COST ACCOUNTING AND COST MANAGEMENT 1

ACCOUNTING FOR FACTORY OVERHEAD

ACCOUNTING FOR FACTORY OVERHEAD
Factory overhead, being an element of product cost, is accounted for as part of the process of making
fair estimates of cost of products and services.

Of the three elements of cost, it is considered the most challenging to control because by its nature, it
accrues from different sources and can increase significantly as a result of day to day decisions
without being directly traceable to a product or job order.

Some of the specific causes of increase in factory overhead are:

- Increases in power rates and in salaries and wages

- Replacement of property and equipment, and
- Additional uniforms, meal subsidies and insurance coverage

FACTORY OVERHEAD DEFINED

- Refers to manufacturing costs not classified as direct materials or as direct labor.

- The sum total of the indirect manufacturing costs or costs that cannot be conveniently
identified with nor directly charged to specific jobs or products or final cost objectives.
- Part of product cost because they add value thereto.
- Examples:
o Indirect materials
o Indirect labor
o Factory repairs and maintenance
o Supervision
o Depreciation of factory property and equipment
o Fringe benefits of factory workers
- Any item of cost that has to be allocated among all jobs processed during a period is charged
to factory overhead.
o Examples:
▪ Losses from spoilage and defective work ( if such losses are inherent in the
nature of the manufacturing process involved)
▪ Cost of idle labor time and
▪ Overtime premium due to greater production volume, inadequate capacity
or slow production
- Other terms used:
o Indirect manufacturing costs
o Manufacturing overhead
o Factory burden
o Factory expense

CHARACTERISTICS OF FACTORY OVERHEAD

• Factory overhead is multi-sources and is an invisible part of the cost of the finished product.
Factory overhead comes from different sources and may increase significantly as a
result of day-to-day decisions. It cannot be traced directly to a job or product based
on stores requisition ( as in the case of direct materials) and time tickets (as in the
case of direct labor)
• Factory overhead consists of different items that differ in behaviour in relation to changes in
volume of production.
Some of them may be fixed, variable or semivariable.
The combined effect of these behaviour patterns brings about significant
fluctuations in cost estimates.

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 COST ACCOUNTING AND COST MANAGEMENT 1
ACCOUNTING FOR FACTORY OVERHEAD
OBJECTIVES IN ACCOUNTING FOR FACTORY OVERHEAD

- To effectively control it
o Actual factory overhead is compared with predetermined figures as shown in
budgets or estimates and the difference (or variance) is analyzed to determine the
probable cause thereof.
o These are brought to the attention of the responsible party or parties so that
remedial measures may be adopted to minimize if not totally eliminate variances in
the future.
- To include it in cost of products or services in an equitable and logical manner
o Considering the nature of factory overhead, procedures are adopted so that factory
overhead is promptly included in costing products or services in amounts that
approximate their reasonable shares in total factory overhead even before the
accumulation of the latter is completed.

CHARGING FACTORY OVERHEAD TO PRODUCTION

- Estimates have to be made in charging factory overhead to products, processes or cost

objectives considering
o the given characteristics of factory overhead,
o the fact that its accumulation can be completed only after the end of an accounting
period (after all adjustments) and
o the requirement for prompt cost information.
- Products and services have to be costed, prices have to be set and decisions have to be made
based on financial projections, which, in turn, are partly based on cost figures.

- Use of Predetermined Factory Overhead Rate

o Paves the way to its equitable and logical allocation.
Formula:
Factory Overhead Rate = Estimated (or budgeted) factory overhead
Estimated (or budgeted) base
o Denominator to be used depends on with what factor does the greater portion of the
numerator varies and the chosen activity level on which both are based.

- Bases used in Charging Factory Overhead to Production:

a Physical output or units of production
b Direct labor hours
c Machine hours
d Direct materials cost
e Direct labor cost
- Illustrative Problem:
The following data are given on the production of Alto Manfacturing Co. for 2013:
Budgeted production volume .................................................... 20,000 units
Budgeted labor hours ................................................................100,000 hrs.
Estimated machine hours .......................................................... 8,000 hrs.
Budgeted materials cost.......................................................... P 50,000
Budgeted labor cost .................................................................P 25,000
Budgeted factory overhead ................................................... P 50,000

Computations:

Based on production volume (physical output):

Factory overhead rate = P 50,000/20,000 units = P 2.50 per unit

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 COST ACCOUNTING AND COST MANAGEMENT 1
ACCOUNTING FOR FACTORY OVERHEAD
Based on labor hours:
Factory overhead rate = P 50,000/100,000 hrs = P.50 per labor hour

Based on machine hours:

Factory overhead rate = P 50,000/8,000 hrs = P6.25 per machine hour
hour

Based on materials cost

Factory overhead rate = P 50,000/P 50,000 = 100% of materials cost

Based on labor cost

Factory overhead rate = P 50,000/P 25,000 = 200% of labor cost

CHOICE OF BASE TO BE USED

- The choice depends on the factor with which the greater portion of total factory overhead
varies (or the sensitivity of the greater amount of overhead to the behaviour of the base being
considered).
o This is to ensure that the rate to be used reflects the reasonable proportion to
beneficial or causal relationship. As a consequence, the amount of factory overhead
charged to a particular job reflects also its reasonable share in the benefits arising
from the incurrence of the total fa/ctory overhead.
a Physical output basis.
- If the greater amount of factory overhead is expected to vary with production, the overhead
rate may be computed based on units of production.
- The simplest to adopt
- Satisfactory when there is only one product.
- When there are two or more products, a rate may be used for each product considering the
relative weight or volume
- Example:
The company’s estimated factory overhead is P 50,000 for its two products, X and Y.
The following data on these products are given:
Product Estimated no. of units produced
Weight per unit
X 5,000 2 kilos
Y 10,000 1.5 kilos
The factory overhead rate for each product is computed as follows:

Product X Product Y Total

Estimated output 5,000 units 10,000 units
Weight per unit 2 kgs 1.5 kgs
Estimated total weight of output 10,000 kgs 15,000 kgs 25,000 kgs
Estimated factory overhead per kilo P2 P2
(P50,000/25,000)
Estimated factory overhead for each product P 20,000 P 30,000 P 50,000
Divide by estimated output 5,000 units 10,000 units
Estimated factory overhead per unit P4 P3
- With the foregoing rates arrived at, applied factory overhead must be P 4,000 for 1,000 units
of Product X (1,000 x P4). For a job order for 500 units of product Y, it shall be P 1,500 (or 500
units x P 3).

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 COST ACCOUNTING AND COST MANAGEMENT 1
ACCOUNTING FOR FACTORY OVERHEAD
- If factory overhead varies not only with the relative weight or number of units of production
but also with other factors such as difficulty of processing and number of hours of processing,
the point system may be used.
o A number of points is assigned to each factor and the allocation of factory overhead is
based on the relative number of total points.
o Assume that in the preceding example, product X and Y are assigned 3 and 2.5 points
per unit respectively, factory overhead rates per unit are computed as follows:

Product Estimated Points Per Total Points Estimated Factory Overhead per
Quantity Unit
Point Product Unit
X 5,000 3.0 P 15,000 P 1.25* P 18,750 P 3.75
Y 10,000 2.5 25,000 1.25 31,250 3.125
P 50,000
* P 50,000/40,000 points = P 1.25

With the rates so arrived at, a job for 1,000 units of product X shall be charged P 3,750 for factory
overhead applied (or 1,000 x P 3.75). An order for 500 units of product Y shall be charged P
1,562.50 (or 500 units x P 3,125).

b Direct labor hours basis

- Requires accumulation of direct labor hours by job or product.
- Used in cases where in the manufacturing processes are labor oriented so that the greater
portion of factory overhead is related to labor hours.
- Advantage: differences in labor rates are disregarded.

c Machine Hour Basis

- Hinges on the added value to products arising from depreciation of high-cost machinery.
- Used in cases where in the different departments use machines extensively so that
investments in machinery are significant and consequently, the greater portion of factory
overhead is related to machine hours.

d Direct materials cost basis

- Used when operations are materials oriented so that the greater amount of factory overhead
is expected to vary with materials cost.
- Not often used because there is no logical relationship between these two.
e Direct labor cost basis
- Used as the basis if the greater portion of factory overhead varies with direct labor cost and
labor rates for similar work are comparable.
- Results in distortion of cost estimates when there are difference in pay rates.

CHOICE OF ACTIVITY LEVEL

- In the given formula for factory overhead, both numerator and denominator are based on the
same activity level. The latter may either be the normal or the expected actual level of
production activity.
o Normal capacity – refers to what has been budgeted for a sufficiently long period.
▪ For convenience, this period is the accounting period or fiscal year.
▪ Use of a factory overhead rate throughout the 12 month period evens out
the effects of the highs and lows in production activity.
▪ Used when estimates of factory overhead can be reasonably estimated at
the start of the period covered.

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 COST ACCOUNTING AND COST MANAGEMENT 1
ACCOUNTING FOR FACTORY OVERHEAD
o Expected actual capacity – refers to the volume of production in the immediate
future.
▪ May be for the next quarter or production period.
▪ FOH rate may be based on this capacity when significant changes in
estimates are expected to occur or when estimates of annual factory
overhead cannot be made reasonably at the start of the year.
▪ Example:
The following data are given on the planned operations of Marvel
Manufacturing Co. for 2013:
Budgeted production volume ........................ 100,000 units
Budgeted factory overhead for 2013 ............. P 60,000
The factory overhead rate is computed as follows:
Factory overhead rate = P 60,000/ 100,000 units = P .60 per unit
o if estimates cannot be made reasonably at the start of the year, the expected actual
production volume and the corresponding estimated factory overhead for the month
or quarter may be used.

