Accounting for Overhead .

*

Accounting for

Overhead.

Learning ObjectivesCompute budgeted factory-overhead rates and apply factory overhead to production.Determine and use appropriate cost drivers for overhead application.Meaning and purpose of normalized overhead rates.Income statement using the variable-costing approach.Income statement using the absorption-costing approach.Production-volume variance, compute it, show how it should appear in the income statement.Why a company might prefer to use a variable-costing approach.

Please analyze each transaction on the next page, starting with transaction a.

2. Solution

Job Order Cost Procedures and Overhead Variances

MaterialsWork in ProcessFinished GoodsCost of Sales

a18,000b8,000b8,000h9,800h9,800i4,800i4,800

c2,000d7,000h9,600h9,600?

g5,60019,4004,800

20,60019,40014,600

1,200

Various AccountsOverhead ControlOverhead AppliedSales

a18,000c2,000g5,600i6,000

d7,000e2,000

i6,000f1,800

5,800??

a. Purchase inventory

b. Issue inventory to production

c. Issue inventory for overhead (cleaning supplies, repairs, etc.

d. Incur labor costs for production

e. & f. Incur more overhead

g. Apply overhead using predetermined application rate (Red)

h. Blue line: actual overhead is greater than applied. (underapplied).

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Identify the two methods for disposing of the standardcost variances at the endof a year and give therationale for each.

Disposition of Standard-Cost VariancesThere are two methods for disposing of the standard cost variances at the end of a year1. An adjustment to income of the current year.2. An assignment to both inventory and cost of goods sold by proration.

Disposition of Standard-Cost VariancesOne view is that in standard costing the standards are viewed as currently attainable.Therefore, variances are not inventoriable and should be treated as adjustments to the income of the period instead of being added to inventories.

Disposition of Standard-Cost VariancesAnother view favors assigning the variances to the inventories and cost of goods sold related to the production during the period the variances arose. This is often called prorating the variances.

Learning ObjectiveCompute the production-volume variance and showhow it should appear in theincome statement.

Production-Volume VarianceA production-volume variance is a variance that appears whenever actual production deviates from the expected volume of production used in computing the fixed overhead rate.

Production-Volume Variance Actual volume- Expected volume Difference X Fixed overhead rate = Production-volume variance

Volume Variance Applied fixed overhead Budgeted fixed overhead= Production-volume varianceIn practice, theproduction-volumevariance is usuallycalled simply thevolume variance.

Other VariancesThe fixed-overhead flexible budget variance (also called the fixed-overhead spending variance or simply the budget variance) is the difference between actual fixed overhead and budgeted fixed overhead.

Fixed Overhead VariancesUniversal Co. uses a standard cost system and prepared the following budget at normal capacity for January: Direct-labor hours (denominator hours)24,000 Variable factory overhead$ 48,000 Fixed factory overhead$108,000 Total factory overhead per direct-labor hour$ 6.50Actual data for January were as follows: Direct-labor hours worked 22,000 Total fixed factory overhead$105,000 Total variable overhead$ 45,000 Standard direct-labor hrs allowed for capacity attained 20,000 Fixed overhead spending variance for January?a. $2,000 favorable b. $3,000 favorable c. $2,000 unfavorable b. $3,000 unfavorable e. other

Fixed Overhead Variances

Sheet1

ANALYSIS OF STANDARD COST VARIANCES

Standard Costing for Variable Overhead

Actual HoursActual RateActual Cost

X=

Spend. Variance

Budget for input

(Based on actual hours worked)Budget for actual

Actual HoursStandard RateHrs Worked

X=

Efficiency Variace

Budget for output

(Based on output or good hours)Budget (Std) for

Standard HoursStandard RateUnits Produced

X=

No Variance Here

Two amounts

Standard Costare equal

Standard Costing for Fixed Overhead

Actual Fixed OverheadGo directly to third box

Actual Cost

X=Spend.

