ACCOUNTING FOR UNDER-OVERAPPLIED FACTORY OVERHEAD:

ACCOUNTING FOR UNDER-OVER APPLIED FACTORY OVERHEAD:

The over or under-applied manufacturing overhead is defined as the difference between manufacturing overhead cost applied to work in process and manufacturing overhead cost actually incurred during a period.

Since predetermined factory overhead rates are based on estimated data, the amount of over appled to production will rarely (if ever) equal the amount of actual overhead incurred. Over the course of a year, however, applied overhead and actual overhead should be very close in amounts (if realistic overhead rates have been used). Over applied in one month is expected to be offset by overhead under applied in another month.

At the end of the year, the balance of the under applied or over applied factory overhead must be eliminated, usually in one of the two ways:

  1. The balance is closed to the cost of goods sold account.
  2. The balance is allocated among work in process inventory, finished goods inventory, and cost of goods sold.

CLOSED TO COST OF GOODS SOLD:

The most common practice closes the balance of the under or over applied factory overhead account to cost of goods sold. This practice is justified because it is quick, and the amount of any under applied or over applied overhead at year end is usually relatively small. The following journal entry close a debit balance (under applied overhead) at the end of the year:

Dec.

31

Work in process — Material

xxxx

Work in process — Labour

xxxx

Work in process — FOH

xxxx

Finished goods

.xxxx

Cost of goods sold

xxxx

Under applied FOH

.

xxxx

 

Dec. 31 Under applied FOH xxxx •

FOH Control

xxxx

 

‘goo. sso. . . s. e. .

te   i                id (increased)  for the amount of under applied

overhead. This is done because under applied overhead means that not enough overhead was applied to production during the year. For .example, assume that actual FOH for the year amounted for Rs. 100,000 and applied FOH amounted to Rs. 90,000. Here, overhead was under applied by Rs.10,000. Thus, production costs were understated by Rs. 10,000 and applied FOH amounted to Rs. 90,000. Here, overhead was under applied by Rs. 10,000. Thus, production costs were understated by Rs. 10,000 and cost of goods sold must be increased to correct the problem.

When an over applied overhead balance occurs at the end of the year, the following journal entry closes the balance of the over applied Factory overhead account:-

Dec.                                                                             31 Overappl ied FOH xxxx

Cost of goods sold                                                                                          xxxx

 

Dec.                                                                               31 Overap-plied FOH xxxx

Work in process — Material                                                                                          xxxx

Work in process — Labour                                                                                          xxxx

…   Work in process — FOH      xxxx

Finishing goods                                                             _                                                                                     xxxx

Cost of goods sold                                                      XXXX

.                                              _ ..

 

Dec. 31 FOH control xxxx

Over applied FOE-I                                             .

xxxx

 

base, cost or goo as sold is credited (decreased) by the amount of over applied

overhead. Over applied overhead means that too much overhead was charged to production

during the year. For example, assume that actual. overhead costs for the year amounted to Rs. 150,000, however, Rs. 170,000 in factory overhead was applied to production. Here, overhead was overapplied by Rs. 20,000. Thus, production was over charged by Rs. 20,000. To correct this problem, the cost of goods sold account is decreased (credited) by Rs. 20,000.

Note: you may. be wondering why the applied (estimated) overhead is charged to production (and entered on the job cost sheets) when actual overhead costs are incurred every day. To address this, we simply need to remember that factory overhead costs are the indirect costs of production — such as utilities, rent, and repairs. As such, it is impossible to trace directly most factory overhead cost to a particular job. c

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