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Factory Overhead

   Factory overhead, also called "manufacturing
   overhead" or "factory burden," comprises the
indirect expenses associated with the operations of
    a manufacturing plant; these costs cannot be
  directly charged to a specific product or project.
     All expenses that fall under under factory
      overhead are divided into three different
subcategories: indirect material, indirect labor and
                other indirect costs.
Direct vs. Indirect Expenses

  every factory or production plant requires
   employees to undertake the production. As these
   employees are associated directly with the
   production process, the wages paid to them are
   considered direct expenses.
  Indirect expenses, on the other hand, are incurred
   indirectly during the production process and do not
   result in actual production. Such expenses often
   facilitate production and make it more efficient.
Components of factory overhead
Indirect material + Indirect labor + other indirect
  costs = factory overhead

 Indirect Material
   Indirect materials are those not directly used as raw
    materials for the production of goods and services.
    The use of indirect material makes the production
    process possible, more efficient and safer. Indirect
    materials include lubricants, fuels, cleaning
    chemicals and protective gear.
Indirect labor
  Indirect labor refers to the cost of those employees
  who are associated with the production process, but
  not on specific units or products; they indirectly
  produce goods and services by supporting the
  production facility. Indirect labor costs include the
  cost of factory supervision, inspection teams,
  superintendents, factory managers and clerks.
Other Indirect Costs

  Other indirect costs include rent, property tax on the
  factory premises, fire insurance, depreciation of the
  plant and machinery, repairs and maintenance of
  machinery, utilities, and taxes. These costs are
  further classified as either fixed or variable factory
  overhead.
Fixed & Variable Factory Overhead

 Expenses that do not change with changes in
  production are called fixed expenses, or fixed
  factory overhead, and include property insurance,
  depreciation, property taxes and salaries for non-
  production employees.
 Variable expenses change in direct proportion to
  the production of goods and services; these
  include heating, electricity, water, indirect labor
  and indirect materials
Examples
 overhead expenses include:
 Indirect material - Welding rods, glues, and product wrappers.
 Indirect labor – Salary for the maintenance staff, technical
    support staff, etc.
   Machine depreciation – This includes the depreciation cost of
    manufacturing equipment.
   Rent – This would include rent that is paid for the manufacturing
    or assembly facilities.
   Property taxes – This is the tax that is paid for the land on
    which the factory sits, or the proportion of which is directly
    attributable to the manufacturing process.
   Factory maintenance supplies – Any supplies or expenses that
    are incurred to keep the factory running. This may include items
    such as grease for the machines and replacement parts.
   Heating and lighting – Heating, lighting, and other utility
    charges.
How to Calculate factory overhead
It is a number that represents the overhead costs of
   producing the product in your factory.
 List every business expense that you’ve incurred
   during the period
 Separate the listed expenses into two smaller lists --
   one covering direct costs and the other indirect costs.
 Add together the list of indirect costs and list of direct
   costs to calculate the overhead costs and the total
   direct costs for your factory and for your factory.
 Divide the overhead costs for the factory by the direct
   costs to calculate the overall overhead rate for the
   factory
How to Calculate Applied Overhead
Costs

 applied overhead costs = budgeted annual rate x
  budgeted annual hours.
 Determine the budgeted annual rate
 Determine the budgeted annual activity hours
  which are also a management estimate
 Multiply the budgeted overhead rate by the
  budgeted annual activity hours.
How to Calculate Actual Overhead
 Determine payroll costs. Average the past 12
  payroll cycles to determine your average monthly
  costs.
 Gather your business credit cards from the past
  year in which money is still owed. Calculate the
  total you have paid each month for all cards.
  Divide by 12 to get your company's average
  credit card expense.
 Calculate all indirect monthly expenses, such as
  rent payments, company car expenses, mileage,
  vendor bills, utility costs, entertainment costs,
  business lunches and supply purchases.
 Calculate all your direct monthly expenses for
  labor or manufacturing that goes towards
  producing services or products for your company
 Add together your average monthly payroll cost,
  your monthly credit card expense and your
  indirect and direct monthly expenses. The total is
  your company's actual overhead. This total needs
  to be accounted for in the budget for your
  business each month
Over-applied or Under-applied
Overhead Rate
 Overhead is the amount of indirect costs
  attributed to units of production that is not directly
  incurred during the production process. The over-
  application or under-application of overhead is
  due to differences between the estimated and
  actual overhead amounts.
 When actual overhead is greater than estimated
  overhead, the amount assigned to inventory costs
  was under-applied.
 If the actual overhead is less than the estimated
  overhead, the amount assigned to inventory costs
  was over-applied.
How to calculate over/under applied
overhead

