Disposition of Underapplied or Overapplied Overhead Balances:
Learning objective of the article:
How is over and under applied overhead is disposed off. Give an example to explain the procedure?
What disposition should be made of an underapplied overhead or overapplied overhead balance remaining in the manufacturing overhead account at the end of a period?
Generally any balance in the account is treated in one of the two ways.
The second method, which allocates the under or overapplied overhead among ending inventories and cost of goods sold is equivalent to using an “actual” overhead rate and is for that reason considered by many to be more accurate than the first method. Consequently, if the amount of underapplied or overapplied overhead is material, many accountants would insist that the second method be used.
Closing out the balance in manufacturing overhead account to cost of goods sold is simpler than the allocation method.
Where the overhead is underapplied following journal entry is made:
|Cost of goods sold||
Where the overhead is overapplied the following journal entry is made:
After passing one of these journal entries, cost of goods sold is adjusted. Consequently cost of goods sold is increased by the amount of underapplied and decreased by the amount of overapplied overhead.
|Cost of Goods Manufactured:|
|Manufacturing overhead applied to work in process||$90,000*|
|Total Manufacturing cost||$200,000|
|Add: Beginning work in process||$30,000|
|Deduct: Ending work in process inventory||$72,000|
|Cost of goods manufactured||$158,000|
|Cost of Goods Sold:|
|Finished goods inventory beginning||$10,000|
|Goods available for sale||$168,000|
|Deduct: Finished goods inventory ending||$49,500|
|Unadjusted cost of goods sold||$118,500|
|Add: Under applied overhead||$5,000*|
|Adjusted cost of goods sold||$123,500|
|*Overhead applied = $90,000 (15,000 Direct labor hours × $6.00 Predetermined overhead rate)
Actual overhead = $95,000
Under applied overhead = $95,000 – $90,000 = $5,000Entry to close the $5,000 of under applied to cost of goods sold would be as follows:
Cost of goods sold————————– 5,000 Dr
Allocation of under or overapplied overhead between work in process (WIP), finished goods and cost of goods sold (COGS) is more accurate than closing the entire balance into cost of goods sold. The reason is that allocation assigns overhead costs to where they would have gone in the first place had it not been for the errors in the estimates going into the predetermined overhead rate.
If the amount of under-applied or over-applied overhead is significant, it should be allocated among the accounts containing applied overhead: Work in Process Inventory, Finished Goods Inventory, and Cost of Goods Sold. A significant amount of “under-applied” or “over-applied” overhead means that the balances in these accounts are quite different from what they would have been if actual overhead costs had been assigned to production.
Allocation restates the account balances to conform more closely to actual historical cost as required for external reporting by generally accepted accounting principles. The above figure uses assumed data for the Cutting and Mounting Department to illustrate the proration of over-applied overhead among the necessary accounts; had the amount been under-applied, the accounts debited and credited in the journal entry would be the reverse of that presented for over-applied overhead. A single overhead account is used in this illustration.
Theoretically, under-applied or over-applied overhead should be allocated based on the amounts of applied overhead contained in each account rather than on total account balances. Use of total account balances could cause distortion because they contain direct material and direct labor costs that are not related to actual or applied overhead. In spite of this potential distortion, use of total balances is more common in practice for two reasons: First, the theoretical method is complex and requires detailed account analysis. Second, overhead tends to lose its identity after leaving Work in Process Inventory, thus making more difficult the determination of the amount of overhead in Finished Goods Inventory and Cost of Goods Sold account balances
You may also be interested in other useful articles from “job order costing system” chapter:
- Measuring Direct Materials Cost in Job Order Costing System
- Measuring Direct Labor Cost in Job Order Costing System
- Application of Manufacturing Overhead
- Job Order Costing System – The Flow of Costs
- Multiple Predetermined Overhead Rates
- Under-applied overhead and over-applied overhead calculation
- Disposition of any balance remaining in the manufacturing overhead account at the end of a period
- Predetermined Overhead Rate and Capacity
- Recording Non-manufacturing Costs
- Recording Cost of Goods Manufactured and Sold
- Job Order Costing in Services Companies
- Use of Information Technology in Job Order Costing
- Advantages and Disadvantages of Job Order Costing System
- Job Order Costing Discussion Questions and Answers
- Job Order Costing Exercises
- Case Studies
Other Related Accounting Articles:
- Over-applied and Underapplied Overhead
- Job Order Costing System Exercises and Problems
- Recording Cost of Goods Manufactured and Sold in Job Order Costing
- Job Order Costing Questions and Answers
- Multiple Predetermined Overhead Rates
- Application of Manufacturing Overhead Cost in Job Order Costing
- Job Order Costing in Service Companies
- Job Order Costing – The Flow of Cost
- Recording Non-manufacturing Costs in a Job Order Costing System
- Job Order Costing System
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