OverviewAs the manufacturing overhead applied during the period is an estimate, there is usually an underapplied or overapplied overhead that needs to be reconciled at the end of the accounting period. Likewise, the journal entry will be required to reconcile the underapplied or overapplied overhead based on whether the company has the debit balance or credit balance of manufacturing overhead at the end of the period. Show
In this case, if the manufacturing overhead has a debit balance it means that that the applied overhead is less than the actual overhead. This will result of the underapplied overhead. Applied overhead < Actual overhead => Underapplied overhead On the other hand, if the manufacturing overhead has a credit balance it means that that the applied overhead is more than the actual overhead. This will result of the overapplied overhead. Applied overhead > Actual overhead => Overapplied overhead Underapplied overhead journal entryAt the end of the accounting period, when the company has a debit balance of manufacturing overhead, it can make the journal entry to reconcile the overhead cost by debiting the cost of goods sold account and crediting the manufacturing overhead account.
Overapplied overhead journal entryOn the other hand, when the applied overhead is more than the actual overhead, the company can make the journal entry to reconcile the overhead cost by debit the manufacturing overhead account and crediting the cost of goods sold account.
ExampleFor example, the manufacturing company ABC finds that it has a $2,000 debit balance of the manufacturing overhead at the end of the accounting period. In this case, it means that the company has underapplied overhead. Hence, it can make the journal entry in order to reconcile the underapplied overhead as below:
After this journal entry, the balance of manufacturing overhead will become zero. It is useful to note that some companies may use the more accurate method, but more time-consuming, to reconcile the underapplied or overapplied overhead. That method will not only allocate the overhead to the cost of goods sold but also to the work in process inventory account and the finished goods inventory account. In that case, the underapplied overhead journal entry will include two more accounts as below:
Similarly, the work in process inventory account and finished goods inventory account will also be added in the overapplied overhead journal entry.
In this presentation, we will review job order costing systems. The general cost flows in a manufacturing environment are depicted here in the form of tea accounts. Note that raw materials is debited when materials are purchased and credited when used. If materials are used directly in the product, work-in-progress is debited. However, if the materials are used indirectly in the product, manufacturing overhead is debited. All costs related to the manufacturing of the actual product are combined in work-inprogress as debt entries to the account. We have already discussed that direct materials are debited to work-in-progress. We also debit the account for direct labor used in the production of a product and debit indirect labor to manufacturing overhead. Lastly, we apply overhead to work-in-progress based on a predetermined overhead rate. Manufacturing overhead is debited to work-in-progress based on the overhead rate and manufacturing overhead is credited for the same amount. All product costs related to production are thus debited to work-in-progress. As the product is completed, we credit work-in-progress and debit finished goods. The product is now ready to sell. Note that the accounts, raw materials, work-in-progress, and finished goods are asset accounts in a manufacturing environment. As the products are sold, we credit finished goods in asset account and debit cost of goods sold in expense account. This completes the general cost flows in a manufacturing company. Let’s discuss manufacturing overhead. We debit this account for actual costs incurred. These costs, while they are product costs, they’re indirectly traced to the product. Then, we credit manufacturing overhead based on a predetermined overhead rate. At the end of the accounting period, we need to determine whether the account has a debit or a credit balance. If the account has a debit balance, manufacturing overhead was under-applied and, if the account has a credit balance, manufacturing overhead was overapplied. We will discuss these over- and under-applied overhead situations a bit later in our presentation. The basic cost flows in a manufacturing environment apply in a job order cost system. The only difference is that, as costs are added to work-in-progress, these costs are added to particular jobs. For example, if raw materials are used for Job 101, the work-inprogress, Job 101 account would be debited, but not Job 102 since this job did not incur any material costs. Let’s take a look at these cost flows in more detail. The cost associated with a product in a job order system include the actual direct materials and direct labor that can be traced to the particular job plus indirect product costs, the manufacturing overhead. Overhead is applied based on a predetermined rate as shown. To calculate the predetermined overhead rate, we use estimated data established before the accounting period begins. We use estimated data because actual overhead data may vary greatly from month to month and, if we were to wait for actual overhead costs, our product costs during the accounting period would not reflect the real cost of making a product. Once the predetermined overhead rate has been determined at the beginning of the accounting period, we use the same rate from month to month, job to job, for the remaining of the year and apply the overhead amount to jobs based on the actual usage of the allocation base that was used to determine the rate. The allocation base could be direct labor hours, direct material used, direct labor costs, direct machine hours, or any other allocation base the company determines to be adequate. Let’s look at an example. Assume the Reeder Corporation began operations January 1, 2007, and plans to use a job order costing system. At the beginning of the year, the company estimated