Problem 15 - Accounting

Question

Western Wood Products Company prepared the following factory overhead cost budget for the Press Department for February 2010, during which it expected to require 10,000 hours of productive capacity in the department: \begin{tabular}{lrr} Variable overhead cost: & & \\ Indirect factory labor & \(\$ 27,500\) & \\ Power and light & 2,600 & \\ Indirect materials & & \\ Total variable cost & \(\$ 54,100\) \\ Fixed overhead cost: & \(\$ 42,000\) & \\ Supervisory salaries & 40,000 & \\ Depreciation of plant and equipment & 12,000 & \\ Insurance and property taxes & & \\ Total fixed cost & & 94,000 \\ \hline Total factory overhead cost & \(\$ 148,100\) \\ \hline \end{tabular} Assuming that the estimated costs for March are the same as for February, prepare a flexible factory overhead cost budget for the Press Department for March for 8,000 , 10,000 , and 12,000 hours of production.

Step-by-Step Solution

Answer

The total overhead costs are $137,280 for 8,000 hours, $148,100 for 10,000 hours, and $158,920 for 12,000 hours.

Step 1: Calculate Variable Overhead Rate per Hour

For the variable overhead, we need to find the rate per hour. The expected total variable overhead cost for 10,000 hours is $54,100. Therefore, the variable overhead rate per hour is \[ \frac{54,100}{10,000} = 5.41 \ \text{dollars per hour} \]

Step 2: Calculate Fixed Overhead Cost

The fixed overhead does not change with the number of production hours. From the data given for February, the total fixed overhead cost is $94,000.

Step 3: Determine Factory Overhead Costs for 8,000 Hours

Using the variable overhead rate from Step 1, calculate the total variable cost for 8,000 hours:\[ 8,000 \times 5.41 = 43,280 \]Add the fixed overhead cost to find the total overhead cost:\[ 43,280 + 94,000 = 137,280 \]

Step 4: Determine Factory Overhead Costs for 10,000 Hours

For 10,000 hours, the variable overhead is already calculated as $54,100 in Step 1. Total overhead cost:\[ 54,100 + 94,000 = 148,100 \]

Step 5: Determine Factory Overhead Costs for 12,000 Hours

Calculate the total variable cost for 12,000 hours:\[ 12,000 \times 5.41 = 64,920 \]Add the fixed overhead cost to find the total overhead cost:\[ 64,920 + 94,000 = 158,920 \]

Key Concepts

Factory Overhead Costs

Factory overhead costs are the expenses incurred during the manufacturing process that cannot be directly linked to the production of specific goods. These costs are essential to running a production department smoothly and include a combination of variable and fixed costs.
Examples of factory overhead costs include:

• Indirect factory labor, which involves efforts by workers who do not physically produce goods but ensure the operation runs efficiently, such as maintenance staff.
• Power and light expenses, as they are necessary to keep the factory operational regardless of how many products are being made.
• Supervisory salaries, as supervisors manage and oversee the production process, but their work is not tied to any single product.

Understanding factory overhead costs helps businesses create accurate budgets, control expenses, and improve financial planning.

Variable Overhead

Variable overhead costs are expenses that fluctuate in direct proportion to production levels. When production increases, variable overhead costs rise; conversely, they decrease when production falls. This is because these costs are directly tied to the amount of output.
In the context of the exercise, the variable overhead rate is calculated as a cost per hour of productive capacity:
1. Indirect factory labor, which might include overtime or temporary workers hired for increased production, reflects variable cost changes.2. Power and light costs can vary significantly as production expands, requiring more energy.To find the overhead cost per unit of output or hour of capacity, divide the total expected variable costs by the expected production level. In this case:\[ \text{Variable Overhead Rate per Hour} = \frac{54,100}{10,000} = 5.41 \ \text{dollars per hour} \]This rate helps predict total variable overhead costs accurately for different levels of production.

Fixed Overhead

Fixed overhead costs remain constant regardless of changes in production volume. These costs are predictable and generally do not fluctuate with the level of output, making them easier to budget for.
Examples include:

• Supervisory salaries, which are typically consistent irrespective of how much is produced.
• Depreciation of plant and equipment, a non-cash expense representing the wear and tear of machinery over time.
• Insurance and property taxes, which are routine expenses incurred as factory buildings are insured and property taxes are levied by local governments.

In the exercise, the total fixed overhead is given as $94,000. This figure remains unchanged regardless of whether the production is 8,000, 10,000, or 12,000 hours. When planning budgets, understanding fixed overhead is crucial for stability and long-term financial planning.

Cost Calculation

Calculating the total factory overhead cost involves summing both variable and fixed overheads. This is central to budgeting and provides insights into efficiency and production planning.
Here's how you calculate total costs for varying production levels:- **For 8,000 Hours**: Use the variable overhead rate multiplied by hours to get the total variable cost: \[ 8,000 \times 5.41 = 43,280 \ \text{dollars} \] Adding fixed overhead: \[ 43,280 + 94,000 = 137,280 \ \text{dollars} \]- **For 10,000 Hours**: The previously calculated variable costs: \[ 54,100 + 94,000 = 148,100 \ \text{dollars} \]- **For 12,000 Hours**: Calculate again using the variable rate: \[ 12,000 \times 5.41 = 64,920 \ \text{dollars} \] Adding fixed costs gives: \[ 64,920 + 94,000 = 158,920 \ \text{dollars} \]These calculations ensure that businesses can predict overhead costs across different levels of operations. Understanding this methodology supports effective business management, enhancing decision-making for scale and resource allocation.