CHAPTER 12
DISCUSSION QUESTIONS
Q12-1. Supervisors’ salaries, indirect labor, overtime or to be performed, i.e., for estimating pur-
premium, supplies, indirect materials, payroll poses. Ordinarily, the base selected should be
tax, factory insurance, and depreciation. closely related to functions represented by
Q12-2. The most important reason for variation in fac- the applied overhead cost. If factory overhead
tory overhead is the presence of fixed and costs are predominantly labor oriented, such
variable expenses. Therefore, as production as supervision and indirect labor, the proper
volume changes from month to month, the base would probably be direct labor hours. If
costs will do likewise. However, overhead also factory overhead costs are predominantly
will change because of improved or decreased related to the cost incurred in the ownership
efficiencies and changes in prices paid for and operation of the machinery, the proper
overhead items such as supplies and repairs. base would probably be machine hours.
Q12-3. Predetermined rates are used when it Another objective in selecting the base is
becomes obvious that any other method of to minimize clerical cost and effort relative to
charging overhead results in inequitable cost- the benefits attained. When two or more
ing and delays the reporting of financial bases provide approximately the same
results. Charging actual overhead to jobs and applied overhead cost to specific units of pro-
products can result in charging unreasonable duction, the simplest base should be used.
amounts of overhead to various periods and Q12-7. (a) Theoretical capacity is actually the maxi-
in delayed reporting of cost data. The use of mum production possible from a given
predetermined rates also enhances control plant with no allowance made for cessation
through analysis of over- or underapplied fac- of operations for holidays, weekends, mate-
tory overhead. rials shortages, or machine breakdowns.
Q12-4. Six bases used for applying factory overhead (b) Practical capacity is theoretical capacity
are units produced, direct materials cost, less an allowance for interruptions such
direct labor cost, direct labor hours, machine as breakdowns, delays in receiving sup-
hours, and transactions. Important considera- plies, and worker absences. Practical
tions in selecting a base are the relationship capacity is usually 75 to 85 percent of
(correlation) of the base used and the use of theoretical capacity.
overhead items in manufacturing operations, (c) Expected actual capacity is practical
as well as the clerical practicability of using a capacity adjusted for the lack of sufficient
particular base. demand in a single operating period and
Q12-5. Predetermined rates are used to charge over- may be used in building operating budg-
head and become the basis for determining ets when expected capacity differs sub-
the cost of a job or product. Therefore, the rea- stantially from normal capacity.
sonableness of such costs is to a large extent (d) Normal capacity is practical capacity
determined by the reasonableness of the adjusted to give consideration to the lack
rates. Since these costs are used for costing of sufficient demand over a period long
inventories and play an important role in estab- enough to include cyclical and seasonal
lishing sales prices, the selection of proper pre- fluctuations. This is usually the basis for
determined rates can be appreciated. long-range planning, standards, and
Q12-6. An objective in selecting the base for a prede- preferably for the determination of over-
termined factory overhead rate is to ensure head rates.
the application of factory overhead in reason- Q12-8. The underapplied overhead will be higher If
able proportion to a beneficial or causal rela- maximum capacity is used and lower if nor-
tionship to jobs, products, or work performed mal is used. If this cost is charged to the
12-1
,12-2 Chapter 12
current period, then maximum capacity will Q12-10. (a) Analyze and identify the overhead trans-
produce a lower, and normal capacity a actions.
higher, operating profit. (b) Journalize the transactions.
Q12-9. (a) Idle capacity costs arise from idle employ- (c) Enter transactions in general and sub-
ees and idle facilities. Idle employees give sidiary ledgers.
rise to costs such as base wages paid, Q12-11. Overhead applied to production is entered
employer’s share of payroll taxes, and as a credit in the factory overhead control
other fringe benefit costs. Idle facilities account. Actual overhead is debited to the
cause capacity costs due to deterioration same account. Therefore, overhead has
with time, approaching obsolescence, been overapplied when the account has a
costs for upkeep, readiness, mainte- credit balance.
nance, repairs, shelter, and protection of Q12-12. Overhead can be overapplied because (a)
valuables such as insurance. actual overhead was less than budgeted; (b)
(b) When idle capacity is present, an attempt capacity utilized was greater than that esti-
should be made to segregate idle mated in computing overhead rates; (c) the
employees and idle facilities through overhead estimate was too high (a mistake);
proper reclassification. The accumulation (d) the production estimate was too low (a
of the cost attributable to these idle work- mistake); (e) combinations of the above.
