COST ACCOUNTING AND CONTROL

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 CONTROL
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
2019: 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 Based on labor
 hours:
Factory overhead rate = P 50,000/100,000 hrs = P.50 per labor hour

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COST ACCOUNTING AND CONTROL
ACCOUNTING FOR FACTORY OVERHEAD

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 factory 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 produ ct 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

Products are given:

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).
- 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.

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COST ACCOUNTING AND CONTROL
ACCOUNTING FOR FACTORY OVERHEAD

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

40,000 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.

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.

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COST ACCOUNTING AND CONTROL
ACCOUNTING FOR FACTORY OVERHEAD

▪ 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.

- 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.

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COST ACCOUNTING AND CONTROL
ACCOUNTING FOR 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 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.

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COST ACCOUNTING AND CONTROL
ACCOUNTING FOR FACTORY OVERHEAD

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
Fixed cost rate P 2,300 P 2,750 P 3,200 P 3,500
Variable cost rate P 20 P8 P5 P4
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.
- 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

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COST ACCOUNTING AND CONTROL
ACCOUNTING FOR FACTORY OVERHEAD

- 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 2019

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:
Good Products, Inc.
Factory Overhead Budget
(Based on 100,000 units)
For 2019

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

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COST ACCOUNTING AND CONTROL
 ACCOUNTING FOR FACTORY OVERHEAD
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:

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, 2019

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

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COST ACCOUNTING AND CONTROL
ACCOUNTING FOR FACTORY OVERHEAD
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 (1,700) P (1,400) P P (8,500) P (13,900)

(2,300)

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 P 9,600 P 9,600

(6,400)

Factory overhead variance – underapplied P 3,100 P 200 P P 1,100 P (4,300)

(overapplied) (8,700)
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
- 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

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COST ACCOUNTING AND CONTROL
ACCOUNTING FOR FACTORY OVERHEAD

(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:
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:

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COST ACCOUNTING AND CONTROL
ACCOUNTING FOR FACTORY OVERHEAD

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:

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.

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COST ACCOUNTING AND CONTROL
ACCOUNTING FOR FACTORY OVERHEAD

- 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 invoice Requisitions journal, voucher register or cash
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 and 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.
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 50 509 510
8

2013

Jan 31 VR – 1 30,750 6,70 11,200 2,300 4,575 3,500 1,600 87

0 5

31 GJ – 5 9,000 9,000
31 GJ – 7 4,500 4,500

31 GJ - 8 3,250 2,300 400 300 25

0

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COST ACCOUNTING AND CONTROL
ACCOUNTING FOR FACTORY OVERHEAD

- 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.

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

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COST ACCOUNTING AND CONTROL
ACCOUNTING FOR FACTORY OVERHEAD

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
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 CONTROL
ACCOUNTING FOR FACTORY OVERHEAD

Example: The predetermined factory overhead rate for 2019 was 80% of budgeted direct labor cost of P
25,000. The production data for 2019 include the following:
Job Order

12 13 14 15 Total

January 1, 2019

Direct materials P 10,000 P 7,000 P 17,000

Direct labor 6,000 3,000 9,000

For the year, 2019

Direct materials 8,000 12,000 25,000 18,000 63,000

Direct labor 4,000 5,000 11,000 6,000 26,000

Jobs 12, 13 and 14 were finished in 2019 but only jobs 12 and 13 were sold during the year.
Actual factory overhead amounted to P 28,600.
Applied factory overhead for 2019 must be P 20,800 (or total direct labor cost incurred in 2019 of
P 26,000 x 80%). With actual factory overhead amounting to P 28,600, the variance of P 7,800 (or P
28,600 minus P 20,800) is considered significant inasmuch as it is almost 38% of the amount applied (or
P 7,800/ P 20,800). The variance is allocated between cost of goods sold and the inventories of work in
process and finished goods based on direct labor cost charged to the job during the year as follows:

Allocation rate = Factory overhead variance

Actual base

= Factory overhead variance, P 7,800 = 30%

Direct labor cost, 2019, P 26,000
To cost of goods sold
Allocation rate Allocated Direct labor cost , 2019
Variance

Job No. 12 P 4,000 30% P 1,200 Job No. 13 5,000 30% 1,500 P 2,700

T0 finished goods invty.:

Job No. 14 11,000 30% 3,300
To work in process invty.:
Job No. 15 6,000 30% 1,800 Factory overhead variance – underapplied P 7,800

With an underapplied factory overhead, the balance of the factory overhead variance account
must be a debit. The disposition would be as follows:

Cost of Goods Sold P 2,700

Finished Goods 3,300
Work in Process 1,800
Factory Overhead Variance P 7,800
The entry provided increases the balances of the three accounts debit inasmuch as the amounts so
charged to them must be their shares in the portion of factory overhead not absorbed in costing during the
period.

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