ACCOUNTING FOR OVERHEAD
- Overhead and activity levels are budgeted/
Overhead- all other cost incurred in the factory
aside from direct materials and direct labor.
PART OF MANUFACTURING COST &
PRODUCT COST
 Part of product/inventoriable cost
 Part of total manufacturing cost
- Includes all cost incurred in the production
process which are not direct materials or
direct labor, also it is not directly traceable
to the products completed but are still
necessary to be incurred to raw materials
to finished goods.
o Indirect materials
o Indirect labor (factory supervisor,
factory janitor)
o Factory insurance
o Factory depreciation of equip and
machineries
o Repairs and maintenance
o Rent
o Utilities
PREDETERMINED OVERHEAD RATES
- Is an allocation rate that is used to
apply the estimated cost of manufacturing
overhead to cost object for a specific reporting
period.
We only estimate the total overhead cost for
the period using a specific allocation rate.
We do not use actual overhead cost incurred.
We used the budgeted/estimated overhead
1. Allows an entity to get immediate cost
information for decision – making and
pricing decision without the need to
wait for the actual overhead cost
which take time to accumulate.
2. When overhead rates are
predetermined, it allows uniform
costing whatever season or
circumstance the company is into
(uniform costing so price won’t
change from time to time)
3. Within the relevant range, there will
be no problem on fluctuations of act
Machine hours
levels and the cost related thereunto.
Budgeted OH cost
Predetermined OH rate=
Specified volume of activity
estimated by an entity for the whole
accounting period
- The numerator and denominator in
determining the POH rate is being studied
well based on management estimates,
SPECIFIED VOLUME OF ACTIVITY
(BASE TO BE USED)
The base to be used should be related to
functions represented by the OH cost being
applied:
 FOH is labor oriented – base should be
direct labor hours/ direct labor cost
 Investment oriented related to operation of
machinery – base should be machine hours
 Is material oriented – base should be
materials cost
1. Direct labor hours
a. The most common used base
or denominator
b. The number of direct labor
hours spent is readily
available in a payroll sheet
Estimated Factory OH
FOHR=
Estimated Dirct Labor Hours
= Factory overhead rate per labor
hour
2. Direct labor cost
a. More reliable than material
cost as labor rates do not
change as often
b. A direct relationship between
labor cost and factory
overhead is needed
c. Available on the payroll sheet
Estimated factory OH
FOHR= ×
Estimated Direct Labor Cost
= Percentage of direct labor cost
3.
a. Direct relationship between
machine hours and factory oh
cost is needed
 b. May occur in companies or - Manufacture only a single product
departments that are largely - Manufacture different products that go
automated so hat majority of through the same series of productive
the factory overhead cost departments
consist of depreciation of
factory equipment Departmental Rate – shall be use when
different products are being manufactured by
Estimated factory OH an entity
FOHR=
Estimated Machine Hours - Also applicable when products do not pass
= Factory Overhead Rate per through the sae series of production
machine hour departments
- Compute for the estimated factory
4. Direct material cost overhead per dept. segment/ cost centers
a. A direct relationship between - Determine the applicable base
direct materials and factory
overhead cost is needed. NORMAL COSTING
b. This may occur in companies – is a costing system that is used to
where a very large part of determine the cost of producing products by
total cost is attributed to using the actual cost of direct labor and direct
direct materials materials and an allocation method for
c. This is not an appropriate overhead.
base to when more than one
product is manufactured by a
company Actual Normal CS Standar
CS d CS
Estimated factory OH Direct
FOHR= × 100actual actual Budget
Estimated Direct Materials Cost
cost ed/
applied
= Percentage of Direct materials Indirect actual Budgeted/ Budget
cost cost applied ed/
applied
5. Units of production
a. Simple method because units
produced are readily Manufacturing overhead (temporary acc)
available Actual overhead Overhead applied to
b. Appropriate when a company cost incurred production
or a development  Indirect  Actual costing –
manufactures only one materials all actual OH
product.  Indirect labor  Normal costing
Estimated factory OH  Utilities – Predetermined
FOHR=  Rent rates
Estimated Units of Production
 Insurance
= Factory overhead rate per unit of
 Depreciation
production

FOHR computed is known as the plant-wide or

blanket rate
OVERHEAD VARIANCE
All departments in the company will use the
same application rate for manufacturing
overhead and the same base 1. With the use of actual costing:
Applicable to entities who: Actual overhead = Applied
overhead
 Since actual amount of overhead is being 2. Indirect actual OH
applied to production labor 2. Normal
2. Normal costing use: 3. Utilities costing –
o Actual overhead not equal 4. Rent predetermine
Applied overhead 5. Insurance d rates
6. Depreciati
on

