actual direct material cost, $16,550; actual factory overhead cost, $14,134; prede- termined factory overhead rate, 200% of direct labor cost. fe the amount of over- or underapplied factory overhead. Required: CalculChapter 12 > Factory Overhead: Planned, Actual. and Applied 12-23 E1213 Problems PI2-1 Disposition of Over- or Underapplied Factory Overhead. The following information is saertible concerning the inventory and cost of goods sold accounts of Hazelhurst ‘Company at the end of the most recent year Workin Finished —_Cost of Process Goods Goods Sold Direct material ite 2.000 $6,000 $12,000 Direct labor — 2.000 16,000 132,000 Applied factory overhead... 2,000 16,000 _32,000 Year-end balance. $6,009 $38,000 $76,000 Applied Factory Overhead has already been clo» xd to Factory Overhead Control. In all previous years, over- or underapplied factory overhead was (reated as an adjustment to income or expense. Beginning inventories of the most recent year were insignifi Required: Give the journal entry to close Factory Overhead Control, assuming: (a) Underapplied factory overhead of $6,000 is to be allocated to inventories and cost of goods sold in proportion to the balances in those accounts (b) Overapplied factory overhead of $6,000 is to be allocated to inventories and cost of goods sold in proportion to the proportion to the balances in those accounts (©) Underapplied factory overhead of $6,000 is to be allocated to inventories and cost of Sold in proportion t the amounts of applied factory overhead contained in goo those accounts. Over: or Underapplied Factory Overhead; Predetermined Rates; Activity Levels: Disposition of Underapplied Amount, Amalgamated Machining is @ shect-metal fabric: tor The company’s total factory overhead costs are a linear function of machine usage. The company’s theoretical capacity is 25,000 machine hours (MH) per year. p wctical capacity +e 18.000 MH per year, and normal capacity is 8.000 MH per year: 10,000 MH were expected to be the actual activity for the year just ended. ‘At the beginning of each year. the company budgets the expected actual factory over- ead costs for the coming year and divides it by the budgeted (expected actual) MH for the coming year. The result is the predetermined factory overhead rate “Actual activity in the year just ended was 9.500 MH, and budgeted factory overhead costs were $3,500,000, The factory overhead budget would be $3.000,000 at normal capacity, Actual factory overhead costs for the year totaled $3,470,000. Required: (1) Calculate the amount of over- or underapplied factory overhead for the year Just ended Q) If the company had used practical capacity as the activity level in its predetermined overhead rate calculation for the year just ended, what would have been the predeter- mined overhead rate per MH? (Calculate to two decimal places, and assume the prac- tical capacity level of activity is within the relevant range.) 3) Without influencing your answer to requirement 1, now assume factory overhead was underapplied by $10,000, Give the end-of-period entries 10 close Applied Factory Overhead to Factory Overhead Control and to close Factory Overhead Control to Cost of Goods Sold.12-24 Part 3 > Planning and Control of Costs (4) Without influencing your answers to the preceding requirements, assume overhead was underapplied by $10,000 and Applied Factory Overhead has already been closed to Factory Overhead Control. The underapplied amount is to be allocated to inventories and cost of goods sold in proportion to the balances in those accounts, The balances in Work in Process, Fil ished Goods, and Cost of Goods Sold are $200,000, $400,000, and $7,400,000, respectively. In all previous years, the over- or underapplied factory over- head was treated as an adjustment to income or expense. Beginning inventories were insignificant. Give the end-of-period entry to close Factory Overhead Control. Pi2-2 Determi ing Variable and Fixed Overhead Cost Behavior. Burlington Company had the following budgeted amounts for production, sales, and costs in April and August , 20A, which are considered to be typical months: April August Produetion in unit sven 10,000 15,000 Sales in units 12,000 16,000 Costs: Depreciation on factory building and equipment $14,500 § 14,500 Heat, light, and power (factory) . 6,000 8,000 Supplies used (factory) 7,000 10,500 Direct materials used 60,000 75,000 ‘Taxes on factory building 1,500 7,500 Bad debt expense... 1,000 1,500 Indirect labor (factory 60,000 70,000 Advertising expense 6,000 8,000 Maintenance (factory) 12,000 18,000 Direct labor 70,000 105,000 Required: (1) Compute the variable overhead per unit for each overhead cost. (2) Compute the fixed overhead for each overhead cost. CGA-Canada (adapted). Reprint with permi Manufacturing costs for December were: Work in Process, December 1 (Job 50). $ 54,000 Materials and supplies requisitioned for: Job 50 ol $ 45,000 Job 51 37,500 Job 52... 25,500 ‘Supplies 3,500 Factory direct labor hou JOD 50 seen 3,500 Job 51 3,000 Job 52 2,000 Labor costs: Direct labor wages $102,000 Indirect labor wages. 15,000 ‘Supervisory salaries. 6,000 Building occupancy costs . 3,500 Factory equipment costs... 