4 6: Determine and Dispose of Underapplied or Overapplied Overhead Business LibreTexts

When this journal entry is recorded, we also record overhead applied on the appropriate job cost sheet, just as we did with direct materials and direct labor. Figure 2.6 shows the manufacturing overhead applied based on the six hours worked by Tim Wallace. Notice that total manufacturing costs as of May 4 for job 50 are summarized at the bottom of the job cost sheet.

Transferred Goods from the Packaging Department to Finished Goods

The actual overhead for the month was $160,000, of which $120,000 should be credited to Accounts Payable and $40,000 should be credited to Accumulated Depreciation. Alternate problemsAlternate problem A Pocket Umbrella, Inc., is considering producing a new type of umbrella. Exercise A The following costs are incurred by an electrical appliance manufacturer. Classify these costs as direct materials, direct labor, manufacturing overhead, selling, or administrative.

  1. After this journal entry, the balance of manufacturing overhead remains $500 (8,500 – 8,000) on the debit side of the ledger.
  2. Overhead is assigned to a job at the rate of $ 2 per machine-hour used on the job.
  3. Other indirect production costs include utilities, insurance, depreciation, property tax, repairs and maintenance, etc.
  4. For another example, assuming the actual overhead cost that has occurred during the period is $11,000 instead while the applied overhead cost is $10,000, the same as the above example.
  5. Motion pictures, printing, and otherindustries where unique jobs are produced use job costing.Hospitals also use job costing to determine the cost of eachpatient’s care.

Ongoing Overapplied Overhead

Also, they may ask the accountants to increase the overhead applied to jobs to give them a better idea of the cost of jobs. If the actual is less than the applied overhead, they may ask the accountants to reduce the overhead applied to jobs. The company assigns overhead to each job on the basis of the machine-hours each job uses. Overhead is assigned to a job at the rate of $ 2 per machine-hour used on the job.

Direct Labor Paid by All Production Departments

Consulting, law, and public accounting firms use job costing to measure the costs of serving each client. Motion pictures, printing, and other industries where unique jobs are produced use job costing. Hospitals also use job costing to determine the cost of each patient’s care. ➢ Record the direct and indirect materials issued in journal entry form. The company compares the cost of each job withthe revenue received to be sure the jobs are profitable. Sometimesthe company learns that certain jobs are too costly considering theprices they can charge.

Why Use a Predetermined Overhead Rate?

Also, did you notice that actual overhead came to $9,800 ($1,000 indirect materials + $2,000 indirect labor + $6,800 other overhead from transaction g) but we applied $9,850 in overhead to the jobs in transaction d? Whenever https://www.business-accounting.net/ we use an estimate instead of actual numbers, it should be expected that an adjustment is needed. We will discuss the difference between actual and applied overhead and how we handle the differences in the next sections.

Summarize the physical flow of units and compute the equivalent units for direct materials, direct labor, and overhead. In this case, the manufacturing overhead is underapplied by $1,000 ($11,000 – $10,000) as the applied overhead cost is $1,000 less than the actual overhead cost that has occurred during the accounting period. Manufacturing overhead includes indirect material, indirect labor, and other types of manufacturing overhead. It is difficult, if not impossible, to trace manufacturing overhead to a specific product, and yet, the total cost per unit needs to include overhead in order to make management decisions. Prepare journal entries to record the costs of jobs and to record the transfer of completed jobs to Finished Goods Inventory and to Cost of Goods Sold.

Alternative Approach to Closing the Manufacturing Overhead Account

Indirect labor records are also maintained through time tickets, although such work is not directly traceable to a specific job. The difference between direct labor and indirect labor is that the indirect labor records the debit to manufacturing overhead while the credit is to factory wages payable. Problem A Total Block, Inc., is considering a new sunscreen packet that contains a skin wipe with sunscreen on it. These would be particularly useful for people who do not want to carry a bottle of sunscreen, according to Sunspot’s marketing manager. Classify the following costs of this new product as direct materials, direct labor, manufacturing overhead, selling, or administrative. When the company needs to assign the indirect production costs of overhead to work in process of a specific job, it needs to do so through the use of the predetermined overhead rate.

Of course, we can also look at it from the perspective of cost of goods sold where we need to add more cost with the debit of the cost of goods sold as the applied overhead cost is less than the cost that actually occurs. If the applied overhead exceeds the actual amount incurred, overhead is said to be overapplied. This is usually viewed as a favorable outcome, because less has been spent than anticipated for the level of achieved production. Figure 3.5 “Summary of Costs to Be Accounted for in Desk Products’ Assembly Department” shows that costs totaling $386,000 must be assigned to (1) completed units transferred out and (2) units in ending WIP inventory.

Prepare journal entries to record the preceding data, as well as the transfer of underapplied or overapplied overhead to Cost of Goods Sold. The total job costof Job 106 is $27,950 for the total work done on the job, includingcosts in beginning Work in Process Inventory on July 1 and costsadded during July. This entry records the completion of Job 106 bymoving the total cost FROM work in process inventory TO finishedgoods inventory.

These illustrations of the disposition of under- and overapplied overhead are typical, but not the only solution. A more theoretically correct approach would be to reduce cost of goods sold, work in process inventory, and finished goods inventory on a pro-rata basis. However, this approach is cumbersome and occasionally runs afoul of specific accounting rules discussed next. In this case, the manufacturing overhead is overapplied by $500 ($10,000 – $9,500) as the applied overhead cost is $500 more than the actual overhead cost that have occurred during the period.

If the amount is material, it should be closed to three different accounts—work-in-process (WIP) inventory, finished goods inventory, and cost of goods sold—in proportion to the account balances in these accounts. The manufacturing overhead account is classified as a clearing account12 . A clearing account is used to hold financial data temporarily and is closed out at the end of the period the starting salary for accounting firm lawyers before preparing financial statements. Financial results for the first 11 months of the current fiscal year (through February 28) are well below expectations of management, owners, and creditors. Although rounding differences still may occur, this will minimize the size of rounding errors when attempting to reconcile costs to be accounted for (step 2) with costs accounted for (step 4).

Exercise B Classify the costs listed in the previous exercise as either product costs or period costs. Although managerial accounting information is generally viewed as for internal use only, be mindful that many manufacturing companies do prepare external financial statements. And, generally accepted accounting principles dictate the form and content of those reports.

Although this chapter focuses on the Assembly department, the Finishing department would also use the four steps to determine product costs for completed units transferred out and ending WIP inventory. Table 3.2 “Production Information for Desk Products’ Assembly Department” presents information for the Assembly department at Desk Products for the month of May. Review this information carefully as it will be used to illustrate the four key steps. Notice that two different work-in-process inventory accounts are used to track production costs—one for each department.

In job order costing, the manufacturing overhead is the cost that relates to the whole production operation but cannot be charged directly to the specific jobs. Likewise, the journal entry for manufacturing overhead starts when the company assigns all the indirect production costs to the overhead first before transferring to the work in process of the specific job. Most companies use either the weighted average or first-in-first-out (FIFO) method to assign costs to inventory in a process costing environment. The weighted average method includes costs in beginning inventory and current period costs to establish an average cost per unit.