Factory Overhead: Planned, Actual, and Applied

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The Nature of Factory OverheadFactory Overhead is generally defined as indirect material, indirect labor and other factory expenses which cannot be directly identified with specific jobs, products, or services.

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Use of a Predetermined Overhead RateBecause of the impossibility of tracing

overhead to specific jobs or specific products, overhead cost is apportioned among jobs and units.

A predetermined overhead rate permits a consistent and logical allocation to each unit of output.

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Basis used in predtermined overhead Rates Physical Output Direct Material Cost Direct Labor Cost Direct Labor Hours Machine Hours

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Physical OutputPhysical output or units of production is the

simplest base for applying factory overhead

Example: If Estimated Factory overhead is $300,000 and the company

intends to produce 250,000 units during the next period, then the FOH per unit is charged $1.2 ( $ 300.000 : 250.000 units).

Then an order with 1,000 completed units, is charged 1,000 x $1.2 = $1,200 of Factory Overhead

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Estimated Factory Overhead = Factory Overhead per unitEstimated units of production

Direct Materials Cost BaseIn some companies, a study of past costs reveals

a high correlation between direct materials cost and overhead

Example: If Estimated Factory overhead totals $300,000 and est.

materials cost $250.000, then the FOH rate is $300,000 : $250,000 = 1.2 or 120 % of its direct materials cost.

So, if the materials cost for an order is $5,000, Factory Overhead charged to the order would be $5.000 x 1.2 = $6,000

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Estimated Factory Overhead x 100 = Factory Overhead as a percentage Estimated material cost of direct materials cost

Direct Labor Cost BaseThis 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.

Example: If Estimated Factory overhead is $300,000 and total

direct labor cost is estimated at $500,000, then FOH rate is $300,000 : $500,000 = 0.6 or 60 %.

So, a job or product with a direct labor cost $12,000 is charged $12.000 x 60% = $7,200 for Factory Overhead.

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Estimated Factory Overhead x 100 = Factory Overhead as a percentage Estimated direct labor cost of direct labor cost

Direct Labor Hour BaseThe use of the direct labor hour base is justified if

there is a strong relationship between direct labor hours and factory overhead

Example: If estimated Factory overhead totals $300,000 and direct

labor hours are est. 60,000, then factory overhead rate is ($300.000 : 60,000) = $5 per direct labor hour

A job with 800 DLH, is charged 800 x $5 = $4,000 for factory overhead

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Estimated Factory Overhead = Factory Overhead per direct labor hourEstimated direct labor hours

Machine Hour BaseWhen machines are used extensively,

machine hours may be the most appropriate basis for applying overhead.

Example: If estimated factory overhead totals $300,000 and a

total of 20,000 machine hours are estimated, the FOH rate is $300,000 : 20,000 machine hours (MH) = $15 per MH

So, a job or product that requires 120 machine hours is charged 120 x $15 = $1,800 for Factory Overhead

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Estimated Factory Overhead = Factory Overhead per machine hourEstimated machine hours

Applied Factory OverheadIt is the amount of overhead included in the

cost of an item or job.= Actual Activity X Predetermined FOH Rate= 20000 hours X $15= 300,000

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Actual Factory OverheadSome actual factory overhead costs are

recorded when incurred, as transactions are journalized and posted to general and subsidiary ledgers.

A basic objectives of accumulating factory overhead is to provide information for control (compare the budgeted amount with the actual incurred).

Source documents used for recording overhead are:Purchase vouchers - general journal

voucherMaterials requisitions - labor time tickets

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Applied Factory Overhead and the Over- or Under applied Amount

At the end of the month or year, applied factory overhead and actual factory overhead are compared.

Actual factory overhead: $140,000The amount of indirect cost incurred.

Less: Applied factory overhead: (130,000)The amount of cost allocated to output.Under applied 10000

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Over- or Underapplied Factory Overhead DispositionUnderapplied:

Cost of Goods Sold10,000 Factory overhead10,000

Overapplied: Factory overhead 10,000

Cost of Goods Sold 10,000

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Disposition of Over- or Underapplied Amount

DeWitt ProductsIncome Statement

For Year Ending December 31, 20-

Sales $1,600,000Less: COGS 1,193,000 Underapplied FOH 8,500

COGS Adjusted1,202,000

Gross Profit 398.000

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Exercise No.01 On November 30, the work in process account of the Bee Dee

Company showed:

Materials charged to the work still in process amounted $4560. Factory overhead is a fixed percentage of direct labour cost.

Required: The individual amounts of factory overhead and direct labour cost charged to closing balance of work in process.

WORK IN PROCESS ACCOUNT

Materials 20800Labour 20160Foh 15840

Finish goods 45600

Exercise No.02 The Millan Company employes 150 people who work 8 hours per day and 5 days a week. Normal capacity for the month is based on assumption that the equivalent of 47 weeks of work can be expected from an employee.

Required:1. The number of direct labour hours to be used in setting up factory overhead rate based on normal capacity.

2. The number of direct labour hours if management and workers agree to work for 10 hours, 4 day a week.

Exercise No.03 The Carrcroft Company estimates its factory overhead for next period at $54,000. it is estimated that 36,000 units will be produced at a material cost of $45,000. production will require 24,000 direct labour hours at an estimated cost of $120,000. The machine will require about 1600 hours.

Required:The predetermined factoryoverhead rate based:

1. Material cost2. Units of production3. Machine Hours4. Direct Labour Cost5. Direct Labour Hours

Exercise No.04 Normal capacity of the Duro Company is set at 90,000 hours. At this level of capacity the fixed overhead is $36,000 and variable overhead is $67,500. Actual results show 75,000 hours worked during the period.

Required:1. Predetermined overhead rate based on normal capacity.

2. The amount of factory overhead applied to production.

Exercise No.05 Speed Co. assembles and sells electric mixers. All parts purchasedand labour is paid on the basis of $32 per mixer assembled. The cost of parts per mixer totals $40. As the company

handles only this one product, the unit cost basis for applying factory overhead is used. Estimated factory overhead for the coming period based on production of 30,000 mixer is as follows:

Indirect materials $220,000 Indirect Labour$240,000

Light and heat 30,000 Depreciation 25,000Miscellaneous 55,000During the period 29,000 mixers were assembled and actual

factory overhead was $565,300.

Required:1. Predetermine overhead rate.2. The amount of factory over applied to production.3. The amount of over or under applied factory

overhead.

Exercise No.06 Normal capacity of a Company ‘s power plant is estimated to be 4750,000 kilowatt hours per month. At this level of activity, fixed overhead is estimated to be $171,000 and variable overhead is $209,000. During November the power plant produced 5000,000 kilowatt hours and actual overhead for the month totaled $393,000.

Required:1. Predetermined overhead rate based on

normal capacity.2.The amount of factory overhead applied to

production.3.Over or under applied factory overhead.

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