6,000 5,000 Other factory cost ‘ion. P12-3, Overhead; Job Order Costing. Biggs Company uses job order cost accumulation. Jobs 50 and 51 were completed during December. The predetermined factory overhead rate is $4.50 per direct labor hour.Chapter 12 > Factory Overhead: Planned, Actual, and Applied P12-4 12-25 Required: (1) Compute the total cost of Job 50. Q) Determine the factory overhead costs applied to Job 52 during December (3) Compute the total factory overhead costs applied during December. (4) Determine the actual December factory overhead inc ured. 5) How should the company dispose of any over- or underapplied factory overhead. assuming that the amount is not significant in relation to total factory overhead? ( Calculate the amount of over- or underapplied factory overhead for December (ICMA adapted) c- Overhead; Job Order Costing, Alabaster Incorporated has made the following manu! turing cost data available for the most recent period Work in process—beginning of period: Factory Job | Mater Labor Overhead _Total__ 1376 $17,500 $22,000 $33,000, $72,500 Costs for the period: Materials Labor Other Total Incurted by Jobs 1376..... $ 1,000 $ 7,000 — $ 8,000 1377. 26,000 53,000 = 79,000, 1378. 12,000 9,000 - 21,000 1379. . wa 4,000 1,000, — 5,000, Not Incurred by Jobs Indirect materials. 18,000 — — 18,000 Indirect labor... — 53,000 —_ 53,000 Employee benetits. — - $23,000 23,000 Depreciation = - 12,000 12,000 Supervision. a 20,000 = 20,000 Total $61,000 $143,000 $35,000 $239,000 Total Factory overhead rate for 20— Budgeted factory overhead: Variable— Indirect materials... $ 16,000 Indirect labor .. 56,000 Employee benefits... 24,000 Fixed— Depreciation. 12,000 ‘Supervision .. 20,000 Total. $128,000 Budgeted direct labor cost cecronmeprenne os $ 80,000 Factory overhead rate per direct labor dollar ($128,000 + $80,000) 160% Required: (1) Compute the actual factory overhead (2) Determine the over- or underapplied factory overhead, (3) Calculate the amount included in cost of goods sold for Job 1376. which’ was the only job completed and sold in the period (4) Determine the cost assigned to the work in process account at the end of the period, unadjusted for any over- or underapplied factory overhead (CMA adapted)12.26 P12-5 P12-6 Part 3 > Planning and Control of Costs Predetermined Rates; Applied Factory overhead, Wunderkind Company set normal capacity at 60,000 machine hours. The expected operating level for the period just ended was 45,000 hours. At this expected actual capacity, variable expenses were estimated to be $29,250 and fixed expenses, $18,000. Actual results show that 47,000 machine hours were used and that actual factory overhead totaled $47,100 during the period. Required: (1) Compute the predetermined factory overhead rate based on normal capacity. (2) Compute the predetermined factory overhead rate based on expected actual capacity. (3) Compute the amount of factory overhead charged to production if the company used the normal capacity rate. (4) Compute the amount of factory overhead charged to production if the company used the expected actual capacity rate. (5) Compute the amount of over- or underapplied factory overhead if the company used the normal capacity rate. (6) Compute the amount of over- or underapplied factory overhead if the company used the expected actual capacity rate. Inventory Costing: Overhead Analysis; Statement of Cost of Goods Sold. The Cost Department of Columbus Company received the following monthly data, pertaining solely to manufacturing activities, from the general ledger clerk: Work in process inventory, January 1... '$ 32,500 Materials inventory, January 1 21,000 Direct labor... 256,000 Materials purchased, on 108,000, Materials returned to suppliers 5,050 Supervision at 17,500 Indirect labor 29,050 Heat, 23,800 ion—factory buildings 7,500 Property tax—iactory facilities 4,000 Insurance on factory buildings... 3,000 Transportation in (overhead). 6,500 Repairs and maintenance—factory equipment 8,250 Depreciation—factory equipment. 7,500 Miscellaneous factory overhead 9,900 Finished goods inventory, January 1 18,000 115,200 Applied factory overhead... Additional data: (a) Physical inventory taken January 31 shows $9,000 of materials on hand. (b) The January 31 work in process and finished goods inventories show the following direct materials and direct labor contents: Direct Materials Direct Labor Work in process... oo $ 9,000 $16,000 (2,000 hrs.) Finished goods mal 10,000 440,000 (5,000 hrs.) (©) Factory overhead is applied to these two ending inventories on the basis of a predeter- ¢ of $3.60 per direct labor hour. mined overhead raChapter 12 > Factory Overhead Case CI2-1 12-27 Planned, Actual, and App Required: (1) ‘Determined the cost assigned to the ending work in process and finished goods jnven- tories, including overhead. 2) Prepare a schedule of the total actual overhead for the month, (3) Calculate the over- or underapplied factory overhead, (4) Prepare a detailed cost of goods sold statement, assuming that over” oF underapplied factory overhead is closed to the cost of goods sold account. or Analysis: Utility of Cost Behavior Information. Catanach Incorporated nd by a predetermined rate on the basis of direct labor hours. Factory ges using current prices and wage Cost Beha assigns factory overh overhead costs for two recent years, adjusted for chan rates, are as follows: Yeart Year 2 Direct labor hours worked... : 2,760,000 2,160,000 Factory overhead costs: Indirect labor «0.0 vo $11,040,000 $ 8,640,000 Employee benetis... = 4,140,000 3,240,000 Supplies $ 2,760,000 2,160,000 POWER on 2,208,000 1,728,000 Heat and light - $552,000 552,000 Supervision ca é 2,865,000 2,625,000 Depreciation 7,930,000 7,980,000 Property taxes and insurance 3,005,000 Tolal factory ovethead cost "$29,880,000 Required: (1) The company expects to operate at a level of activity of 2,300,900 direct labor hours next year. Using the data from the two recent years, calculate the estimated total fac tory overhead for next year. 2) Explain how the company can use the computed cost behavior information for: (a) Evaluation of product pricing decisions (b) Cost control evaluation (c) Developmental of budgets (ICMA adapted)