Introduction To Management Accounting: Accounting For Overhead Costs

Introduction to Management Accounting
Chapter 13
Accounting for Overhead Costs
2008 Prentice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgstahler 13 - 1
Learning Objective 1
Accounting for Factory Overhead
Methods for assigning overhead costs to the products is an important part of accurately measuring product costs.
Budgeted Overhead Application Rates
1. 2. 3. 4. 5.
Select one or more cost drivers. Prepare a factory overhead budget. Compute the factory overhead rate. Obtain actual cost-driver data. Apply the budgeted overhead to the products. 6. Account for any differences between the amount of actual and applied overhead.
Budgeted Overhead Application Rates
Overhead rates are budgeted; they are estimates. The budgeted rates are used to apply overhead based on actual events.
Budgeted overhead application rate = Total budgeted factory overhead Total budgeted amount of cost driver
Illustration of Overhead Application

Enriquez Machine Parts Company selects a single costallocation in each department for applying overhead, machine hours in machining and direct-labor in assembly. The companys budgeted manufacturing overhead for the machining department is $277,800. Budgeted machine hours are 69,450. The budgeted overhead application rate is: $277,800 69,450 = $4 per machine hour
Illustration of Overhead Application
Suppose that at the end of the year Enriquez had used 70,000 hours in Machining. How much overhead was applied to Machining?
Choice of Cost-Allocation Bases
No one cost allocation base is right for all situations. The accountants goal is to find the costallocation base that best links cause and effect.
Choice of Cost-Allocation Bases
A separate cost pool should be Identified for each cost-allocation base.
Base 1
Pool 1
Base 2
Pool 2
Normalized Overhead Rates
Normal product costs include an average or normalized chunk of overhead.
Actual direct material + Actual direct labor + Normal applied overhead = Cost of manufactured product
Disposing of Underapplied or Overapplied Overhead

Suppose that Enriquez applied $375,000 to its products. Also, suppose that Enriquez actually incurred $392,000 of actual manufacturing overhead during the year. $392,000 actual 375,000 applied $ 17,000 Underapplied
The $375,000 becomes part of Cost of Goods Sold when the product is sold. The $17,000 must also become an expense.
Disposing of Underapplied or Overapplied Overhead

The applied overhead is $17,000 less than the amount incurred. It is:
Overapplied overhead occurs when the amount applied exceeds the amount incurred.
Immediate Write-Off
This method regards the $17,000 as a reduction in current income and adds it to Cost of Goods Sold. Manufacturing Overhead 375,000 392,000 17,000 0 Applied Overhead (Budgeted)
Cost of Goods Sold Incurred Overhead (Actual) 17,000
Prorating Among Inventories

This method prorates the $17,000 of underapplied overhead to Work-In Process (WIP), Finished Goods, and Cost of Goods Sold accounts assuming the following ending account balances: Work-in-Process Inventory Finished Goods Inventory Cost of Goods Sold Total $ 155,000 32,000 2,480,000 $2,667,000
Prorating Among Inventories
$17,000 155/2,667 = 988 to Work-in-Process Inventory $17,000 32/2,667 = $204 to Finished Goods Inventory $17,000 2,480/2,667 = $15,808 to Cost of Goods Sold
Variable and Fixed Application Rates
The presence of fixed costs is a major reason of costing difficulties.
Some companies distinguish between variable overhead and fixed overhead for product costing.
Variable Versus Absorption Costing
Variable costing excludes fixed manufacturing overhead from the cost of products.
Variable costing Absorption costing
Absorption costing includes fixed manufacturing overhead in the cost of products.

Facts and Illustration
Basic Production Data at Standard Cost Direct material Direct labor Variable manufacturing overhead Standard variable costs per unit $205 75 20 $300

The annual budget for fixed manufacturing overhead is $1,500,000
Budgeted production is 15,000 computers.

Sales price = $500 per unit
$20 per computer is variable overhead.

Fixed S&A expenses = $650,000
Sales commissions = 5% of dollar sales


Units Opening inventory Production Sales Ending inventory 20X7 17,000 14,000 3,000 20X8 3,000 14,000 16,000 1,000
There are no variances from the standard variable manufacturing costs, and the actual fixed manufacturing overhead incurred is exactly $1,500,000.
Variable- Costing Method Cost of Goods Sold

20X7 20X8
(thousands of dollars) Variable expenses: Variable manufacturing cost of goods sold Opening inventory, at standard costs of $300 Add: variable cost of goods manufactured at standard, 17,000 and 14,000 units Available for sale, 17,000 units Ending inventory, at $300 Variable manufacturing cost of goods sold
$ 900
5100 5100 900 $4200
4200 5100 300 $4800
3,000 units $300 = $900,000 1,000 units $300 = $300,000

Variable-Costing Method Comparative Income Statement

(thousands of dollars) Sales, 14,000 and 16,000 units Variable expenses: Variable manufacturing cost of goods sold Variable selling expenses, at 5% of dollar sales Contribution margin Fixed expenses: Fixed factory overhead Fixed selling and admin. expenses Operating income, variable costing
1
20X7 $7,000
20X8 $8,000
42001
48001
350 $2,450
$1,500 650 $ 300
400 $2,800
$1,500 650 $ 650
from Cost of Goods Sold previous calculation
Fixed-Overhead Rate
The fixed-overhead rate is the amount of fixed manufacturing overhead applied to each unit of production.
budgeted fixed manufacturing overhead Fixed overhead rate = expected volume of production
$1,500,000 15,000 = $100
Absorption-Costing Method Cost of Goods Sold