If:
1. To record various indirect cost
1. Actual overhead > Applied oh actually incurred
 Overhead at the end of the period is under
applied (kulang) Factory overhead control Xx
2. Actual OH < Applies OH Salaries and wages payable Xx
Supplies inventory Xx
 Over applied
Accu, depreciation xx
1. Overhead variance is immaterial
a. The amount of variance is closed FOCH Account: an account record used to
against COGS track and control the indirect manufacturing
b. Underapplied=COGS increase cost incurred in a production process
c. Overapplied= COGS decreases
2. Overhead Variance is material A suspense account that represents the
a. The amount is closed and accumulation of all manufacturing overhead
prorated against the accounts in cost during a specific accounting period.
which applied overhead resided:
Sample OH Dr. Cr.
WIP inv., FG inv. And COGS item
TYPES OF OVERHEAD Indirect Factory OH Salaries
labor payable
Indirect Factory OH Inventory or
OVERHEAD material supplies
function Elem Beha norm Controll Factory Factory OH Prepaid
s ents viour ality ability insurance insurance
producti Indir Fixed Nor Controll Factory Factory OH Accumulate
on ect mal able Depreciation d
mate depreciation
rial Taxes/ Factory OH Taxes and
Adminis Indir Varia abnor Uncontr utilities utilities
tration ect ble mal ollable payable
labor 2. Applying the overhead:
Selling Indir Semi
ect - WIP inv Xx
expe varia Manufacturing OG control xx
nses be (Amount is computed POHR multiplied by the
distribut activity volume for the period)
ion
3. Completion of work in process inv:

FG inv Xx
OVERHEAD JOURNAL ENTRIES
WIP inv xx

Manufacturing overhead 4. Sales of goods:

Actual overhead Overhead applied to
cost incurred production COGS Xx
1. Indirect 1. Actual FG inv xx
materials costing – all
The Factory Overhead account is not a typical
account. It does not represent an asset, liability,
expense, or any other element of financial
statements. Instead, it is a “suspense” or
“clearing” account.
Amounts go into the account and are then
transferred out to other accounts. In this case,
actual overhead goes in, and applied overhead
goes out
ALLOCATION APPORTIONMENT, AND
ABSORPTION OF OVERHEAD
Allocation of overhead
 When items of cost are identifiable directly
with some products or departments such
cost are charged to cost centres. This
process is known as cost allocation
 It is complete distribution of an item of
overhead to the departments or products on
logical or equitable basis is called
allocation.
 Where a cost can be clearly identified with
a cost center or cost unit, then it can be
allocated to that particular cost center.
Allocation of OH
- Allocation is a direct process of identifying
overheads to cost units or cost centers. So
the term allocation means allotment of
whole item of cost to a particular cost
center or cost object without any division.
Apportionment of OH
 Cost apportionment is the allotment of
proportion of items to cost centers
 When items of cost cannot be directly
charged to or accurately identifiable
with any cost centers, they are
prorated or distributed amongst the
centers on some predetermined and
suitable basis.
Apportionment of overhead costs means to
divide total cost of overhead among different
departments or branches or cost centers of a
company
With this, we can compare the revenue of
each department with their total cost. Then
take decisions relating to particular
department.
Allocation Apportionment
Deals with the Deals with proportion
whole items of cost of items of cost
Direct process of Needs a suitable basis
departmentalization for sub-division of
of overheads the cost
Whether a particular item of expense can be
allocated or apportioned does not depends
on the nature of expense, but depends on the
relation with the cost centre or cost unit to
which it is to be charged
Service and producing department
Producing department
These departments perform the primary
purpose of the company—to produce goods
and services for consumers.
They are cost accumulation centers in which
work is performed directly on the goods being
produced.
Examples of operating departments are the
assembly departments of manufacturing firms
and the departments in hotels that take and
confirm reservations.
Service department
Service or support department is a unit in an
organization that contributes in a very indirect
way to the conversion of raw materials to
finished goods. They are, however and still,
involved in producing goods.
The costs of service departments are allocated
to the producing departments because they
exist to support the producing departments.
This method of allocation makes it possible to
assess the department’s operational efficiency.
If the internal cost for a service is greater than
the price charged by an external supplier, the
service department could be considered for
elimination.
Methods of allocating service department
cost
 1. Direct method
a. Most widely used method
b. Ignores any service rendered
by one service department to
another
c. It allocates each service
department’s total cost
directly to the producing
departments
2. Sequential/step method
a. Recognizes services rendered
by service departments to
another departments
b. Sequence typically starts with
the department that renders
service to the greatest number
of other service department
and ends with the department
that renders service to the
least number of other
departments
c. Once a service department’s
cost are allocated, no
subsequent service
department cost are allocated
to it
3. Algebraic method
a. Allocates cost by explicitly
including mutual services
rendered among all
departments.

Absorption of Overhead

 The ultimate aim of Overhead

Accounting is to absorb them in the
product units produced by the firm.
 Thus, the indirect costs or overhead
will have to be distributed over the
final products so that the charge is
complete.
 This process is known as cost
absorption or ‘Absorption’ of
overheads.
 FOH rate is used here!

When OH variance is material:

The amount of OH is closed and prorated
against accounts in which applied overhead
resides: work-in process inventory, finished
goods inventory, and cost of goods sold.

Cost Accounting