Accounting For Factory Overhead
Accounting For Factory Overhead
Accounting For Factory Overhead
Service or support department is a unit in an organization that contributes in a very indirect way to the conversion of raw materials
in a finished product. These units are the purchasing, personnel, warehousing and maintenance department. Since these departments support
the production department, the costs incurred must be allocated to production departments to determine the full costs of a product.
NOTES:
1. Using the step-down method, if the problem is silent, allocate first the department that serves the most number of departments, if
applicable.
2. If No.1 is not applicable, allocate first the service department that has the highest cost.
Illustration:
The RESA Cinema has two service departments (Uberita and Dayag) and two producing departments (P1 and P2).
Required: Compute the allocated cost to departments P1 and P2 using the following method:
1. Direct method
2. Step-down method (cost of department Uberita is allocated first)
3. Step-down method (cost of department Dayag is allocated first)
4. Reciprocal method
Activity-Based Costing (ABC) – is a systematic costing method that uses activities to allocate factory overhead costs and other indirect
costs to products. ABC can provide more accurate data on product cost by using multiple cost drivers that reflect more accurately the causes
of incurred costs.
In summary, ABC is a ‘two-stage’ allocation process. First, overhead costs are traced to activities; then, overhead costs are
allocated to products on the basis of the activities performed by a particular product.
ACTIVITY-BASED MANAGEMENT (ABM) integrates ABC with other concepts such as Total Quality Management (TQM) and target
costing to produce a management system that strives for excellence through cost reduction (e.g., eliminating non value-added activities) and
continuous process improvement.
EXERCISES
Required: Categorize each of the activities as either value-added or non-value-added for the companies noted.
Determine the appropriate level for each of the following activities. Indicate whether the activity is unit-level (UL), batch-level (BL),
product-level (PL), facility-level (FL):
1. Equipment set-ups 9. Machine hours
2. Plant supervision and landscaping 10. Indirect materials
3. Prime cost 11. Safety costs at winery
4. Packaging and shipment 12. Truckload shipping costs
5. Advertising 13. Building maintenance costs
6. Heating, lighting and security 14. Bottle and cork cost
7. Designing and changing 15. Development cost of new, after-dinner wine
8. Product order processing 16. Tasting and testing costs
Adventure Company has identified activity centers to which overhead costs are assigned. The cost pool amounts for these centers and their
selected activity drivers for 2015 are as follows:
PRODUCTS
Finn Jake Ice King
Direct costs P 80,000 P 80,000 P 90,000
Machine hours 30,000 10,000 20,000
Number of setups 130 380 270
Pounds of materials 500,000 300,000 800,000
Number of units produced 40,000 20,000 60,000
Direct labor hours 32,000 18,000 50,000
Required:
1. Determine the pool rates
2. Allocate the overhead using the pool rates determined above
3. Determine the total cost of the job
Company incurs P800,000 in manufacturing overhead costs. The company has been allocating
Hercules
overhead to individual product lines based on direct labor hours.
Cost Driver Amount in Cost Pool Amount of Activity
Direct labor hours P 300,000 40,000
Number of batches 300,000 1,000
Number of shipments 200,000 500
Total overhead costs P 800,000
V. Activity-Based Costing
Hawk Construction manufactures and installs standard and custom-made cabinetry for residential homes.
Last year, the company incurred P200,000 in overhead costs. After implementing activity-based costing
(ABC), the company’s accountant identified the following information:
Activity Allocation Base Proportion of Overhead Cost
Materials delivery & handling Number of deliveries 30%
Inspections Number of inspections 25%
Supervision Hours of supervisor time 20%
Purchasing Number of purchase orders 25%
During the past year, Hawk accepted a customer order for a set of custom-made cabinets that would require the following:
Direct labor cost (25 hours at P15 per hour) P 375
Direct materials (wood) (900 ft at P3 per foot) P 2,700
Number of deliveries 3
Number of inspections 5
Hours of supervisor time 5
Number of purchase orders 3
Questions:
