Accounting for Overhead Costs. Chapter 13. Pioneered the “direct business model “ of selling computers Many orders are taken over the internet Need to know product cost Chapter focuses on applying overhead to products. Learning Objective 1. Compute budgeted factory-overhead rates
Methods for assigning overhead costs
to the products is an important part of
accurately measuring product costs.
1. Select one or more cost drivers.
2. Prepare a factory overhead budget.
3. Compute the factory overhead rate.
4. Obtain actual cost-driver data.
5. Apply the budgeted overhead
to the products.
6. Account for any differences between the
amount of actual and applied overhead.
Budgeted overhead application rate
= Total budgeted factory overhead
÷ Total budgeted amount of cost driver
Enriquez Machine Parts Company’s
budgeted manufacturing overhead for
the machining department is $277,800.
Budgeted machine hours are 69,450.
What is the rate?
$277,800 ÷ 69,450 = $4 per machine hour
Suppose that at the end of the year Enriquez
had used 70,000 hours in Machining.
How much overhead was applied to Machining?
70,000 × $4 = $280,000
No one cost driver is right for all situations.
The accountant’s goal is to find the
driver that best links cause and effect.
A separate cost pool should
be identified for each driver.
“Normal” product costs include
an average or normalized
chunk of overhead.
Actual direct material
+ Actual direct labor
+ Normal applied overhead
= Cost of manufactured product
Suppose that Enriquez applied
$375,000 to its products.
Also, suppose that Enriquez incurred
$392,000 of actual manufacturing
overhead during the year.
How much was underapplied?
$392,000 actual – $375,000 applied = $17,000
Prorate $17,000 of underapplied
overhead assuming the following
ending account balances:
Work-in-Process Inventory $ 155,000
Finished Goods Inventory 32,000
Cost of Goods Sold 2,480,000
$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
The presence of fixed costs is a
major reason of costing difficulties.
Some companies distinguish between
variable overhead and fixed
overhead for product costing.
This section compares two
methods of product costing.
Variable costing excludes fixed
from inventoriable costs.
Absorption costing treats fixed
as inventoriable costs.
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 2003 2004
Opening inventory – 3,000
Production 17,000 14,000
Sales 14,000 16,000
Ending inventory 3,000 1,000
Variable manufacturing cost
of goods sold
Opening inventory, at – $ 900
standard costs of $300
Add: variable cost of goods
manufactured at standard,
17,000 and 14,000 units 5100 4200
Available for sale, 17,000 units 5100 5100
Ending inventory, at $300 900¹ 300²
cost of goods sold $4200$4800Cost of Goods Sold forVariable- Costing Method
¹3,000 units × $300 = $900,000 ²1,000 units × $300 = $300,000
Sales, 14,000 and 16,000 units $7,000 $8,000
cost of goods sold 42004800
Variable selling expenses,
at 5% of dollar sales 350 400
Contribution margin $2,450 $2,800
Fixed factory overhead $1,500 $1,500
Fixed selling and admin. expenses 650 650
Operating income, variable costing $ 300 $ 650Comparative Income Statement for Variable-Costing Method
The fixed-overheadrateis the
amount of fixed manufacturing
overhead applied to each
unit of production.
$1,500,000 ÷ 15,000 = $100
Beginning inventory $ – $1,200
Add: Cost of goods manufactured
at standard, of $400* 6,800 5,600
Available for sale $6,800 $6,800
Deduct: Ending inventory 1,200 400
Cost of goods sold, at standard $5,600$6,400Cost of Goods Sold forAbsorption-Costing Method
*Variable cost $300
Fixed cost 100
Standard absorption cost $400
Sales $7,000 $8,000
Cost of goods sold, at standard 5,6006,400
Gross profit at standard $1,400 $1,600
Production-volume variance* 200 F 100 U
Gross margin or gross profit “actual” $1,600 $1,500
Selling and administrative expenses 1,000 1,050
Operating income, variable costing $ 600 $ 450Comparative Income Statement for Absorption-Costing Method
*Based on expected volume of production of 15,000 units:
2003: (17,000 – 15,000) × $100 = $200,000 F
2004: (14,000 – 15,000) × $100 = $100,000 U
Applied fixed overhead – Budgeted fixed overhead
= (Actual volume × Fixed-overhead rate) –
(Expected volume × Fixed-overhead rate)
In practice, the production-volume variance
is usually called simply the volume variance.
A production-volume variance arises when
the actual production volume achieved
does not coincide with the expected
volume of production used as a denominator
for computing the fixed-overhead rate.
There is no production-volume
variance for variable overhead.
Absorption unit cost is higher.
variance exists only under
Under 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.
The difference between income reported
under these two methods is entirely due to
the treatment of fixed manufacturing costs.
Under absorption costing, these costs are
treated as assets (inventory) until the
associated goods are sold.
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
All variances other than the
production-volume variance are
essentially 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.
Production > Sales
Variable costing income is lower
than absorption income.
Production < Sales
Variable costing income is higher
than absorption income.