 Determine the estimated cost driver. it can be
  estimated direct labor hours or machine hours.
 Calculate the overhead rate. The amount of
  budgeted overhead costs can include items such
  as indirect labor, indirect materials and other
  indirect costs. The total budgeted overhead costs
  are divided by the estimated cost driver to arrive
  at the overhead rate.
 Determine the actual cost driver. The actual cost
  driver is based on actual production activity; it can
  be actual direct labor hours worked or actual
  machine hours used in production.
 Apply and calculate the overhead by multiplying
  the actual cost driver by the overhead rate. The
  applied overhead is compared to actual overhead
  costs to determine if the amount is over-applied
  or under-applied.
How to Calculate Overhead Cost
Per Unit

 Define overhead costs and expenses. These are all
  costs associated with direct labor and materials.
 Determine average hourly wage. Each employee's
  contribution should be classified as either direct or
  indirect labor. Direct labor works directly with product,
  whereas indirect labor supports direct labor
 Estimate the number of workdays available in a given
  calendar year. Subtract the average number of days
  labor will not be working (holidays, weekends,
  vacations, sick leave, etc.) from 365.
 Multiply the number of workdays available for
    labor by eight (for an eight-hour work day). This
    gives you an estimate for the total number of
    labor hours worked.
   Multiply number of total labor hours by average
    labor wage determined in Step 2.
   Add all overhead expenses, as defined in Step 1,
    to the dollar amount in Step 5. This is your total
    overhead cost.
   Look up the average number of units sold per
    month and multiply by 12.
   Divide total overhead costs by average number of
    units. This is your overhead cost per unit.
Variance analysis

 For the purpose of over or applied factory
 overhead analysis two separate variance are
 computed as follows:

   Budget or spending variance
   Volume or capacity variance
Budget or spending variance
 Factory Overhead spending variance is the
  difference between actual expenses incurred and the
  budgeted allowance based on actual hours worked.
 The spending variance is the responsibility of the
  department manager, who is expected to keep actual
  expenses within the budget.
 Formula of Spending Variance:
[Actual factory overhead – Budgeted allowance based
  on actual hours worked*]
*[Fixed expenses budgeted + Variable expenses (actual
  hours worked × variable overhead rate)]
Volume or capacity variance
 It is the difference between the budgeted overhead
  estimated for the capacity attained and factory
  overhead during the period
 Responsibility of this overhead is rest on the top
  management because of the policy decisions about
  the utilization of the plant and equipment.
 Formula of Idle Capacity Variance:
[Budgeted allowance based on actual hours worked* –
  (Actual hours worked × Standard overhead rate)]
*Fixed expenses budgeted + Variable expenses (actual
  hours worked × variable overhead rate)
Example of variance analysis

Fixed factory overhead           Rs. 40,000
Variable factory overhead            60,000
Total factory overhead             1,00,000

 Variable overhead rate = 60,000 = Rs. 3 per D. L
                            20,000   Hr.
 Budget variance


Actual factory overhead           Rs. 80,000
(Factory overhead budgeted
 for the capacity attained)
Fixed overhead           40,000
Variable overhead        51,000
 (Rs. 3 x 17000)                     91,000
   Budget variance                 Rs.11,000
 ( cr. Or unfavorable)
 Volume variance


