Applied Factory Overhead

Take one more look at the "work in process" factory floor picture, and think about the factory overhead that is being "used" to process the pipe. What components can you identify or contemplate? Likely, your list will include utilities costs, insurance, factory maintenance, depreciation on the equipment, some supplies, and similar items. As discussed earlier in the chapter, these costs must be attached to the products. But, the method of attachment is by applying overhead based on a predetermined estimated rate - again, because it is virtually impossible to associate or match the incurrence of actual overhead with each job actually produced.

Assume the pipe factory applies overhead at the rate of $25 per direct labor hour. Remember that 200 hours were needed for the job in question. Thus, $5,000 ($25 x 200) is the amount of applied factory overhead. The following entries are similar to those that were used to record the direct labor; compare them, and pick out the account that differs:

Work in Process Inventory 5,000

Factory Overhead 5,000

Applied factory overhead to production (200 hours @$25)

Finished Goods Inventory 5,000

Work in Process Inventory 5,000

Transferred processed pipe to finished goods

Cost of Goods Sold 5,000

Finished Goods Inventory 5,000

Delivered finished goods to customer

An account entitled "Factory Overhead" was uniquely credited in the first of the above entries. What does this credit really represent? This account is one of the more confusing to explain; it is challenging for students to grasp. As a result, there is a separate section later in this chapter (Accounting for Actual and Applied Overhead). But, for the moment, accept this truncated explanation: The credit to Factory Overhead is the allocation tool used to pass out the actual overhead costs to jobs in progress; the actual overhead costs are captured via debits to this account through a separate process described later in this chapter.

Overview

The preceding information can be combined and summarized as follows:

This graphic illustrates how the total job cost was measured as $18,000. The general journal would include the following entries:

Financial Statement Impact Scenarios

How job cost data appears on the financial statements depends on its condition at the financial statement date. Considering the pipe illustration:

o If the raw pipe had not yet started into production, its $10,000 cost would appear in the raw materials inventory category on the balance sheet:

o If the pipe was in production but not complete, the total cost in the Work in Process account as of the balance sheet date would be aggregated and presented as work in process inventory on the balance sheet. For example, assume all of the raw material was in process, but only half of the necessary labor tasks had been performed; in this case, the Work in Process Inventory account would include $14,000 ($10,000 direct material + $1,500 labor + $2,500 applied overhead):

o If the drill pipe was completed but unsold, the finished goods inventory would be carried at $18,000 on the balance sheet:

o If the drill pipe was sold for $25,000, the income statement would include sales ($25,000) and cost of goods sold ($18,000), netting to the $7,000 gross profit: