lOMoARcPSD|10895444

ACC 204 - Accounting for Overhead - by Guererro

Accountancy (Polytechnic University of the Philippines)

StuDocu is not sponsored or endorsed by any college or university

Downloaded by John Frivaldo (johnfrivs03@gmail.com)
 lOMoARcPSD|10895444

Chapter6

Manufacturing Overhead
Accounting: .
Actual.and ·Applied ' .

' -
The previous chapters dis9ussed in depth the first two elements of production
cost; material and labort costs. The third element of production cost, the
man(!,{acturing overhead costs. will be discussed in this chapter and in
Chapter 7. Some of the problems encountered in accounting manufacturing
overhea.d costs has been introduced earlier. This chapter will discuss in
detail (1) the procedures in applying manufacturing overhead using a single
predeterniined overhead rate, and (2) the procedures in recording
manufqcturing overhead. Chapter 7 will discuss (1) the departmentalization
of manufacturing overhead, and (2) the calculation and use of separate
departmental overhead rates.

NATURE OF MANUFACTURING OVERHEAD

· Manufacturing ov~rhead costs are generally defined as those costs that

are -not conveniently identified with particular or:ders or units of products.
Simply stated, manufacturing overhead includes all factory ·costs other
·than direct materials and • direct labor. Other names used for
manufacturing overhead are manufacturing expenses, factory burden,
factory overhead, factory expenses and indirect manufacturing costs.

199

Downloaded by John Frivaldo (johnfrivs03@gmail.com)

 lOMoARcPSD|10895444

?_!20~0- -~------------------~~- ~ facturing OverheadAccounJtng: Actual and Applied 201

·••"-TTWACTURING OVERHEAD COSTS CONTROL OF MANUFACTURING OVERHEAD COSTS

TYPES OF ~w" .

. uf tunn' g costs are common to all products manufactured th Of the three elements of costs, manufacturing overhead costs require the
Smee man ac . t' h , ey
ted to production after certain assump ions ave been mad JllOSt exte~sive study because they represent the most difficult problem
are alloca · · f th t t · e.
The following is a partial listmg o e mos common cos s m a tYPical in accounting.
factory operation:
The size of a company, and the types of ptoducts-manufacture,d are key
Indirect Materials factors to be considered to account for manufacturing overhead. A small
Factory supplies company producing only one product or a few products may simply keep
Lubricants a separate general ledger account for each manufacturing overhead costs.
Cleaning supplies If there are many types of overhead costs, manufacturing overhead
Small tools analysis sheets should be maintained. These analysis sheets function as a
Packaging materials subsidiary ledger that is controlled by the Manufacturing Overhead
Other items used in small amounts in manufacturing Corttrol account in the general ledger.

Indirect labor CHARGING MANUFACTURING OVERHEAD TO PRODUCTION

Factory supervisors . '
Factory clerical workers Under actual costing as discussed in Chapter 1, manufacturing overhead
_Factory pay~~li clerks costs is charged to production at an arbitrary manufacturing overhead
Receiving clerks costs using an arbitrary overhead application rate determined at the end
Storeroom clerks of the period. The procedure is inconvenient on the part of the
Storeroom supervisors management, because complete costing of jobs finished· during the period
Purchasing clerks will have to be deferred until the end of the period. For this reason, actual
Overtime premium (unless the tim e 18
. identified
. . . a specific job)
with costing is not widely used in practice.
Other Manufacturing Overhead To avoid delay in the costing of jobs as experienced in actual costing,
Employee fringe benefits most companies use the normal costing. The essence of normal costing
Employer contributions
is that it uses a predetermined overhead rate to allocate manufacturing
Worker's compensation i
Factory utilities nsurance overhead costs to jobs.
Rent of factory buildi .
~epreciation: of facto;\:~house and equipment PURPOSE OF OVERHEAD RATES
roperty taxes g and equipment ·
G~ou~ health insurance . It is important for ~anagement to know how much a particular job costs.
Fire ~surance . for factory employees Such information enables management to assess efficiency, to change
RepaJ.rs and · · procedures if necessary and to aid in determining the selling prices. While
Inventory shmat1ntainance material and labor costs can be determined as soon as the job is finished,
Spoiled goods
or age
the manufacturing overhead costs are not readily available. Accordingly;
predetermined overhead rate are used to estimate the manufacturini
overhead costs.