Budgeted overhead allowance         Rs. 91,000
for the capacity attained
applied factory overhead              85,000
volume variance( dr. unfavorable)   Rs. 6,000

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Factory overhead slides

  • 1. Factory Overhead Factory overhead, also called "manufacturing overhead" or "factory burden," comprises the indirect expenses associated with the operations of a manufacturing plant; these costs cannot be directly charged to a specific product or project. All expenses that fall under under factory overhead are divided into three different subcategories: indirect material, indirect labor and other indirect costs.
  • 2. Direct vs. Indirect Expenses  every factory or production plant requires employees to undertake the production. As these employees are associated directly with the production process, the wages paid to them are considered direct expenses.  Indirect expenses, on the other hand, are incurred indirectly during the production process and do not result in actual production. Such expenses often facilitate production and make it more efficient.
  • 3. Components of factory overhead Indirect material + Indirect labor + other indirect costs = factory overhead  Indirect Material  Indirect materials are those not directly used as raw materials for the production of goods and services. The use of indirect material makes the production process possible, more efficient and safer. Indirect materials include lubricants, fuels, cleaning chemicals and protective gear.
  • 4. Indirect labor  Indirect labor refers to the cost of those employees who are associated with the production process, but not on specific units or products; they indirectly produce goods and services by supporting the production facility. Indirect labor costs include the cost of factory supervision, inspection teams, superintendents, factory managers and clerks.
  • 5. Other Indirect Costs  Other indirect costs include rent, property tax on the factory premises, fire insurance, depreciation of the plant and machinery, repairs and maintenance of machinery, utilities, and taxes. These costs are further classified as either fixed or variable factory overhead.
  • 6. Fixed & Variable Factory Overhead  Expenses that do not change with changes in production are called fixed expenses, or fixed factory overhead, and include property insurance, depreciation, property taxes and salaries for non- production employees.  Variable expenses change in direct proportion to the production of goods and services; these include heating, electricity, water, indirect labor and indirect materials
  • 7. Examples  overhead expenses include:  Indirect material - Welding rods, glues, and product wrappers.  Indirect labor – Salary for the maintenance staff, technical support staff, etc.  Machine depreciation – This includes the depreciation cost of manufacturing equipment.  Rent – This would include rent that is paid for the manufacturing or assembly facilities.  Property taxes – This is the tax that is paid for the land on which the factory sits, or the proportion of which is directly attributable to the manufacturing process.  Factory maintenance supplies – Any supplies or expenses that are incurred to keep the factory running. This may include items such as grease for the machines and replacement parts.  Heating and lighting – Heating, lighting, and other utility charges.
  • 8. How to Calculate factory overhead It is a number that represents the overhead costs of producing the product in your factory.  List every business expense that you’ve incurred during the period  Separate the listed expenses into two smaller lists -- one covering direct costs and the other indirect costs.  Add together the list of indirect costs and list of direct costs to calculate the overhead costs and the total direct costs for your factory and for your factory.  Divide the overhead costs for the factory by the direct costs to calculate the overall overhead rate for the factory
  • 9. How to Calculate Applied Overhead Costs  applied overhead costs = budgeted annual rate x budgeted annual hours.  Determine the budgeted annual rate  Determine the budgeted annual activity hours which are also a management estimate  Multiply the budgeted overhead rate by the budgeted annual activity hours.
  • 10. How to Calculate Actual Overhead  Determine payroll costs. Average the past 12 payroll cycles to determine your average monthly costs.  Gather your business credit cards from the past year in which money is still owed. Calculate the total you have paid each month for all cards. Divide by 12 to get your company's average credit card expense.  Calculate all indirect monthly expenses, such as rent payments, company car expenses, mileage, vendor bills, utility costs, entertainment costs, business lunches and supply purchases.
