Job Order Costing

23 Determine and Dispose of Underapplied or Overapplied Overhead

As you’ve learned, the actual overhead incurred during the year is rarely equal to the amount that was applied to the individual jobs. Thus, at year-end, the manufacturing overhead account often has a balance, indicating overhead was either overapplied or underapplied.

If, at the end of the term, there is a debit balance in manufacturing overhead, the overhead is considered underapplied overhead. A debit balance in manufacturing overhead shows either that not enough overhead was applied to the individual jobs or overhead was underapplied. If, at the end of the term, there is a credit balance in manufacturing overhead, more overhead was applied to jobs than was actually incurred. This shows the actual amount was overapplied overhead.

The actual overhead costs are recorded through a debit to manufacturing overhead. The same account is credited when overhead is applied to the individual jobs in production, as shown:

A T-account for Manufacturing Overhead showing the debit as actual cost and the credit as applied costs.

Since the overhead is first recorded in the manufacturing overhead account, then applied to the individual jobs, traced through finished goods inventory, and eventually transferred to cost of goods sold, the year-end balance is eliminated through an adjusting entry, offsetting the cost of goods sold. If manufacturing overhead has a debit balance, the overhead is underapplied, and the resulting amount in cost of goods sold is understated. The adjusting entry is:

A journal entry lists Cost of Goods Sold with space for a debit entry, and Manufacturing Overhead with space for a credit entry.

If manufacturing overhead has a credit balance, the overhead is overapplied, and the resulting amount in cost of goods sold is overstated. The adjusting entry is:

A journal entry lists Cost of Goods Sold with space for a debit entry, and Manufacturing Overhead with space for a credit entry, and the note “Application of overhead to Cost of Goods Sold”.

Returning to our example, at the end of the year, Dinosaur Vinyl had actual overhead expenses of $256,500 and applied overhead expenses of $250,000, as shown:

A T-account for Manufacturing Overhead showing the debit as actual cost of $256,500 and the credit side as applied costs of $250,000.

Since manufacturing overhead has a debit balance, it is underapplied, as it has not been completely allocated. The adjusting journal entry is:

A journal entry lists Cost of Goods Sold with a debit of 6,500, Manufacturing Overhead with credit of 6,500, and the note “Application of underapplied overhead to Cost of Goods Sold”.

If the overhead was overapplied, and the actual overhead was $248,000 and the applied overhead was $250,000, the entry would be:

A journal entry lists Manufacturing Overhead with a debit of 2,000, Cost of Goods Sold with credit of 2,000, and the note “Application of overapplied overhead to Cost of Goods Sold”.

To adjust for overapplied or underapplied manufacturing overhead, some companies have a more complicated, three-part allocation to work in process, finished goods, and cost of goods sold. This method is typically used in the event of larger variances in their balances or in bigger companies. (You will learn more about this in future cost or advanced managerial accounting courses.)

Kraken Boardsports
(credit: modification of images provided courtesy of Kraken Boardsports, CC BY 4.0)

A photograph shows a person climbing a snow-covered hill carrying a winch on wheels. A photograph shows a person ski-boarding on a lake.

Kraken Boardsports manufactures winches for snow and ski boarders to snow ski without a mountain or water ski without a lake ((Figure)). End-of-year data show these overhead expenses:

Chart showing the following expenses: Indirect materials $25,000, Indirect labor 31,750, Depreciation of factory equipment 50,000, Factory utility expenses 17,500, Factory supervisor salaries 85,000.

Kraken Boardsports had 6,240 direct labor hours for the year and assigns overhead to the various jobs at the rate of $33.50 per direct labor hour.

How much overhead was overapplied or underapplied during the year? What would be the journal entry to adjust manufacturing overhead?

Solution

The total overhead incurred is the total of:

Chart adding the overhead expenses: Indirect materials $25,000, Indirect labor 31,750, Depreciation of factory equipment 50,000, Factory utility expenses 17,500, Supervisor salaries 85,000 added together equal $209,250 of Actual overhead incurred.

The total overhead applied is $209,040, which is calculated as:

$33.50/direct labor hours × 6,240 direct labor hours.

The balance in manufacturing overhead is a debit balance of $210:

A T-account for Manufacturing Overhead showing a debit for actual costs of 209,250, a credit for applied costs of $209,040 and a balance on the debit side of 210.

The adjusting journal entry is:

A journal entry lists Cost of Goods Sold with a debit of 210 and Manufacturing Overhead with a credit of 210.