that it would incur $320,000.00 in manufacturing overhead and would work 40,000 direct labor hours, therefore, the company’s predetermined overhead rate is $8.00 per direct labor hour. During the year, the company purchased $150,000.00 of raw materials and used $100,000.000 in Job 101 and $20,000.00 in Job 102. Twenty-five thousand dollars of raw materials were indirectly used in the completion of these jobs. Also, during the year, labor costs for Job 101 totaled $150,000.00 and $35,000.00 for Job 102. The company also incurred labor costs of $50,000.00 indirectly used in the completion of these jobs. In total, direct product workers worked 35,000 hours for the year. Additional overhead costs incurred for the year were $225,000.00. Job 101 was completed and sold during the year and Job 102 was partially completed at the end of the year. Let’s see the flow of these costs in our job order costing system. First, the raw materials account is debited for the purchases made during the year. The offsetting account would be either accounts payable or cash. We then debit work-in-progress Job 101 for the materials directly used in production and debit manufacturing overhead for the indirect materials used in the production of these jobs. The offsetting account in this case is raw materials for the total of the materials used. Labor costs are now added to the jobs. If direct labor costs, these costs are debited to the actual jobs and, if indirect costs, we debit manufacturing overhead. The offsetting account would be wages or salaries payable or cash. The additional manufacturing overhead costs incurred are debited to the account manufacturing overhead. The offsetting account would be either accounts payable or cash. At this point, we need to apply the predetermined overhead to the rates. Recall that the rate for overhead was $8.00 per direct labor hour worked. Since Job 101 used 30,000 hours, manufacturing overhead applied will be 240,000. We debit work-in-progress Job 101 for this amount and credit manufacturing overhead. We then apply overhead to Job 102 using the same rate, $8.00 per direct labor hour worked. Job 102 used 5,000 hours during the year, so the amount of overhead to apply to Job 102 is $40,000.00. We debit work-in-process Job 102 and credit manufacturing overhead for the same amount. Lastly, Job 101 was completed during the year, so we add the debits in the account and transferred the goods to finished goods by debiting finished goods and crediting work-inprogress Job 101. If Job 101 was then sold, we would debit costs of goods sold and credit finished goods. Let’s now calculate the accounts’ ending balances. What is the total of all inventory accounts at year end for the Reeder Corporation? Assuming Job 101 sold for $750,000.00, what is the company’s gross margin on this sale? For the Reeder Corporation, was manufacturing overhead over- or under-applied at the end of the period? Speaking of the under-applied manufacturing overhead, let’s take a closer look at the disposition of the this under-application. Notice that, at the end of the accounting period, the manufacturing overhead account had a 20,000-dollar debit balance, therefore, the overhead was under-applied. This under-application must be disposed of at the end of the year. There are two methods of disposition. One, close the debit balance in manufacturing overhead to cost of goods sold or, two, allocate the debit balance to the jobs worked during the year in proportion to the amount of overhead applied to each. Let’s take a look at these scenarios. To close the manufacturing overhead to cost of goods sold, we debit cost of goods sold and credit manufacturing overhead. To allocate the under-applied overhead to the jobs, we first determine the proportion of overhead previously applied to each job and then we take the amount of under-applied overhead and multiply the proportion of overhead previously allocated for each job. For Job 101, take $20,000.00 multiplied by 86 percent, and that equals $17,200.00. For Job 102, take $20,000.00 multiplied by 14 percent, and that equals $2,800.00. We then debit finished goods for Job 101’s share of the under-applied overhead and debit work-in-progress Job 102 for its portion of the under-application. The overhead account is credited for the total amount. Note that we use finished goods to apply Job 101’s portion since the job was completed during the year and is now in finished goods inventory. This example shows under-applied overhead. If overhead would have been over-applied, the general steps and calculations would be the same. However, we would debit manufacturing overhead and credit costs of goods sold and/or the jobs to dispose of the over-application. When manufacturing overhead has a credit balance?A debit balance in manufacturing overhead shows either that not enough overhead was applied to the individual jobs or overhead was underapplied. If, at the end of the term, there is a credit balance in manufacturing overhead, more overhead was applied to jobs than was actually incurred.
Is manufacturing overhead has a credit balance at the end of the period then?A credit balance at the end of the period in the manufacturing overhead account indicates that the overhead is overapplied. When the applied overhead is more than the actual overhead, the overhead is said to be overapplied.
What happens when you credit manufacturing overhead?If manufacturing overhead has a debit balance, the overhead is underapplied, and the resulting amount in cost of goods sold is understated. The adjusting entry is: If manufacturing overhead has a credit balance, the overhead is overapplied, and the resulting amount in cost of goods sold is overstated.
Which of the following statements is true if the manufacturing overhead account has a debit balance at the end of the period?Explanation: If the manufacturing overhead account has a debit balance then this means that the actual overhead incurred was more than the overhead costs applied to jobs. The overhead costs applied is based on a predetermined overhead rate.
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If manufacturing overhead has a credit balance at the end of the period, then
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