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Accounting for Overhead Costs

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

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Accounting for Overhead Costs

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  1. Accounting forOverhead Costs Chapter 13

  2. 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

  3. Learning Objective 1 • Compute budgeted • factory-overhead rates • and apply factory • overhead to production.

  4. Accounting for Factory Overhead Methods for assigning overhead costs to the products is an important part of accurately measuring product costs.

  5. Budgeted OverheadApplication Rates Steps: 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.

  6. Budgeted OverheadApplication Rates Budgeted overhead application rate = Total budgeted factory overhead ÷ Total budgeted amount of cost driver

  7. Illustration of Overhead Application 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

  8. 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

  9. Objective 2 • Determine and use appropriate • cost drivers for overhead • application.

  10. Choice of Cost Drivers No one cost driver is right for all situations. The accountant’s goal is to find the driver that best links cause and effect.

  11. Choice of Cost Drivers A separate cost pool should be identified for each driver. Driver 1 Pool 1 Driver 2 Pool 2

  12. Learning Objective 3 • Identify the meaning and • purpose of normalized • overhead rates.

  13. 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

  14. Disposing of Underapplied or Overapplied Overhead Suppose that Enriquez applied $375,000 to its products. Also, suppose that Enriquez incurred $392,000 of actual manufacturing overhead during the year.

  15. Disposing of Underapplied or Overapplied Overhead How much was underapplied? $392,000 actual – $375,000 applied = $17,000

  16. Manufacturing Overhead 392,000 375,000 17,000 0 Cost of Goods Sold 17,000 Immediate Write-Off

  17. Prorating Among Inventories 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 Total $2,667,000

  18. 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

  19. The Use of 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.

  20. Variable VersusAbsorption Costing This section compares two methods of product costing. Variable costing Absorption costing

  21. Variable VersusAbsorption Costing Variable costing excludes fixed manufacturing overhead from inventoriable costs. Absorption costing treats fixed manufacturing overhead as inventoriable costs.

  22. Basic Production Data at Standard Cost Direct material $205 Direct labor 75 Variable manufacturing overhead 20 Standard variable costs per unit $300 Facts and Illustration

  23. 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. Fixed S&A expenses = $650,000 Sales commissions = 5% of dollar sales

  24. Facts and Illustration Units 2003 2004 Opening inventory – 3,000 Production 17,000 14,000 Sales 14,000 16,000 Ending inventory 3,000 1,000

  25. Learning Objective 4 • Construct an income statement • using the variable-costing • approach.

  26. (thousands of dollars) 2003 2004 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 900¹ 300² Variable manufacturing cost of goods sold $4200$4800 Cost of Goods Sold forVariable- Costing Method ¹3,000 units × $300 = $900,000 ²1,000 units × $300 = $300,000

  27. (thousands of dollars) 2003 2004 Sales, 14,000 and 16,000 units $7,000 $8,000 Variable expenses: Variable manufacturing cost of goods sold 42004800 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 Comparative Income Statement for Variable-Costing Method

  28. Learning Objective 5 • Construct an income statement • using the absorption- • costing approach.

  29. Fixed-Overhead Rate The fixed-overheadrateis the amount of fixed manufacturing overhead applied to each unit of production. $1,500,000 ÷ 15,000 = $100

  30. (thousands of dollars) 2003 2004 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 Cost of Goods Sold forAbsorption-Costing Method *Variable cost $300 Fixed cost 100 Standard absorption cost $400

  31. (thousands of dollars) 2003 2004 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 $ 450 Comparative 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

  32. Learning Objective 6 • Compute the production- • volume variance and show • how it should appear in • the income statement.

  33. Production-Volume Variance 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.

  34. – Expected volume × Fixed overhead rate = Production-volume variance Production-Volume Variance Actual volume

  35. Production-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. Do 13-43

  36. Reconciliation of Variable Costing and Absorption Costing Absorption unit cost is higher. Output-level (production-volume) variance exists only under absorption costing.

  37. 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.

  38. Reconciliation of Variable Costing and Absorption Costing 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.

  39. Learning Objective 7 • Explain how a company might • prefer to use a variable- • costing approach.

  40. 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.

  41. Flexible-Budget Variances All variances other than the production-volume variance are essentially flexible-budget variances.

  42. Flexible-Budget Variances Flexible-budget variances measure components of the differences between actual amounts and the flexible-budget amounts for the output achieved.

  43. Flexible-Budget Variances Flexible budgets are primarily designed to assist planning and control rather than product costing.

  44. Effects of Sales and Productionon Reported Income Production > Sales Variable costing income is lower than absorption income. Production < Sales Variable costing income is higher than absorption income.

  45. End of Chapter 13

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