ers or facilities in excess of a reasonable Q12-13. Over- or underapplied factory overhead may
budgeted amount might be in some kind be prorated among work in process, finished
of overhead account to be treated sepa- goods, and cost of goods sold, or it may be
rately as a “management by exception” treated entirely as a period cost. The first
factor. Idle capacity costs should be method would have a smaller effect on cost
accounted for separately for these rea- of goods sold and therefore on the net
sons: (1) to prevent distortion and confu- income for the period.
sion in the analysis of production costs; Q12-14. The existence of large underabsorbed vari-
(2) to facilitate income determination; (3) ances does not necessarily mean that unit
to control operations; and (4) to plan next costs are incorrect. An analysis of the under-
year’s budget adequately. absorbed figures will indicate (a) whether
(c) Excess capacity cost has been identified actual overhead is too high or whether
with those capacity costs that result from expenses have been incorrectly estimated;
greater production capacity than the com- and (b) what part of the underabsorption is
pany could ever hope to use, or from caused by unused capacity. If actual over-
unbalanced equipment or machinery head is considered to be too high and there
within departments. In creating the fore- is idle capacity, unit costs computed are
cast budget, it is important to isolate the more reasonable than they would be if over-
excess capacity cost so that manage- head rates were computed to absorb all of
ment can be made aware of its responsi- the actual overhead.
bility regarding the excess investment in
labor and machines.
12-2
, Chapter 12 12-3
EXERCISES
E12-1
(1) $1,750,000 fixed overhead and $720 variable overhead per ton, calculated as
follows:
For both the normal capacity and expected actual capacity, the problem states
the total budgeted overhead cost and the number of tons of activity. The high-
low method of estimating cost behavior can be used to determine the over-
head budget, using those two points:
Budgeted
Activity Level Tons Overhead
Normal capacity 6,000 $6,070,000
Expected actual 5,000 5,350,000
Difference 1,000 $ 720,000
$720, 000
Variable = = $720 va riable overhead per ton
overhead rate 1, 000 tons
Budgeted fixed overhead = $5,350,000 total overhead
– ($720 × 5,000) variable overhead
= $5,350,000 – $3,600,000 = $1,750,000
or, budgeted
fixed overhead = $6,070,000 total overhead
– ($720 × 6,000) variable overhead
= $6,070,000 – $4,320,000 = $1,750,000
DISCUSSION QUESTIONS
Q12-1. Supervisors’ salaries, indirect labor, overtime or to be performed, i.e., for estimating pur-
premium, supplies, indirect materials, payroll poses. Ordinarily, the base selected should be
tax, factory insurance, and depreciation. closely related to functions represented by
Q12-2. The most important reason for variation in fac- the applied overhead cost. If factory overhead
tory overhead is the presence of fixed and costs are predominantly labor oriented, such
variable expenses. Therefore, as production as supervision and indirect labor, the proper
volume changes from month to month, the base would probably be direct labor hours. If
costs will do likewise. However, overhead also factory overhead costs are predominantly
will change because of improved or decreased related to the cost incurred in the ownership
efficiencies and changes in prices paid for and operation of the machinery, the proper
overhead items such as supplies and repairs. base would probably be machine hours.
Q12-3. Predetermined rates are used when it Another objective in selecting the base is
becomes obvious that any other method of to minimize clerical cost and effort relative to
charging overhead results in inequitable cost- the benefits attained. When two or more
ing and delays the reporting of financial bases provide approximately the same
results. Charging actual overhead to jobs and applied overhead cost to specific units of pro-
products can result in charging unreasonable duction, the simplest base should be used.
amounts of overhead to various periods and Q12-7. (a) Theoretical capacity is actually the maxi-
in delayed reporting of cost data. The use of mum production possible from a given
predetermined rates also enhances control plant with no allowance made for cessation
through analysis of over- or underapplied fac- of operations for holidays, weekends, mate-
tory overhead. rials shortages, or machine breakdowns.
