The entry would debit the Factory Overhead Control account and credit Cost of Goods Sold (or an equivalent expense account). By doing so, the overapplied overhead cost is recognized as a reduction in expenses in the period in which it occurred. Addressing underapplied overhead involves adjusting journal entries to increase COGS and inventory values, thereby aligning them with actual costs. This adjustment ensures that financial statements accurately reflect the company’s expenses and profitability. Regular variance analysis and monitoring are crucial for identifying and correcting both overapplied and underapplied overhead. By maintaining accurate overhead allocation, companies can improve their financial reporting and make more informed strategic decisions.

What Is Underapplied (vs. Overapplied) Overhead in Budgeting?

In order to determine whether overhead was over or under applied for the period, the company’s cost account balances the manufacturing overhead account. If credits exceed debits, then overhead was over applied, if debits exceed credits than overhead was under applied. In the rare occurrence that the amounts are equal, overhead is considered to be neither over nor under applied. The opposite of overapplied overhead is underapplied overhead, which occurs when a company has applied more overhead to products than it has actually incurred.

What Happens to Ending Work-in-Process Inventory?

See it applied in this 1992 report on Accounting for Shipyard Costs and Nuclear Waste Disposal Plans from the United States General Accounting Office. Overhead costs include the costs of labor that isn’t directly used to create a product or service being sold. Labor costs for building new facilities, for example, fall into the category of overhead. When allocating funds, business managers don’t always know the specific labor costs for such tasks. For instance, a manager might know that Facility A needs renovations but must hire a professional to determine which specific renovations it needs.

• Applied overhead is the overhead allocated to a specific department in a business, based on expected overhead costs.
• That figure is the company’s «applied» overhead, the amount assigned to items in inventory.
• All jobs appear in Cost of Goods Sold sooner orlater, so companies simply adjust Cost of Goods Sold instead of theinventory accounts.
• Overapplied overhead is the result of the manufacturing overhead costs that are applied to the production process is more than the actual overhead cost that actually incurs during the accounting period.
• The process begins by identifying the amount of overapplied overhead, which is the difference between the allocated overhead and the actual overhead incurred.
• Recall from Chapter 1 that manufacturing overhead consists of all costs related to the production process other than direct materials and direct labor.

Financial and Managerial Accounting

Although those jobs are still inWork in Process or Finished Goods Inventory, companies usuallyadjust the Cost of Goods Sold account instead of each inventoryaccount. Adjusting each inventory account for a small overheadadjustment is usually not a good use of managerial and accountingtime and effort. All jobs appear in Cost of Goods Sold sooner orlater, so companies simply adjust Cost of Goods Sold instead of theinventory accounts. When overhead has been overapplied, the proper accounting is to debit the manufacturing overhead cost pool and credit the cost of goods sold in the amount of the overapplication. Doing so results in the actual amount of overhead incurred being charged through the cost of goods sold.

Facilities Costs

For example, when a company incurs $150,000 in overhead after budgeting only $100,000, it has an underapplied overhead of $50,000. This is referred to as an unfavorable variance because it means that the budgeted costs were lower than actual costs. Put simply, the business went over budget making the cost of goods sold more than expected.

Applying Overhead

Instead, overhead applied represents a portion of estimated overhead costs that is assigned to a particular job. Once the period concludes, actual overhead costs and actual activity overapplied overhead levels are recorded. The next step involves comparing the allocated overhead, calculated using the predetermined rate, to the actual overhead incurred.

• In some cases, the overapplied overhead may also be allocated to work-in-process (WIP) inventory and finished goods inventory accounts, depending on where the overhead costs were initially applied.
• We leave the morecomplicated procedure of allocating overhead balances to inventoryaccounts to textbooks on cost accounting.
• If credits exceed debits, then overhead was over applied, if debits exceed credits than overhead was under applied.
• The entry would debit the Factory Overhead Control account and credit Cost of Goods Sold (or an equivalent expense account).
• In this case we would, debit the factory overhead account and credit the cost of goods sold account for the difference.
• The predetermined overhead rate8 is calculated prior to the year in which it is used in allocating manufacturing overhead costs to jobs.
• Facility costs, especially those for financing renovations or renting facilities, also account for a big share of overapplied overhead.

Overapplied and Underapplied

This will ensure the company’s financial statements accurately reflect the actual overhead costs incurred during the period. Conversely, if the actual overhead costs incurred exceed the allocated overhead costs, it is referred to as underapplied factory overhead. Thus each job will be assigned $30 in overhead costs for every direct labor hour charged to the job. The assignment of overhead costs to jobs based on a predetermined overhead rate is called overhead applied9. Remember that overhead applied does not represent actual overhead costs incurred by the job—nor does it represent direct labor or direct material costs.