FACTORY OVERHEAD VARIANCE

- the difference between the total amount of factory overhead charged to production
(applied factory overhead) and what has been incurred (actual factory overhead)

- Example:
In the Agoo Manufacturing Co., estimated factory overhead is P 100,000 based on the
estimated production volume of 50,000 units for 2013. The predetermined factory overhead
rate must be P 2.00 per unit computed as follows:

Factory overhead rate = P 100,000 / 50,000 units = P 2.00 per unit

Thus, a job for 3,000 units with direct materials and direct labor costs of P 20,000 and P
15,000, respectively, must have accumulated cost of P 41,000, arrived at as follows:

Direct materials P 20,000

Direct labor 15,000
Factory overhead applied (3, 000 units x P 2.00) 6,000
Accumulated cost P 41,000

In the given example, P 6,000 of total factory overhead is absorbed in costing the particular
job. Other jobs worked on during the period are to be charged also for factory overhead at
the same rate. Thus, if actual number of units processed is more or less 50,000 units, actual
factory overhead must also be more or less equal to the budgeted figure of P 100,000.
Applied Factory Overhead – equal to predetermined factory overhead rate multiplied by actual
capacity
Predetermined FOH rate x Actual Capacity
- In the given example, if all the jobs worked on during the period were for 40,000 units,
applied factory overhead is computed as follows:
Applied factory overhead = Predetermined FOH rate x Actual Capacity
= P 2 x 40,000 units
= P 80,000
- Total factory overhead charged to production (or absorbed in costing) is the product of
40,000 units x P 2 or P 80,000.
o This is compared with actual factory overhead to arrive at the factory overhead
variance.
o Variance may be underapplied or overapplied.

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 COST ACCOUNTING AND COST MANAGEMENT 1
ACCOUNTING FOR FACTORY OVERHEAD
- Underapplied Factory Overhead
o Applied Factory overhead is not sufficient to cover the amount incurred
o Can also be called as underabsorbed or unapplied factory overhead
o Assumed to be unfavourable in general.
o Assume that in the preceding example, factory overhead incurred amount to P
82,000. FOH Variance must be difference of P 2,000 which is underapplied because
the applied amount is not sufficient to cover actual factory overhead.
▪ Factory overhead variance:
Actual FOH P 82,000
Less:
Applied FOH (40,000 units x P2) 80,000
Factory overhead variance – underapplied P 2,000
▪ Computation shows that only P 80,000 is absorbed in product costing
during the period whereas the accumulated amount of overhead amounts
to P 82,000.
- Overapplied Factory Overhead
o Applied factory overhead exceeds factory overhead incurred (actual factory
overhead),
o Generally assumed to be favourable
o Assume that in the given example, actual factory overhead amounts to P 75,000. The
difference would be a favourable variance of P 5,000 computed as follows:
▪ Factory overhead variance:
Actual FOH P 75,000
Less:
Applied FOH (40,000 units x P2) 80,000
Factory overhead variance –overapplied P (5,000)
▪ Computation shows that although P 80,000 is absorbed in product costing,
only P 75,000 is incurred so that the difference is overabsorbed.

FIXED AND FLEXIBLE BUDGETS

- Analysis of FOH varies depending on whether the budget is fixed or flexible.

- The FOH budget is fixed when budget allowances for other levels of operations cannot be
estimated because of lack of information as to the behaviour patterns of factory overhead.
- The FOH budget is flexible when budget allowances for other levels of operations can be
reasonably estimated because of sufficiency of information.
May be on the fixed or variable portion of factory overhead or on the behaviour
patterns of the different factory overhead items.

- Example A:
Estimated FOH is P 100,000 based on 50,000 direct labor hours.
Budget is fixed because the budget allowances for other capacities cannot be
estimated due to lack of information on either fixed or variable portion thereof.

- Example B:
Estimated FOH is P 100,000 based on 50,000 direct labor hours. Fixed FOH is P 25,000
Budget is flexible because with the additional information on fixed factory overhead,
budget allowances for other production levels can be estimated.
With Fixed FOH given at P 25,000, the variable portion of the budget based on 50,000
hours must be the remaining P 75,000 (P100,000 – P 75,000).
Variable rate = (P 100,000 – P 25,000)/ 50,000 hours = P 1.50 per hour

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 COST ACCOUNTING AND COST MANAGEMENT 1
ACCOUNTING FOR FACTORY OVERHEAD
Fixed and Variable Overhead (Assumptions use in Flexible budgets)

- Fixed cost remains constant in amount within the relevant range*

Relevant range – refers to the series of volumes within which the expected behaviour of
cost is valid.

- Variable cost varies in amount in direct proportion to changes in volume of operations within
the relevant range.

Example:

Within the range of 100 units to 500 units of production, fixed cost is P 2,000 per annum and
variable cost is at P 3 per unit.

The fixed and variable costs and the corresponding rates per unit are tabulated as follows:

Units of Prodution
100 250 400 500
Fixed cost P 2,000 P 2,000 P 2,000 P 2,000
Variable cost 300 750 1,200 1,500
Total P 2,300 P 2,750 P 3,200 P 3,500
Fixed cost rate P 20 P8 P5 P4
Variable cost rate 3 3 3 3

Note:
With fixed cost remaining constant in amount, the fixed cost rate decreases with an increase in
production volume.

In the case of variable cost, the amount increases in direct proportion to the change in volume so
that the rate per unit remains constant.

Conclusions:

- Fixed cost is constant in amount within the relevant range so that the fixed cost rate varies
inversely with the volume of operations.
- Variable cost is variable in amount so that the variable cost rate is constant within the
relevant range.

