dinal Factory Overhead

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Factory OverheadFactory OverheadCosting and AccountingCosting and Accounting

Costing and Accounting for ProductCosting and Accounting for Product


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Factory Overhead

Presentation by

Khadijah Waseem

Roma Feroze

Sameena Abid

Samra Khan

Sadaf Siddique

Sundas Kanwal


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Topics to be discussed

Factory Overhead Rate

Plant-wide or Departmental Rates

Departmentalization of Factory Overhead

Selection of Factory Overhead Absorption

Base

Selection of capacity Level Variance Analysis


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Factory Overhead

The sum of all the indirect elements ofcost incurred to manufacture a product

Indirect material+

Indirect labour

+

Other indirect costs

=

Factory Overhead


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Factory Overhead

Also known as:

Factory burden

Manufacturing expense

Manufacturing overhead

Factory expense

Indirect manufacturing cost


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Factory Overhead

Indirect Materials

It is that material which does not form a part ofthe finished product

Examples are coal, lubricating oil, grease, sandpaper, etc

There are some items w

hich

may become apart of the finished products like nuts, screws,bolts etc, but these are still considered indirectmaterials


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Factory Overhead Indirect labour

It is not directly engaged in theproduction operations

They only assist in production operations

Examples are supervisors wages, salary

to clerks, salary to inspectors, peons,watchmen, janitors etc


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Factory Overhead Indirect Costs

All indirect costs, other than indirect materialsand indirect labour, are considered

Indirect expenses like rent, depreciation,lighting, normal spoilage, property taxes,insurance etc


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Computation of the predeterminedfactory overhead rate

FOH rate =

Budgeted total factory overhead .

Budgeted volume of application base

Overhead rates are budgeted; they areOverhead rates are budgeted; they are

estimates. The budgeted rates are used toestimates. The budgeted rates are used to

apply overhead based on actual eventsapply overhead based on actual events


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Factors consideredBase To Be Used

Physical Output - [estimated Factory OH / PO]

Direct materials cost - [estimated Factory OH / DMC]

Direct labor cost - [estimated Factory OH / DLC]

Direct labor hours - [estimated Factory OH / DLH]

Machine hours - [estimated Factory OH / MH]

Activity Level to Use Expected capacity


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The result is the Overhead Absorption Rate

Divide the estimated overhead by the base

Identify the estimated overhead and baseIdentify the estimated overhead and base

Calculation of FOH Rate


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It would be easier to see it with figuresIt would be easier to see it with figures

So the overhead rate would be Rs. 10/hSo the overhead rate would be Rs. 10/h

FOH rate = 10,000 = Rs.10 per labour hour1,000

If we have an overhead cost ofRs. 10,000 andan overhead base of1,000 labor hours, wewould divide 10,000 by 1,000 to get an overhead

absorption rate of Rs. 10 per labour hour

Example


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Plantwide Rate It means a single factory overheadabsorption rate established for entirefactory

Formula:

Total estimated FOH

Total Estimated Base


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Example

Plantwide Rate = 120,000 = Rs.2 per Hour

60,000

Dept 1 (Rs.) Dept 2 (Rs.) Dept 3(Rs.) Total

EstimatedFOH

20,000 40,000 60,000 120,000

EstimatedDLH

20,000 20,000 20,000 60,000


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Departmental Rate

It means a separate factory overhead

absorption rate for all departmentsthrough which the product passes

Formula =Estimated Departmental FOH

Estimated Base


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Example

Departmental Rate

For department 1 = 20,000 = Rs.1 per Hour

20,000


20,000


20,000

Dept 1 (Rs.) Dept 2 (Rs.) Dept 3 (Rs.) Total

EstimatedFOH

20,000 40,000 60,000 120,000

EstimatedDLH

20,000 20,000 20,000 60,000


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Product ZProduct ZProduct XProduct X

DepartmentB

DepartmentCDepartmentA

Product YProduct Y

Departmental RateDepartmental Rate


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DepartmentalizationIt is the process of determining the factory overhead cost

of each department involved in production

Production Departments

Production Departments

are directly involved inmanufacturing of productslike

o Cutting

o Stitchingo finishing and packing of

departments of agarment factory

Service Departments

Service Departments are

not directly involved inmanufacturing ofproducts but provideservices to supportoperations in productiondepartments like

o repair andmaintenance

o Purchasing

o storeroom etc


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Stages ofDepartmentalization

It involves the following two stages:

Stage 1Stage 1

Stage 2Stage 2

Allocation of Direct Departmental FOHAllocation of Direct Departmental FOH

Apportionment ofIndirect DepartmentalApportionment ofIndirect Departmental

FOHFOH


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Allocation of Direct Departmental FOH meansAllocation of Direct Departmental FOH means

to allocate items ofFOH to a particularto allocate items ofFOH to a particulardepartment by directly identifying themdepartment by directly identifying them

Departmental costs are directly allocated toDepartmental costs are directly allocated torelevant departmentsrelevant departments

It involves:It involves:

oo Indirect materialsIndirect materials

oo Overtime premiumsOvertime premiums

oo Depreciation of plant & machineryDepreciation of plant & mac

hinery

Allocation of Direct DepartmentalAllocation of Direct Departmental

FOHFOH

Stage 1Stage 1


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Apportionment of IndirectApportionment of IndirectDepartmental FOHDepartmental FOH

Here, the cost is distributedHere, the cost is distributedamong the departmentsamong the departmentsaccording to the estimatedaccording to the estimatedvalue of resources consumedvalue of resources consumedby each departmentby each department

Stage 2Stage 2


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Types of Secondary apportionment

ReciprocalReciprocalapportionmentapportionmentoo The secondaryThe secondary

apportionment in such aapportionment in such a

a way thata way thatinterdependence amonginterdependence amongservice departments isservice departments isrecognized while prorecognized while pro--rating the costsrating the costs

oo There are two methodsThere are two methodsemployed for reciprocalemployed for reciprocal

apportionmentapportionmenti.i. Repeated apportionmentRepeated apportionment

methodmethod

ii.ii. Algebraic methodAlgebraic method

NonNon--ReciprocalReciprocalapportionmentapportionment

The secondary apportionment inThe secondary apportionment in

such a a way that once cost of asuch a a way that once cost of aservice department has beenservice department has beenapportioned, cost of no otherapportioned, cost of no otherdepartment is the apportioned todepartment is the apportioned toitit

It has the following two forms:It has the following two forms:

i.i. Cost of service departmentsCost of service departments

are apportioned to serviceare apportioned to servicedepartments onlydepartments only

ii.ii. Cost of service departmentsCost of service departmentsare apportioned toare apportioned toproduction as well as serviceproduction as well as servicedepartmentsdepartments


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After preparing estimates of factory overhead forproduction departments, the next step is to select afactory overhead absorption base for each production

department

The most simple and direct measure of activity of amanufacturing concern is number of units produced

In process costing industries like sugar, cement etc.Kg. or a bag may be regarded as unit of output; abottler may use a bottle or a liter as a unit of output.

SELECTION OF FACTORY OVERHEADSELECTION OF FACTORY OVERHEADABSORPTION BASEABSORPTION BASE


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Example

In job costing industries each unit of output isquite different from the other.For example, a furniture manufacturer produces

o chairso tables

o beds and many other items, each according tospecifications of customers.

In such a situation because of the dissimilarities, aunit of output can neither be used to measure the activity

nor as base for factory overhead absorption.Therefore, some other common denominator

should be adopted to measure the activity and as base forapplying factory overhead to the products


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DIRECT LABOUR COSTTotal amount required to pay workers and employees during aweek, month or other period

DIRECT LABOUR HOURSDirect labor hours worked by all mining employees at a mining

operation during the year. Includes hours worked by thoseemployees engaged in production, preparation, development,maintenance, repair, shop or yard work management, andtechnical or engineering work. Excludes office workers. Excludesvacation and leave hours

MACHINE HOURSOne machine working for one hour. In cost accounting, machinehour (and not the labor hour) is used for applying overheadcosts to work-in-process inventory in mechanized production


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DIRECT MATERIAL COSTPart of raw material cost that can be specificallyand consistently associated with or assigned to

the manufacture of a product, a particular workorder, or provision of a service

PRIME COSTTotal of direct material costs and direct laborcosts


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Selection of Capacity Level

Capacity Level means ability to produce

Industries producing homogeneous products mayexpress their capacity level in terms ofunits ofproduction

To calculate estimated FOH, its necessay to select

an appropriate capacity level at which the cost andthe cost deriver should be estimated


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Types of Capacity Levels

Theoretical CapacityTheoretical Capacity

It is the maximum capacity level attained if there wereIt is the maximum capacity level attained if there were

100% utilization of time, which is impossible. It is the starting100% utilization of time, which is impossible. It is the startingpoint of measurement of practical capacitypoint of measurement of practical capacity

Practical CapacityPractical CapacityIt is the maximum activity level attained under efficientIt is the maximum activity level attained under efficient

working conditionsworking conditions

Expected Actual CapacityExpected Actual Capacity

IIt is the expected activity level to be attained during ant is t

he expected activity level to be attained during anaccounting yearaccounting year

Normal CapacityNormal Capacity

IIt is the average of the expected actual capacity over at is the average of the expected actual capacity over anumber of yearsnumber of years


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Variance Analysis

Variance is the difference between an actualVariance is the difference between an actualFOH and an expected FOHFOH and an expected FOH

The process by which the total differenceThe process by which the total differencebetween standard and actual results isbetween standard and actual results isanalyzed is known as variance analysisanalyzed is known as variance analysis

When actual results are better than the expectedWhen actual results are better than the expectedresults, we have a favorable variance (F).results, we have a favorable variance (F).

If, on the other hand, actual results areIf, on the other hand, actual results areworse than expected results, we have anworse than expected results, we have anadverse (A)adverse (A)


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Favourable/Unfavourable VarianceFavourable/Unfavourable Variance


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Budget VarianceBudget Variance

Flexible budgets are primarily designed to assistFlexible budgets are primarily designed to assist

planning and control rather than product costingplanning and control rather than product costing

Budget variances measure components ofBudget variances measure components of

the differences between actual amounts and thethe differences between actual amounts and the

flexibleflexible--budget amounts for the output achievedbudget amounts for the output achieved


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Remember that overhead absorption rateRemember that overhead absorption rate ==

Budgeted fixed productionOverheadBudgeted fixed productionOverheadBudgeted level of activityBudgeted level of activity

Capacity VarianceCapacity Variance

It is the difference between the capacity estimated orIt is the difference between the capacity estimated or

actually achievedactually achieved


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Got Questions?


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Thats all

Thanks!

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