Over and Under-allocated Overhead

Learning Outcomes

  • Adjust for over and under-allocated overhead

At the end of the month, Jackie notices that her Factory Overhead account looks like this:

Factory Overhead
Debit Credit
2,500
3,000
300
Double line Double line200

 

She used a standard rate to allocate Factory Overhead to jobs during the month that assigned $3,000 of overhead based on $3 per direct labor dollars:

Job Sheet Job 1 Job 2 Job 3 Total WIP
Subcategory, Direct Materials
      Wood 100 100 100 300
      Wheels/trucks 50 100 150
Direct Labor 400 600 1000
Overhead allocation ($3/DL$) 1200 1800 0 3000
Total Job Cost Single Line1750Double line Single Line2600Double line Single Line100Double line Single Line4450Double line

 

Actual overhead was $2,800 ($2,500 rent and $300 materials).

Therefore, the Factory Overhead account shows a credit balance of $200, which means it was over-allocated. In order to reconcile that account, the financial accountants would make the following journal entry:

Date Account/Explanation Debit Credit
Jul 31 Factory Overhead           200
      Cost of Goods Sold               200
To adjust over-allocated factory overhead

 

A journal entry dated July 31 shows a debit of $200 to Factory Overhead and a credit of $200 to Cost of Goods Sold with the note “To adjust under-allocated factory overhead”. Each line item in the journal entry points to the corresponding debit or credit on its respective t-account.

Finally, Jackie will run a trial balance to make sure all debits equal credits and to summarize the accounts as follows:

A t-account for Checking Account shows a debit of $150,000 beginning balance, credits of $2,500, $400, $50, $600, and $100, a debit of $2,000, and a debit of $148,350 ending balance. A t-account of Raw Materials - Direct shows a debit of $3,000 beginning balance, credits of $100, $100, and $100, and a debit of $2,700 ending balance. A t-account for Work in Process shows a debit of $100 beginning balance, debits of $450, $100, $700, $100, and $3,000, a debit of $4,350, and a debit of $100 ending balance. A t-account for Raw Materials - indirect shows a debit of $1,000 beginning balance, a credit of $300, and a debit of $700 ending balance. A t-account for finished goods shows a debit of $4,350 beginning balance, a credit of $1,750, and a debit of $2,600 ending balance. A t-account for Owner’s Capital shows a credit of $150,000 beginning and ending balance.
A t-account for Accounts Payable shows a credit of $3,000 beginning balance, a credit of $1,000, and a credit of $4,000 ending balance. A t-account for Sales Revenue shows a credit of $2,000 beginning and ending balance. A t-account for Factory Overhead shows a debit of $2,500 beginning balance, a $3,000 credit, debits of $300 and $200, and a debit of $0 ending balance. A t-account for Cost of Goods Sold shows a debit of $1,750 beginning balance, a $200 credit, and a debit of $1,550 ending balance.

 

DR CR    Notes
Checking Account     148,350
  • Should agree with bank reconciliation
Raw Materials – direct         2,700
  • 54 units at $50 each
Raw Materials – indirect           700
  • Per physical count
Work in Process           100
  • Job 3 just started
Finished Goods         2,600
  • Job 2 completed but not yet sold
Accounts Payable           4,000
  • Due to suppliers for raw materials bought on credit
Owner’s Capital       150,000
  • Initial investment by Jackie Ma
Sales Revenue                 2,000
  • Job 1 sold to
Cost of Goods Sold 1,550
  • Job 1 sold to
Factory Overhead             –
  • Allocated to Jobs
Single Line    156,000Double line Single Line      156,000Double line

 

We can see that after accounting for the overhead, which was over-allocated to Jobs 1 and 2, by recording it as an adjustment to Cost of Goods Sold, it improves MaBoards’ financial gross profit by $200. As long as those final adjustments are not material to the financial statements taken as a whole, managerial accountants feel that the additional benefit of having real-time information makes up for the lack of precision that comes with estimating Factory Overhead by using a standard rate during the month.

Instead of plugging under- or over-allocated overhead into cost of goods sold as an unassigned (to any job) amount, we could re-allocate factory overhead to jobs based on the actual amount of overhead incurred, but that would be of more interest to financial accountants, who are focused on historical data.

Obviously, the managerial accountants will adjust the rate based on historical and projected information.

Watch this video to see how to dispose of overallocated or under-allocated overhead.

You can view the transcript for “Underapplied or Overapplied Manufacturing Overhead (how to dispose of it)” here (opens in new window).

Now, let’s check your understanding of adjusting Factory Overhead at the end of the month.

Practice Question