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A fresh graduate employed as an accountant of a manufacturing company and is working on over applied and under applied overheads.
Explain how you would assist him/her in computing over applied and under applied overheads. Give numerical examples
Sample Answer
Computing Overapplied and Underapplied Overheads: A Practical Guide for Accountants
As a seasoned accountant in a manufacturing company, assisting a fresh graduate in computing overapplied and underapplied overheads is essential for accurate cost allocation and financial reporting. Let’s walk through the process step by step and provide numerical examples to illustrate these concepts effectively.
Understanding Overapplied and Underapplied Overheads
– Overapplied Overheads: Overapplied overheads occur when the actual overhead costs incurred are less than the overhead costs allocated or applied to production. This results in an excess of overhead applied compared to the actual expenses.
– Underapplied Overheads: Underapplied overheads, on the other hand, occur when the actual overhead costs exceed the overhead costs allocated or applied to production. This leads to a shortfall in overhead applied compared to the actual expenses.
Steps to Compute Overapplied and Underapplied Overheads
1. Determine Actual Overhead Costs: Calculate the actual overhead costs incurred during the accounting period. This includes expenses such as indirect labor, utilities, rent, and depreciation.
2. Calculate Applied Overhead Costs: Determine the predetermined overhead rate by dividing the estimated total overhead costs by the estimated activity base (e.g., direct labor hours, machine hours). Then, apply this predetermined rate to actual activity levels to calculate applied overhead costs.
3. Compare Actual vs. Applied Overhead Costs: Find the difference between actual overhead costs and applied overhead costs to identify whether there is an overapplication or underapplication of overhead.
4. Adjust Cost of Goods Sold: Allocate the overapplied or underapplied overhead amount to Cost of Goods Sold or Manufacturing Overhead accounts to ensure accurate cost allocation and financial statements.
Numerical Examples
Let’s consider a manufacturing company with the following data for a given accounting period:
– Actual Overhead Costs: $100,000
– Estimated Overhead Costs: $90,000
– Estimated Activity Base (Direct Labor Hours): 10,000 hours
– Actual Activity (Direct Labor Hours): 9,800 hours
Calculations:
1. Predetermined Overhead Rate:
Predetermined Overhead Rate = Estimated Total Overhead Costs / Estimated Activity Base
Predetermined Overhead Rate = $90,000 / 10,000 hours
Predetermined Overhead Rate = $9 per direct labor hour
2. Applied Overhead Costs:
Applied Overhead Costs = Actual Activity x Predetermined Overhead Rate
Applied Overhead Costs = 9,800 hours x $9
Applied Overhead Costs = $88,200
3. Identifying Overapplied or Underapplied Overheads:
Actual Overhead Costs – Applied Overhead Costs = Actual vs. Applied Difference
$100,000 – $88,200 = $11,800
Since the actual overhead costs exceeded the applied overhead costs by $11,800, this indicates an underapplied overhead situation.
By guiding the fresh graduate through these calculations and examples, they can gain a better understanding of how to handle overapplied and underapplied overheads effectively in a manufacturing company’s accounting processes.
