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Factory Overhead Expenses

What are factory overhead expenses, and what distinguishes them from other manufacturing costs? What other terms are used to describe factory overhead expenses

Factory overhead expenses are costs relating to the general production of goods and services that can’t be assigned directly to a particular product. The term is used in accounting and finance contexts as one of the many production cost components, also known as manufacturing overheads or factory overhead costs.

Factory overhead expenses are distinguishable from direct material manufacturing costs, which underpin industry-specific terminologies such as production overhead, indirect materials and labor hours.

The term factory overhead was first introduced by Raymond W. Goldsmith in his 1937 article “Overhead Cost”. However, the concept predates this date and has been synonymous with production overheads which replaced the former term manufacturing overheads.

Historically, manufacturing overheads have comprised both indirect material costs (or direct labor costs) and indirect labor costs. Indirect labor includes employment such as supervisory staff and maintenance workers (Bragg, 2019).

What are factory overhead expenses?

Factory overhead expenses are production related expenses that may not be directly attributable to a product. A factory can be run as a lean factory or a lean mill, and lean factories have been documented to operate more efficiently. Often, this efficiency is attributed to the use of overhead production costs such as factory overhead expenses. Examples of commonly produced overhead expenses include:

– Indirect material costs

– Indirect labor costs

– Maintenance costs (e.g. custodial services)

While overhead expenses are often descriptive, it can be a challenge to clearly define what represents an overhead cost. For example, maintenance staff may work as part of a factory line and thus their salaries may be considered to be direct labor costs rather than indirect material costs or indirect labor costs.

What are three categories of factory overhead expenses? Give examples of each.

Three types of factory overhead expenses are direct labor, indirect labor, and manufacturing power.

Direct labor is the cost of hiring people to work on production lines or as part of a project team assigned to a specific task or project. Indirect labor is the cost of paying people to oversee, train and supervise other workers. Manufacturing power is the cost of purchasing machines, tools, and equipment for routine production operations (Jonick, 2017).

Each type of factory overhead expense may be identified by a specific item code. For example, indirect labor would be recorded as the “ITL” line item in a manufacturing overhead cost sheet.

Factory overhead expenses can be categorized by the type of product produced or by the type of manufacturer.

Manufacturing overhead expenses are those expenditures related to production or to the equipment used in producing a product.

What are the distinguishing characteristics of variable, fixed, and semi variable factory overhead costs?

Factory overhead costs are the expenses incurred in producing goods and services. These are not associated with particular units of production but instead derive from common factory functions like heating, maintenance, utilities, and management. The factory overhead cost is divided into three categories: variable total overhead, fixed total overhead, and semi-variable total overhead.

Fixed factory overhead costs are the expenses that do not vary as a result of changes in production volumes or levels — which is why they’re sometimes referred to as “fixed” expenses.

For example, the cost of a factory’s heating system in the winter would fall under fixed overhead expenses because the costs would not vary with production levels. Fixed costs are generally incurred regardless of how much or what is produced, so they are said to be “overhead” because they don’t directly relate to a company’s products. Fixed costs are committed — that is, already paid for — as soon as a company pays for them. They are expenses that will happen even if there is no production at all.

Semi-variable factory overhead costs are the expenses incurred in producing goods and services that could increase or decrease as a result of production levels.

The cost of machinery, for example, is not fixed because it typically needs to be replaced every few years or so (or it will break down). But these expenses do not change at the same rate as fixed overhead. Semi-variable factory overhead refers to the portion of the factory overhead cost that increases and decreases at the same rate as production volumes.

Variable factory overhead costs are the expenses that could increase (or decrease) as a result of changes in production levels. Examples include the cost of purchasing machines, parts, and other raw materials; the cost of materials used in production; and any factory employee salaries or benefits.

Variable factory overhead is not fixed because it does not follow production volumes or levels — i.e., it’s not “overhead” per se—and these expenses can vary with production volumes and levels.

When a product’s cost is composed of fixed and variable costs, what effect does the increase or decrease in production have on per unit cost?

Fixed cost is the amount of money that will be spent for a certain activity no matter how many units are produced. Variable costs depend on how much production takes place.

If the production increases, variable costs will also increase but fixed costs stay the same. If production decreases, then variable costs decrease while fixed costs remain the same. Although this article covers only one effect on per unit cost, it is important to remember that there are other effects such as demand and marginal revenue or profit (MRP).

When the quantity produced increases, the change in total cost will be different for fixed and variable costs. The total cost will increase by a greater proportion due to an increase in fixed costs than it would from an increase in only variable costs. The total cost of producing Q1 units is made up of fixed + variable costs.

Per unit costs are affected by the change in quantity produced.

The increase in fixed costs is greater than the increase in variable costs because fixed costs have to be paid no matter how many units are produced. A smaller quantity of product will result in a larger percentage increase for fixed expenses than for variables. If a company increases its production, it will experience an increased cost per unit sold and will also face unexpected additional expenses that were not previously planned.

Total cost is affected by the initial and final quantities produced.