Budget allowance

- Based on any capacity within the relevant range is equal to the fixed portion of factory
overhead plus the variable portion based on the actual capacity.
- For a fraction of a year, say a quarter, the budget allowance should be equal to one-fourth of
the annual fixed cost plus the variable cost (variable rate x actual base).
- If the volume of production for the first quarter is 110 units, the budget allowance must be
equal to P 830 computed as follows:
Budget allowance for 110 units in the first quarter:
Fixed cost (P 2,000 x ¼) P 500
Add-
Variable cost (P 3 x 110 units) 330
Budget allowance P 830

- In computing for budget allowances, bear in mind the period covered because fixed cost,
being a period cost may be stated per annum, per quarter, or even per month.

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 COST ACCOUNTING AND COST MANAGEMENT 1
ACCOUNTING FOR FACTORY OVERHEAD
- Equation Y = a + bx may also be applied.
Y = unknown value
a = fixed portion
b = variable rate
x = base

- Based on 110 units produced in one quarter, the equivalent of y is arrived at as follows:
Y = a + bx
Y = (P2,000/4) + [P3(110 units)]
Y = P 500 + 330
Y = P 830
- In analyzing FOH variances, the budget allowance based on utilized capacity substitutes for
budgeted FOH under flexible budget analysis as emphasized under analysis of FOH variance
in this chapter.

FACTORY OVERHEAD BUDGET

- The following is an example of the factory overhead budget showing the different subsidiary
ledger accounts.
Good Products, Inc.
Factory Overhead Budget
(Based on 100,000 units)
For 2013
Supervision P 80,000
Indirect materials 10,000
Indirect labor 12,000
Overtime Premium 9,000
Repairs and maintenance 12,000
Light and Power 35,000
Fuel and oil 10,000
Water 7,000
SSS Contributions 8,500
Medicare contributions 2,000
Employees’ Compensation Contributions 900
Pag-ibig Contributions 3,000
Pensions 9,600
Vacations and holidays 8,000
Depreciation- Buildings 20,000
Depreciation – Machinery and equipment 12,000
Tools expense 2,000
Property tax 5,500
Fire insurance 2,500
Total budgeted factory overhead P 250,000

- The above given budget is a fixed budget because allowances for other production levls
cannot be reasonably estimated due to lack of information on how much is the fixed or the
variable portion.
- Inasmuch as the FOH budget consists of fixed, variable and semi variable items, the latter are
analyzed into fixed and variable using any of the methods taken up in Management Services.
After such segregation, the budget may appear as follows:

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 COST ACCOUNTING AND COST MANAGEMENT 1
ACCOUNTING FOR FACTORY OVERHEAD
Good Products, Inc.
Factory Overhead Budget
(Based on 100,000 units)
For 2013
Fixed Variable Total
Supervision P 80,000 P 80,000
Indirect materials 3,000 P7,000 10,000
Indirect labor 4,000 9,000 12,000
Overtime Premium 9,000 9,000
Repairs and maintenance 5,000 7,000 12,000
Light and Power 2,000 33,000 35,000
Fuel and oil 4,000 6,000 10,000
Water 2,000 5,000 7,000
SSS Contributions 6,000 2,500 8,500
Medicare contributions 1,400 600 2,000
Employees’ Compensation Contributions 300 600 900
Pag-ibig Contributions 1,800 1,200 3,000
Pensions 4,000 5,600 9,600
Vacations and holidays 5,000 3,000 8,000
Depreciation- Buildings 20,000 20,000
Depreciation – Machinery and equipment 12,000 12,000
Tools expense 1,500 500 2,000
Property tax 5,500 5,500
Fire insurance 2,500 2,500
Total budgeted factory overhead P 160,000 P 90,000 P 250,000

Fixed rate per unit

P160,000/100,000 units P 1.60

Variable rate

P 90,000/100,000 units P .90

Factory overhead rate P 2.50

- Budget allowance for say, 94,000 units must be P 244,600.

Computation:
Fixed P 160,000
Variable (.90 x 94,000 units) 84,600
Budget allowance based on 94,000 units P 244,600
- The flexible budget is preferred over the fixed budget because it reflects the cost behaviour
patterns.
- It facilitates the preparation of financial projections and makes variance analysis more logical.

Overhead Variance and Budget Allowance per Budget

- Monthly or quarterly overhead variances are determined so that prompt remedial measures
may be adopted thereby minimizing the over-all variance for the whole year.
- Aside from this, quarterly reports are being prepared in most of the business organizations.
- Computation for FOH rate remains the same, that is, based on the budgeted capacity for one
year to even out the highs and the lows.
- Budget allowance for utilized capacity for a given quarter must be computed based on the
budgeted fixed overhead per quarter and the variable overhead rate based on the annual
budgeted figure.
- Assume in the given example wherein the annual fixed overhead is P 160,000 and the variable
overhead rate is P .90 per unit based on an annual budgeted 100,000 units of output, utilized
capacities and actual factory overhead were as follows:

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 COST ACCOUNTING AND COST MANAGEMENT 1
ACCOUNTING FOR FACTORY OVERHEAD

Units of Production Actual Factory Overhead

First Quarter 22,000 P 58,100
Second Quarter 24,000 60,200
Third Quarter 29,000 63,800
Fourth Quarter 19,000 48,600
Quarterly Overhead Variances and their Analysis

Good Products, Inc.

