Direct labor and manufacturing overhead costs think huge production facilities! This careful tracking of production costs for each jetliner provides management with important cost information that is used to assess production efficiency and profitability.
Question: Since the manufacturing overhead account is a clearing account, it must be closed at the end of the period. How do we close the manufacturing overhead account? Answer: Most companies simply close the manufacturing overhead account balance to the cost of goods sold account. The term material describes a relatively large amount. How do we close the manufacturing overhead account when the amount is material?
Answer: If the amount is material, it should be closed to three different accounts—work-in-process WIP inventory, finished goods inventory, and cost of goods sold—in proportion to the account balances in these accounts. Although this approach is not as common as simply closing the manufacturing overhead account balance to cost of goods sold, companies do this when the amount is relatively significant.
A manufacturing overhead account is used to track actual overhead costs debits and applied overhead credits. This account is typically closed to cost of goods sold at the end of the period. Review Problem 2. Chan allocates overhead to jobs based on machine hours, and it expects that , machine hours will be required for the year. Calculate the predetermined overhead rate. Why might Chan Company use machine hours as the overhead allocation base?
The bill will be paid next month. Make the journal entry to record this transaction. Job used a total of 2, machine hours. Make the journal entry to record manufacturing overhead applied to job What other document will include this amount? Is overhead overapplied or underapplied? Explain your answer. Make the journal entry to close the manufacturing overhead account assuming the balance is immaterial. Make the journal entry to close the manufacturing overhead account assuming the balance is material.
Solutions to Review Problem 2. The more machine hours used, the higher the overhead costs incurred. Thus there is a link between machine hours and overhead costs, and using machine hours as an allocation base is preferable. Machine hours are also easily tracked, making implementation relatively simple.
Overhead is overapplied because actual overhead costs are lower than overhead applied to jobs. Also, the manufacturing overhead account has a credit balance.
Skip to main content. Module 2: Cost Management. Search for:. Using a Predetermined Overhead Rate The goal is to allocate manufacturing overhead costs to jobs based on some common activity, such as direct labor hours, machine hours, or direct labor costs.
Calculating the Predetermined Overhead Rate Question: How is the predetermined overhead rate calculated? Answer: Companies typically look at the following two items when determining which allocation base to use: Link to overhead costs.
The goal is to find an allocation base that drives overhead costs, often called a cost driver. The more direct labor hours worked, the higher the overhead costs incurred. Thus direct labor hours or direct labor costs would be used as the allocation base. The overhead cost per unit from Figure is combined with the direct material and direct labor costs as shown in Figure to compute the total cost per unit as shown in Figure.
After reviewing the product cost and consulting with the marketing department, the sales prices were set. The sales price, cost of each product, and resulting gross profit are shown in Figure. Sales of each product have been strong, and the total gross profit for each product is shown in Figure. Using the Solo product as an example, , units are sold at a price of? The cost of goods sold consists of direct materials of?
With , units, the direct material cost is? The resulting Gross Profit is? Computing Actual Overhead Costs As manufacturing technology becomes less expensive and more efficient, the mix between overhead and labor changes so that tasks are more computerized tasks and involve less direct labor; the traditional use of direct labor hours or direct labor dollars changes accordingly.
If the predetermined overhead rate is based on direct labor hours and set at the beginning of the year but manufacturing technology leads to a reduction in direct labor during the year, the number of direct labor hours may be less than estimated. This reduces the amount of overhead applied so that the overhead is more likely to be underapplied at the end of the year. Why do companies not wait until the end of the period and compute an actual overhead rate based on actual manufacturing costs and actual units?
Figure Active Frame, Inc. The manufacturing of clear glasses takes 45, direct labor hours and involves 1, parts and inspections. The manufacturing of tinted glasses takes , direct labor hours and involves 1, parts and inspections. The traditional method applies? What is the amount of overhead per direct labor hour applied to the clear glass products?
It takes 80, direct labor hours to manufacture the Party Line and 93, direct labor hours to manufacture the Holiday Line. Overhead consists of? The machine setup pool has 52, setups for the Party product and 98, setups for the Holiday product. The packaging cost pool has 26, parts in the Party product and 39, parts for the Holiday product. Using the traditional cost method of direct labor hours, what is the predetermined overhead rate? Figure What is the predetermined overhead rate, and when is it typically estimated?
The predetermined overhead rate is the amount of manufacturing overhead that is estimated to be applied to each product or department depending on the cost system used job order costing or process costing. It typically is estimated at the beginning of each period by dividing the estimated manufacturing overhead by an activity base. While it is most commonly a year, the period can be a year, quarter, or month as determined by management.
In traditional allocation systems, that base is typically direct labor hours, direct labor dollars, or machine hours. In activity-based costing systems, the activity base is one or more cost drivers. Figure Steeler Towel Company estimates its overhead to be? It expects to have , direct labor hours costing? Calculate the predetermined overhead rate using:. Figure Crystal Pools estimates overhead will utilize , machine hours and cost?
It takes 2 machine hours per unit, direct material cost of? What is the cost of each unit produced? Figure A company estimated , direct labor hours and? The actual overhead was? What is the predetermined overhead rate, and how much was applied during the year?
Figure Cozy, Inc. It estimates? What is the predetermined overhead rate if a small blanket takes 1 machine hour and a large blanket takes 2 machine hours? Figure Green Bay Cheese Company estimates its overhead to be? Figure Boarders estimates overhead will utilize , machine hours and cost? It takes 4 machine hours per unit, direct material cost of? Figure A company estimated 50, direct labor hours and? What is the predetermined overhead rate if a small blanket takes 2 hours of direct labor and a large blanket takes 3 hours of direct labor?
It manufactures three products and estimates these costs:. If the labor rate is? Figure Five Card Draw manufactures and sells 24, units of Diamonds, which retails for? Determining the manufacturing overhead expenses can also help you create a budget for manufacturing overhead.
You can set aside the amount of money needed to cover all overhead costs. According to the Generally Accepted Accounting Principles GAAP standards, the manufacturing overhead should be added to direct labor and direct materials costs to determine the cost of goods sold and the value of the inventory.
These costs must be included in the stock valuation of finished goods and work in progress. Both COGS and the inventory value must be reported on the income statement and the balance sheet. In order for a manufacturer's financial statements to be in compliance with GAAP, a portion of the manufacturing overhead must be allocated to each item produced. To allocate manufacturing overhead costs, an overhead rate is calculated and applied.
When this is done in a precise and logical manner, it will give the manufacturer the true cost of manufacturing each item. The allocation of costs is necessary to establish realistic figures for the cost of each unit manufactured. Manufacturing overhead is an essential part of running a manufacturing unit. Tracking these costs and sticking to a proper budget can help you to determine just how efficiently your business is performing and help you reduce overhead costs in the future.
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