Final answer:
Factory overhead can be over- or under-applied due to variations in actual factory overhead costs, changes in production volume compared to expectations, and the use of actual costing. 'Spreading the overhead' refers to dividing fixed costs by the quantity of output produced, thus lowering the average fixed cost per unit as production volume increases.
Step-by-step explanation:
Factory overhead can be over- or under-applied for several reasons. First, actual factory overhead costs often vary from year to year due to changes in utility rates, material costs, and other factors beyond the company's control. Therefore, when a company budgets for overhead based on previous years or estimated costs, the actual amount can differ.
Additionally, production volume may change from what was expected, which can impact overhead application. If a company expects to produce a certain amount of goods but falls short, the fixed costs allocated per unit will be higher, leading to over-applied overhead. Conversely, if production exceeds expectations, the overhead cost spread across more units may result in an under-applied overhead.
When companies use actual costing, they apply the real costs incurred to the production, which varies throughout the year, and can result in overhead being over or under-applied at any point in time.
Understanding the concept of 'spreading the overhead' involves recognizing that fixed costs, such as rent for a factory or cost of machinery, are constant regardless of production levels. Dividing these fixed costs by the output quantity results in the average fixed cost. For instance, with a fixed cost of $1,000, the more you produce, the lower the average fixed cost per unit will be. This curve demonstrates the decreasing average fixed cost as production increases, reflecting the spreading of the overhead over more units.