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.
-
Closed out to cost of goods
sold.
-
Allocated between work in
process (WIP), finished goods and cost of goods sold in proportion to the
overhead applied during the current period in the ending balances of these
account.
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 |
Manufacturing overhead |
Dr |
Cr |
Where the overhead is
overapplied the following journal entry is made:
|
Manufacturing overhead |
Cost of goods sold |
Dr |
Cr
|
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.
Example:
| Cost of
Goods Manufactured: |
|
| Direct materials |
$50,000 |
| Direct labor |
$60,000 |
|
Manufacturing overhead
applied to work in process |
$90,000* |
|
--------- |
| Total
Manufacturing cost |
$200,000 |
| Add: Beginning
work in process |
$30,000 |
| |
---------- |
| |
$230,000 |
| Deduct: Ending
work in process inventory |
$72,000 |
| |
---------- |
| Cost of goods
manufactured |
$158,000 |
|
======== |
|
|
|
|
| Cost of
Goods Sold: |
|
| Finished goods
inventory beginning |
$10,000 |
|
$158,000 |
|
----------- |
| 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 = $5,000
Entry to close the $5,000 of
under applied to cost of goods sold would be as follows:
Cost of goods
sold-------------------------- 5,000 Dr
Manufacturing
overhead------------------------- 5,000 Cr |
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.
Example:
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
|
