4.6 Determine and Dispose of Underapplied or Overapplied Overhead
2 min read•june 18, 2024
is a crucial aspect of . It involves applying indirect costs to products using predetermined rates. This process helps companies allocate expenses and determine product costs accurately, impacting financial reporting and decision-making.
Variances between applied and actual overhead are common. These differences, whether overapplied or underapplied, affect the and net income. Understanding how to calculate and dispose of these variances is essential for maintaining accurate financial statements.
Applying Manufacturing Overhead
Calculation of overhead variances
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- applied to products using a
- calculated as
- Common allocation bases include direct labor hours, direct labor costs, or machine hours
- This process is known as
- calculated as
- Actual overhead costs incurred often differ from the amount of overhead applied
- occurs when applied manufacturing overhead exceeds actual manufacturing overhead
- occurs when applied manufacturing overhead is less than actual manufacturing overhead
- Difference between applied and actual overhead calculated at the end of the period
- Overapplied or equals applied manufacturing overhead minus actual manufacturing overhead
- Positive difference indicates (applied > actual)
- Negative difference indicates underapplied overhead (applied < actual)
- This analysis is part of in cost accounting
- Overapplied or equals applied manufacturing overhead minus actual manufacturing overhead
Disposal of overhead variances
- made to close the manufacturing overhead account and transfer the balance to appropriate accounts
- For overapplied overhead (credit balance in manufacturing overhead account)
- Debit Manufacturing Overhead account to clear the credit balance
- Credit account to reduce COGS and increase net income
- For underapplied overhead (debit balance in manufacturing overhead account)
- Debit Cost of Goods Sold account to increase COGS and reduce net income
- Credit Manufacturing Overhead account to clear the debit balance
Impact of variances on COGS
- Overapplied overhead results in an overstatement of COGS during the period
- Adjusting entry reduces COGS, thereby increasing net income
- Indicates that the company applied more overhead to products than actually incurred
- Underapplied overhead results in an understatement of COGS during the period
- Adjusting entry increases COGS, thereby reducing net income
- Indicates that the company applied less overhead to products than actually incurred
- Impact on COGS affects the company's reported profitability for the period
- Overapplied overhead leads to higher reported net income
- Underapplied overhead leads to lower reported net income
Cost Allocation and Overhead Rate Calculation
- involves assigning indirect costs to cost objects
- is crucial for accurate cost allocation
- Estimated overhead costs divided by estimated
- Helps in determining the amount of overhead to be applied to each product or service
- Accurate cost allocation and overhead rate calculation are essential for effective cost accounting practices
Key Terms to Review (21)
Adjusting Entries: Adjusting entries are journal entries made at the end of an accounting period to update account balances and ensure the financial statements accurately reflect the company's financial position and performance. These entries are necessary to properly match revenues and expenses, as well as to recognize assets, liabilities, and other items that may have been overlooked or incorrectly recorded during the period.
Allocation Base: The allocation base is the measure used to distribute or allocate overhead costs to individual products or jobs in a cost accounting system. It serves as the basis for assigning indirect costs to cost objects in a fair and systematic manner.
Cost Accounting: Cost accounting is a branch of managerial accounting that focuses on the identification, measurement, analysis, and reporting of an organization's costs. It provides valuable information to managers for decision-making, planning, and control of an organization's operations.
Cost Allocation: Cost allocation is the process of assigning indirect or overhead costs to specific cost objects, such as products, services, or departments, based on a rational and systematic method. It is a crucial concept in managerial accounting that helps organizations accurately determine the true cost of their operations and make informed decisions.
Cost of goods sold: Cost of Goods Sold (COGS) represents the direct costs attributable to the production of goods sold by a company. This amount includes the cost of materials and labor directly used to create the product.
Cost of Goods Sold: Cost of Goods Sold (COGS) represents the direct costs associated with the production or acquisition of the goods or services sold by a business during a specific accounting period. It is a fundamental concept in managerial accounting that helps organizations track and manage their inventory and profitability.
Full-cost accounting: Full-cost accounting (FCA) is an approach to accounting that takes into account all direct and indirect costs associated with a product or activity, including environmental and social costs. It aims to provide a more comprehensive view of the true cost of business operations.
Manufacturing overhead: Manufacturing overhead includes all indirect costs associated with the production process, such as utilities, maintenance, and factory supplies. It does not include direct materials or direct labor costs.
Manufacturing Overhead: Manufacturing overhead refers to the indirect costs associated with the production of goods in a manufacturing organization. These are the costs that cannot be directly traced to a specific product but are necessary for the overall manufacturing process. Manufacturing overhead encompasses a wide range of expenses, including indirect materials, indirect labor, and other factory-related costs.
Overapplied overhead: Overapplied overhead occurs when the estimated overhead costs allocated to production exceed the actual overhead costs incurred. This results in a credit balance in the overhead account at the end of the accounting period.
Overapplied Overhead: Overapplied overhead refers to a situation where the amount of overhead costs allocated to production is greater than the actual overhead costs incurred during a given period. This occurs when the predetermined overhead rate used for allocation is higher than the actual overhead rate based on the actual level of activity.
Overhead Absorption: Overhead absorption is the process of allocating and distributing overhead costs to products or services in order to determine the full cost of production. It is a critical component of managerial accounting, as it allows businesses to accurately price their offerings and make informed decisions.
Overhead Rate Calculation: Overhead rate calculation is the process of determining the rate at which overhead costs are applied to products or services in a manufacturing or service-based organization. It involves estimating the total overhead costs and dividing them by an appropriate activity base to arrive at a predetermined overhead rate, which is then used to allocate overhead costs to individual cost objects.
Overhead variances: Overhead variances are the differences between actual overhead costs and standard overhead costs allocated to production. They help in assessing cost control and efficiency in manufacturing processes.
Overhead Variances: Overhead variances refer to the differences between the actual overhead costs incurred by a business and the overhead costs that were budgeted or applied to production. These variances provide insights into the efficiency and effectiveness of a company's overhead management and can help identify areas for improvement.
Predetermined overhead rate: The predetermined overhead rate is a calculation used to allocate estimated manufacturing overhead costs to products or job orders, based on a specific activity base, such as direct labor hours or machine hours. It is determined before the period begins and helps in budgeting and costing processes.
Predetermined Overhead Rate: The predetermined overhead rate is a method used in job order costing to apply overhead costs to individual jobs or products. It is calculated by dividing the estimated total overhead costs for a period by the estimated activity base, such as direct labor hours or machine hours, for that same period. This rate is then used to apply overhead to each job based on the job's actual usage of the activity base.
Underapplied overhead: 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.
Underapplied Overhead: Underapplied overhead refers to the situation where the actual overhead costs incurred by a business exceed the amount of overhead that has been applied or allocated to the production of goods or services. This occurs when the predetermined overhead rate used to apply overhead to products or jobs is lower than the actual overhead rate.
Variance analysis: Variance analysis is the process of comparing budgeted financial performance to actual financial performance to identify discrepancies. It helps managers understand why variances occur and how to address them for better future planning.
Variance Analysis: Variance analysis is a management accounting technique used to identify and evaluate the differences between actual and expected or budgeted performance. It provides insights into the causes of these variances, enabling managers to make informed decisions and take corrective actions to improve operational efficiency and financial performance.