Accounting for Factory

Overhead

Chapter
1-1
 Learning Objective 1

Compute underapplied or
overapplied overhead cost and
prepare the journal entry to
close the balance in
Manufacturing Overhead to
the appropriate accounts.

Chapter
1-2
 Comparison of Actual and Normal Costing

Elements of product Actual Costing Normal Costing

Direct Materials Actual Actual
Direct Labor Actual Actual
Factory overhead Actual Applied

Chapter
1-3
 Overhead Application Example

PearCo’s actual overhead for the year was

$650,000 with a total of 170,000 direct
labor hours worked on jobs.
How much total overhead was applied to
PearCo’s jobs during the year? Use
PearCo’s predetermined overhead rate of
$4.00 per direct labor hour.
Overhead Applied During the Period
Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000

Chapter
1-4
 Disposition of Under or Overapplied OH

PearCo’s Method

$30,000 $30,000 may be

may be allocated closed directly to
to these accounts. cost of goods sold.

OR
Work in Finished
Process Goods

Cost of Cost of
Goods Sold Goods Sold

Chapter
1-5
 Disposition of Under or Overapplied OH

Chapter
1-6
 Allocation of OH Between Accounts

Assume the overhead applied in ending Work in

Process Inventory, ending Finished Goods Inventory,
and Cost of Goods Sold is shown below:

Percent of Allocation
Amount Total of $30,000
Work in process $ 68,000 10% $ 3,000
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total $ 680,000 100% $ 30,000

Chapter
1-7
 Allocation of OH Between Accounts

We would complete the following allocation of

$30,000 overapplied overhead:
Percent of Allocation
Amount Total of $30,000
Work in process $ 68,000 10% $ 3,000
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total $ 680,000 100% $ 30,000

10% × $30,000

Chapter
1-8
 Allocation of OH Between Accounts

Percent of Allocation
Amount Total of $30,000
Work in process $ 68,000 10% $ 3,000
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total $ 680,000 100% $ 30,000

Chapter
1-9
 Learning Objective 2

Computation of
Factory Overhead
Rate

Chapter
1-10
 Factors to be considered in the computation of OH Rate

BASE TO USE
The base to be used should be related to functions
represented by the overhead being applied.
Example:
If the factory overhead is labor oriented, the most
appropriate base to use is direct labor hours or direct
labor cost.
• Material Cost
• Units of production
• Machine hours
• Direct labor cost
• Direct labor hours
Chapter
1-11
 Base to use
Example:
The RT Company estimates factory overhead at P450,000
for the next fiscal year. It is estimated that 90,000
units will be produced at a material cost of P600,000.
Conversion will require an estimated 100,000 labor hours
at a cost of P3.00 per hour, with 45,000 machine hours.
Compute the predetermined factory overhead rate based
on:
a. Material Cost
b. Units of production
c. Machine hours
d. Direct labor cost
e. Direct labor hours
Chapter
1-12
 Base to use
Solution:
a. Factory Overhead rate = P450,000/ P600,000
= 75% of direct material cost

b. Factory Overhead rate = P450,000/90,000 units

= P5.00 per unit

c. Factory Overhead rate = P450,000/45,000 machine hours

= P10.00 per machine hour

Chapter
1-13
 Base to use

Solution:
d. Factory Overhead rate = P450,000/P300,000 DL cost
= 150% of direct labor cost
e. Factory Overhead rate = P450,000/P100,000 DL hours
= P4.50 per direct labor hour

Chapter
1-14
 Factors to be considered in the computation of OH Rate

ACTIVITY LEVEL TO USE

In the estimation of manufacturing overhead, as well as the
estimation of the base to be used for allocation, it is
important to determine what capacity of production should
be adopted.
a. Theoretical capacity
b. Practical capacity
c. Expected capacity
d. Normal capacity

Chapter
1-15
 Activity Level to Use
a. Ideal or Theoretical – is the level of capacity based
on producing at full efficiency.
b. Practical capacity – is the level of capacity that
reduces theoretical capacity by considering
unavoidable operating interruptions, such as
scheduled maintenance time, shut-downs for holidays
and so on.
Note:
Both theoretical and practical capacity measures
capacity in terms of WHAT A PLANT CAN SUPPLY -
available capacity. With difficulty, practical capacity
is attainable.

Chapter
1-16
 Activity Level to Use

c. Expected capacity – is the level of capacity utilization that

managers expect for the current budget period, which is
typically one year.
d. Normal capacity – is the level of capacity utilization that
satisfies average customer demand over a period (say two
or three years) that includes seasonal, cyclical and trend
factors.
Note:
In contrast, normal and expected capacity utilization
measures capacity level in terms of DEMAND for the
output of the plant, that is the amount of available
capacity the plant expects to use based on the demand for
its products.

Chapter
1-17
 End of the chapter

Chapter
1-18