Quarterly Overhead Variances and their Analysis
For the Year Ended, December 31, 2013
Factory overhead variance
Quarter
First Second Third Fourth For the
Year
Actual Factory overhead P 58,100 P 60,200 P 63,800 P 48,600 P 230,700
Less:
Applied factory overhead
First quarter: 22,000 units x P2.50 55,000
Second quarter: 24,000 x 2.50 60,000
Third quarter: 29,000 x 2.50 72,500
Fourth qtr.: 19,000 x 2.50 47,500 235,000
Factory overhead variance – underapplied
P 3,100 P 200 P (8,700) P 1,100 P (4,300)
(overapplied)

Budget allowance on utilized capacity

Fixed Factory overhead P 40,000 P 40,000 P 40,000 P 40,000 P 160,000
Variable factory overhead
First quarter: 22,000 units x P0.90 19,800
Second quarter: 24,000 x 0.90 21,600
Third quarter: 29,000 x 0.90 26,100
Fourth qtr.: 19,000 x 0.90 17,100 84,600
Budget allowance on utilized capacity P 59,800 P 61,600 P 66,100 P 57,100 P 244,600
Analysis:
Spending Variance
Actual factory overhead P 58,100 P 60,200 P 63,800 P 48,600 P 230,700
Less:
Budget allowance on actual capacity P 59,800 P 61,600 P 66,100 P 57,100 P 244,600
Spending variance – unfav. (fav) P P P (2,300) P P
(1,700) (1,400) (8,500) (13,900)
Idle capacity variance:
Budget allowance on actual capacity P 59,800 P 61,600 P 66,100 P 57,100 P 244,600
Less:
Applied factory overhead 55,000 60,000 72,500 47,500 235,000
Idle capacity variance – unfav. (fav) P 4,800 P 1,600 P (6,400) P 9,600 P 9,600
Factory overhead variance – underapplied P 3,100 P 200 P (8,700) P 1,100 P (4,300)
(overapplied)
ANALYSIS OF FACTORY OVERHEAD VARIANCES
- Reasons for analyzing FOH:
o To determine their possible causes
o To call the attention of the parties responsible thereof
o To minimize variances in the future operations
- May be analyzed into spending and capacity variances.
- Formula vary depending on whether the budget being used is fixed or flexible
- Spending variance (expense or budget variance)
Due to incurring an amount that differs from what has been budgeted or allowed per budget
- Idle capacity variance (capacity or volume variance)
Due to operating at a level different from what is normal or budgeted

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 COST ACCOUNTING AND COST MANAGEMENT 1
ACCOUNTING FOR FACTORY OVERHEAD
- Formula:
Fixed Budget Analysis Flexible Budget analysis
Spending variance:
Actual Factory overhead P xx Actual Factory overhead P xx
Less: Less:
Budgeted factory overhead xx Budget allowance on actual capacity xx
Spending variance – unfav (fav) P xx P xx
Idle capacity variance:
Budgeted factory overhead P xx Budget allowance on actual capacity P xx
Less: Less:
Applied factory overhead xx Applied factory overhead xx
Idle capacity variance–unfav (fav) P xx
P xx
Note:
(a) the subtrahend in computing for spending variance is the minuend in computing for idle
capacity or volume variance
(b) under flexible budget analysis, budget allowance for actual capacity substitutes for
budgeted factory overhead.
Visual aid:
Fixed Budget Analysis Flexible Budget Analysis

Actual Factory Overhead

Spending Variance

Budgeted factory Overhead

Spending Variance

Budget allowance based on

actual capacity

Idle Capacity Variance Idle Capacity variance

Applied factory overhead

- When the formula are used and the same sequence of items is observed, a positive variance is
unfavourable and vice versa. The spending variance is also called controllable variance under
flexible budget analysis.
- Example:
Budgeted factory overhead based on 50,000 units of production is P 200,000. This includes
fixed factory overhead of P 50,000. Actual production output is 45,000 units and factory
overhead incurred amounts to P 181,000.
- Computation:
Factory overhead variance:
Actual factory overhead P 181,000
Less – Applied factory overhead (P 4 x 45,000 units) 180,000

Factory overhead variance – unfavourable P 1,000

The analysis of the variance under the fixed budget analysis would be as follows:

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 COST ACCOUNTING AND COST MANAGEMENT 1
ACCOUNTING FOR FACTORY OVERHEAD
Fixed Budget Analysis:
Actual factory overhead P 181,000

Spending variance (P 19,000) favourable

Budgeted factory overhead 200,000

Capacity variance 20,000 unfavorable

Applied factory overhead 180,000 __________

Factory overhead variance P 1,000 unfavorable

From the foregoing analysis

o Spending variance is favourable because factory overhead incurred is less than
budgeted factory overhead by P 1,000.
o (Idle) capacity or volume variance is unfavourable because actual capacity is lower
than budgeted capacity by 5,000 units.
▪ Another way of arriving at the capacity variance (fixed budget analysis) is
by multiplying the difference between budgeted and actual capacities by
the FOH rate as follows:
Capacity or volume variance = (Budgeted capacity – Actual capacity) x FOH rate
= (50,000 – 45,000 units) x P 4 = P 20,000
Conversion into Flexible Budget
- Assuming that the fixed portion of FOH is given at P 75,000, the variable portion of budgeted
FOH must be P 125,000 (or P 200,000 – 75,000).
o Computation:
Fixed rate = P 75,000/50,000 units = P 1.50 per unit
Variable rate = P 125,000/ 50,000 units = P 2.50 per unit
Computation for FOH rate and its components (alternative computation)
Factory overhead rate = Fixed FOH, P75,000 + Variable FOH, P 125,000
50,000 units 50,000 units
= P 1.50 + P 2.50 = P 4 per unit