Downloaded by John Frivaldo (johnfrivs03@gmail.com)

 lOMoARcPSD|10895444

~~'...-------------------------.:C~~
?._02
· Manufacturing Overhead Accounting: Actual and Applied
203

DETERMINING THE OVERHEAD RATE Direct Labor Costs Basis

Aprede~~mme
of
~e:
. d head rate is simply a rate calculated at the beginning
year. This rate is comput\:)d by the preparation of a
a pufenot '~suove.rhead budget based on a certain activity level This
man ac unng . . . .·
This method is widely used beca.use it is simple and easy to use. Data
concerning direct labor costs of each job is available from the payroll
records and time tickets. Predetermined overhead rate is calculated by
budgeted manufacturing ov~rhead 1s then d!v1ded by the esbma~ed dividing the estimated manufacturing overhead costs by the estimated .
amount or quantity, such as direct labor cos~s: direct labor ho~rs'. machine direct labor costs. The calculation results in the percentage of direct labor
hours, or some other basis for the same activity level. The rat10 1s usually costs as follows:
called the overhead application rate. Once the overhead application rate
has been determined, the overhead on each job is estimated by determining Estimated Manufacturing Overhead Costs
the actual base selected on the job and applying the rate. = Percentage of Direct Labor Costs
Estimated Direct Labor Costs
TYPES OF OVERHEAD RATE BASES Using the data given in Illustration 6-1, the rate is:
The primary purpose of using a predetermined overhead rate is to charge P 96,000
a fair share ofoverhead costs to each job. A number of bases for determining = 48% of direct labor costs
overhead rates may be used to compute an overhead application rate. P200,000
The common bases.are as follows:
Hence, if actual direct labor costs incurred on a particular job totaled
Direct labor costs P6,000, the applied overhead would be P2,880 (P6,000 x 48%).
Direct labor hours
Direct material costs The direct labor costs basis is usually used in cases where the
Machine hours manufacturing overhead costs vary with direct labor costs.
Units of production
Direct Labor Hour Basis
J:~v:~~ an\p~oductio_n figures used in the computation are usually
om u get estimates at the start of the year. This method assumes that overhead costs tend to vary with the number
of hours of direct labor used. The overhead application rate base on direct
Illustration 6-1 labor hours is compu~d as follows:
To illustrate the computation
following budgeted data £ th procedures for each basis, assume the Estimated Manufacturing Overhead Costs
or e year: = Rate per Direct Labor Hour
Estimated Direct Labor Hours
~::ufactur~ng overhead costs
D" her of units of production P96,000
Using the.figures in.Illustration 6-1, the rate is:
irec~ materia) costs 24,000 units
Machine hours P480,000
P96,000
D~ect labor hours 12,000 hours = P2.40 per direct labor hour
Direct labor costs 40,000 hours 40,000Hrs.
~ - - -_ _ _ _ __.::
P~20~0~,o~oo~-

Downloaded by John Frivaldo (johnfrivs03@gmail.com)

 lOMoARcPSD|10895444

Manufacturing Overhead Accounting: Actual and Applied 205

. b equired 2 250 direct. hours to be completed, the overh d Again, using the data in Illustration 6-1• the rate pe r .-.
Therefiore, if a JO r ' ea u,ac h'1ne h our 18'
· .
applied would be P5,400 (2,250 x P2.40). _
P96,000
The direct labor hours basis is appropriate w.hen there is a correlation = PB per machine hour
between total manufacturing overhead costs and the number of direct 12,000
labor hours. Hence, if the job required 400 machine hours, the overhead costs to be
applied to that job would be P3,200 (400 x P8). ·
Direct Material Cost Basis
This basis is u~ually used in automated factory where ~achines perform
Overhead may be applied on the basis of direct materials used to produce most of the work and each item goes through a similar sequence of
the prod\lct. The estimated manufacturing overhead costs are divided by machines. However, a machine hour basis is not appropriate if different
the estimated direct materials costs to compute the percentage of kinds of machines are used for various products:
materials costs to be applied as overhead as follows:

Estimated Manufacturing Ouerhead Costs

Units of Production Basis
. . · · = Percentage of Materials Costs
Estww.ted Direct Materials Costs • Overhead may be applied on the basis of the number of units manufactured
during the period. To compute the overhead cost to be applied to each
Using the figures in Illustration 6-1 the percentage is: unit of production, the estimated manufacturing overhead costs are
divided by the estimated total number of units of production, as shown
P 96,000 below:
=· 20%of materials costs.
P480,000
Estimated Manufacturing Ouerhead Costs
- - - - - - - - ' - - - - - - - - = Ouerhea.d Cost per Unit of Production
!:~~:a~!~ direct _materials ~osts used on a specific job is P22,000, the Estimated Units of Production
e applied to th at Job would be P4,400 (P22,000 x 20%).
Using the data in Illustration 6-1, the rate is equal to:
To use materials costs as a ha h
approximately the se, eac product manufactured must require
. same amount of mater·18l . b P96,000
distributed uniformly th h s, or materials usage- must e = P4 per unit
roug out the manufacturing process. P24,000
Machine Hours ~asis Therefore, if a job of 1,200 units were produced, the overhead applied to
the job would be P4,800 (1,200 x P4)
?verhead may be applied as a r .
performed principall b ate _for each machine hour when work 1s
application rate div'd yth y m~chmes. To determine the overhead The units of production basis have limited uses. This rate is used only if
1 the manufacturing process is a simple one and only if one type, or a few
the e8 t·imated number
' eof e estimated
hi "
manu1acturing overhead costs bY
. - mac ne hours as follows: similar types, of products are produced. For example, if Product X requires
Estima.ted Manuf . 40 hours to be produced and Product Y requires 5 hours, it would be
----:::---...:..=a.c: t:u,nng Ouerhea,d Costs inappropriate to base overhead on units of production. Product X is
Estimated M;;;:-.- - - - - = Rate per Machine· Hour obviously going to require more overhead.
in.e Hours

Downloaded by John Frivaldo (johnfrivs03@gmail.com)

 lOMoARcPSD|10895444

±
2Q06~ - - - - - - - - - - - - - - - - - - - - - - -~ C~hapter6 Manufacturing Overhead Accounting: Actual and Applied 20 7

.ANNUALIZED OVERHEAD APPLICATION RATE Recording Applied Manufacturing Overhead Costs

Two major reasons justify the use of an annualized overhead application At the end_of the month, entries are made to record the estimated
rates. These are: 111anufacturmg
. b · overhead
db to. be charged to production . The amount £or t'-uu,
'-
ent1:Y 1s o tame Y totaling the overhead entries on the job cost sheets
1. To overcome fluctuations in the computed unit cost due to durmg the mo?th. Assume that the applied manufacturing overhead
changes in the level of volume from month to month. (This is the column of the Job cost sheets show a total of P540,000. Therefore, the
dominant reason). journal entry to record the applied manufacturing overhead is:
2. To overcome fluctuations in the computed unit costs due to
seasonal calendar, and other factors that may affect the total Work in Process 540,000
level of overhead costs incurred each month. Manufacturing Overhead Control 540,000
To record applied manufacturing overhead
SELECTING THE OVERHEAD BASIS for the month.
In the computation of predetermined manufacturing overhead rate It should be noted that the Work in Process account is not to be debited
greater emphasis should be made on the selection of the base to be used'. for any of. the actual manufacturing overhead costs.
The overhead rate basis select!)d by a company will depend on many
factors, such as the type of goods produced, amount of machinery employed, Recording Actual Manufacturing Overhead Costs
type oflabor used, wage rates paid, and cost and time involved in collecting
the n:cessary data. The following principles should be observed in selecting Assume that the actual manufacturing overhead costs incurred totaled
a basis, · P640,000. This is recorded by a debit to manufacturing overhead control
account kept in the general ledger. Details of the general ledger account
The rate can be easily computed. are kept in a subsidiary overhead ledger which are usua:lly taken from
The factor chosen as the basis must be one that can easily be several source documents such as, store requisition for indirect materials,
measured on each job. overhead analysis sheets and analysis of time tickets for indirect labor.
The
1 t·amount
h" of. overhead cos t s mcurred
· must have some direct
re a ions ip with the base selected. • OVERAPPLIED OR UNDERAPPLIED OVERHEAD

RECORDING MANUFACTURING OVERHEAD COSTS The amount of manufacturing overhead incurred will never equal the
amount of overhead applied at the end of the period except by coincidence.
The preceding sections discussed h . The following will result if the actual overhead is not the. same with the
~mputed using several h · ow _the. overhead application rate 1s
O
discussion will be centere;er had application methods. In this section, applied overhead:
manufacturing overhead 0 ~ ow to record the applied and the actual 1. Overapplied overhead (a credit balance in Manufacturing
between the manufact . cos s, ahnd the disposition of the difference Overhead Control account) results when product costs are
•
pre det ermined urmg
rate and th over ead costs that were applied at the overstated because the actual overhead costs were lower than
actually incurred. e manufacturing overhead costs that were
expected (applied overhead). . . .
2. Underapplied overhead (a debit balance m Manufacturing
To facilitate the cos . Overhead Control account) results when product costs are
are
. b segregated fromt the
analysis • Prie d manufacturipg overhead costs
act ' the ap undllrstated because the actual overhead costs were high~r than
1
Jo cost s~ets under the appuli~ drecorded costs by recording them' in the
expected (applied overhead). .
·e manufact urmg· overhead column.

