Overhead Application and Disposition Managerial Accounting Prepared by Diane Tanner University of North Florida Chapter 32

2 Assigning Overhead Costs to Products/Services  Occurs when normal costing is used  Manufacturing overhead is ‘allocated’ to products based on a predetermined overhead rate (POHR)  Allocation causes the manufacturing overhead costs that are assigned to products to not be exact…..only an estimate of how much cost is used by each product

3 Accounting for Overhead in a Normal Costing System  When actual overhead costs are incurred  Debit to MOH expense account  Apply (allocate) overhead to products  Determine a ‘rate’ to apply (allocate) overhead  Before the period begins  Predetermined MOH rate  Multiply the rate times the actual activity  Debit WIP for the amount applied  Credit MOH expense for the amount applied  When is overhead applied ? As the activity occurs

4 Predetermined Overhead Rate  The rate at which manufacturing overhead is applied (added) to products  Referred to as ‘predetermined overhead rate’ (POHR)  Why? Because it is determined ‘before’ the period begins Estimated Manufacturing Overhead Cost Estimated Activity POHR =

5 Selecting an Activity  The denominator of the pre-determined 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

6 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. 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 49,50051,250 1,750 overapplied

7 Applying 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 49,50049, overapplied 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. 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.

8 Applying Overhead 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 49,50049,152 Underapplied 348 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 hours. 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 hours.

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

Disposing of Over/Underapplied  Any balance at yearend in the MOH account must be ‘closed’ or ‘adjusted’ to a zero balance  Why? MOH is not a product account that is 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 MOH at year end  If material in amount  Allocate to work in process, finished goods, and cost of goods sold  Because these accounts contain all of the MOH incurred by a company

Disposition of MOH Example 11 Mfg. Overhead Actual overhead $49,500 Cost of Goods Sold 400, ,250 Overhead Applied $51,250 1,750 Some balances of accounts prior to adjustments appear below for Pearco: Cost of Goods Sold $400,000 Actual MOH costs 49,500 Estimated MOH costs 50,000 Applied MOH costs 51,250 1,750 overapplied 1,750 adjustment 0

12 The End