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Accounting for Overhead. Learning Objectives Compute 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.
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Learning Objectives Compute 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”.
Identify the two methods for disposing of the standard cost variances at the end of a year and give the rationale 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 Variances • One 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 Variances • Another 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.
Compute the production- volume variance and show how it should appear in the income statement. Learning Objective
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 DifferenceX Fixed overhead rate = Production-volume variance
Volume Variance Applied fixed overhead – Budgeted fixed overhead= Production-volume variance In practice, the production-volume variance is usually called simply the volume 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 Variances Universal 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 $ 6.50 Actual 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
Actual, Normal, and Standard Costing Both normal absorption costing and standard absorption costing generate production-volume variances. Favorable Variance Unfavorable Variance
Flexible-Budget Variances All 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 Variances Flexible budgets are primarily designed to assist planning and control rather than product costing.
Variable vs. Absorption Costing The 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 rateis 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 AZIZ • ICAP STUDENTS • MODULE B FINANCIAL ACCOUNTING • BUSINESS ECONOMICS • MODULE D COST ACCOUNTING • COMPLETION OF SYLLABUS IN 2 MONTHS • JOIN KHALID AZIZ • 0322*3385752 • R1173, ALNOOR SOCIETY, BLOCK 19. F.B.AREA, KARACHI.
Reconciliation of Variable Costing and Absorption Costing • 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.
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 Costs Variable Costs Raw materials $1.50 per unit produced Direct labor 1.00 per unit produced Factory overhead $150,000 .50 per unit produced Selling & admin. 80,000 .50 per unit sold There 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-Bates Bates 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 office 10,000 Under absorption costing, the inventoriable costs are a. $680,000 b. $730,000 c. $750,000 d. $800,000
Direct Costing Questions Using the variable costing method, which of the following costs are assigned to inventory? Variable selling and Variable factory administrative costsoverhead costs A Yes Yes B Yes No C No No D No Yes
Direct Costing Questions At 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 of a. $0 b. $20,000 c. $70,000 d. $90,000
Direct Costing Questions Fixed 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.
Product-Costing Systems Affect Operating Income Absorption- and variable-costing systems affect operating income because of their treatment of fixed factory overhead. Absorption-costing systems, both normal and standard, generate production-volume variances 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 Objective Construct absorption and contribution format income statements and identify which is better for decision making.
Absorption Approach • The 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 Approach • In contrast, the contributionapproach 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 follows Fixed 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 sold What 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- 4 of 6 Repeat your computations, except assume that the company uses the absorption costing method.
JOIN KHALID AZIZ • PIPFA STUDENTS • INTERMEDIATE • FINANCIAL ACCOUNTING • PERFORMANCE MEASUREMENT • COMPLETION OF SYLLABUS IN 3 MONTHS • JOIN KHALID AZIZ • 0322*3385752 • R1173-ALNOOR SOCIETY BLOCK 19 F.B.AREA-KARACHI.
KHALID Company – 2 of 5 You 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.
