Factory Overhead: Practical Problems and Solutions

Factory Overhead Application Methods Problem 1 IQIZ estimated its factory overhead for the next period at $160,000. It is estimated that 40,000 units will be produced at a materials cost of $200,000. Production will require 40,000 man-hours at an estimated wage cost of $80,000. The machines will run for approximately 25,000 hours. Required: Calculate the factory overhead rate that may be used in a…

Read more

Important Techniques of Factory Overhead Costing

Factory Overhead Absorption Methods/Methods for FOH Application 1. Direct Material Cost Basis Direct material cost basis = (Estimated FOH for the period / Estimated D.M. cost) x 100 2. D.L. Cost Basis D.L. Hours Basis = (Estimated FOH for the period / Estimated D.L. Cost) x 100 3. D.L. Hours Basis (Estimated FOH for the period / Estimated D.L. hours) = Per D.L. hour 4. Machine Hours Basis (Estimat…

Read more

Predetermined Overhead Rate

Predetermined Overhead Rate: Definition A predetermined overhead rate is an allocation rate given for indirect manufacturing costs that are involved in the production of a product (or several products). It is used to estimate future manufacturing costs. The estimate is made at the beginning of an accounting period, before the commencement of any projects or specific jobs for which the rate is need…

Read more

Calculating the Machine Hour Rate

What Is Machine Hour Rate? A machine hour rate is the hourly cost in terms of factory overheads to operate a particular machine. It is obtained by dividing the factory expenses associated with the machine for a given period by the number of hours worked by the machine during that period. In Thothadri, Nafeesa, and Jalalutheen’s seminal 2019 book entitled Cost Accounting, the machine hour rate is d…

Read more

Blanket Absorption Rate and Departmental Absorption Rate

Blanket Absorption Rate Blanket absorption rate is used in relation to the recovery or absorption of overheads. For ease and simplicity, a common absorption rate for overheads may be used across a factory for all jobs and units of production, irrespective of the department in which they were produced. This is known as the blanket absorption rate. A common absorption rate is not appropriate when a…

Read more

Methods of Factory Overhead Absorption

These methods apply to absorbing the factory overhead: (1) Units of Output Method Absorption of the factory overhead occurs based on the number of units manufactured. Dividing the overhead expenses by the number of units of output obtains the overhead rate. Formula Overhead rate = factory overhead of the department / number of units of output. Example If the factory overhead for department ‘A’ for…

Read more

Actual Overhead Rate and Pre-Determined Overhead Rate

Overhead rates that are established for the absorption of overheads may be divided into two parts: Actual Overhead Rate Pre-Determined Overhead Rate 1. Actual Overhead Rate The actual overhead rate is based on the actual amount of overhead to be absorbed and the actual quantum or value of the base selected (e.g., direct wages, cost of materials, machine hours, direct labor hours, etc.). The actual…

Read more

Under-absorption and Over-absorption of Overheads

What is Under-absorption and Over-absorption of Overheads? Where the absorption of overheads is made using a rate based on actual data, the overhead absorbed must be equal to the actual overhead incurred. But where a pre-determined rate is used, there is generally a difference between the overhead absorbed and the overhead incurred. If the absorbed amount is less than the actual overhead, there is…

Read more

Selling and Distribution Overheads

Selling and Distribution Overheads: Definition According to the terminology adopted by the Institute of Cost and Management Accountants in England, selling overheads refer to “the cost incurred in promoting sales and retaining customers.” Additionally, distribution overheads are “the cost of the process which begins with making the packed product available for despatch and ends with making the rec…

Read more

Administrative Overheads

It is common practice to classify and separately collect production, administrative, selling, and distribution costs. Administrative overheads are related to office expenses. By contrast, selling and distribution expenses are related to marketing. All these expenses combined give the total selling cost. In accounting for the production overheads and valuing closing stock, no administrative, sellin…

Read more