Over-Under Applied Overhead Transcript
Costing Methods > Job Costing > Over-Under Applied Overhead
Since manufacturing overhead is debited for the amount of actual overhead and credited for the amount of applied overhead, some of you have probably deduced that this account balance might not be zero at the end of the period. In fact almost never is.
A debit balance in manufacturing overhead at the end of the period means that overhead is under-applied. Another way to think of this term is too little overhead has been applied to the jobs. A credit balance in manufacturing overhead at the end of the period, means that overhead is over-applied. Another way to think of that term is too much overhead has been applied to the jobs.
Over- or under-applied overhead creates two problems for company.
The first is that jobs haven't been properly costed.
The second is that any balance in manufacturing overhead, an expense account, is going to end up on the income statement in the wrong place and possibly in the wrong period.
There are a few different ways that companies can remove the balance from manufacturing overhead.
The more complicated way is to prorate the balances between WIP, FGI and Cost of Goods Sold. This method is fairly common and usually taught in a cost accounting course.
The simpler method, and the one that's used in Principles of Accounting, is to move the balances to Cost of Goods Sold and just assume all of the jobs have been sold or that the amount is immaterial.
Let's look at an example.
Let's assume that manufacturing overhead is under-applied by $50,000.
So we move $50,000 from manufacturing overhead to Costs of Goods Sold by crediting overhead and debiting Costs of Goods sold. Now we've increased the cost of our sold products. Since manufacturing overhead was under- applied and therefore, our jobs were under- costed, this now increases the cost of our jobs to the correct amount.
What if manufacturing overhead is over-applied by $100,000?
We move the 100,000 from manufacturing overhead to Cost of Goods Sold by debiting overhead and crediting Cost of Goods Sold. Now we've decreased the cost of our sold products. Since manufacturing overhead was over-applied, and therefore our jobs were all over costed, this now decreases the cost of our jobs to the correct amount.
The journal entry to remove the under-applied balance looks like this:
it's a debit to Cost of Goods Sold and a credit to manufacturing overhead. This adjusts Cost of Goods Sold to the correct amount and zeros out the balance in manufacturing overhead.
The journal entry to remove over-applied balance looks like this:
a debit to manufacturing overhead and a credit to Costs of Goods Sold. This adjusts the Cost of Goods Sold account to the correct amount and zeros out the balance in manufacturing overhead.
And that concludes this short video on accounting for over- and under-applied overhead.