The over or under-applied manufacturing overhead is defined as the difference between manufacturing overhead cost applied to work in process and manufacturing overhead cost actually incurred during a period.
If the manufacturing overhead cost applied to work in process is more than the manufacturing overhead cost actually incurred during a period, the difference is known as over-applied manufacturing overhead. The occurrence of over or under-applied overhead is normal in manufacturing businesses because overhead is applied to work in process using a predetermined overhead rate.
Over or under-applied manufacturing overhead is actually the debit or credit balance of manufacturing overhead account (also known as factory overhead account).
Actual manufacturing overhead costs are debited and applied manufacturing overhead costs are credited to manufacturing overhead account. The debit or credit balance in manufacturing overhead account at the end of a month is carried forward to the next month until the end of a particular period – usually one year. At the end of the year, the balance in manufacturing overhead account (over or under-applied manufacturing overhead) is disposed off by either allocating it among work in process, finished goods and cost of goods sold accounts or transferring the entire amount to cost of goods sold account. Under this method, the amount of over or under-applied overhead is disposed off by allocating it among work in process, finished goods and cost of goods sold accounts on the basis of overhead applied in each of the accounts during the period.
Under this method the entire amount of over or under applied overhead is transferred to cost of goods sold. What is the purpose of factory overhead and how can this information be used to minimize the cost of the product.
Question: We have discussed how to assign direct material and direct labor costs to jobs using a materials requisition form, timesheet, and job cost sheet.
Answer: Recall from Chapter 1 "What Is Managerial Accounting?" that manufacturing overhead consists of all costs related to the production process other than direct materials and direct labor. The goal is to allocate manufacturing overhead costs to jobs based on some common activity, such as direct labor hours, machine hours, or direct labor costs. Thus each job will be assigned $30 in overhead costs for every direct labor hour charged to the job. Question: Now that we know how to calculate the predetermined overhead rate, the next step is to use this rate to apply overhead to jobs.
Recording the application of overhead costs to a job is further illustrated in the T-accounts that follow. 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. Question: Although we used direct labor hours as the allocation base for Custom Furniture Company’s predetermined overhead rate, organizations use various other types of allocation bases. It may make more sense to use several allocation bases and several overhead rates to allocate overhead to jobs. Actual overhead costs can fluctuate from month to month, causing high amounts of overhead to be charged to jobs during high-cost periods. Actual overhead cost data are typically only available at the end of the month, quarter, or year. Question: Using a predetermined overhead rate to apply overhead costs to jobs requires the use of a manufacturing overhead account. Other examples of actual manufacturing overhead costs include factory utilities, machine maintenance, and factory supervisor salaries. The manufacturing overhead account is classified as a clearing accountAn account used to hold financial data temporarily until it is closed out at the end of the period.. Question: Because manufacturing overhead costs are applied to jobs based on an estimated predetermined overhead rate, overhead applied (credit side of manufacturing overhead) rarely equals actual overhead costs incurred (debit side of manufacturing overhead).
Answer: Two terms are used to describe this difference—underapplied overhead and overapplied overhead. Underapplied overheadOverhead costs applied to jobs that are less than actual overhead costs.
Boeing Company is the world’s leading aerospace company and the largest manufacturer of commercial jetliners and military aircraft combined.
Since most of Boeing’s products are unique and costly, the company likely uses job costing to track costs associated with each product it manufactures.
Question: Since the manufacturing overhead account is a clearing account, it must be closed at the end of the period.
Answer: Most companies simply close the manufacturing overhead account balance to the cost of goods sold account.


