Manufacturing Overhead Cost Standards
Manufacturing Overhead Cost Standards:
Learning Objective of the article:
- How manufacturing overhead standards are set?
Procedures for establishing and using standard factory overhead rates are similar to the methods of dealing with the estimated direct and indirect factory overhead and its application to jobs and products. An overhead budget for the rate calculation provides a budget allowance for a specific, predetermined level of activity, while a flexible budget provides allowance for various levels of activity. Both type of budgets aim for the control of factory overhead. Control is achieved by keeping actual expenses within ranges established by the budget. The maximum limit of a range is the amount set up in the flexible budget. However for costing jobs or products it is necessary to establish a normal overhead rate based on total estimated overhead rate at normal capacity volume.
An example of the effect of volume on overhead cost per unit is as follows:
Production volume (units) | 80,000 | 90,000 | 100,000 | 110,000 |
———- | ———- | ———- | ———- | |
Factory overhead: | ||||
Variable | $112,000 | $126,000 | $140,000 | $154,000 |
Fixed | 60,000 | 60,000 | 60,000 | 60,000 |
———- | ———- | ———- | ———- | |
Total | $172,000 | $186,000 | $200,000 | $214,000 |
====== | ====== | ====== | ====== | |
Factory overhead per unit: | ||||
Variable | $1.40 | $1.400 | $1.40 | $1.400 |
Fixed | 0.75 | 0.667 | 0.6 | 0.545 |
———- | ———- | ———- | ———- | |
Total unit overhead cost | $2.15 | $2.067 | $2.00 | $1.945 |
====== | ====== | ====== | ====== |
The example indicates the basic pattern of overhead behavior. Fixed expenses remain fixed, within a normal range of activity, as volume (output) changes, but they vary per unit. The greater the number of units, the smaller the amount of fixed overhead per unit. Variable expenses, on the other hand, increase proportionately with each increase of volume (output) and remain fixed per unit.
This characteristics of overhead behavior is important in establishing a standard factory overhead rate. Overhead absorption is accomplished by selecting a plant capacity as the base for charging variable and fixed overhead to jobs or products.
Variable expenses should be measured and controlled at any volume by the supervisors with the help of a flexible budget. The variable expenses in the flexible budget correspond to applied variable overhead, and variable overhead variances result from a comparison of actual variable costs with the flexible budget (applied) variable factory overhead.
Fixed expenses can be absorbed fully only by operating at the volume on which the rate is based. If the base set for overhead absorption is reached, budgeted and absorbed cost figures will be identical. Since this is highly improbable, a difference occurs between budgeted fixed expenses and absorbed fixed overhead, and fixed overhead variances from an analysis of this difference. For purposes of analysis, budgeted fixed overhead is used. Any difference that might occur between budgeted and fixed overhead becomes a part of the variable overhead variances in the methods of analysis presented in this section of the website. Alternatively this difference can be identified as a separate variance, called the fixed spending variance.
Standard Factory Overhead Rate:
The standard factory overhead rate is a predetermined rate that is usually based on the direct labor hours. Other bases may also be used, e.g., direct labor dollars or machine hours. The use of direct labor dollars, however, may cause some distortion in the variance calculation. because the actual direct labor dollar figure includes any labor rate variations from the standard rate. The data from the following flexible budget for department is used to illustrate the calculation of standard overhead rate and overhead variances.
Department 3 |
||||
Capacity | 80% | 90% | 100% | |
Standard production | 800 | 1,000 | 1,200 | |
Direct labor hours | 3,200 | 4,000 | 4,800 | |
Variable factory overhead: | ||||
Indirect labor | $1,600 | $2,000 | $2,400 | $0.50 / dlh |
Indirect materials | 960 | 1,200 | 1,440 | $0.30 |
Supplies | 640 | 800 | 960 | $0.20 |
Repairs | 480 | 600 | 720 | $0.15 |
Power and light | 160 | 200 | 240 | $0.05 |
———– | ———– | ———– | ———– | |
Total variable factory overhead | $3,840 | $4,800 | $5,760 | $1.20 per dlh |
====== | ====== | ====== | ====== | |
Fixed factory overhead: | ||||
Supervisor | $1,200 | $1,200 | $1,200 | |
Depreciation on machinery | 700 | 700 | 700 | |
Insurance | 250 | 250 | 250 | |
Property tax | 250 | 250 | 250 | |
Power and light | 400 | 400 | 400 | |
Maintenance | 400 | 400 | 400 | |
———– | ———– | ———– | ||
Total fixed factory overhead | $3,200 | $3,200 | $3,200 | $3,200 per month |
———– | ———– | ———– | ====== | |
Total factory overhead | $7,040 | $8,000 | $8,960 | $3,200 per month + $1.20 per dlh |
====== | ====== | ====== | ====== |
Assuming that 90% column represents normal capacity, the standard overhead rate is computed as follows:
Total factory overhead / Direct labor hours = $8,000 / 4,000 = $2 per standard direct labor hour
At 90% capacity level, the rate consists of:
Total variable factory overhead / Direct labor hours = $4,800 / 4,000 = $1.20 variable factory overhead rate
Total fixed factory overhead / Direct labor hours = $8,000 / 4,000 = $0.80 fixed factory overhead rate
Total factory overhead rate at normal capacity:
($1.20 + $0.80) = $2.00
You may also be interested in other articles from “standard costing and variance analysis” chapter
- Standard Costs and Management By Exception
- Setting Standard Costs – Ideal Versus Practical Standards
- Direct Materials Price and Quantity Standards
- Direct Materials Price Variance
- Direct Materials Quantity Variance
- Direct Labor Rate and Efficiency Standards
- Direct Labor Rate/Price Variance
- Direct Labor Efficiency | Usage | Quantity Variance
- Manufacturing Overhead Standards
- Overall or net factory overhead variance.
- Controllable variance
- Volume variance
- Spending variance
- Idle capacity variance
- Efficiency variance
- Spending variance
- Variable efficiency variance
- Fixed efficiency variance
- Idle capacity variance
- Mix and Yield Variance – Definition and Explanation
- Materials Mix and Yield Variance
- Labor Yield Variance
- Factory Overhead Yield variance
- Variance Analysis and Management By Exception
- Managerial importance and usefulness of variance analysis
- Advantages and Disadvantages of Standard Costing System
- Standard Costing Discussion Questions and Answers
- Standard Costing and Variance Analysis Formulas
- Standard Costing and Variance Analysis Problems and Solution
- Standard Costing and Variance Analysis Case Study
Other Related Accounting Articles:
- Factory Overhead Volume Variance
- Fixed Overhead Efficiency Variance
- Variable Overhead Efficiency Variance
- Factory Overhead Efficiency Variance
- Factory Overhead Controllable Variance
- Overall or Net Factory Overhead Variance
- Standard Costing and Variance Analysis Formulas
- Factory Overhead Yield Variance
- Managerial Usefulness/Importance of Variance Analysis
- Direct Labor Yield Variance
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