Downloaded by John Frivaldo (johnfrivs03@gmail.com)

 lOMoARcPSD|10895444

Chapter6 Manufacturing Overhead Accounting: Actual and Applied 209

208
At the end of the month the balanc_e of the Manufa_cturing Overhead Allocation:
Control account is closed to Overapplied or Underapplied Manufacturing
Overhead ac~ount in the general ledger. In o~r exam_ple, there is Account Percentage Allocated
underapplied overhead of Pl00,000 because tne apph~d- overhead Balances to Total Amount
(P540,000) is lower than the actual overhead (P640,000). This 1s recorded Work in Process P40,000 10% Pl0,000
by the following journal entry: Finished Goods 80,000 20% 20,000
Cost of Goods Sold 280,000 70% 70,000
Underapplied Manufacturing Overhead 100,000 Pl00,000
P400,000 100%
Manufacturing Overhead Control 100,000 --
To close manufacturing overhead control
account at the end of the month. Journal Entry:
Disposition of Overapplied or Underapplied Manufacturing Work in Process Inventory 10,000
Overhead Finished Goods Inventory 20,000
Cost of Goods Sold _ 70,000
At the end of the year, Overapplied or Underapplied Manufacturing 100,000
Overhead account must be closed. The disposition of the overapplied or U.nderapplied Mfg. Overhead
underapplied overhead will depend on the materiality of the amount. To close underapplied manufacturing
overhead at end of year.
Assumption 1:
The above procedure is so difficult and time-consuming that the theoretical
If the ai~ount is material, from the viewpoint of accountin theo the benefits obtained usually do not warrant the amount of work involved. In
f~a~°iid:::~~~!dwov1?ead sho':ld be .allocated pr~portio1:;'~tely · addition, most of the goods worked on during the year have probfibly
ai"e still in process some a
sold, thus, the ov;ra lier
fintt 0
; du~ng the year. Some of the goods
s e . goo. s, and some have already been
been transferred to finished goods and sold to customers, so that most of
the · overapplied or underapplied overhead would be closed to Cost of
allocated among Wo~[ • p°r underF~PJ?hed balance should logically be Goods Sold. For this reasons, Assumption 2 below is usually used in
Sold. m rocess, imshed Goods, and Cost of Goods
practice.
To illustrate, assume that the ear d - Assumption 2:
of goods sold were as follows: Y en bajances of inventories and cost
If the amount is immaterial, it is customary to close underapplied or
Work in Finished Cost of overapplied overhead costs directly to the Cost of Goods Sold account. In
Process Goods Goods Sold our example above, the entry to close the underapplied overhead of
Direct Materials Pl0,000 Pl00,0O0 is as follows:
Direct Labor P40,000 Pl00,000
15,000 20,000 90,000
Applied Overhead 100,000
Total -15,000
P40,000
20,000
PBO 000
90,000 Cost of Goods Sold
Underapplied Mfg. Overhead
100,000

The underapplied =
in proportion to ho~erhead of Pl00,000 is ll
P280,000 To close underapplied manufacturing
overhead at ·end of year.
entry to close tht eir respective balance ;hocated to the three accounts
· e underapplied overh l e allocation and the journal
ea are as follows:

Downloaded by John Frivaldo (johnfrivs03@gmail.com)

 lOMoARcPSD|10895444

~2!!:_10~-----------------------=;~ Manufacturing Overhead Accounting: Actual and Appli~d