  • 11.  Calculate all your direct monthly expenses for labor or manufacturing that goes towards producing services or products for your company  Add together your average monthly payroll cost, your monthly credit card expense and your indirect and direct monthly expenses. The total is your company's actual overhead. This total needs to be accounted for in the budget for your business each month
  • 12. Over-applied or Under-applied Overhead Rate  Overhead is the amount of indirect costs attributed to units of production that is not directly incurred during the production process. The over- application or under-application of overhead is due to differences between the estimated and actual overhead amounts.  When actual overhead is greater than estimated overhead, the amount assigned to inventory costs was under-applied.  If the actual overhead is less than the estimated overhead, the amount assigned to inventory costs was over-applied.
  • 13. How to calculate over/under applied overhead  Determine the estimated cost driver. it can be estimated direct labor hours or machine hours.  Calculate the overhead rate. The amount of budgeted overhead costs can include items such as indirect labor, indirect materials and other indirect costs. The total budgeted overhead costs are divided by the estimated cost driver to arrive at the overhead rate.
  • 14.  Determine the actual cost driver. The actual cost driver is based on actual production activity; it can be actual direct labor hours worked or actual machine hours used in production.  Apply and calculate the overhead by multiplying the actual cost driver by the overhead rate. The applied overhead is compared to actual overhead costs to determine if the amount is over-applied or under-applied.
  • 15. How to Calculate Overhead Cost Per Unit  Define overhead costs and expenses. These are all costs associated with direct labor and materials.  Determine average hourly wage. Each employee's contribution should be classified as either direct or indirect labor. Direct labor works directly with product, whereas indirect labor supports direct labor  Estimate the number of workdays available in a given calendar year. Subtract the average number of days labor will not be working (holidays, weekends, vacations, sick leave, etc.) from 365.
  • 16.  Multiply the number of workdays available for labor by eight (for an eight-hour work day). This gives you an estimate for the total number of labor hours worked.  Multiply number of total labor hours by average labor wage determined in Step 2.  Add all overhead expenses, as defined in Step 1, to the dollar amount in Step 5. This is your total overhead cost.  Look up the average number of units sold per month and multiply by 12.  Divide total overhead costs by average number of units. This is your overhead cost per unit.
  • 17. Variance analysis  For the purpose of over or applied factory overhead analysis two separate variance are computed as follows:  Budget or spending variance  Volume or capacity variance
  • 18. Budget or spending variance  Factory Overhead spending variance is the difference between actual expenses incurred and the budgeted allowance based on actual hours worked.  The spending variance is the responsibility of the department manager, who is expected to keep actual expenses within the budget.  Formula of Spending Variance: [Actual factory overhead – Budgeted allowance based on actual hours worked*] *[Fixed expenses budgeted + Variable expenses (actual hours worked × variable overhead rate)]
  • 19. Volume or capacity variance  It is the difference between the budgeted overhead estimated for the capacity attained and factory overhead during the period  Responsibility of this overhead is rest on the top management because of the policy decisions about the utilization of the plant and equipment.  Formula of Idle Capacity Variance: [Budgeted allowance based on actual hours worked* – (Actual hours worked × Standard overhead rate)] *Fixed expenses budgeted + Variable expenses (actual hours worked × variable overhead rate)
  • 20. Example of variance analysis Fixed factory overhead Rs. 40,000 Variable factory overhead 60,000 Total factory overhead 1,00,000  Variable overhead rate = 60,000 = Rs. 3 per D. L 20,000 Hr.
  • 21.  Budget variance Actual factory overhead Rs. 80,000 (Factory overhead budgeted for the capacity attained) Fixed overhead 40,000 Variable overhead 51,000 (Rs. 3 x 17000) 91,000 Budget variance Rs.11,000 ( cr. Or unfavorable)
  • 22.  Volume variance Budgeted overhead allowance Rs. 91,000 for the capacity attained applied factory overhead 85,000 volume variance( dr. unfavorable) Rs. 6,000

Editor's Notes

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