How do you know if manufacturing overhead is Overapplied or Underapplied?
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The causes / reasons of under or over-applied overhead can be complex. Nevertheless the basic problem is that the method of applying overhead to jobs using a predetermined overhead rate assumes that actual overhead costs will be proportional to the actual amount of the allocation base incurred during the period. If, for example, the predetermined overhead rate is $6 per machine hour, then it is assumed that actual overhead cost incurred will be $6 for every machine hour that is actually worked. There are actually two reasons why this may not be true. First, much of the overhead often consists of fixed costs that do not grow as the number of machine hours incurred increases. Second, spending on overhead items may or may not be under control. If individuals who are responsible for overhead costs do a good job, those costs should be less than were expected at the beginning of the period. If they do a poor job, those costs will be more than expected.
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Example:Suppose that two companies A and B have prepared the following estimated data for the coming year: Company Now assume that because of unexpected changes in overhead spending and changes in demand for the companies’ products, the actual overhead cost and the actual activity recorded during the year in each company are as follows: Company ABActual manufacturing overhead costs$290,000$130,000Actual machine-hours68,000—Actual direct materials costs—$90,000For each company, note that the actual data for both cost and activity differ from the estimates used in computing the predetermined overhead rate. This results in underapplied overhead and overapplied overhead as follows:Company For company A, notice that the amount of overhead cost that has been applied to work in process ($272,000) is less than the actual overhead cost for the year ($290,000). Therefore the overhead is under-applied. Also notice that original estimate of overhead in company A ($300,000) is not directly involved in this computation. Its impact is felt only through the $4 predetermined overhead rate that is used.For B company the amount of overhead cost that has been applied to work in process (WIP) ($135,000) is greater than the actual overhead cost for the year ($130,000), and so overhead is over-applied. A summary of the concepts discussed so for is presented below:At the beginning of the periodEstimated total manufacturing overhead cost ÷Estimated total units in the allocation base=Predetermined overhead rate During the period Predetermined overhead rate×Actual total units of the allocation base incurred during the period=Total manufacturing overhead appliedAt the end of the period Actual total manufacturing overhead cost–Total manufacturing overheadapplied=Under-applied (over-applied) overhead What disposition should be made of any under or over applied overhead balance remaining in the manufacturing overhead account at the end of a period? To understand the procedure of disposing off any under or over applied overhead see disposition of any balance remaining in the manufacturing overhead account at the end of a period page. What causes the factory overhead account to be over Underapplied?Underapplied overhead refers to the amount of actual factory overhead costs that are not allocated to units of production. This situation arises when the standard allocation amount per unit of production does not equate to the actual amount of overhead costs incurred in a reporting period.
What happens when manufacturing overhead is Overapplied?When overhead has been overapplied, the proper accounting is to debit the manufacturing overhead cost pool and credit the cost of goods sold in the amount of the overapplication. Doing so results in the actual amount of overhead incurred being charged through the cost of goods sold.
How to calculate over or under allocated manufacturing overhead?To compute the overhead rate, divide your monthly overhead costs by your total monthly sales and multiply it by 100. For example, if your company has $80,000 in monthly manufacturing overhead and $500,000 in monthly sales, the overhead percentage would be about 16%.
What are the two ways that an under or overapplied factory overhead balance can be disposed of at the end of a fiscal 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.
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