2JJ
Fi~ancial Statements Presentation
Analysis of Overapplied or Underapplied Overhead
Statement of Financial Position (FP)
Underapplied manufacturing overhea~ is tr_eate~ as a deferred charge An analysis of the underapplied or overapplied overhead is more
and is shown under Prepaid Expenses m t~e mterim sta~ment of FP. On meaningful when used in the context of a flexible budgeting and standards
the other hand overapplied manufacturmg overhead 1s shown in the cost system, which will be discussed in· Part II. A brief summary of the
interim statem~nt of FP as other liabilities. At the end of the year, any basic ideas involved, however, will help in the analysis of the difference
balance of underapplied or overapplied .manufacturing overhead is closed between the actual costs and applied costs.
to Cost of Goods Sold. Thus the balance will not appear on the end-of.
year statement of FP. To illustrate, assume the following data for Jenjen Printers, Inc. for the
year 2018:
Statement of Comprehensive Income (CI)
Budgeted Manufacturing Overhead:
The overapplied or underapplied overhead is included in the Cost of Goods Fixed Overhead Coste
Sold section of the yearly statement of CI. It is shown below as an P 600,000
Variable Overhead Costs 1,020,000
adjustment to Cost of Goods Sold. If overhead has been underapplied,
less overhead was charged to production than what was ·actually incurred, Total Budgeted Overhead Pl,620,000
resulting in the understatement of the Cost of Goods Sold. Therefore, the
Divided by Budgeted Direct Labor Hours (Basis) .600,000
amount of the understated overhead is added to Cost of Goods Sold. If
overhead has been overapplied, more overhead was charged to production Predetermined Overhead Rate per Hour P 2.70
than was incurred, resulting in an overstatement of Cost of Goods Sold.
The amount of overstated overhead is therefore subtracted from Cost of Applied Manufacturing Overhead (200,000 DL Hrs x P2. 70) P 540,000
Goods Sold. Actual Manufacturing Overhead '640,000
Underappli,ed Overhead P 100,000
Jenjen Printers, Inc.
Statement of Comprehensive Income
Year Ended December 81, 2018
An analysis of the above data for the year shows that P600,000 are ri:,ced
costs. That is, they do not vary substantially (in total) regardleSB of ch~~s
Salee in the number of labor hours worked during the year: The remammg
Cost of Goods Sold: Pxx budgeted costs of Pl,020,000 are variable cost& These costs.tend to vary
Finished Goode Inventory, Jan. 1 in proportion to the number of direct labor hours worked dunn~ the year.
Add: Cost of Goods Manufactured J;>xx Thus out of the total overhead application rate of P2. 70 per direct labor
2!. hour,' Pl.00 per hour {P600,000/600,000 hours) is for budgeted fixed costs.
Total Goods Available for Sale
xx
The balance, Pl. 70 per hour, is for estimated variable costs.
Lese: Finished Goods Inventory, Dec. 31
Cost of Goods Sold xx If the actual direct labor hours worked in a given month are equal to the
tdd: Underapplied Overhead for year xx number of direct labor hours budgeted of 50,000 hours (600,000 ~ours per
oet of Goode sold (adjusted) year + 12 months), the amount of fixed overhead charged to work m proce88
Gross Profit 2! for the month will be exactly equal to the actual fµ<ea <:°a.ts_of P50th000
Operating Expenses incurred in the month (P600,000 + 12 months). However ifit leSB: an
xx
Comprehensive Income 50,000 hours worked during the month, the fixed coS t s a~plied hv:!,!de
....!! · the actual fixed overhead costs, whi
Pxx less than . ch will dremainlied
unc ......-
= at P50,000. Thus, the fixed overhead costs will be un erapp ·

Downloaded by John Frivaldo (johnfrivs03@gmail.com)

 lOMoARcPSD|10895444

.
~21~2~ - ~ - - - - - - - - - - - - ~ - - ~,

. h e more than 50,000 hours of direct lab

On _the other hanhd, h1f tfixer~ :sts will exceed P50,000. In this case t~r
dunng the mont , t e e . ·i1 b d . . ' e
fixed overhead will be overapplied. There · WI e un erap~ 1ied fixed
•h d · f Pl OO £or each hour less than 50,00.0 hours of dir,ect labor
over ea o . f dir t 1 b 50 0
used during the month. For each hour O ec a or o~er , 00 .hours
used during the month, fixed over)iead will be overapplied by PLOO.

This overapplication or underapplication of fixed overhead is due to the

fact that the number .of labor hours actually worked during the month
deviates from the estimated number of labor hours u~ed in computing
the overhead rate. This deviation is called a volume variance or capacity
variance. The remainder of the underapplied or overapplied overhead
represents the amount by which actual expenditures exceed the amount
that should have been spent for .overhead based on the 'number of hours
worked. This amount is called a spending variance or controllable
variance.

The
- Pl00,000 underapplied overhe~d can now be analyzed
.
as follo~s:
Volume Variance:
~ed overhead applied (PLOO x 20,0,000 actual hrs.)
Fu::ed overhead budgeted P200,000
Volume variance (unfavorable) -600,000
Spending Variance: · P400,000
Actuai overhead incurred for month
Budgeted overhead for hours worked· P640,000
Fixed .
ariabl~ (P200,ooo hrs x p 1. 70) P600,000
Spendingvanance (favorable) · 340,000 940,000
Net Variance (unfavorable) 300,000
PlOO,OO__Q
The _variance is unfavorable if the . --
applied to production. On th th ac~ual costs are more than the costs
actual overhead costs are 1 e oher hand, the variance is favorable if the
detailed analysis of varianc::s ;d:~
thd~ costs a~plied to producti_on. The
e iscussed 1n Part II.

Downloaded by John Frivaldo (johnfrivs03@gmail.com)