Treatment of Under/Over applied FOH

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Treatment of Under/Over applied FOH
There are three methods of treating FOH under/over applied.
1. Adjustment in the entire production
2. Adjustment in the Cost of goods sold
3. Adjustment in the Net Profit
1.
Adjustment in the entire production
Let’s take an example; here is the format of Cost of goods sold, how under /over
applied FOH charged to entire production?
Particulars
Direct Material Consumed
Opening inventory
Add Net Purchases
Material available for use
Less Closing inventory
Direct Material used
Add Direct labor
Prime cost
Add Factory overhead Cost
Total factory cost
Add Opening Work in process
Cost of good to be
manufactured
Less Closing Work in process
Cost of good manufactured
Add Opening finish goods
Cost of good to be sold
Less closing finish goods
Cost of good to sold at normal
Rs
Calculation of FOH
10,000
100,000
110,000
20,000
90,000
60,000
150,000
90,000
240,000
30,000
270,000
50,000
220,000
100,000
320,000
10,000
310,000
Applied FOH (60,000 x 150%) 90,000
It is given that applied FOH is based
On % of Direct labor Cost. here we
Do not need to calculate FOH rate.
Variance.
It is come to learn that at the end of production the
actual FOH was 80,000.this information will be also
available in question. Now we do variance analysis
Under/Over applied FOH cost
Applied FOH Cost
Less Actual FOH Cost
Over applied FOH cost
90,000
80,000
10,000
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There are three component of Entire production
We adjust under/over applied FOH effect to all these three components
1. Work in process inventory (Closing)
2. Finished goods inventory (Closing)
3. Cost of goods sold
Entire production includes three items; work in process inventory, finished goods inventory,
And cost of goods sold. These three items are the three parts in which total cost of production
(Either finished or semi finished) has been divided.
Why we add or less for under /Over Applied FOH?
The concept of addition to and subtraction from the relevant amount is that because there is a
Favorable variance i.e. the applied factory overhead cost is more than the actual cost
therefore,
To make correction in the information containing cost items (entire production) there must be
Subtraction equal to the amount which was over added.
Obviously the difference will be added if there is an unfavorable variance i.e. the applied
factory overhead cost is less than the actual cost. This is so because the cost charged is lesser
than the Actual, and to make the cost items (entire production) equal to their actual figures
we need Addition of further amount.
Treatment.
We charged them on the apportioned based cost. We know that in the question the variance is
over applied Rs.10, 000. Now we apportioned on the value of Work-in-process closing
inventory, Finished goods closing inventory, Cost of goods sold bases
We know the values of these components which we have already calculated while preparing
the Cost of goods sold
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Calculations of apportionment of over applied FOH Rs.10,000
Work-in-process inventory (closing)
Finished goods inventory (Closing)
Cost of goods sold
Total
50,000
10,000
310,000
370,000
Work-in-process inventory (closing)
Finished goods inventory (Closing)
Cost of goods sold
50,000 x10,000/370,000= 1351
10,000 x10,000/370,000= 270
310,000 x10,000/370,000=8,378
Adjustment in the Entire Production
Work-in-process inventory (closing)
Finished goods inventory (Closing)
Cost of goods sold
(50,000 - 1,351) =48,649
(10,000 - 270)= 9,730
(310,000 - 8,378)= 301,622
Adjustment in the Cost of Goods Sold
Some times it is required to adjust all of the variance in the cost of goods sold, here the same
Principle of addition or subtraction will be followed which has already been discussed in the
Above paragraphs. This is so because the cost of goods sold is also a cost item. The amount of
Cost of goods sold before adjustment is known as cost of goods sold at normal and after
Adjustment is known cost of goods sold at actual.
Cost of goods sold at normal
Add over applied FOH
310000
10000
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Cost of goods sold at actual
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300000
Adjustment in the Income Statement
Sales
Less Cost of goods sold (at normal)
Gross profit
Less Operating expenses
Selling and marketing
Distribution
Administrative
Operating profit
Less Financial Expenses
Interest on loan
Profit before tax
Less Income Tax
Net profit
Add over-applied FOH cost
Net profit
600,000
310,000
290,000
50,000
30,000
20,000
190,000
50,000
140,000
60,000
80,000
10,000
90,000
Please considered that Point.
Principle of addition or subtraction of factory overhead variance is reverse in income
statement.
This is so because here the amount of net profit is adjusted for the variances, which is income in
Nature.
Over-application of factory overhead cost causes an increase in the cost of goods sold which
Reduces the gross profit and also the net profit, so to bring the amount of net profit at its actual
Amount we need to add over-applied factory overhead cost in the net profit. Obviously in case of
Under application of factory over head cost the variance will be subtracted from the amount of net
Profit.
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