1. Principles of Cost Accounting, 16th Edition, Edward J
Principles of Cost Accounting, 16th Edition, Edward J. VanDerbeck, ©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

2. Chapter 4
Accounting for Factory Overhead

3. Learning Objectives Identify cost behavior patterns.
Separate semivariable costs into variable and fixed components.
Prepare a budget for factory overhead costs.
Account for actual factory overhead.

4. Learning Objectives (cont.)
Distribute service department factory overhead costs to production departments.
Apply factory overhead using predetermined rates.
Account for actual and applied factory overhead.

5. Factory Overhead
Overhead costs are a very big deal costing companies, large and small, thousands of dollars each year.
It must be allocated in a rational way to all jobs produced during the period.
All costs incurred in the factory that are not chargeable directly to the finished product are called factory overhead.

6. Factory Overhead Factory Overhead includes:
(1) indirect materials consumed in the factory, such as glue and nails in the production of wooden furniture and oil used for maintaining factory equipment.
(2) indirect factory labor, such as wages of janitors, forklift operators and supervisors, and overtime premiums paid to all factory workers.

7. Factory Overhead (cont.)
(3) all other indirect manufacturing expenses, such as insurance, property taxes, and depreciation on the factory building and equipment.

8. Cost Behavior Patterns
Variable costs are costs that vary in direct proportion to volume changes.
Fixed costs are costs that remain the same in total, when production levels increase or decrease.
Semivariable costs have characteristics of both variable and fixed costs.

9. Cost Behavior Patterns

10. Analyzing Semivariable Factory Overhead Costs
Observation Method relies heavily on the ability of an observer to detect a pattern of cost behavior by reviewing past cost and volume data.
High-Low Method compares a high production volume and its related cost to a low production volume with its related cost.

11. Analyzing Semivariable Factory Overhead Costs
Scattergraph method estimates a straight line along which the semivariable costs will fall.

12. Analyzing Semivariable Factory Overhead Costs
The high-low and statistical scattergraph methods use historical cost patterns to predict future costs and are, therefore subject to limitations that apply to all forecasting techniques.
Statistical software packages are often used to analyze semivariable factory overhead.

13. Analyzing Semivariable Factory Overhead Costs
Least-squares regression method uses all of the data to separate a semivariable cost into its fixed and variable elements based on the equation for a straight line:
Y = a + bX, where:
X = activity level
Y = the total semivarible cost
a = the total fixed cost
b = the variable cost per unit

14. Analyzing Semivariable Factory Overhead Costs

15. Budgeting Factory Overhead Costs
Budgets are management’s operating plans expressed in quantitative terms, such as units of production and related costs.
The segregation of fixed and variable cost components permits the company to prepare a flexible budget. A flexible budget is a budget that shows estimated costs at different production volumes.

16. Accounting for Actual Factory Overhead
Cost accounting systems are designed to accumulate, classify, and summarize the factory overhead costs actually incurred.

17. Schedule of Fixed Costs

18. Summary of Factory Overhead

19. Distributing Service Department Expenses
Departments are divided into two classes: service departments and production departments.
A service department is an essential part of the organization, but it does not work directly on the product.
A production department performs the actual manufacturing operations that physically change the units being processed.

20. Distributing Service Department Expenses
Direct Distribution Method
Sequential Distribution or Step-Down Method
Reciprocal Method

21. Direct Distribution Method

22. Sequential Distribution Method

23. Applying Factory Overhead to Production
Predetermined factory overhead rates are computed by dividing the budgeted factory overhead cost by the budgeted production.
The budgeted production may be expressed in such terms as machine hours, direct labor hours, direct labor cost, and units produced.
Management should give a high priority to attaining the most accurate predetermined factory overhead rate.

24. Applying Factory Overhead to Production
Direct Labor Cost Method
Direct Labor Hour Method
Machine Hour Method
Activity-based Costing Method

25. Accounting for Actual and Applied Factory Overhead
Entry to apply estimated FOH to production:
Work in Process XXX
Applied Factory Overhead XXX

26. Accounting for Actual and Applied Factory Overhead
At the end of the period, the applied factory overhead account is closed to the FOH control account:
Applied Factory Overhead XXX
Factory Overhead XXX

27. Under and Over applied Factory Overhead
The debit balance indicates that the factory overhead costs were underapplied or underabsorbed.
The credit balance indicated that the factory overhead costs were overapplied or overabsorbed.

28. Under and Over applied Factory Overhead
At the end of the year, the balance of the under and overapplied account will be closed to Cost of Goods Sold, or allocated on a pro rata basis to Work in Process, Finished Goods, and Cost of Goods Sold.

29. Period and Product Cost
Period cost
Costs that directly reduce net income for the current period.
Product Cost
Costs that are included as part of the inventories and expensed when the goods are sold.