Accounts Receivable and Inventory Management

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Foundation University

Masters in Business Administration

MBA 06a
Managerial Accounting

Report on

Factory Overhead: Actual, Planned and Applied

Submitted to:

Engr. Marlon Tanilon

Submitted by:

Hazel R. Tanilon

04 February 2012

Factory Overhead
• Defined as indirect material, indirect labor and other that cannot be conveniently identified with or charged directly to specific jobs, products, or other final cost objects. • Other Terminologies:

▪ Factory Burden
▪ Manufacturing Expenses
▪ Manufacturing Overhead
▪ Factory Expense
▪ Indirect Manufacturing Cost

Nature of Factory Overhead

❖ Characteristics of Factory Overhead

▪ Related to the product. Overhead is invisible part of the finished product. Yet overhead is as much a part of a product’s manufacturing cost as direct materials and direct labor. ▪ Related to the volume of production. Overhead can be fixed, variable and semi variable. As volume changes, the different overhead cost behavior patterns cause per-unit manufacturing cost to fluctuate considerably. As a result, some method is needed to determine an amount of overhead charged to the units produced.

❖ Use of a Predetermined Overhead Rate

▪ Because of the impossibility of tracing overhead to specific jobs or specific products, overhead cost is allocated across jobs and units. ▪ A predetermined overhead rate permits a consistent and logical allocation to each unit of output ▪ It serves management’s needs for product cost information, to identify inefficiencies, and to smooth out the illogical month-to-month fluctuations that would otherwise appear in reported unit costs.

Factors Considered in Selecting Overhead Rates

• Based to Be Used
• Ordinarily the base should be closely related to functions represented by the overhead cost being applied. If overhead is mostly labor (cost of supervision and fringe benefits), then the proper base is probably direct labor cost or direct labor hours. • When two or more bases result in approximately the same applied factory overhead cost for each job or product, the simplest, most easily measured base should be used.

• Physical Output -
• simplest base for applying factory overhead • Estimated Factory OH/physical output

Example:
If estimated Factory overhead is P300,000 and the company intends to produce 250,000 units during the next period, then the FOH per unit is P1.2(P300,000/250,000 units). Then an order with 1,000 completed units, is charged 1,000*1.2= P1,200.00 Factory Overhead Cost.

• Direct Material Cost Base -
• In some companies, a study of past reveals a high correlation between materials cost and overhead. • The material cost base is of limited use, because in most cases no logical relationship exist between the direct materials cost of a product and the use or creation of factory overhead in its production. • Estimated Factory OH/ DMC

Example:

If estimated Factory overhead totals P300,000 and estimated materials cost P250,000, then the FOH rate is P300,000/P250,000 = 1.2 or 120% of its direct materials cost.So, if the materials cost for an order is P5,000.00, Factory Overhead charged to the order be P5,000 x 1.2 = P 6,000.00.

• Direct Labor Cost base
• This method’s use is logical...
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