Fixed Budget Analysis:

Actual factory overhead P 181,000

Spending variance (P 6,500) favourable

Budgeted allowance on utilized capacity 187,500

Fixed P 75,000
Variable (P 2.50 x 45,000 units) 112,500 Capacity variance 7,500 unfavorable

Applied factory overhead 180,000 __________

Factory overhead variance P 1,000 unfavorable
Analysis: Inasmuch as fixed FOH is assumed constant, the spending variance (under flexible
budget analysis) must be due to incurring an amount of variable FOH different from what is
allowed based on utilized capacity.

Comparison:
Actual FOH Budget allowance
Fixed P 75,000 P 75,000
Variable (P 181,000 – 75,000) 106,000 (P 2.50x 45,000) 112,500
P 181,000 P 187,500
- Spending variance may also be computed by comparing the variable OH incurred with the
corresponding budget allowance as follows:

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 COST ACCOUNTING AND COST MANAGEMENT 1
ACCOUNTING FOR FACTORY OVERHEAD
Spending variance:
Actual FOH P 181,000
Less: Fixed OH 75,000
Variable FOH P 106,000
Less: Budget allowance for Variable OH based on actual capacity
(P 2.50 x 45,000 units) 112,500
Spending variance (favourable) P (6,500)

- (Idle) Capacity or volume variance may also be arrived at by multiplying the difference between
budgeted and actual capacity by the fixed FOH rate as follows:
Capacity or volume variance:
Budgeted capacity 50,000 units
Actual capacity 45,000 units
Difference 5,000
Multiply by
Fixed FOH rate P75,000/50,000 units P 1.50
Capacity or volume variance (unfavourable) P7,500
o Analysis: Based on the computation, it may be said that the capacity or volume
variance is due to the over- or under- absorption of fixed FOH. In the given example,
P 7,500 of fixed FOH was not included in costing because actual capacity is lower by
5,000 units.
- Analysis of Interim Overhead Variances
o FOH variances must be analyzed at regular intervals during an accounting period or
fiscal year.
o It may be done monthly or quarterly so that the different parties concerned can
adopt remedial measures to minimize variances for the remainder of the year.

ACCOUNTING FOR ACTUAL FACTORY OVERHEAD

Although FOH is charged to production periodically or upon completion of a job, the different FOH
items are incurred from day to day. They vary in nature and in principal supporting business papers
and are therefore recorded in different books of original entry.
- Those requiring disbursements are recorded in the voucher register or cash disbursements
journal;
- Those arising from period adjustments are recorded in the general ledger;
- And, those arising from stores requisition are recorded in the requisitions journal or
summarized and subsequently recorded in the general journal.
- Examples:
PRINCIPAL SOURCE DOCUMENTS AND BOOKS OF ORIGINAL ENTRY IN RECORDING FACTORY OVERHEAD
Factory overhead Principal source documents Books of Original Entry
Indirect materials Stores requisition Requisitions Journal or General Ledger
Indirect labor Payroll/Daily time report Voucher register, cash disbursements journal or
general journal
Fuel and Oil Stores requisition/purchase Requisitions journal, voucher register or cash
invoice disbursements journal
SSS contributions Schedule of contributions Voucher register or cash disbursements journal
Medicare contributions Schedule of contributions Voucher register or cash disbursements journal
Employees’ compensation insurance Schedule of contributions Voucher register or cash disbursements journal
Depreciation Journal voucher*for adjustments General journal
Insurance expense(for expired portion) Journal voucher*for adjustments General journal
Overtime premium Overtime authority/time card Voucher register or cash disbursements journal
Vacation/ sick leave Vacation/sick leave memoranda Voucher register or cash disbursements journal
from personnel department
Medical/dental expenses Purchase invoice or retainer’s bills Voucher register or cash disbursements journal

CONTROLLING ACCOUNT AND SUBSIDIARY RECORDS

- The general ledger account Factory Overhead Control is used for all FOH items incurred.
- They are recorded in journals ad the details are kept in FOH subsidiary ledgers or FOH
analysis sheet.
- Factory Overhead Analysis Sheet
o The details of the postings to the FOH control account are entered in subsidiary
records or subsidiary ledgers. Oftentimes, a FOH analysis sheet suffices.

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Illustration:
FACTORY OVERHEAD CONTROL ACCOUNT AND SUBSIDIARY RECORD
FACTORY OVERHEAD CONTROL
Date Particulars Ref. Amount Date Particulars Ref Amount
2013
Jan 31 VR – 1 30,750
31 GJ – 5 9,000
31 GJ – 7 4,500
31 GJ - 8 3,250

FACTORY OVERHEAD ANALYSIS SHEET

Date Particulars Ref. Total 502 503 504 505 506 507 508 509 510
2013
Jan VR – 30,750 6,700 11,200 2,300 4,575 3,500 1,600 875
31 1
31 GJ – 5 9,000 9,000
31 GJ – 7 4,500 4,500
31 GJ - 8 2,300 400 300 250
3,250

- The column headings may be the corresponding codes per chart of accounts for the different
items.

