Absorption C 5

Controllership
WEEK 4
(Class 8)
Prof. Bianca Quirantes Checon

CLASS 8 (AUG 25)
Absorption costing: manufacturing overhead (part I)
ASSIGNING MANUFACTURING
OVERHEAD TO PRODUCTS/SERVICES
Part I: Plantwide overhead rate, and under/(over)applied overhead.
Production flow and cost assigning
(absorption costing)
Work in process inventory

(production ends)
Direct materials +
(consumed)
Direct labor
+ + Finished goods inventory
Manufacturing overhead (goods are sold)
+ Cost of Goods Sold

(+ revenue)

(production ends)
Direct materials +
(consumed)
Direct labor
Total manufacturing costs + Cost of Goods Sold

(+ revenue)

(production ends)
Direct materials +
(consumed)
Direct labor

(fixed + variable)
+ Cost of Goods Sold

(+ revenue)
How to assign it to
different products?
Example: brigadeiro recipe
Instructions:
“(1) In a small sauce pan, mix the sweet condensed milk, the cocoa
powder, the salt and the butter.
Bring the sauce pan to the stove and heat it over medium-low heat.
(2) Cook it, mixing constantly (this is important, otherwise it will
burn!) until it thickens. A way to know is to run your wooden spoon
(or spatula) in the middle of the mixture. If it takes a while for the
mixture to move, then your brigadeiro is ready!”
Olivia’s Cuisine (2014)

Example: brigadeiro recipe
Instructions:
“(1) In a small sauce pan, mix the sweet condensed milk, the cocoa
powder, the salt and the butter.
Bring the sauce pan to the stove and heat it over medium-low heat.
(2) Cook it, mixing constantly (this is important, otherwise it will
burn!) until it thickens. A way to know is to run your wooden spoon
(or spatula) in the middle of the mixture. If it takes a while for the
mixture to move, then your brigadeiro is ready!”
If we start to produce both brownies and brigadeiros, how can

we allocate manufacturing overhead between both products?
Challenges on assigning manufacturing
overhead to products
1) Manufacturing overhead is an indirect cost (“impossible or

very difficult to trace to a specific product”).
2) Manufacturing overhead is composed by different types

of costs (from grease used in machines to the salary of the
production manager).
3) Average costs of manufacturing overhead can vary from

one period to another (company having large amounts of fixed
manufacturing overhead – automation).
Challenges on assigning manufacturing
overhead to products
1) Manufacturing overhead is an indirect cost (“impossible or

difficult to trace to a specific product”).
HOW TO SOLVE IT?

2) Manufacturing overhead is composed by different types
of costs (from grease used in machines to the salary of the
production manager).
3)
A: ALLOCATION BASE!
Average costs of manucfaturing overhead can vary from
one period to another (company having large amounts of fixed
manufacturing overhead – automation).
Allocation base
• Measure of activity (tip: usually connected to direct variable

costs!)
e.g., Direct labor-hours, Machine-hours, Direct labor cost, Direct
materials usage, Total of products
• Used to assign overhead costs to products and services

Assigning manufacturing overhead to
products/services
𝐏𝐫𝐞𝐝𝐞𝐭𝐞𝐫𝐦𝐢𝐧𝐞𝐝 𝐨𝐯𝐞𝐫𝐡𝐞𝐚𝐝 𝐫𝐚𝐭𝐞

𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑡𝑜𝑡𝑎𝑙 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡
=
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑡𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑎𝑙𝑙𝑜𝑐𝑎𝑡𝑖𝑜𝑛 𝑏𝑎𝑠𝑒
• Computed before the period begins
• Allocation base: Direct labor-hours, Machine-hours, Direct labor

cost, Direct materials usage, Total of products
EXTRA PROBLEM
Available on e-class/printed version
Underapplied/(overapplied) overhead
What do we do if the actual manufacturing

overhead was higher than the estimated
manufacturing overhead at the beginning of the
period?
Underapplied/(overapplied) overhead
Underapplied/(overapplied) overhead = Actual manufacturing costs (-)

Predetermined manufacturing costs
Assumption that actual overhead costs will be proportional to the actual

amount of the allocation base incurred during the period.
Why do we have differences?

(1) Fixed costs on manufacturing overhead (do not change
considering the activity base level);
(2) Efficiency on overhead spending.
Disposition of under/overapplied overhead
Two options:
(A) Closed to Cost of Goods Sold.

(B) Closed proportionally to Work in Process, Finished Goods, and
Cost of Goods Sold.
Disposition of under/overapplied overhead
Two options:
(A) Closed to Cost of Goods Sold.

(B) Closed proportionally to Work in Process, Finished Goods, and
Cost of Goods Sold.
Net income has the fair adjustment for the

under/(over)applied overhead!
Important note:
→ Unless stated otherwise, you can consider the reported

manufacturing overhead as the accurate one (i.e., there are no
underapplied or overapplied amounts)!
For next class (Aug 30)
• Summary (1 page max.)

– GAR, pages 89-92 (ABC versus absorption costing)
– Turn in: next class (Aug 30, 8:59 am → e-class).
• Problems: #10, #11, #12.
• Readings
– GAR, Ch. 2 (pp. 73-80), Ch. 4, appendix 4B.
Thank you!
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Controllership

Prof. Bianca Quirantes Checon

Work in process inventory

Manufacturing overhead (goods are sold)

+ Cost of Goods Sold

Work in process inventory

Manufacturing overhead (goods are sold)

Total manufacturing costs + Cost of Goods Sold

Work in process inventory

Manufacturing overhead (goods are sold)

+ Cost of Goods Sold

Olivia’s Cuisine (2014)

If we start to produce both brownies and brigadeiros, how can

1) Manufacturing overhead is an indirect cost (“impossible or

2) Manufacturing overhead is composed by different types

3) Average costs of manufacturing overhead can vary from

1) Manufacturing overhead is an indirect cost (“impossible or

HOW TO SOLVE IT?

• Measure of activity (tip: usually connected to direct variable

• Used to assign overhead costs to products and services

𝐏𝐫𝐞𝐝𝐞𝐭𝐞𝐫𝐦𝐢𝐧𝐞𝐝 𝐨𝐯𝐞𝐫𝐡𝐞𝐚𝐝 𝐫𝐚𝐭𝐞

• Computed before the period begins

• Allocation base: Direct labor-hours, Machine-hours, Direct labor

What do we do if the actual manufacturing

Underapplied/(overapplied) overhead = Actual manufacturing costs (-)

Assumption that actual overhead costs will be proportional to the actual

Why do we have differences?

(A) Closed to Cost of Goods Sold.

(A) Closed to Cost of Goods Sold.

Net income has the fair adjustment for the

→ Unless stated otherwise, you can consider the reported

• Summary (1 page max.)

• Problems: #10, #11, #12.

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