1. How much overhead should be applied to the above customer order?
2. What is the total product (manufacturing) cost for the above customer order?
SOLUTION:
Application rates:
Materials & delivery handling: P60,000 ÷ 300 deliveries = P200/delivery
Inspections: P50,000 ÷ 1,000 inspections = P50/inspection
Supervision: P40,000 ÷ 4,000 supervision hours = P10/hour
Purchasing: P50,000 ÷ 2,000 purchase orders = P25/order
1. The direct method of allocating service department costs ignores all of the interactions between service departments.
2. Which of the following methods of allocating the costs of service departments provides the broadest recognition of department
served?
a. Reciprocal allocation b. Step-down allocation c. Direct allocation d. Arbitrary allocation
4. ABC can be applied to manufacturing overheads only; it is not applicable to selling and administrative overheads.
6. Move time and storage time are examples of non-value-added costs that can be eliminated without deterioration of product quality,
performance or perceived value to the customers.
7. A tool that focuses on manufacturing process and seeks to reduce or optimize the activities performed within the process is
a. Process value analysis b. Re-engineering c. Benchmarking d. Answer not given
11. Which of the following is typically regarded as a cost driver in traditional costing practices?
a. Number of purchase order processed c. Number of transactions processed
b. Number of customers served d. Number of direct labor hours worked
12. ABC
a. requires the identification of cost drivers
b. is used only in JIT operations
c. applied only to discretionary fixed costs
d. does not help identify activities as value-adding or non-value-adding
17. Cadott Manufacturing produces three products. Production and cost information show the following:
Model X Model Y Model Z
Units produced 1,000 3,000 6,000
Direct labor hours 2,000 1,000 2,000
Number of inspections 20 30 50
Inspection costs totaled P50,000. Using direct labor hours as the allocation base, inspection costs allocated to each unit of Model X
would be
a. P5.00 b. P10.00 c. P20.00 d. Some other amount
18. Using the same data in No. 17, inspection costs allocated to each unit of Model Y using ABC would be:
a. P3.33 b. P5.00 c. P10.00 d. Some other amount
19. Genco manufactures two versions of a product. Production and cost information show the following:
Model A Model B
Units produced 100 200
Material moves 10 40
DL hours per unit 1 3
Material handling costs total P100,000. DL hours are used to allocate overhead costs. The material handling costs allocated to each
unit of Model A would be:
a. P143 b. P200 c. P333 d. Some other amount
20. Using the same data in No. 19, the material handling costs allocated to each unit of Model B using ABC would be:
a. P200 b. P333 c. P400 d. Some other amount
21. Waupaca Company produces three products with the following production and cost data:
Model A Model B Model C
Units produced 2,000 6,000 12,000
DL hours (total) 4,000 2,000 4,000
Number of setups 100 150 250
Number of shipments 200 225 275
Engineering change orders 15 10 5
Overhead costs include setups P45,000; shipping costs P70,000; and engineering costs P90,000. What would be the per unit
overhead cost for Model B if ABC were used?
a. P11.00 b. P33.00 c. P61.50 d. Some other amount
22. Kimball Company produces two products in a single factory. The following production and cost information has been determined:
Model 1 Model 2
Units produced 10,000 2,000
Material moves (total) 100 40
Testing time (total) 250 125
DL hours per unit 1 5
The controller has determined total overhead to be P480,000. P120,000 relates to material moves; P150,000 relates to testing; the
remainder is related to labor time. If Kimball uses DL hours to allocate overhead to each model, what would overhead per unit be
for Model 1?
a. P1.00 b. P12.00 c. P24.00 d. P40.00
SOLUTIONS:
21. [(P45,000 x 150/500) / 6,000] + [(P70,000 x 225/700) / 6,000] + [(P90,000 x 10/30) / 6,000] = P11.00
22. P480,000 / [(10,000 x 1) + (2,000 x 5)] = P24