The increase in fixed costs is greater than the increase in variable costs because fixed expenses can’t be reduced or eliminated once production has begun. The only thing that can be done to reduce the production of a product is to reduce the number of units produced. If a company decides to significantly reduce its production, it will experience a great deal of uncertainty.

What effect does a change in volume have on the total variable costs, fixed costs, and semi variable costs?

If the volume of a company’s production increases, the total variable cost is expected to go down and the fixed costs are expected to stay unchanged.

This is because both volume and cost per unit will increase proportionally. The only outlier will be that the semi variable costs go up as well. This is because when the volume goes up, it means more units have been manufactured which will lead to more variances in final outcomes due to problems such as defective products.

When the volume goes up, the variable costs do not change. The variable costs (cost of goods sold) are directly correlated to the volume, as they are made per unit produced. However, total fixed costs will go down due to economies of scale.

The total variable cost is a function of quantity demanded and price per unit. When the total quantity demanded increases, by law the total variable cost will decrease proportionally because it is directly proportional to the quantity demanded (Drury, 2018).

If the price per unit is constant, as in a situation where demand and supply are in equilibrium, then the total variable cost will remain constant. However, if the price per unit decreases as the quantity demanded increases, then the total variable cost will decrease as well.

If the total variable cost decreases while total fixed costs remain unchanged, then semi variable costs must increase. If a company makes 10 units and ends up with 1 defective unit which is discarded after standard testing and only 9 units are usable, then its semi variable costs will increase. Semi variable costs are not directly correlated to volume because they are made per unit produced.

In summary, if the volume of a company’s production increases, its total variable costs will decrease and its total fixed costs will remain unchanged.

This is because the total fixed costs remain unchanged while the volume of production increases, while the total variable costs decrease when both variables change proportionally. Semi variable costs must increase because they are not directly proportional to the volume and therefore there are more defective units when the volume of production increases.

Distinguish between a step variable cost and a step fixed cost

The difference between a step variable cost and a step fixed cost is that the step variable cost changes depending on the amount of production, while the step fixed cost does not change with production output.

The following are examples of each:

If you have a job where you only produce 200 units per day and your direct material is $1 per unit, then your daily material expense would be $200.

On the other hand, if you produce 300 units per day while paying $0.85 per unit, then your direct material cost would be $300, but your daily material cost is still $200.

In this example, the daily variable cost is not affected by output even though it is a step variable cost. However, in the example below where you produce 1000 units per day and pay $0.85 per unit, your direct material cost is $1,000 while your daily material cost is $200. This time your variable cost is affected by output.

In this example with fixed costs, the variable costs are not able to change depending on how much you produce while maintaining a given level of output. In contrast to this example with variable costs, the fixed cost changes depending on how much you produce.

Thus, it can be seen that the step variable cost and step fixed cost are exactly opposite from each other. When comparing the two, then it is necessary to identify which type of cost is being compared. Moreover, the amount of production must be consistent in both scenarios.

It should also be noted that these are only a few examples of how they differ; there are others as well.

What are the advantages and disadvantages of the scattergraph method as compared to the high-low method?

A scattergraph is a visual method of displaying observations mapped on different variables. It helps in forecasting, selecting and interpreting the data when analysing trends. The scattergraph has many advantages over the high-low method of analysis.

The scattergraph is more accurate than the high-low method because it helps prevent errors in viewing relationships between two variables when they are plotted on two axes with only one independent variable at a time. Unlike the high-low method, it does not require a list to be created before it could begin to be used. With the scattergraph, all data can be plotted on two axes at once, which is more efficient and convenient for the user.

By mapping the observations on both variables simultaneously instead of one variable at a time in order to view their relationships, the scattergraph can easily highlight any outliers that might have been missed without its use.

In addition, it allows us to answer queries easily. A scattergraph can also be used to show the relationship between two variables with more than one independent variable. By plotting more than two variables, the scattergraph helps us identify patterns and clusters in the data, and as a result, draw inferences which are not possible with a high-low method.

Scattergraph is appropriate when both variables are continuous in nature and have no common feature. It can be used for representing third dimension data for clustering, trend or any other purpose. It is also used when we have an observation that is not a continuous scale and there are no other variables that can be used or when the units of the observation are changed.

For example, if we have a survey on corruption within a country and these data are seen as daily occurrences, then the survey length will not be linear but non-linear. In this case, the scattergraph is almost used for filtering out the outliers from our data set.

DISADVANTAGES:

The scattergraph only gives a visual impression of data. It does not provide information about context or where data may be clustered, so it can be difficult to infer trends or patterns from just looking at the graph.

The scattergraph method is time-consuming to set up; you need to choose the right axes, and one of the axes should always be scaled so that you can infer trends in the data.

The scattergraph method does not provide any statistical or machine-learning advice, so it is difficult to say whether the graph provides meaningful information about your data at all. (e.g. Does the graph indicate that there is a possible linear relationship between the two variables, or does it show that there is a strong quadratic relationship?)

The scattergraph method may be suitable for small- and medium-sized data sets, but for larger, more complex datasets (e.g. with thousands of rows), you will probably need to use a more sophisticated visualization technique.