Key Concepts and Summary

  • Overhead is allocated to individual jobs based on the estimated overhead costs for the year and may be overapplied or underapplied for the year.
  • Overhead is underapplied when not all of the costs accumulated in the manufacturing overhead account are applied during the year.
  • Overhead is overapplied when more overhead is applied to the jobs than was actually incurred.
  • The amount of overhead overapplied or underapplied is adjusted into the cost of goods sold account.

(Figure)Why is the manufacturing overhead account debited as expenses are recognized and then credited when overhead is applied?

Expenses normally have a debit balance, and the manufacturing overhead account is debited when expenses are incurred to recognize the incurrence. When the expenses are allocated to the asset, the work in process inventory, the expense account manufacturing overhead is credited. This is in accordance with the expense recognition principle. The timing of the expense follows the revenue, and when the costs are allocated to inventory, they become a part of the product’s cost and are recognized when the asset is sold.

(Figure)A company has the following information relating to its production costs:

A chart of information including: Machine hours 25,000, Direct labor cost $550,000, Indirect labor 45,000, Plant maintenance 259, 300, Plant supervision 90,000, Plant depreciation 150,000, Plant utilities 48,000, Indirect material 5,000.

Compute the actual and applied overhead using the company’s predetermined overhead rate of $23.92 per machine hour. Was the overhead overapplied or underapplied, and by how much?

(Figure)Coop’s Stoops estimated its annual overhead to be $85,000 and based its predetermined overhead rate on 24,286 direct labor hours. At the end of the year, actual overhead was $90,000 and the total direct labor hours were 24,100. What is the entry to dispose of the overapplied or underapplied overhead?

(Figure)Mountain Peaks applies overhead on the basis of machine hours and reports the following information:

A chart showing Overhead budget $350,000, actual $352,000; Machine hours budget 50,000, 49,000 actual; Direct materials $210,000, and Direct labor $350,000.

  1. What is the predetermined overhead rate?
  2. How much overhead was applied during the year?
  3. Was overhead over- or underapplied, and by what amount?
  4. What is the journal entry to dispose of the over- or underapplied overhead?

(Figure)The actual overhead for a company is $74,539. Overhead was based on 6,000 direct labor hours and was $2,539 underapplied for the year.

  1. What is the overhead application rate per direct labor hour?
  2. What is the journal entry to dispose of the underapplied overhead?

(Figure)When setting its predetermined overhead application rate, Tasty Box Meals estimated its overhead would be $100,000 and would require 25,000 machine hours in the next year. At the end of the year, it found that actual overhead was $102,000 and required 26,000 machine hours.

  1. Determine the predetermined overhead rate.
  2. What is the overhead applied during the year?
  3. Prepare the journal entry to eliminate the underapplied or overapplied overhead.

(Figure)Queen Bee’s Honey, Inc., estimated its annual overhead to be $110,000 and based its predetermined overhead rate on 27,500 direct labor hours. At the end of the year, actual overhead was $106,000 and the total direct labor hours were 29,000. What is the entry to dispose of the overapplied or underapplied overhead?

(Figure)Mountain Tops applies overhead on the basis of direct labor hours and reports the following information:

A chart showing Overhead budget $450,000, actual $452,000; Direct labor hour budget 75,000, 77,000 actual; Direct materials $195,000, and Direct labor $333,865

  1. What is the predetermined overhead rate?
  2. How much overhead was applied during the year?
  3. Was overhead overapplied or underapplied, and by what amount?
  4. What is the journal entry to dispose of the overapplied or underapplied overhead?

(Figure)The actual overhead for a company is $73,175. Overhead was based on 4,500 machine hours and was $3,325 overapplied for the year.

  1. What is the overhead application rate per direct labor hour?
  2. What is the journal entry to dispose of the underapplied overhead?

(Figure)When setting its predetermined overhead application rate, Tasty Turtle estimated its overhead would be $75,000 and manufacturing would require 25,000 machine hours in the next year. At the end of the year, it found that actual overhead was $74,000 and manufacturing required 24,000 machine hours.

  1. Determine the predetermined overhead rate.
  2. What is the overhead applied during the year?
  3. Prepare the journal entry to eliminate the under- or overapplied overhead.

(Figure)If a company bases its predetermined overhead rate on 100,000 machine hours, and it actually has 100,000 machine hours, would there be an underapplied or overapplied overhead?

Glossary

overapplied overhead
situation when the overhead applied to the individual jobs is greater than the actual overhead; when overhead is overapplied, the manufacturing overhead has a credit balance
underapplied overhead
situation when the overhead applied to the individual jobs is less than the actual overhead; when overhead is underapplied, the manufacturing overhead has a debit balance