mse608c – engineering and financial cost analysis calculating and accounting for overhead
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MSE608C – Engineering and Financial Cost Analysis
Calculating and Accounting for Overhead
Overhead Costs• Overhead manufacturing costs are expenses that
are difficult or too costly to assign directly to product.
• The method for allocating Overhead must be:– Rational– Able to identify a cause/effect relationship between costs and
products– Applied consistently– Fair to responsible managers– Based on timely cost data– Based on accepted cost accounting rules and procedures.
Calculating the Overhead Rate
• When measuring and allocating Overhead there are three decisions that must be made by the Cost Accountant.1. What costs become Overhead?
2. What will be the Cost-allocation base?
3. What will be the Overhead Rate?
• Different choices will result in different costs.
Calculating the Overhead Rate
1. What items become Overhead?– Identify the Prime Costs (Direct Labor and Direct Material); – all other Manufacturing costs will become Overhead.– Apply the Materiality concept.
2. What will be the Cost-allocation base?– Direct-labor hours– Direct-labor dollars– Material-dollars– Machine-hours– Units of Production
Calculating the Overhead Rate
3. What will be the Overhead (Burden) Rate?Step 1. Budget Overhead for the next accounting period
Step 2. Budget cost-allocation base for the accounting period.
Step 3. Calculate the applied Overhead Rate.
Total Overhead Costs
Overhead Rate = Total Cost-allocation base
Over-absorbed and Under-absorbed Overhead
• There is little chance the actual amount of Overhead incurred will equal the amount applied!– Applied Overhead was based on both budgeted overhead costs and
budgeted utilization of the cost-allocation base.
• Under-absorbed Overhead– The amount applied is less than the actual amount spent on
Overhead during the accounting period.
• Over-absorbed Overhead– The amount applied is more than the actual amount spent on
Overhead during the accounting period.
The Overhead Variance Account
• In the Journal there is a special account called Overhead Variance.
• A credit variance = Over-absorbed Overhead• A debit variance = Under-absorbed Overhead
Overhead Variance
Actual Overhead Expenses
(Debit)Applied Overhead
(Credit)
Journal Entries for Incurring Overhead
Indirect Wages Payable
$100
Allowance forDepreciation
$200
Production Supplies
$50
Factory Utilities
$150
Overhead Variance
$100
Finished GoodsInventory
In-ProcessInventory
Cost-of-Goods-Sold$200
$50
$150
Allocating Overhead
Indirect Wages Payable
$100
Allowance forDepreciation
$200
Production Supplies
$50
Factory Utilities
$150
Overhead Variance
$100
Finished GoodsInventory
$350
In-ProcessInventory
$75$225 $50
Cost-of-Goods-Sold$200
$50
$150 $225
$350
$350
$350
Direct Labor
$75
Raw Material Inv.
$$$$$ $50
$$$$$
Wages Payable
$$$$$
Accounts Payable
$$$$$
Overhead Allocation Methods
Full-absorption Costing– Allocates VARIABLE and FIXED Overhead costs.
• Variable Costing– Allocates only VARIABLE Overhead costs.
• Activity Based Costing (ABC)– Allocates overhead costs to the products that use them.
Only useful when multiple products are manufactured in the same facility.
Assessment
• What is Overhead and why do we have to allocate it?
• Define Under-absorbed Overhead? Define Over-absorbed Overhead?
• Which is the only allowable method for reporting Overhead on financial reports, Full or Variable Absorption?