8 2 Under- or Over-Applied Overhead Financial and Managerial Accounting

<p>The overhead absorption rate is calculated to include the overhead in the cost of production of goods and services. Consequently, applied overhead may be stripped away from a cost object for the purposes of some types of decision making. Similarly, the application of factory overhead to a product may obscure its actual cost for the purposes of establishing a short-term price for a specific customer order. Always keep in mind that the goal is to "zero out" the Factory Overhead account and measure the actual cost incurred. To reduce cost of goods sold for the overapplied overhead</p> <h2>The difference between actual overhead and applied overhead</h2> <p>Because fixed costs do not change within a relevant range, there is no adjustment of budgeted fixed costs from a static to a flexible budget. So far, we haven’t used a singleactual overhead figure in our calculations. Notice that fixed overhead remains constant at each of the production levels, but variable overhead changes based on unit output. 10,000 divided by the level of activity (direct labor hours) of 2,000 hours. You incur the same amount of fixed costs regardless of how efficiently you produce your goods. Fixed overhead volume variance occurs when the actual production volume differs from budgeted production.</p> <p>The first stage of accounting for overheads is when calculating applied overheads. At the end of each accounting period, companies calculate the balance on the factory overhead account. Over time, the actual overheads keep accumulating on the debit side of the factory overhead account. The accounting for applied overheads may differ from one company to another.</p> <h2>Chapter 2: Job Order Cost System</h2> <ul><li>In other words, they can establish if the applied overheads were higher or lower than anticipated compared to the actual.</li><li>In this case, actual overhead goes in, and applied overhead goes out.</li><li>To determine the amount of overhead to assign to each product line, following information are given.</li><li>Note that the manufacturing overhead account has a credit balance when overhead is overapplied because more costs were applied to jobs than were actually incurred.</li><li>The applied overhead is then calculated by multiplying the predetermined rate by the actual number of allocation base units used in the production process.</li><li>Over time, the actual overheads keep accumulating on the debit side of the factory overhead account.</li></ul> <p>The predetermined rate, on the other hand, is constantfrom month to month. For example, heating costs aregreater during winter months. Since 2014, she has helped over one million students succeed in their accounting classes. Kristin is also the creator of Accounting In Focus, a website for students taking accounting courses.</p> <h2>What is included in manufacturing overhead?</h2> <p>What do we do when we <a href="https://zero2profit.site/2021/03/25/summary-constraint-management/">https://zero2profit.site/2021/03/25/summary-constraint-management/</a> have the actual overhead numbers? Actual overhead is the amount that the company actually incurred. So far, we haven’t used a single actual overhead figure in our calculations. First, we calculated the predetermined overhead rate by dividing estimated overhead by estimated activity. Let’s review how we got applied overhead.</p> <p>Next, we look at how we correct ourrecords when the actual and our applied (or estimated) overhead donot match (which they almost never match!). Notice how the predetermined rate isbased on ESTIMATED overhead and the ESTIMATED base or level ofactivity. Most manufacturing and service organizationsuse predetermined rates. Byassigning energy costs to jobs based on the number ofmachine-minutes or hours the job uses, we have a pretty good ideaof the energy costs required to produce the job. Just as automobile mileage is agood cost driver for measuring the cause of gasoline consumption,machine-hours is a measure of what causes energy costs.</p> <h2>Applied Overhead Versus Actual Overhead</h2> <p>This applied overhead is an approximation. In the previous post, we discussed <a href="http://www.zh-xs.com/?p=83828">http://www.zh-xs.com/?p=83828</a> using the predetermined overhead rate to apply overhead to jobs. Next, we look at how we correct our records when the actual and our applied (or estimated) overhead do not match (which they almost never match!).</p> <ul><li>Without a predetermined rate, companies do not know the costs of production until the end of the month or even later when bills arrive.</li><li>Using labor hours as the allocation base, compute for the fixed overhead volume variance.</li><li>Manufacturing companies hope the differences will not be significant at the end of the accounting period.