Budgeted Fixed OH for inputVariance

(Based on actual hours worked)

Go directly to third boxBudget for actual

Hrs WorkedNo

X=Efficiency

Variance

Budgeted Fixed Overhead for outputTwo amts

(Based on std hours worked)Budget (Std) forare equal

Units Produced

X=Volume

Standard HoursStandard RateStandard CostVariance

X=

Fixed Overhead Variances-Universal

Sheet1

ANALYSIS OF STANDARD COST VARIANCES

Standard Costing for Variable Overhead

Actual HoursActual RateActual Cost

X=

Spend. Variance

Budget for input

(Based on actual hours worked)Budget for actual

Actual HoursStandard RateHrs Worked

X=

Efficiency Variace

Budget for output

(Based on output or good hours)Budget (Std) for

Standard HoursStandard RateUnits Produced

X=

No Variance Here

Two amounts

Standard Costare equal

Standard Costing for Fixed Overhead

Actual Fixed OverheadGo directly to third box

Actual Cost

X=$105,000Spend.

Budgeted Fixed OH for inputVariance

(Based on actual hours worked)$3,000

Go directly to third boxBudget for actual

Hrs WorkedNo

X=$108,000Efficiency

Variance

Budgeted Fixed Overhead for outputTwo amts

(Based on std hours worked)Budget (Std) forare equal

Units Produced

X=$108,000Volume

Standard HoursStandard RateStandard CostVariance

20,000X$4.50=$90,000($18,000)

*Actual, Normal, and Standard CostingFavorable VarianceUnfavorable VarianceBoth normal absorption costing andstandard absorption costing generateproduction-volume variances.

*Flexible-Budget VariancesAll variances other than the production-volume variance are essentially flexible-budget variances.

*Flexible-Budget VariancesFlexible-budget variances measure components of the differences between 1. actual amounts and 2. the flexible-budget amounts for the output achieved.

*Flexible-Budget VariancesFlexible budgets are primarilydesigned to assist planning andcontrol rather than product costing.

Variable vs. Absorption CostingThe differences between variable-costing and absorption-costing methods are based on the treatment of fixed manufacturing overhead.

Variable vs Absorption CostingVariable costing excludes fixed manufacturing overhead from inventoriable costs.

Absorption costing treats fixed manufacturing overhead as inventoriable costs.

Fixed-Overhead RateThe fixed-overhead rate is the amount of fixed manufacturing overhead applied to each unit of production.It is determined by dividing the budgeted fixed overhead by the expected volume of production for the budget period.

Reconciliation of Variable Costing and Absorption CostingThe difference in income equals the difference in the total amount of fixed manufacturing overhead charged as expense during a given year.

JOIN KHALID AZIZICAP STUDENTSMODULE B FINANCIAL ACCOUNTING BUSINESS ECONOMICSMODULE D COST ACCOUNTINGCOMPLETION OF SYLLABUS IN 2 MONTHSJOIN KHALID AZIZ0322*3385752R1173, ALNOOR SOCIETY, BLOCK 19. F.B.AREA, KARACHI.


Reconciliation of Variable Costing and Absorption CostingUnder absorption costing, fixed overhead appears in the cost of goods sold and also in the production volume variance.Under variable costing, fixed overhead is a period cost.

Direct Costing Questions- JV Co. -1 JV Co. began its operations on January 1, and produces a single product that sells for $7.00 per unit. Standard capacity is 100,000 units per year. 100,000 units were produced and 80,000 units were sold in the year. Costs and expenses were as follows:Fixed CostsVariable CostsRaw materials $1.50 per unit producedDirect labor 1.00 per unit producedFactory overhead$150,000.50 per unit producedSelling & admin.80,000.50 per unit soldThere were no variances from the standard variable costs. Unit cost under absorption costing is:a. $2.50. b. $3.00. c. $3.50. d. $4.50.

Direct Costing Questions- JV Co. -2

Sheet1

Fixed CostsVariable Costs

Raw materials$1.50per unit produced

Direct labor$1.00per unit produced

Factory overhead$150,000$0.50per unit produced

Selling & admin.$80,000$0.50per unit sold

Units Produced100,000

Fixed OH per unit1.50

Raw materials$1.50

Direct labor$1.00

Factory OH- variable$0.50

Cost per Unit$4.50

Direct Costing Questions-BatesBates Co. incurred the following costs: Direct materials and direct labor $600,000 Variable factory overhead 80,000 Straight-line depreciation: Production machinery 70,000 Factory building 50,000 Sales office10,000Under absorption costing, the inventoriable costs area. $680,000 b. $730,000 c. $750,000 d. $800,000

