Elements of Cost - Factory Overhead

THE ELEMENTS OF COSTS
–
FACTORY OVERHEAD
Nature of Manufacturing Overhead
 Manufacturing overhead costs are generally defined as those costs that

are not conveniently identified with particular orders 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.
Types of Manufacturing Overhead
Costs
 Since manufacturing costs are common to all products manufactured, they
are allocated to production after certain assumptions have been made.
 The following is a partial listing of the most common costs in a typical
factory operation :
Indirect Materials
Factory supplies
Lubricants
Cleaning supplies
Small tools
Packaging materials
Other items used in small amounts in manufacturing
Indirect Labor
Factory payroll clerks

Receiving clerks
Storeroom clerks
Storeroom supervisors
Purchasing clerks
Overtime premium (unless the time is identified with a specific job)
Other Manufacturing Overhead
Employee fringe benefits

Employer contributions
Worker’s compensation insurance
Factory utilities
Rent of factory building, warehouse and equipment
Depreciation of factory building and equipment
Property taxes
Group health insurance for factory employees
Fire Insurance
Repairs and maintainance
Inventory shortage
Spoiled goods
Control of Manufacturing Overhead
 Of the three elements of costs, manufacturing overhead costs require the

most extensive study because they represent the most difficult problem in
accounting.
Charging Manufacturing Overhead
to Production
 Under actual costing manufacturing overhead cost is charged to
production at an arbitrary manufacturing overhead costs using an arbitrary
overhead application rate determined at the end of the period.
 The procedure is inconvenient on the part of the management, because
complete costing of jobs finished during the period will have to be deferred
until the end of the period. For this reason, actual costing is not widely used
in practice.
 To avoid delay in the costing of jobs as experience in actual costing, most
companies use the normal costing. The essence of normal costing is that it
uses a predetermined overhead rate to allocated manufacturing overhead
costs to jobs.
Purpose of Overhead Rates
While materials and labor costs can be determined as soon as the job is
finished, the manufacturing overhead costs are not readily available.
Accordingly, predetermined overhead rate are used to estimate the
manufacturing costs.
Determining the Overhead Rate
 A predetermined overhead rate is simply a rate calculated at the

beginning of a period, usually a year.
 This rate is computed by the preparation of a manufacturing overhead
budget based on a certain activity level.
 This budgeted manufacturing overhead is then divided by the estimated
amount or quantity, such as direct labor costs, direct labor hours, machine
hours, or some other basis for the same activity level. The ratio is usually
called the overhead application rate.
 Once the overhead application rate has been determined, the overhead
on each job is estimated by determining the actual base selected on the
job and applying the rate.
Types of Overhead Rate Bases
 The primary purpose of using a predetermined overhead rate is to charge a

fair share of overhead costs to each job.
 A number of bases for determining overhead rate may be used to
compute an overhead application rate.
Common Bases are as follows
Direct labor costs
Direct labor hours
Direct material costs
Machine hours
Units of production
Direct Labor Cost Basis
 This method is widely used and 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 dividing the estimate manufacturing costs
by the estimated direct labor costs. The calculation results in the percentage of direct
labor costs.
Estimate Manufacturing Overhead Costs = Percentage of Direct Labor Cost

Estimated Direct Labor Costs
The direct labor cost basis is usually used in cases where the
manufacturing overhead costs vary with direct labor costs.
Direct Labor Hour Basis
 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 labor hours is computed as
follows:
Estimated Manufacturing Overhead Costs = Rate per Direct

Labor Hour
Estimated Direct Labor Hours
The direct labor hours basis is appropriate when there is a

correlation between total manufacturing overhead costs and
the number of direct labor hours.
Direct Material Cost Basis
 Overhead may be applied on the basis of direct materials used to product the product.
 The estimated manufacturing overhead costs are divided by the estimated direct material cost
to compute the percentage of material costs to be applied as overhead as follows:
Estimated Manufacturing Overhead Costs = Percentage of Materials Cost

Estimated Direct Materials Costs
To use materials costs as a base, each product manufactured must require

approximately the same amount of materials, or material usage must be
distributed uniformly throughout the manufacturing process.
Machine Hours Basis
 Overhead may be applied as a rate for each machine hour when work is
performed principally by machines.
 To determine the overhead application rate, divide the estimated number of
machine hours as follows:
Estimated Manufacturing Overhead Costs = Rate per Machine Hours

Estimated Machine Hours
This basis is usually used in automated factory where machines perform most of the
work and item goes through a similar sequence of machines. However a machine
hour is not appropriate if different kind of machines are used for various products
Units of Production Basis
Overhead may be applied on the basis of the number of units manufactured during the
period.
To compute the overhead costs to be applied to each unit of production, the estimated
manufacturing overhead costs are divided by the estimated total number of units of
production as shown below:
Estimated Manufacturing Overhead Costs = Overhead Cost per unit

of Production
Estimated Units of Production
The units of production have limited uses. This rate is used only if the
manufacturing process is a simple one and only if one type, or a few
similar types, of products are produced.
Assignment
Assume the following budgeted data for the year :
Manufacturing overhead costs P96,000
Number of units of production 24,000 units
Direct material costs P480,000
Machine hours 12,000 hours
Direct labor hours 40,000 hours
Direct labor costs P200,000
Compute for the overhead rate using the
1. Direct labor cost basis
2. Direct Labor Hour Basis
3. Direct Material Cost Basis
4. Machine Hours Basis
5. Units of Production Basis
Selecting the Overhead Basis
The overhead rate basis selected by a company will depend on many factors,
such as the type of goods produced, amount of machinery employed, type of
labor used, wage rates paid, and the cost and time involved in collecting the
necessary data.
The following principles should be observed in selecting a basis
 The rate can be easily computed
 The factor chosen as the basis must be the one that can easily be
measured on each job
 The amount of overhead costs incurred must have some direct relationship
with the base selected

Elements of Cost - Factory Overhead

Uploaded by

Copyright:

Available Formats

Elements of Cost - Factory Overhead

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Elements of Cost - Factory Overhead

Uploaded by

Copyright:

Available Formats

THE ELEMENTS OF COSTS

 Manufacturing overhead costs are generally defined as those costs that

Factory payroll clerks

Employee fringe benefits

 Of the three elements of costs, manufacturing overhead costs require the

 A predetermined overhead rate is simply a rate calculated at the

 The primary purpose of using a predetermined overhead rate is to charge a

Estimate Manufacturing Overhead Costs = Percentage of Direct Labor Cost

Estimated Manufacturing Overhead Costs = Rate per Direct

The direct labor hours basis is appropriate when there is a

Estimated Manufacturing Overhead Costs = Percentage of Materials Cost

To use materials costs as a base, each product manufactured must require

Estimated Manufacturing Overhead Costs = Rate per Machine Hours

Estimated Manufacturing Overhead Costs = Overhead Cost per unit

You might also like