Differentiate between an independent variable and a dependent variable and give an example of each

An independent variable is measured as the cause, or agent that causes a change in a system. A dependent variable is then measured as the effect of this change. An example of an independent variable would be the temperature which has an effect on the dependent variables such as air pressure and volume.

An example of a dependent variable would be how long someone can hold their breath, which will depend on the person’s age and gender.

A dependent variable is always measured with respect to the change caused to it by one or more independent variables. In a physics experiment, these variables may be the amounts of oxygen and hydrogen in a particular reaction. The dependent variable will measure some change in the system compared with a baseline or control value – for example, pressure or volume as a result of changes to the amounts of gases (Gerald, 2018).

In an experimental design, one variable is chosen as independent (inherently “causal”) and all others are treated as dependent (inherently “response” or sometimes “effect”). The dependent variables are measured as the effects of changes in one independent variable.

The independent variable is controlled by the researcher, and the others are observed. An example would be measuring the amount of time it takes to complete a 0-mile crossing of a river to determine how deep the water is. An independent variable is also called a cause variable, or a variable that causes a change in the dependent variable.

In epidemiology, it is common to look at both causes (for example smoking and lung cancer), and effects (such as the number of cigarettes smoked per day). An example would be the different cigs smoked per day by men and women. While these are not independent variables, they are both indirectly caused by differences in age (the “cause”), which may depend on gender (the “effect”).

What are two types of departments found in a factory? What is the function or purpose of each?

There are two major types of departments: production and service. Production is geared towards building items that will be sold, while service departments provide services to the other employees or the company.

There are two major types of departments: production and service. Production is geared towards building items that will be sold, while service departments provide services to the other employees or the company. In the company described below, each is the case of a production department (Hanum et al., 2020).

First and foremost is the building department. This department has one purpose: to construct and build safe, functioning buildings that will house employees and equipment. The building’s location should be right in front of the manager’s desk to keep an eye on what is being built at all times making sure that it can be completed on time (if not, you run the risk of being fired).

The department also has a few other jobs, the most important being to make sure the building is painted and cleaned frequently. The paint and cleaner are purchased through profit on some jobs and have to be paid for by the company.

No matter the purpose of the building, it will be furnished and equipped with appliances, furniture, and equipment as best as possible to accommodate employees. Safety is also a prime concern for this department.

These types of buildings are also used to house all kinds of machinery produced by the company in order to help complete production jobs faster. The machinery is housed in a separate building to keep it safe, but also out of the way so employees can move freely throughout the office space. The department has one main job: to make sure that all machines are properly maintained, that repairs are made and that when needed, new parts or replacement parts are bought.

The service department employs important workers to accomplish the goals set by the production department. The production department will send other departments their jobs as they occur or as they feel they should be conducted.

What are the shortcomings of waiting until the actual factory overhead expenses are known before recording such costs on the job cost sheets?

There are some shortcomings in this method. Primary among them is that the costs to be incurred during production can change while the job is being executed. For example, if an unforeseen problem arises during production and requires a more expensive solution to be implemented, the cost of that solution cannot be accumulated on the job-cost sheet. This method also does not take into account any one-time factory overhead expenses that might occur while production continues. For example, if a new machine must be rented to complete a job in time, the cost of renting it cannot be accumulated on the job-cost sheet because it is not directly attributable to the job.

Another shortcoming of this method is that it does not record indirect costs incurred at the beginning of the manufacturing process. For example, assume a company purchases $1000 of raw materials for production. If it uses job costing, only direct material costs will appear on cost sheets for each job processed in that period. The indirect material costs that the company paid to have the raw materials delivered to the plant will not appear on any of the job-cost sheets and will not be accounted for anywhere in its financial statements.

We can also determine that this method fails to give an accurate picture of factory overhead expenses. For example, if $1000 of indirect material was purchased and used, it is impossible to determine how much of that $1000 is attributable to specific jobs based on cost sheets alone. It is necessary to examine the company job-cost sheets to determine how much of the indirect material cost was attributable to each job processed. There are many more shortcomings with this method, but these are sufficient for examination here.

A better means of determining the total factory overhead expenses incurred by using a job costing system would be to accumulate all factory overhead expenses while they occur at different stages throughout production.

 

References

Bragg S. M. (2019). Cost accounting fundamentals : essential concepts and examples (Sixth). Accounting Tools.

Jonick C. & Open Textbook Library. (2017). Principles of managerial accounting. University of North Georgia Press. Retrieved October 26 2022 from https://open.umn.edu/opentextbooks/textbooks/1240.

Drury, C. (2018). Cost and management accounting. Cengage Learning.

Gerald, B. (2018). A brief review of independent, dependent and one sample t-test. International Journal of Applied Mathematics and Theoretical Physics4(2), 50-54.

Hanum, B., Haekal, J., & Adi Prasetio, D. E. (2020). The Analysis of Implementation of Enterprise Resource Planning in the Warehouse Division of Trading and Service Companies, Indonesia. International Journal of Engineering Research and Advanced Technology-IJERAT (ISSN: 2454-6135)6(7), 37-50.

Last Updated on October 26, 2022

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