Direct Costing QuestionsUsing the variable costing method, which of the following costs are assigned to inventory?Variable selling andVariable factoryadministrative costsoverhead costsAYesYesBYesNoCNoNoDNoYes

Direct Costing QuestionsAt the end of Killo Co.s first year of operations, 1,000 units of inventory remained on hand. Variable and fixed manufacturing costs per unit were $90 and $70, respectively. If Killo uses absorption costing rather than variable (direct) costing, the result would be a higher pretax income ofa. $0 b. $20,000 c. $70,000 d. $90,000

Direct Costing QuestionsFixed manufacturing costs of $70,000 would be reported as part of the cost of ending inventory under the absorption method, but would be shown as part of expense on the income statement under direct costing. This is the first year, so we do not have a difference in the cost of beginning inventory for these two methods.

Sheet1

Fixed mfg. costs per unit$70

Units in ending inventory1,000

$70,000

Sheet2

Sheet3

Product-Costing Systems Affect Operating IncomeAbsorption- and variable-costing systemsaffect operating income because of theirtreatment of fixed factory overhead.

Absorption-costing systems, both normal and standard, generate production-volumevariances that also affect income.

Effects of Sales & Production on Reported IncomeProduction > SalesVariable costing income is lowerthan absorption income.Production < Sales Variable costing income is higher than absorption income.

Summary CommentsThe difference between income reported under these two methods is entirely due to the treatment of fixed manufacturing costsUnder absorption costing, these costs are treated as assets (inventory) until the associated goods are sold.

Learning ObjectiveConstruct absorption andcontribution format incomestatements and identify which is better for decision making.

Absorption ApproachThe absorption approach is a costing approach that considers all factory overhead (both variable and fixed) to be product (inventoriable) costs.Factory overhead becomes an expense in the form of manufacturing cost of goods sold only as sales occur.

Contribution ApproachIn contrast, the contribution approach is used by many companies for internal (management accounting) reporting.It emphasizes the distinction between variable and fixed costs.The contribution approach is not allowed for external financial reporting.

BABAR began operations on January 1, 2007, and produces a single product that sells for $9.00 per unit. BABAR uses an actual (historical) cost system. In 2007, 100,000 units were produced and 90,000 units were sold. There was no work-in-process inventory at December 31, 2007. Costs and expenses for 2007 were as followsFixed costsVariable costs Raw materials ---$1.75 per unit produced Direct labor --- 1.25 per unit produced Factory overhead $100,000 .50 per unit produced Selling and admin 70,000 .60 per unit soldWhat is the operating income for 2007 using the direct costing method?a. $181,000 b. $271,000 c. $281,000 d. $361,000

BABAR Corporation 2 of 6

Sheet1

Apex - Direct Costing (100,000 units produced)

Sales$900,000

Variable Manufacturing Costs

Materials$1.75175,000

Labor1.25125,000

Variable Overhead0.5050,000

Mfg. Costs for 100,000 units3.50350,000

Ending Inventory-10,000 units

Variable mfg. cost of goods sold

Variable selling and admin.$0.60

Margin

Fixed Manufacturing Exp.

Fixed Selling and Admin. Exp.

Net Operating Income


Sheet1

Apex - Direct Costing (100,000 units produced)

Sales$900,000



Labor1.25125,000



Ending Inventory-10,000 units(35,000)

Variable mfg. cost of goods sold(315,000)

Variable selling and admin.$0.60(54,000)

Margin531,000

Fixed Manufacturing Exp.(100,000)

Fixed Selling and Admin. Exp.(70,000)

Net Operating Income$361,000

BABAR Corporation- 4 of 6Repeat your computations, except assume that the company uses the absorption costing method.


