34 5.4 Assigning Manufacturing Overhead Costs to Jobs
-
-
Last updated
- Dec 28, 2020
Learning Objectives
- Understand how manufacturing overhead costs are assigned to jobs.
Question: We have discussed how to assign direct material and direct labor costs to jobs using a materials requisition form, time sheet, and job cost sheet. The third manufacturing cost—manufacturing overhead—requires a little more work. How do companies assign manufacturing overhead costs, such as factory rent and factory utilities, to individual jobs?
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. The activity used to allocate manufacturing overhead costs to jobs is called an allocation base7. Once the allocation base is selected, a predetermined overhead rate can be established. The predetermined overhead rate8 is calculated prior to the year in which it is used in allocating manufacturing overhead costs to jobs.
Calculating the Predetermined Overhead Rate
Question: How is the predetermined overhead rate calculated?
The predetermined overhead rate calculation for Custom Furniture is as follows:
Thus each job will be assigned $30 in overhead costs for every direct labor hour charged to the job. The assignment of overhead costs to jobs based on a predetermined overhead rate is called overhead applied9. Remember that overhead applied does not represent actual overhead costs incurred by the job—nor does it represent direct labor or direct material costs. Instead, overhead applied represents a portion of estimated overhead costs that is assigned to a particular job.
Question: Now that we know how to calculate the predetermined overhead rate, the next step is to use this rate to apply overhead to jobs. How do companies use the predetermined overhead rate to apply overhead to jobs, and how is this information recorded in the general journal?
-
-
Selecting an Allocation Base
Question: Although we used direct labor hours as the allocation base for Custom Furniture Company’s predetermined overhead rate, organizations use various other types of allocation bases. The most common allocation bases are direct labor hours, direct labor costs, and machine hours. What factors do companies consider when deciding on an allocation base?
Why Use a Predetermined Overhead Rate?
Question: The use of a predetermined overhead rate rather than actual data to apply overhead to jobs is called normal costing11. Most companies prefer normal costing over assigning actual overhead costs to jobs. Why do most companies prefer to use normal costing?
Using a Manufacturing Overhead Account
Question: Using a predetermined overhead rate to apply overhead costs to jobs requires the use of a manufacturing overhead account. How is the manufacturing overhead account used to record transactions?
-
-
Underapplied and Overapplied Overhead
Question: Because manufacturing overhead costs are applied to jobs based on an estimated predetermined overhead rate, overhead applied (credit side of manufacturing overhead ) rarely equals actual overhead costs incurred (debit side of manufacturing overhead). What terms are used to describe the difference between actual overhead costs incurred during a period and overhead applied during a period?
| debit | credit |
|---|---|
| actual overhead | Overhead cost |
| cost incurred | applied to jobs |
| $6,000 | $9,000 |
| $3,000 (balance) |
Business in action 5.1 – Job Costing at Boeing
Boeing Company is the world’s leading aerospace company and the largest manufacturer of commercial jetliners and military aircraft combined. Boeing provides products and services to customers in 150 countries and employs 165,000 people throughout the world.
Source: Photo courtesy of prayitno, http://www.flickr.com/photos/34128007@N04/5293183651/.
Since most of Boeing’s products are unique and costly, the company likely uses job costing to track costs associated with each product it manufactures. For example, the costly direct materials that go into each jetliner produced are tracked using a job cost sheet. Direct labor and manufacturing overhead costs (think huge production facilities!) are also assigned to each jetliner. This careful tracking of production costs for each jetliner provides management with important cost information that is used to assess production efficiency and profitability. Management can answer questions, such as “How much did direct materials cost?” “How much overhead was allocated to each jetliner?” or “What was the total production cost for each jetliner?” This is important information when it comes time to negotiate the sales price of a jetliner with a potential buyer like United Airlines or Southwest Airlines.
Source: Boeing, “Home Page,” http://www.boeing.com.
Closing the Manufacturing Overhead Account
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?
-
-
Alternative Approach Closing the Manufacturing Overhead Account
Question: Although most companies close the manufacturing overhead account to cost of goods sold, this is typically only done when the amount is immaterial (immaterial is a common accounting term used to describe an amount that is small relative to a company’s size). The term material describes a relatively large amount. How do we close the manufacturing overhead account when the amount is material?
-
-
For example, suppose a company has $2,000 in underapplied overhead (debit balance in manufacturing overhead) and that the three account balances are as follows:
The $2,000 is closed to each of the three accounts based on their respective percentages. Thus $1,200 is apportioned to WIP inventory (= $2,000 × 60 percent), $600 goes to finished goods inventory (= $2,000 × 30 percent), and $200 goes to cost of goods sold (= $2,000 × 10 percent). The journal entry to close the $2,000 underapplied overhead debit balance in manufacturing overhead is as follows:
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.
Key Takeaway
- Most companies use a normal costing system to track product costs. Normal costing tracks actual direct material costs and actual direct labor costs for each job and charges manufacturing overhead to jobs using a predetermined overhead rate. The predetermined overhead rate is calculated as follows:
2. 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 5.3
- Chan Company estimates that annual manufacturing overhead costs will be $500,000. Chan allocates overhead to jobs based on machine hours, and it expects that 100,000 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?
- Chan Company received a bill totaling $3,700 for machine parts used in maintaining factory equipment. The bill will be paid next month. Make the journal entry to record this transaction.
-
Job 153 used a total of 2,000 machine hours. Make the journal entry to record manufacturing overhead applied to job 153. What other document will include this amount?
-
Job 153 used a total of 2,000 machine hours. Make the journal entry to record manufacturing overhead applied to job 153. 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.
Definitions
- The activity used to allocate manufacturing overhead costs to jobs.
- A rate established prior to the year in which it is used in allocating manufacturing overhead costs to jobs.
- The assignment of overhead costs to jobs based on a predetermined overhead rate.
- The allocation base that drives overhead costs.
- A method of costing that uses a predetermined overhead rate to apply overhead to jobs.
- An account used to hold financial data temporarily until it is closed out at the end of the period.
- Overhead costs applied to jobs that are less than actual overhead costs.
- Overhead costs applied to jobs that exceed actual overhead costs.