</li><li>This is the amount that you must adjust cost of goods sold to bring it to the actual cost.</li><li>To calculate manufacturing overhead, you need to add all the indirect factory-related expenses incurred in manufacturing a product.</li><li>To calculate a predetermined overhead rate, acompany divides the estimated total overhead costs for a period byan estimated base (or expected level of activity).</li></ul> <p>In other words, they can establish if the applied overheads were higher or lower than anticipated compared to the actual. On the other side, this account will also accumulate actual overheads. This amount remains in the factory overhead account until the end of the accounting period.</p> <p>How much cost of goods sold should be reported if unadjusted cost of goods sold is $2,134,000? Over the course of the year, K’s applied $578,000 worth of inventory to it’s jobs. K’s Kustom Furniture estimated overhead at the beginning of the year to be $567,000. Have you applied too much or too little? Imagine that there are two groups of accountants inside a company. Job 106 had 875 machine hours and Job 107 had 4,050 machine hours.</p> <p>If applied overhead is less than actual overhead, overhead is under-applied. 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. The two amounts can then be compared afterwardwhich is known as Under- or Overapplied Manufacturing Overhead.When Manufacturing Overhead has a DEBIT balance, overhead is saidto be UNDERAPPLIED, meaning that the overhead applied to work inprocess or to the certain job is LESS than the overhead incurred.On the contrary, when manufacturing overhead has a CREDIT balance,overhead is OVERAPPLIED, meaning that the overhead assigned to workin process or to the certain job is GREATER than the overheadincurred. The debit or credit balance in manufacturing overhead account at the end of a month is carried forward to the next month until the end of a particular period – usually one year.</p> <p>Since many indirect costs are difficult to gauge as production occurs, actual overhead is measured in retrospect, as opposed to the forward-looking estimating that is applied overhead. The actual overhead costs are recorded through a debit to manufacturing overhead. Actual manufacturing overhead costs are debited and applied manufacturing overhead costs are credited to manufacturing overhead account. If, on the other hand, the manufacturing overhead cost applied to work in process is less than the manufacturing overhead cost actually incurred during a period, the difference is known as under-applied manufacturing overhead. If the manufacturing overhead cost applied to work in process is more than the manufacturing overhead cost actually incurred during a period, the difference is known as over-applied manufacturing overhead.</p> <p>Variable costs are inventoriable costs – they are allocated to units of production and recorded in inventory accounts, such as cost of goods sold. Manufacturing overhead (also known as factory overhead, factory burden, production overhead) involves a company’s manufacturing operations. The commonly used allocation bases in manufacturing are direct machine hours and direct labor hours. The allocation base is the basis on which a business assigns overhead costs to products.</p> <p>In this case, actual overhead goes in, and applied overhead goes out. The indirect labor would relate to the cost of factory staff not directly involved in production. Since manufacturing overhead has a debit balance, it is underapplied, as it has not been completely allocated. This shows the actual amount was overapplied overhead.</p> <p>This differs <a href="https://ycaceres.com/index.php/2021/03/18/what-is-a-chart-of-accounts-in-bookkeeping/">https://ycaceres.com/index.php/2021/03/18/what-is-a-chart-of-accounts-in-bookkeeping/</a> from actual overhead, which is derived from the actual costs incurred during a reporting period. Certainly, the actual overhead, the company’s true indirect manufacturing costs, will not match up to the estimated numbers. Since the applied overhead is in the cost of goods sold at the end of the period, it has to be adjusted to reflect the actual overhead.</p> <p>When the accounting period ends, the actual and applied overheads may vary. This activitycould be total expected <a href="https://accountingcoaching.online/2-4-actual-vs-applied-factory-overhead/">actual vs applied overhead</a> machine-hours, total expected directlabor-hours, or total expected direct labor cost for the period.Companies set predetermined overhead rates at the beginning of theyear in which they will use them. To solve this, manufacturing overheads are predetermined based on historical data and applied to manufacturing jobs at a fixed rate. By and large, production incurs three main types of expenses – labor costs, material costs, and manufacturing overhead costs.</p>