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5 Under- or Over-applied Overhead | Managerial Accounting

Managerial Accounting

Chapter 2: Job Order Cost System

2.5 Under- or Over-applied Overhead

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Since we will be using the concept of the predetermined overhead rate

many times during the semester, lets review what it means again.

Applying Manufacturing Over…

Over…

We know overhead is applied using estimated or budgeted overhead

and a base. Actual overhead costs may be di erent and we will not have
all of those costs until late in the year. Estimated may be close but is
rarely accurate with what really happens, so the result is Over-applied or
Under-applied Overhead. At the end of the year, we will compare the
applied overhead to the actual overhead and if applied overhead is
GREATER than actual overhead, overhead is over-applied. If applied
overhead is less than actual overhead, overhead is under-applied. But
how do we correct it?

Underapplied or Overapplied …

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Example – Creative Printers

We learned, in the previous pages, that Creative Printers had applied

overhead to Jobs 106 and 107 for a total amount of $9,850. Actual over-
head was $9,800 from indirect materials $1,000, indirect labor of $2,000
and other overhead of $6,800. If we compare applied overhead $9,850
and actual overhead $9,800, we see a di erence of $50 over-applied
since the applied amount is greater than the actual overhead. Compa-
nies generally transfer the balance of the Overhead account to Cost of
Goods Sold at the end of the accounting period. Some companies do
this monthly; others do it quarterly or annually. The journal entry to trans-
fer Creative Printers’ overhead balance to Cost of Goods Sold for the
month of July is as follows:

Debit Credit

Overhead 50

Cost of goods sold 50

To record over-applied overhead.

Why does the previous entry reduce the Cost of Goods Sold by $50?
The overhead cost applied to the jobs was too high—it was overapplied.
Thus, the cost of jobs was overstated or we charged to much cost to
jobs. Although those jobs are still in Work in Process or Finished Goods
Inventory, companies usually adjust the Cost of Goods Sold account in-
stead of each inventory account. Adjusting each inventory account for a
small overhead adjustment is usually not a good use of managerial and
accounting time and e ort. All jobs appear in Cost of Goods Sold sooner
or later, so companies simply adjust Cost of Goods Sold instead of the
inventory accounts.

If applied overhead was less than actual overhead, we have under-ap-

plied overhead or not charged enough cost. The entry to correct under-
applied overhead, using cost of goods sold, would be (XX represents the
amount of under-applied overheard or the di erence between applied
and actual overhead):

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17/04/2021 2.5 Under- or Over-applied Overhead | Managerial Accounting

Debit Credit

Cost of goods sold XX

Overhead XX

To record under-applied overhead.

In this book, we assume companies transfer overhead balances to Cost

of Goods Sold. We leave the more complicated procedure of allocating
overhead balances to inventory accounts to textbooks on cost
accounting.

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