20X7 $ 20X8 $1,200
(thousands of dollars) Beginning inventory Add: Cost of goods manufactured at standard, of $400* Available for sale Deduct: Ending inventory Cost of goods sold, at standard *Variable cost Fixed cost Standard absorption cost $300 100 $400
6,800 $6,800 1,200 $5,600
5,600 $6,800 400 $6,400
Absorption-Costing Method Comparative Income Statement

(thousands of dollars) 20X7 20X8
Sales Cost of goods sold, at standard Gross profit at standard Production-volume variance* Gross margin or gross profit actual Selling and administrative expenses Operating income, variable costing
$7,000 5,6001 $1,400 200 F $1,600 1,000 $ 600
$8,000 6,4001 $1,600 100 U $1,500 1,050 $ 450
*Based on expected volume of production of 15,000 units: 20X7: (17,000 15,000) $100 = $200,000 F 20X8: (14,000 15,000) $100 = $100,000 U 1From Cost of Goods Sold previous calculation
Production-Volume Variance
A production-volume variance appears when actual production deviates from the expected volume of production used in computing the fixed overhead rate. Production-volume variance = (actual volume expected volume) X fixed overhead rate
In practice, the production-volume variance is usually called simply the volume variance.
Production-Volume Variance
There is no production-volume variance for variable overhead. The production-volume variance for fixed overhead arises because of the conflict between accounting for control (flexible budgets) and accounting for product costing (applied rates).
A flexible budget for fixed overhead is a lump-sum budgeted amount; volume does not affect it. However, applied fixed cost depends on actual volume.
Variable Costing and Absorption Costing
The difference between income reported under these two methods is entirely due to the treatment of fixed manufacturing costs.
Variable Costing and Absorption Costing

On a variable-costing income statement, costs are separated into the major categories of fixed and variable. Revenue less all variable costs (both manufacturing and non-manufacturing) is the contribution margin. On an absorption-costing income statement, costs are separated into the major categories of manufacturing and non-manufacturing. Revenue less manufacturing costs (both fixed and variable) is gross profit or gross margin.
Why Use Variable Costing?
One reason is that absorption-costing income is affected by production volume while variable-costing income is not. Another reason is based on which system the company believes gives a better signal about performance.
Flexible-Budget Variances
All variances other than the production-volume variance are essentially flexible-budget variances. All other variances appear on both variableand absorption-costing income statements.
Flexible-Budget Variances
Flexible-budget variances measure components of the differences between actual amounts and the flexible-budget amounts for the output achieved.
Flexible budgets are primarily designed to assist planning and control rather than product costing.
Effects of Sales and Production on Reported Income
Production > Sales
Variable costing income is lower than absorption income.

Production < Sales Variable costing income is higher than absorption income.
The End
End of Chapter 13

Introduction To Management Accounting: Accounting For Overhead Costs

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Introduction To Management Accounting: Accounting For Overhead Costs

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Introduction to Management Accounting

Accounting for Overhead Costs

Accounting for Factory Overhead

Budgeted Overhead Application Rates

Budgeted Overhead Application Rates

Illustration of Overhead Application

Illustration of Overhead Application

Choice of Cost-Allocation Bases

Choice of Cost-Allocation Bases

A separate cost pool should be Identified for each cost-allocation base.

Normalized Overhead Rates

Normal product costs include an average or normalized chunk of overhead.

Disposing of Underapplied or Overapplied Overhead

Disposing of Underapplied or Overapplied Overhead

Cost of Goods Sold Incurred Overhead (Actual) 17,000

Prorating Among Inventories

Prorating Among Inventories

Variable and Fixed Application Rates

The presence of fixed costs is a major reason of costing difficulties.

Variable Versus Absorption Costing

Absorption costing includes fixed manufacturing overhead in the cost of products.

Facts and Illustration

Facts and Illustration

Budgeted production is 15,000 computers.

$20 per computer is variable overhead.

Sales commissions = 5% of dollar sales

Facts and Illustration

Variable- Costing Method Cost of Goods Sold

5100 5100 900 $4200

4200 5100 300 $4800

3,000 units $300 = $900,000 1,000 units $300 = $300,000

Variable-Costing Method Comparative Income Statement

from Cost of Goods Sold previous calculation

$1,500,000 15,000 = $100

Absorption-Costing Method Cost of Goods Sold

6,800 $6,800 1,200 $5,600

5,600 $6,800 400 $6,400

Absorption-Costing Method Comparative Income Statement

$7,000 5,6001 $1,400 200 F $1,600 1,000 $ 600

$8,000 6,4001 $1,600 100 U $1,500 1,050 $ 450

Variable Costing and Absorption Costing

Variable Costing and Absorption Costing

Why Use Variable Costing?

Effects of Sales and Production on Reported Income

Production > Sales

Variable costing income is lower than absorption income.

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