Question: Although most companies close the manufacturing overhead account to cost of goods sold, this is typically only done when the amount is immaterial (immaterial is a common accounting term used to describe an amount that is small relative to a company’s size). Answer: 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. Although this approach is not as common as simply closing the manufacturing overhead account balance to cost of goods sold, companies do this when the amount is relatively significant.
A manufacturing overhead account is used to track actual overhead costs (debits) and applied overhead (credits). Chan Company received a bill totaling $3,700 for machine parts used in maintaining factory equipment.
Assume Chan Company incurs actual manufacturing overhead costs of $470,000 and applies overhead of $510,000 for the year.
Make the journal entry to close the manufacturing overhead account assuming the balance is immaterial. Make the journal entry to close the manufacturing overhead account assuming the balance is material. If Chan’s production process is highly mechanized, overhead costs are likely driven by machine use. Overhead is overapplied because actual overhead costs are lower than overhead applied to jobs. Neither the service provider nor the domain owner maintain any relationship with the advertisers. On the other hand; if the manufacturing overhead cost applied to work in process is less than the manufacturing overhead cost actually incurred during a period,  the difference is known as under-applied manufacturing overhead. Predetermined overhead rate is computed at the beginning of the period using estimated information and is used to apply manufacturing overhead cost throughout the period.
Actual overhead costs are debited as they are incurred and applied overhead costs are credited as they are applied to work in process.
Lets say we have actual overheads 110 Dr and applied 100 Cr, now how to dispose off this 100 Cr balance, if this remains in the account then it will keep on increasing. Because manufacturing overhead costs are difficult to trace to specific jobs, the amount allocated to each job is based on an estimate. The activity used to allocate manufacturing overhead costs to jobs is called an allocation baseThe activity used to allocate manufacturing overhead costs to jobs.. Custom Furniture Company estimates annual overhead costs to be $1,140,000 based on actual overhead costs last year.
Custom Furniture uses direct labor hours as the allocation base and expects its direct labor workforce to record 38,000 direct labor hours for the year. The assignment of overhead costs to jobs based on a predetermined overhead rate is called overhead appliedThe assignment of overhead costs to jobs based on a predetermined overhead rate.. How do companies use the predetermined overhead rate to apply overhead to jobs, and how is this information recorded in the general journal?
Because manufacturing overhead is applied at a rate of $30 per direct labor hour, $180 (= $30 ? 6 hours) in overhead is applied to job 50. Figure 2.6 "Overhead Applied for Custom Furniture Company’s Job 50" shows the manufacturing overhead applied based on the six hours worked by Tim Wallace. The most common allocation bases are direct labor hours, direct labor costs, and machine hours. The goal is to find an allocation base that drives overhead costs, often called a cost driverThe allocation base that drives overhead costs.. This approach, called activity-based costing, is discussed in depth in Chapter 3 "How Does an Organization Use Activity-Based Costing to Allocate Overhead Costs?". An allocation base should not only be linked to overhead costs; it should also be measurable. For example, utility costs might be higher during cold winter months and hot summer months than in the fall and spring seasons. Managers prefer to know the cost of a job when it is completed—and in some cases during production—rather than waiting until the end of the period. One rate is used to record overhead costs rather than tabulating actual overhead costs at the end of the reporting period and going back to assign the costs to jobs.
Recall that manufacturing overhead costs include all production costs other than direct labor and direct materials.


All these costs are recorded as debits in the manufacturing overhead account when incurred. The overhead costs applied to jobs using a predetermined overhead rate are recorded as credits in the manufacturing overhead account. A clearing account is used to hold financial data temporarily and is closed out at the end of the period before preparing financial statements.
What terms are used to describe the difference between actual overhead costs incurred during a period and overhead applied during a period? Boeing provides products and services to customers in 150 countries and employs 165,000 people throughout the world. For example, the costly direct materials that go into each jetliner produced are tracked using a job cost sheet.
Thus $1,200 is apportioned to WIP inventory (= $2,000 ? 60 percent), $600 goes to finished goods inventory (= $2,000 ? 30 percent), and $200 goes to cost of goods sold (= $2,000 ? 10 percent). Normal costing tracks actual direct material costs and actual direct labor costs for each job and charges manufacturing overhead to jobs using a predetermined overhead rate. Chan allocates overhead to jobs based on machine hours, and it expects that 100,000 machine hours will be required for the year.
In case of trademark issues please contact the domain owner directly (contact information can be found in whois). I understand this treatment because at the end of the day overhead allocated to inventory will be standard, the rest is expensed.
How do companies assign manufacturing overhead costs, such as factory rent and factory utilities, to individual jobs? Remember that overhead applied does not represent actual overhead costs incurred by the job—nor does it represent direct labor or direct material costs.
Notice that total manufacturing costs as of May 4 for job 50 are summarized at the bottom of the job cost sheet. The three most common allocation bases—direct labor hours, direct labor costs, and machine hours—are relatively easy to measure.
The actual manufacturing overhead costs incurred in a period are recorded as debits in the manufacturing overhead account.
You saw an example of this earlier when $180 in overhead was applied to job 50 for Custom Furniture Company. Direct labor and manufacturing overhead costs (think huge production facilities!) are also assigned to each jetliner. Thus there is a link between machine hours and overhead costs, and using machine hours as an allocation base is preferable. The predetermined overhead rateA rate established prior to the year in which it is used in allocating manufacturing overhead costs to jobs.
Instead, overhead applied represents a portion of estimated overhead costs that is assigned to a particular job. Direct labor hours and direct labor costs can be measured by using a timesheet, as discussed earlier, so using either of these as a base for allocating overhead is quite simple. For example, assume Custom Furniture Company places $4,200 in indirect materials into production on May 10.
Note that the manufacturing overhead account has a debit balance when overhead is underapplied because fewer costs were applied to jobs than were actually incurred. Note that the manufacturing overhead account has a credit balance when overhead is overapplied because more costs were applied to jobs than were actually incurred.
This careful tracking of production costs for each jetliner provides management with important cost information that is used to assess production efficiency and profitability.
Machine hours can also be easily measured by placing an hour meter on each machine if one does not already exist. Management can answer questions, such as “How much did direct materials cost?,” “How much overhead was allocated to each jetliner?,” or “What was the total production cost for each jetliner?” This is important information when it comes time to negotiate the sales price of a jetliner with a potential buyer like United Airlines or Southwest Airlines.



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