Lec_11_ACCG304_Standard Costing_2

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					ACCG304 Lecture 11 Standard Costing Factory Overhead
Lecture Objective
Factory overhead is applied to production using a predetermined rate. Prior topics relating to product costing include, Job Costing and Process Costing and the use and operation of a predetermined overhead rate was used. The under / over applied overhead rate needs to be further analysed into fixed and variable components, and related to budget or spending variances , factory efficiency and capacity utilisation considerations need to be analysed.

Lecture Outline 11.1 11.2 11.3 11.4 11.5 11.6 11.7
Factory Overhead Setting Standards Flexible Budget for overhead Overhead Variance methods Journal entries for overhead Disposition of Variances Lecture Demonstration Problem

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11.1

Factory Overhead

Variance analysis for overhead is more complicated than that for direct materials and direct labour because of the variety and classification of costs included in overhead. Factory overhead includes all those factory costs which cannot be classified as direct materials or direct labour. The many costs that make up aggregate overhead exhibit cost behaviour patterns that include all of the following cost classifications: (a) (b) (c) Variable Costs Fixed Costs Semi-Variable (Mixed) costs

Because of the cost behaviour pattern of FIXED and VARIABLE costs, standard overhead costs when compared to actual overhead costs, must be adjusted for changes in activity levels. This is handled through the use of FLEXIBLE BUDGETS which may be adjusted to show total overhead at various levels of activity.

11.2

Setting standards

The procedure used to calculate standard overhead costs requires the completion of the following steps: (a) (b) (c) Classify costs according to their behaviour, be it fixed or variable. Mixed costs need to be broken down into fixed and variable components. Forecast overhead costs for the coming year.

(d)

A DENOMINATOR LEVEL OF ACTIVITY needs to be calculated which is usually based on NORMAL CAPACITY represented by either an output measure such as Units of Production or on an input measure such as Direct Labour Hours, Direct Labour Cost, Machine Hours etc.

(e)

Two overhead rates are developed, namely: • VARIABLE OVERHEAD RATE and • FIXED OVERHEAD RATE calculated by dividing the forecast of overhead costs [calculated in ( c )] by the denominator level of activity [calculated in ( d ) ].

11.3

Flexible Budget for Overhead

The flexible budget formula may be expressed as follows:

Total Cost = Fixed Cost + Unit Variable Cost x (Activity Measure)

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Having analysed cost behaviour patterns for each item of overhead, it is possible to complete the above formula and develop a standard overhead rate.

For example:
Budgeted Variable Costs per machine hour Budgeted Fixed Costs in total for the year Expected machine Hours for the coming year = $2.00 per machine hr. = = $100,000 20,000

Total Expected Overhead Costs at 20,000 Machine Hour level using the above flexible budget formula is: Total Overhead Cost = $100,000 + $2.00 (20,000) = $140,000

Using FLEXIBLE BUDGETING TECHNIQUES if Expected Machine Hours were changed to 30,000, then the calculation of total overhead would be as follows: Total Overhead Cost = $100,000 + $2.00 (30,000) = $160,000

The Standard Overhead rate per machine hour at NORMAL CAPACITY is calculated as follows: Variable rate per hour Fixed Rate per hour ($100,000 / 20,000) TOTAL OVERHEAD RATE = = = $2.00 $5.00 $7.00

11.4

Overhead variance methods

There is no uniform set of overhead variances as accountants have differing views regarding the best way to determine factory overhead variances. The three variances may be interpreted as follows: (a) OVERHEAD SPENDING VARIANCE This variance represents the difference between the costs actually incurred and the flexible budget allowance for these costs based on the actual hours worked. OVERHEAD EFFICIENCY VARIANCE This variance relates to variable overhead costs and indicate the additional variable overhead incurred due to inefficiencies. OVERHEAD VOLUME VARIANCE This variance relates solely to FIXED overhead and indicates whether normal capacity has been achieved If actual production exceeds the normal capacity allowance then the volume variance is favourable and conversely, if actual production is less than normal capacity then the volume variance is unfavourable.

(b)

(c)

The following template will be used to calculate the above variances :

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Input Actual Overhead Incurred

Input Flexible Budget based on Actual hours worked
Variable: Fixed:

Output Flexible Budget based on standard hours allowed for good production
Variable: Fixed:

Output Good Production * Standard O/H Cost

O/H Spending Var.

O/H Efficiency Var. Total Overhead Variance

O/H Volume Var

11.5

Journal entries for overhead

Journal Entries for factory overhead using the four variance method are as follows: Debit Factory Overhead Control Credit Accounts Payable To record actual overhead incurred.

Debit Work In Process Credit Factory Applied Overhead To record overhead applied to production. The journal entry to ISOLATE OVERHEAD variances is as follows: Debit Factory Applied Overhead Debit/Credit Overhead Spending Variance Debit/Credit Overhead Efficiency Variance Debit/Credit Overhead Volume Variance Credit Factory Overhead Control To close actual and applied overhead accounts and to isolate all overhead variances.

11.6

Disposition of variances

At the end of an accounting period (usually one year) variance accounts need to be closed. Although there are a number of methods available for the disposal of variances, the two most popular methods used are: (a) (b) To treat variances as a PERIOD COST and write them off to the Profit & Loss account. Alternately, if the variances are abnormally large, then they may need to be apportioned between INVENTORIES (comprising Work In Process and Finished Goods) and COST OF SALES.

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Method 1, treating variances as a period cost, will be the preferred method at this stage for the disposition of variances, the journal entries for which are as follows:
Debit C.O.G.S Credit Unfavourable Variances and/or

Debit

Favourable Variances Credit C.O.G.S

Unfavourable variances reduce the standard reported profits whereas, favourable variances are treated as gains and increase the standard profit figures.

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11.7

Lecture Demonstration Problem:
The standard cost for one its best selling

PP Production makes plastic household products. products is as follows: Direct material Direct Labour Factory Overhead

250grams @ $2.00 per Kg 15 minutes @ $8.00 per hour 15 minutes @ $8.00 per hour

Total Standard Cost Per Unit The overhead standard was based on the following ANNUAL budgets: Fixed Factory Overhead Variable Factory Overhead Normal Production Capacity August production and cost data was : Units Produced Direct materials purchased 5,100 Kgs. actual cost $10,608 Direct Materials issued to production 5,040 kgs. Direct Labour Incurred 5,000 hours, actual cost $39,750.

$0.50 $2.00 $2.00 ------$4.50 ==== $384,000 $ 96,000

240,000 units

19,800

Factory Overhead Incurred during the month totalled $41,000 of which $33,000 was fixed overhead cost.

REQUIRED
(a) (b) (c) Calculate the Material Price and Material Quantity variance assuming that the material price variance is isolated at time of purchase. Calculate the Direct Labour Rate and Direct Labour Efficiency variances. Calculate the factory overhead, Spending, Efficiency and Volume variances.

Analysis of Direct Material Variances
Input Actual Qty * Actual Price
Purchases

Input Actual Qty * Standard Price

Usage

Output Actual Good Prodn * Standard Cost

RM Price Var

RM Usage Var

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Analysis of Direct Labour Variances
Input Actual Hours * Actual Rate Input Actual Hours * Standard Rate Output Actual Good Prodn * Standard Cost

Labour Rate Var

Labour Efficiency Var
Total Labour Variance

Analysis of factory overhead variances
Input Actual Overhead Incurred Input Flexible Budget based on Actual hours worked Output Flexible Budget based on standard hours allowed for good production Output Good Production * Standard O/H Cost

O/H Spending Var.

O/H Efficiency Var. Total Overhead Variance

O/H Volume Var

Overhead Rates - Calculation and Analysis
Overhead Rate Per Unit Per Hour Variable Rate Fixed Rate Total Overhead Rate

Budgeted Fixed Overhead at Normal Capacity

Normal Capacity – Units of production Normal Capacity – In Hours

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Standard Costing - Revision Question
Stanton and Main Pty. Ltd. uses a standard cost system in accounting for the manufacturing costs of its single product. Standard cost data for one unit of product is as follows; Direct materials, 16 kgs. @ $1.65 per Kg. Direct labour, 1.8 hrs. @ $14.00 per hr. Factory Overhead Applied $ 26.40 25.20 48.00 $ 99.60

The company purchased 5,000 Kgs of material during the month at a cost of $8,600. Any materials price variance is recorded when materials are purchased and all inventories are carried at standard cost. There were no opening stocks of raw materials at the beginning of the month. A physical check of inventory showed 600 kgs of raw material stock on hand at the end of the month. During the month employees worked a total worked a total 450 hours at a cost of $6,550. Factory overhead is applied on the basis of direct labour hours. Factory overhead totaling $15,000 was incurred during the month; $5,000 of this amount was considered to be fixed with the remaining amount treated as variable overhead. A total of $144,000 was budgeted for factory overhead for the year; the break up of this amount was 40% fixed and 60% variable. There were no opening or closing inventories of work in process during the month. During the month 260 units were produced.

Required.
Prepare a schedule of standard cost variances for the month

Analysis of Direct Material Variances
Input Actual Qty * Actual Price Input Actual Qty * Standard Price Output Actual Good Prodn * Standard Cost

Purchases

Usage

RM Price Var

RM Usage Var

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Lecture 11 – Standard Costing – Factory Overhead

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Analysis of Direct Labour Variances
Input Actual Hours * Actual Rate Input Actual Hours * Standard Rate Output Actual Good Prodn * Standard Cost

Labour Rate Var

Labour Efficiency Var
Total Labour Variance

Analysis of factory overhead variances
Input Actual Overhead Incurred Input Flexible Budget based on Actual hours worked Output Flexible Budget based on standard hours allowed for good production Output Good Production * Standard O/H Cost

O/H Spending Var.

O/H Efficiency Var. Total Overhead Variance

O/H Volume Var

Overhead Rates - Calculation and Analysis
Overhead Rate Per Unit Per Hour Variable Rate Fixed Rate Total Overhead Rate Budgeted Fixed Overhead at Normal Capacity

Normal Capacity – Units of production Normal Capacity – In Hours


				
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