Code Account Title

502 Supervision
503 Indirect labor
504 Labor Fringe benefits
505 Indirect materials
506 Power
507 Light
508 Water
509 Depreciation – Building
510 Depreciation – Machinery and Equipment

- The postings to the FOH control account are made from the voucher register (VR), requisition
journal (RJ), and general journal (GJ).
- For every posting in the general ledger account FOH control, the corresponding entries on the
analysis sheet show the particular overhead item being charged.
- Thus, the total of the debits to FOH control account should be equal to the footing for the total
column on the analysis sheet. The latter should be equal to the total of all the footings for the
different columns.

DISPOSITION OF FACTORY OVERHEAD VARIANCES

- FOH variance, when insignificant in amount, is treated as a period cost and is shown as an
adjustment to cost of goods sold. As such, it is closed to Cost of Goods Sold or to Income and
expense Summary.
- When the variance is significant in amount, it is treated as an adjustment to cost of goods
sold, and the inventories of work in process and finished goods. The variance appears in
income statements prepared for internal use only.

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JOURNAL ENTRIES
The entry related to applied FOH vary depending on whether the amount charged to production is
credited to FOH control or to applied FOH.
- Factory overhead charged to production is usually credited to Applied Factory Overhead to
separate it from actual factory overhead. The latter is debited to Factory Overhead Control.
o Periodically, or at year end, the former is closed to the latter so that whatever
balance is left must the factory overhead variance.
- To illustrate, assume the FOH charged to production is P 20,800 and actual FOH amounts to P
21,000. The entries would be as follows:
a. To charge overhead to production:
Work in Process P 20,800
Applied Factory Overhead P 20,800
b. To take up factory overhead incurred:
Factory Overhead Control 21,000
Cash and Other Credits 21,000

c. To close Applied FOH to FOH Control

Applied Factory Overhead 20,800
Factory Overhead Control 20,800
d. To close the variance to cost of goods sold:
Cost of Goods Sold 200
Factory Overhead Control 200
- If the account Applied FOH is not used and the credit is directly to FOH Control, the entries for
a and b would be as follows:
a. To charge overhead to production
Work in Process 20,800
Factory Overhead control 20,800

b. To take up factory overhead incurred

Factory overhead Control 21,000
Cash and other credits 21,000
At this point, the account Factory Overhead Control would appear as follows:
Factory Overhead Control
Actual 21,000 Applied 20,800

The debit balance of P 200 is the variance. This is closed to cost of goods sold as follows:
Cost of Goods Sold 200
Factory Overhead Control 200
- The use of the accounts applied factory overhead and factory overhead variance clearly
separates the corresponding amounts and any adjustments thereto.
- The use of “factory overhead variance” account requires the use of only one general ledger
account for both underapplied and overapplied FOH which are offset anyway against each
other to even out the periodic differences between applied and actual FOH during the year.
Based on these, the entries would be as follows:
a. To charge overhead to production:
Work in Process P 20,800
Applied Factory Overhead P 20,800
b. b. To take up factory overhead incurred:
Factory Overhead Control 21,000
Cash and Other Credits 21,000
c. To set up the variance or close applied factory overhead and factory overhead
control:
Applied Factory Overhead 20,800
Factory Overhead Variance 200
Factory Overhead Control 21,000

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 COST ACCOUNTING AND COST MANAGEMENT 1
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d. To close the variance to cost of goods sold:
Cost of Goods Sold 200
Factory Overhead Control 200

Factory overhead variances per interim statements

- Factory overhead variance may be underapplied for some quarters and overapplied for
others
- Quarterly variances may be set up on working papers only or by journal entries.
- If journal entries are made, the account Factory overhead variance is preferably used with
undeapplied overhead as debit and overapplied, as credit. The variance for the year is the
balance of the account at year end. This is presented on the annual income statement
prepared for internal use only.
- Based on the previous illustration, the postings to the factory overhead variance account
should be as shown below if journal entries were made quarterly to set up the variance.

Factory Overhead Variance

2013 2013
March 31 3,100 Sept 30 8,700
June 30 200
Dec. 31 1,100

The year-end credit balance of P 4,300 is the overapplied factory overhead for the year. As part of
the year-end closing entries, the variance is closed to cost of goods sold.
Factory overhead variance is significant
When the amount of factory overhead variance is significant, the probable causes thereof are
determined and may even bring about a revision in the factory overhead rate. Whether a revision is
effected or not, the fact that actual factory overhead differs from the amount applied requires an
adjustment to the jobs or processes already costed.
- For those already completed and sold, the adjustment is to cost of goods sold;
- For those already completed but not yet sold, the adjustment is to finished goods; and
- For those not yet completed, it is to work in process.

