Overhead Allocation and Disposition Chapter 31 Managerial Accounting Overhead Allocation and Disposition Prepared by Diane Tanner University of North Florida Copyright ©2015. University of North Florida. All rights reserved.

Assigning Overhead Costs to Products Manufacturing overhead cost is allocated to products Why is it allocated? Either impossible or not feasible to identify to a specific product Allocation involves Determining a basis on which to distribute the cost Calculating a rate Assigning a portion of the estimated overhead to each product A portion of the MOH costs are removed from the MOH account and added to the other costs of the product accumulated in the WIP account DR Work in Process CR Manufacturing overhead

Predetermined Overhead Rate The rate at which manufacturing overhead is allocated (applied) to products Referred to as ‘predetermined overhead rate’ (POHR) Determined ‘before’ the period begins At which time, the actual costs are unknown Estimated Manufacturing Overhead Cost Estimated Activity POHR =

Selecting an Activity Often called a cost driver The denominator of the predetermined overhead rate is ‘estimated activity’ Common estimated activities include Number of units to be produced Number of direct labor hours to be used Number of direct labor dollars to be incurred Number of machine hours to be used Based on management’s best guess of what causes costs to increase Often called a cost driver

Allocating Manufacturing Overhead Allocating overhead means to assign a portion of the overhead cost to a product Often called ‘applying’ overhead Each time the ‘activity’ occurs, the allocation amount is added to the product cost Allocation amount POHR × Actual activity Example Suppose the POHR is $2 per direct labor hour Each time one hour of direct labor is used, the company will assign $2 of overhead to the specific product.

Under and Overapplied Overhead A balance usually remains in the MOH expense account at the end of the period Possible balances in MOH Debit balance Underapplied = Not MOH enough was ‘applied’, i.e. not enough MOH cost was added to products Credit balance Overapplied = Too much MOH was ‘applied’. i.e., too much MOH cost was added to products

Applying Overhead Based on Units McAlister Company provided the following amounts: Estimated MOH costs = $50,000 Actual MOH costs = $49,500 Estimated units to be produced = 4,000 Actual units produced = 4,100 The company allocates overhead based on units produced. Step 1: Determine the allocation rate (POHR) = $50,000/4,000 = $12.50/unit Step 2: Apply overhead: Applied = $12.50 x 4,100 = $51,250 MOH 49,500 51,250 1,750 overapplied

Applying Overhead Based on DL Hours McAlister Company provided the following amounts: Estimated MOH costs = $50,000 Actual MOH costs = $49,500 Estimated direct labor hours = 12,500 Actual direct labor hours = 12,400 The company allocates overhead based on DL hours. Step 1: Determine an allocation rate (POHR) = $50,000/12,500 = $4.00/DL hour Step 2: Apply overhead: Applied = $4.00 x 12,400 = $49,600 MOH 49,500 49,600 100 overapplied

Applying Overhead Based on DL Cost McAlister Company provided the following amounts: Estimated MOH costs = $50,000 Actual MOH costs = $49,500 Estimated direct labor cost = $156,250 Actual direct labor cost = $153,600 The company allocates based on DL cost. Step 1: Determine an allocation rate (POHR) = $50,000/156,250 = $0.32 per DL$ Step 2: Apply overhead: Applied = $0.32 x $153,600 = $49,152 MOH 49,500 49,152 Underapplied 348

Disposing of Over/Underapplied Any balance at year end in the MOH account must be ‘closed’ or ‘adjusted’ to a zero balance Why? MOH is a temporary product account Not reported on the financial statements Disposition is based on materiality If immaterial in amount Close directly to cost of goods sold Because this account will contain most of the overhead cost at year end If material in amount Allocate proportionately to work in process, finished goods, and cost of goods sold Because these accounts contain all of the manufacturing overhead costs incurred by a company Overhead

Disposition of MOH Example Some balances of accounts prior to adjustment appear below for Perco: Cost of goods sold $400,000 Actual MOH costs 49,500 Estimated MOH costs 50,000 Applied MOH costs 51,250 Cost of Goods Sold Mfg. Overhead Actual overhead $49,500 Overhead Applied $51,250 400,000 1,750 1,750 overapplied 398,250 1,750 adjustment

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