Underapplied overhead

Definition

Underapplied overhead occurs when the actual overhead costs incurred are greater than the overhead costs allocated to products. This difference indicates that less overhead was applied to production than actually incurred, often requiring adjustment at the end of the period.

5 Must Know Facts For Your Next Test

1. Underapplied overhead results in a debit balance in the Manufacturing Overhead account.
2. It typically requires a year-end adjustment to align the cost records with actual expenses.
3. Underapplied overhead can be disposed of by allocating it to Cost of Goods Sold or proportionally among Work in Process, Finished Goods, and Cost of Goods Sold.
4. Causes of underapplied overhead include underestimated budgeted costs or inefficient production processes.
5. Managers analyze underapplied overhead to identify areas for cost control and efficiency improvements.

Review Questions

• What does underapplied overhead indicate about a company's actual and allocated overhead costs?
• How is underapplied overhead typically disposed of at the end of an accounting period?
• What are some common causes of underapplied overhead?

Related terms

Overapplied Overhead: Occurs when the allocated overhead costs exceed the actual incurred costs.

Predetermined Overhead Rate: A rate used to allocate estimated manufacturing overhead costs to products based on a chosen activity base.

Cost of Goods Sold (COGS): The direct costs attributed to the production of goods sold by a company, including raw materials and direct labor but excluding indirect expenses like distribution.