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 COST ACCOUNTING AND COST MANAGEMENT 1
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EXERCISES
1. You are required to compute for the 2013 factory overhead rate of Bueno Manufacturers,
Inc. using each of the different bases form the following data:
Budgeted factory overhead P 480,000
Budgeted production volume 50,000 units
Budgeted materials cost P 300,000
Budgeted labor cost P 1,200,000
Budgeted labor hours 60,000 hours
Estimated machine hours 30,000 hours
2. As of December 31, 2013, the inventory of work in process of Bueno Manufacturers, Inc.
(refer to NO. 1 is in the form of job no. 12 which was started on in 2013. The prime costs
and other relevant data on this job are given below:
Job 12
Direct materials cost P 75,000
Direct labor cost P 25,000
No. of units 3,000
Labor hours 1,000
Machine hours 600
Required: Cost of work in process inventory using each of the factory overhead rates as
arrived at No. 1.
3. Amargo Mfg. Co. produces two products, A and B. In computing for the overhead rate per
unit, the company assigns points to different factors such as the length of time required in
processing and differences in specifications. The following data are given for 2013:
Product A Product B
No. of points per unit 5 3
Estimated output 6,000 8,000
The budgeted factory overhead for 2013 is P 405,000.
Required: Factory overhead rate per unit.
Exercises 4 to 6 are a group of exercises pertaining to the same company, Golden
Manufacturers, Inc. They are aimed at training students to correlate different cost data while
solving short exercises.
4. Golden Manufacturers, Inc. applies factory overhead at P 8 per direct labor hour. Actual
factory overhead and actual labor hours for 2013 were P 470,500 and 58,000 hours,
respectively. Normal capacity is 60,000 hours.
Instructions:
a Compute for the factory overhead variance.
b Make the journal entries that relate to factory overhead in 2013.
5. Analyze the factory overhead variance of Golden Manufacturers, Inc. based on the given in
Exercise 4.
6. Assume that the fixed factory overhead of Golden Manufacturers (exercise 4) amounts to P
120,000.
Required:
a Variable factory overhead rate.
b Budget allowance based on actual capacity.
c Spending variance.
d Idle capacity variance.
e Alternative computation for spending and volume variance.
7. Fixed and variable overhead rates of Subic Mfg. Co. are P 3 and P 5 per labor hour,
respectively, based on 40,000 budgeted labor hours. Budgeted capacity for 2013 is 20,000
units because two (2) hours of labor are required to finish a unit of the product.
Subic Mfg. Co. produced 19,500 units in 38,200 hours and incurred P 306,200 of factory
overhead.
Required:
a Budgeted factory overhead for 2013.
b Budget allowance based on actual capacity for 2013
c Factory overhead variance
d Analysis of the overhead variance

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 COST ACCOUNTING AND COST MANAGEMENT 1
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8. Assume that the budgeted production and the corresponding labor hours are given as follows:
No. of units Labor hours
First quarter 4,000 x 2 = 8,000
Second quarter 7,000 14,000
Third quarter 6,000 12,000
Fourth quarter 3,000 6,000
Actual labor hours and factory overhead incurred for the different quarters are as follows:
Actual labor hours Factory overhead incurred
First quarter 8,100 P 73,000
Second 12,900 95,500
Third quarter 11,300 80,500
Fourth quarter 5,900 57,200
Total 38,200 P 306,200
Instruction:
For each quarter, compute for the following:
a Factory overhead variance c Spending variance
b Budget allowance d Idle capacity variance
Supply the answer.
1. Job no. 629 was sold at a gross margin of 50% or for P 36,000. Its cost includes direct
materials of P 8,000 with factory overhead applied at 60% of direct labor cost. How much
factory overhead was charged to the job?
2. The Amazon Manufacturing Co. uses the point system in charging overhead to its three
products because of variations in the nature of processing and other specifications. The
following data are given on the products:
Product A Product B Product C
Estimated output (units) 8,000 5,000 3,000
Assigned number of points 6 5 4
Budgeted factory overhead for the year is P 297,500.
The overhead rate per unit of each of the products must be:
3. Budgeted Factory Overhead for 2013 is P 400,000 based on normal capacity of 50,000 labor
hours. Fixed factory overhead is P 40,000. How much is the budget allowance on actual
capacity of 45,000 labor hours?
4. Assume that in no. 3 above, budgeted and actual capacities for the first quarter of 2013
were 10,000 and 9,000 labor hours, respectively. How much is the budget allowance for the
quarter?
5. Factory overhead variance is under absorbed P 3,000 and spending variance is favourable
P 2,000. Budget allowance on actual capacity is P 30,000. How much is applied factory
overhead?
6. At 10,000 units of production, idle capacity variance is unfavourable P 4,500 while at
30,000 units, it is favourable P 1,500. The fixed cost rate based on normal units of
production ought to be?
7. Fixed and variable overhead rates are P 5 and P 8per unit of output (respectively) based on
budgeted production volume for 2013 of 60,000 units. The company produced 58,000 units
and incurred P 765,200 of factory overhead.
The unfavourable (favourable) spending and idle capacity variance must be:
8. The factory overhead rate is P 20 per direct labor hour. The company’s budget for 2013
shows budgeted units of production of 30,000 with three (3) hours of labor required to
finish a unit.
For 2013, the company produced 32,000 units expending 96,500 labor hours and incurring
P 1,863,300 of overhead. Budget allowance based on actual capacity is P 1,867,500 and idle
capacity variance is P 32,500. What is the variable overhead rate?
9. Factory overhead variance is over absorbed P 9,000. The factory overhead rate of P 10 per
labor hours was arrived at by using an estimated capacity of 20,000 labor hours. The fixed
overhead rate is P 3 per labor hour.
With utilized capacity equal to 18,900 labor hours, how much factory overhead must have
been incurred?

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