Q12-4. Six bases used for applying factory overhead (b) Practical capacity is theoretical capacity
are units produced, direct materials cost, less an allowance for interruptions such
direct labor cost, direct labor hours, machine as breakdowns, delays in receiving sup-
hours, and transactions. Important considera- plies, and worker absences. Practical
tions in selecting a base are the relationship capacity is usually 75 to 85 percent of
(correlation) of the base used and the use of theoretical capacity.
overhead items in manufacturing operations, (c) Expected actual capacity is practical
as well as the clerical practicability of using a capacity adjusted for the lack of sufficient
particular base. demand in a single operating period and
Q12-5. Predetermined rates are used to charge over- may be used in building operating budg-
head and become the basis for determining ets when expected capacity differs sub-
the cost of a job or product. Therefore, the rea- stantially from normal capacity.
sonableness of such costs is to a large extent (d) Normal capacity is practical capacity
determined by the reasonableness of the adjusted to give consideration to the lack
rates. Since these costs are used for costing of sufficient demand over a period long
inventories and play an important role in estab- enough to include cyclical and seasonal
lishing sales prices, the selection of proper pre- fluctuations. This is usually the basis for
determined rates can be appreciated. long-range planning, standards, and
Q12-6. An objective in selecting the base for a prede- preferably for the determination of over-
termined factory overhead rate is to ensure head rates.
the application of factory overhead in reason- Q12-8. The underapplied overhead will be higher If
able proportion to a beneficial or causal rela- maximum capacity is used and lower if nor-
tionship to jobs, products, or work performed mal is used. If this cost is charged to the
12-1
,12-2 Chapter 12
current period, then maximum capacity will Q12-10. (a) Analyze and identify the overhead trans-
produce a lower, and normal capacity a actions.
higher, operating profit. (b) Journalize the transactions.
Q12-9. (a) Idle capacity costs arise from idle employ- (c) Enter transactions in general and sub-
ees and idle facilities. Idle employees give sidiary ledgers.
rise to costs such as base wages paid, Q12-11. Overhead applied to production is entered
employer’s share of payroll taxes, and as a credit in the factory overhead control
other fringe benefit costs. Idle facilities account. Actual overhead is debited to the
cause capacity costs due to deterioration same account. Therefore, overhead has
with time, approaching obsolescence, been overapplied when the account has a
costs for upkeep, readiness, mainte- credit balance.
nance, repairs, shelter, and protection of Q12-12. Overhead can be overapplied because (a)
valuables such as insurance. actual overhead was less than budgeted; (b)
(b) When idle capacity is present, an attempt capacity utilized was greater than that esti-
should be made to segregate idle mated in computing overhead rates; (c) the
employees and idle facilities through overhead estimate was too high (a mistake);
proper reclassification. The accumulation (d) the production estimate was too low (a
of the cost attributable to these idle work- mistake); (e) combinations of the above.
ers or facilities in excess of a reasonable Q12-13. Over- or underapplied factory overhead may
budgeted amount might be in some kind be prorated among work in process, finished
of overhead account to be treated sepa- goods, and cost of goods sold, or it may be
rately as a “management by exception” treated entirely as a period cost. The first
factor. Idle capacity costs should be method would have a smaller effect on cost
accounted for separately for these rea- of goods sold and therefore on the net
sons: (1) to prevent distortion and confu- income for the period.
sion in the analysis of production costs; Q12-14. The existence of large underabsorbed vari-
(2) to facilitate income determination; (3) ances does not necessarily mean that unit
to control operations; and (4) to plan next costs are incorrect. An analysis of the under-
year’s budget adequately. absorbed figures will indicate (a) whether
(c) Excess capacity cost has been identified actual overhead is too high or whether
with those capacity costs that result from expenses have been incorrectly estimated;
greater production capacity than the com- and (b) what part of the underabsorption is
pany could ever hope to use, or from caused by unused capacity. If actual over-
unbalanced equipment or machinery head is considered to be too high and there
within departments. In creating the fore- is idle capacity, unit costs computed are
cast budget, it is important to isolate the more reasonable than they would be if over-
excess capacity cost so that manage- head rates were computed to absorb all of
ment can be made aware of its responsi- the actual overhead.
bility regarding the excess investment in
labor and machines.
12-2
, Chapter 12 12-3
EXERCISES
E12-1
(1) $1,750,000 fixed overhead and $720 variable overhead per ton, calculated as
follows:
For both the normal capacity and expected actual capacity, the problem states
the total budgeted overhead cost and the number of tons of activity. The high-
low method of estimating cost behavior can be used to determine the over-
head budget, using those two points:
Budgeted
Activity Level Tons Overhead
Normal capacity 6,000 $6,070,000
Expected actual 5,000 5,350,000
Difference 1,000 $ 720,000
$720, 000
Variable = = $720 va riable overhead per ton
overhead rate 1, 000 tons
Budgeted fixed overhead = $5,350,000 total overhead
– ($720 × 5,000) variable overhead
= $5,350,000 – $3,600,000 = $1,750,000
or, budgeted
fixed overhead = $6,070,000 total overhead
– ($720 × 6,000) variable overhead
= $6,070,000 – $4,320,000 = $1,750,000