Sheet1

Apex - Direct Costing

Sales$900,000



Labor1.25125,000






Margin531,000

Fixed Manufacturing(100,000)

Fixed Selling and Admin(70,000)


Apex - Absorption Costing (100,000 units produced)

Sales$900,000



Labor1.25125,000


Fixed Manufacturing Costs1.00100,000

Mfg. Costs for 100,000 units4.50

Ending Inventory-10,000 units

Cost of goods sold

Gross Margin

Variable selling and admin.$0.60

Fixed Selling and Admin

Net Operating Income


Sheet1

Apex - Direct Costing

Sales$900,000



Labor1.25125,000






Margin531,000

Fixed Manufacturing(100,000)

Fixed Selling and Admin(70,000)


Apex - Absorption Costing (100,000 units produced)

Sales$900,000



Labor1.25125,000


Fixed Manufacturing1.00100,000



Cost of goods sold405,000

Gross Margin495,000

Variable selling and admin.$0.6054,000

Fixed Selling and Admin70,000124,000


JOIN KHALID AZIZPIPFA STUDENTSINTERMEDIATE FINANCIAL ACCOUNTINGPERFORMANCE MEASUREMENTCOMPLETION OF SYLLABUS IN 3 MONTHSJOIN KHALID AZIZ0322*3385752R1173-ALNOOR SOCIETY BLOCK 19 F.B.AREA-KARACHI.


KHALID Company 1 of 5

Sheet1

Absorption vs. Variable Costing

Gordon Company began operations on January 1, 2003.

Gordon Company produces a single product.

Gordon uses an actual (historical) cost system.

Fixed costVariable cost




Selling and admin.$70,000$1.00per unit sold

Selling Price per unit$10


Units sold80,000

Ending inventory20,000

Operating income under variable costing method is _____?

Operating income under absorption costing method is _____?

Sheet2

Sheet3

KHALID Company 2 of 5You are encouraged to print the following slides one slide per page (rather than 6 slides per page) so that you can avoid having small print.


2. Example

Absorption and Variable Costing Compared

Gordon Company began its operations on January 1, 2003, and produces a single product.






Selling and administrative$70,000$1.00per unit sold



Units sold80,000


Operating income for 2003 under the variable (direct) costing method is:

ABSORPTION COSTINGDIRECT COSTING

Sales$800,000Sales$800,000

Cost of SalesVariable Cost of Sales

Beginning Inventory0Beginning Inventory0

Production CostsProduction Costs

(Variable & Fixed)(Variable only)

1. Direct Materials1. Direct Materials

2. Direct Labor2. Direct Labor

3. Variable Overhead3. Variable Overhead

4. Fixed Overhead

Total Mfg. CostsTotal Var. Mfg. Costs

Ending InventoryEnding Inventory

Cost of SalesVar. Cost of Sales

Other Variable Costs:

Variable Sell & Admin.

Total Other Variable Costs

Gross ProfitContribution Margin

Non-ManufacturingFixed Manufacturing

Expensesand Other Fixed Expenses

Variable Sell & AdmFixed Factory Overhead

Fixed Sell. & AdminFixed Selling & Admin.

Total Non-mfg. ExpensesTotal Fixed Expenses

Net IncomeNet Income

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2. Example

Absorption and Variable Costing Compared

Gordon Company began its operations on January 1, 2003, and produces a single product.






Selling and administrative$70,000$1.00per unit sold



Units sold80,000


Operating income for 2003 under the variable (direct) costing method is:

ABSORPTION COSTINGDIRECT COSTING

Sales$800,000Sales$800,000

Cost of SalesVariable Cost of Sales

Beginning Inventory0Beginning Inventory0

Production CostsProduction Costs

(Variable & Fixed)(Variable only)

1. Direct Materials300,0001. Direct Materials300,000

2. Direct Labor125,0002. Direct Labor125,000

3. Variable Overhead75,0003. Variable Overhead75,000

4. Fixed Overhead120,000

Total Mfg. Costs620,000Total Var. Mfg. Costs500,000

Ending Inventory124,000Ending Inventory100,000

Cost of Sales496,000Var. Cost of Sales400,000

Other Variable Costs:

Variable Sell & Admin.80,000

Total Other Variable Costs80,000

Gross Profit304,000Contribution Margin320,000

Non-ManufacturingFixed Manufacturing

Expensesand Other Fixed Expenses

Variable Sell & Adm80,000Fixed Factory Overhead120,000

Fixed Sell. & Admin70,000Fixed Selling & Admin.70,000

Total Non-mfg. Expenses150,000Total Fixed Expenses190,000

Net Income$154,000Net Income$130,000

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KHALID Company 5 of 5Please explain why you obtained different answers with the two different methods?

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Accounting for Overhead .

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