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  • 1. Accounting for Overhead Costs Introduction to Management Accounting Chapter 13
  • 2. Accounting for Factory Overhead Methods for assigning overhead costs to the products is an important part of accurately measuring product costs. Learning Objective 1
  • 3. Budgeted Overhead Application Rates 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. Steps:
  • 4. Budgeted Overhead Application Rates Budgeted overhead application rate = Total budgeted factory overhead ÷ Total budgeted amount of cost driver Overhead rates are budgeted; they are estimates. The budgeted rates are used to apply overhead based on actual events.
  • 5. Illustration of Overhead Application The company’s 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 Enriquez Machine Parts Company selects a single cost-allocation in each department for applying overhead, machine hours in machining and direct-labor in assembly.
  • 6. 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? 70,000 × $4 = $280,000
  • 7. Choice of Cost-Allocation Bases No one cost –allocation base is right for all situations. The accountant’s goal is to find the cost- allocation base that best links cause and effect. Learning Objective 2
  • 8. 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
  • 9. 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 Learning Objective 3
  • 10. 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.
  • 11. Disposing of Underapplied or Overapplied Overhead The applied overhead is $17,000 less than the amount incurred. It is: Underapplied Overapplied overhead occurs when the amount applied exceeds the amount incurred.
  • 12. Immediate Write-Off Incurred Overhead (Actual) Applied Overhead (Budgeted) This method regards the $17,000 as a reduction in current income and adds it to Cost of Goods Sold. Manufacturing Overhead 392,000 375,000 17,000 0 Cost of Goods Sold 17,000
  • 13. 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 $ 155,000 Finished Goods Inventory 32,000 Cost of Goods Sold 2,480,000 Total $2,667,000
  • 14. 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
  • 15. 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.
  • 16. Variable Versus Absorption Costing Variable costing excludes fixed manufacturing overhead from the cost of products. Absorption costing includes fixed manufacturing overhead in the cost of products. Variable costing Absorption costing
  • 17. Facts and Illustration Basic Production Data at Standard Cost Direct material $205 Direct labor 75 Variable manufacturing overhead 20 Standard variable costs per unit $300
  • 18. Facts and Illustration 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. Sales commissions = 5% of dollar sales Fixed S&A expenses = $650,000
  • 19. Facts and Illustration Units 20X7 20X8 Opening inventory – 3,000 Production 17,000 14,000 Sales 14,000 16,000 Ending inventory 3,000 1,000 There are no variances from the standard variable manufacturing costs, and the actual fixed manufacturing overhead incurred is exactly $1,500,000.
  • 20. Variable- Costing Method Cost of Goods Sold ¹ 3,000 units × $300 = $900,000 ²1,000 units × $300 = $300,000 Learning Objective 4 Variable expenses: 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 $300 900 ¹ 300 ² Variable manufacturing cost of goods sold $4200 $4800 (thousands of dollars) 20X7 20X8
  • 21. Variable-Costing Method Comparative Income Statement 1 from Cost of Goods Sold previous calculation Sales, 14,000 and 16,000 units $7,000 $8,000 Variable expenses: Variable manufacturing cost of goods sold 4200 1 4800 1 Variable selling expenses, at 5% of dollar sales 350 400 Contribution margin $2,450 $2,800 Fixed expenses: Fixed factory overhead $1,500 $1,500 Fixed selling and admin. expenses 650 650 Operating income, variable costing $ 300 $ 650 ( thousands of dollars) 20X7 20X8
  • 22. Fixed-Overhead Rate The fixed-overhead rate is the amount of fixed manufacturing overhead applied to each unit of production. $1,500,000 ÷ 15,000 = $100 budgeted fixed manufacturing overhead expected volume of production Fixed overhead rate =
  • 23. Absorption-Costing Method Cost of Goods Sold *Variable cost $300 Fixed cost 100 Standard absorption cost $400 Learning Objective 5 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 $6,400 (thousands of dollars) 20X7 20X8
  • 24. Absorption-Costing Method Comparative Income Statement *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 Sales $7,000 $8,000 Cost of goods sold, at standard 5,600 1 6,400 1 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 $ 450 ( thousands of dollars) 20X7 20X8
  • 25. Production-Volume Variance Production-volume variance = (actual volume – expected volume) X fixed overhead rate In practice, the production-volume variance is usually called simply the volume variance. Learning Objective 6 A production-volume variance appears when actual production deviates from the expected volume of production used in computing the fixed overhead rate.
  • 26. 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.
  • 27. Variable Costing and Absorption Costing The difference between income reported under these two methods is entirely due to the treatment of fixed manufacturing costs.
  • 28. 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.
  • 29. 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. Learning Objective 7
  • 30. Flexible-Budget Variances All variances other than the production-volume variance are essentially flexible-budget variances. All other variances appear on both variable- and absorption-costing income statements.
  • 31. Flexible-Budget Variances Flexible budgets are primarily designed to assist planning and control rather than product costing. Flexible-budget variances measure components of the differences between actual amounts and the flexible-budget amounts for the output achieved.
  • 32. 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.
  • 33. The End End of Chapter 13