Management Accounting Fundamentals

By: Naveed Ahmad Mughal

Accounting
for FOH
Activity Based Costing (ABC)
ABC measures a variety of different factory
activities and their relationship to overhead cost
Used in companies where overhead rate cannot be
ascertained on the commonly used bases
Designed to take into account all the different cost
and distribute them as accurately as possible to the
products
This approach is best when the company has
significant nonvolume-related costs in its plant which
are not caused by traditional cost drivers such as
labor hours and machine hours.

Activity Based Costing (contd)
ABC Steps
Identify activities
Group activities into activity centers
Collect costs associated with activity centers
into cost pools
Cost pools are usually organized by
categories
Examples: Unit-level, Batch-level, Product-level,
and Factory level activities
Identify a cost driver for each category
Applying Manufacturing Overhead
Allocation of manufacturing overhead is
conducted in two steps:
Estimated overhead costs are computed by
departments and recorded on job cost sheets
Total overhead accumulated is charged to
production by posting it to the Work in
Process account in the general ledger
Entries in the General Ledger
At the end of the month entries are made in the
general ledger
Posting to departmental manufacturing
overhead accounts
A credit balance represents over-applied overhead
A debit balance represents under-applied overhead
Accounting for Actual and
Applied Factory Overhead
Entry to apply estimated factory overhead to
production
Work in Process XX
Applied Factory Overhead XX

At the end of the period, the applied factory overhead
account is closed to factory overhead.
Applied Factory Overhead XX
Factory Overhead Control XX
Flow of Entries to Record Applied
Overhead Costs
Overapplied or Underapplied
Overhead
Monthly procedure
Balance of the manufacturing overhead
account are closed at the end of each month
in the general ledger
It represents the cumulative overapplied or
underapplied overhead to date
Overapplied or Underapplied
Overhead (contd)
End-of-year procedures
Both overapplied and underapplied overhead
must be closed
As it is difficult to allocate these costs into
various manufacturing stages costs are
allocated to Cost of Goods Sold only
Overapplied or Underapplied
Overhead (contd)
Examples of closing entries
Overapplied costs:
Overapplied Manufacturing Overhead dr.
Cost of Goods Sold cr.
Underapplied costs
Cost of Goods Sold dr.
Underapplied Manufacturing Overhead cr.

Control of Manufacturing
Overhead Costs
The method used to record manufacturing
overhead cost depends on:
Size of the company
How it is organized
Types of products manufactured
Account in use: Manufacturing Overhead
Control account in the general ledger
Departmentalization of
Overhead
Separate control accounts
Maintain a control account for each different
manufacturing overhead cost
Single control accounts
Subsidiary ledger by type of cost
Subsidiary ledger by department
Recording Overhead Costs
Voucher register entries
Invoice comparison with purchase order
Preparation of voucher including a notation of
department to be charged
Distribution memorandum indicates how the cost is
to be distributed
Enter into voucher register upon approval
Charge the cost to the appropriate
departmental overhead analysis sheet
Recording Overhead Costs
(contd)
General journal vouchers
Most manufacturing overhead costs include
fixed costs
Involves the preparation of a schedule of
monthly fixed overhead costs
The schedule is attached to the journal voucher
and posted to departmental overhead analysis
sheet.

Summary Schedule of
Departmental Costs
Schedule shows the total amount of each
type of cost incurred in each department
Prepared at the end of each month
Subsidiary ledger should agree with its related
control account
Allocating Overhead to Jobs
Overhead cost must be associated with
products or jobs
This ensures that the transfer will parallel the
work flow
First step distributing overhead costs to
departments
Recording Overhead
Distribution in the General
Ledger
At the end of the month the distribution of
overhead costs is entered in the general
ledger
Manufacturing overhead control is closed into
separate departmental overhead accounts
Distribution of service department costs are
journalized in the order of allocation
Flow of Entries to Record Distribution of
Overhead Costs
Distributing Service Department
Factory Overhead Costs
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 departments
relationship to other departments is necessary.
Costs should be distributed in proportion to
services provided
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-Down 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
service departments to each other.