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I'm Larry Walther, this is principlesofaccounting.com Chapter 19.
And it covers job costing and modern cost management systems.
This module is going to look at actual and applied overhead and
how we deal with the differences between those.
Recognize that in the earlier module, we showed how,
as overhead was applied to production, remember we debited work in process, and
we credited an account called factory overhead.
And at that time, I said, don't worry too much about the factory overhead,
we'll cover it later.
Well, now is later.
Now we're going to look at this factory overhead account.
And so, factory overhead,
we've seen the credit when we apply overhead to production.
Let's look at the debit.
The debits relate to a variety of overhead cost, indirect labor,
indirect material, other items like insurance, factory depreciation, taxes,
utilities, maintenance and so forth.
In each case we’re going to debit the overhead account for those costs.
The credits will be essentially eventually cashed, but
in the meantime salaries payable, supplies, inventory,
prepaid insurance, accumulated depreciation or whatever.
Importantly, selling general administrative costs are not
considered to be part of manufacturing overhead.
They're expensed separately as a period expense.
We're only concerned with factory overhead items in this case.
So here's the journal entry to record the overhead.
There's our credits to our payables, our supplies,
our accumulated depreciation, all of our manufacturing overhead costs.
The offsetting debit goes to factory overhead.
Now the factory overhead account is unique.
It's not a typical account.
It's not an element of financial statements.
You won't find it in a balance sheet or income statement.
It's not an asset, a liability expense.
It's a suspense account, a temporary account, a clearing account.
We're gonna put our amounts into the factory overhead account and
take them out of the factory overhead account.
Actual costs are placed into the overhead account and
applied costs are taken out of the overhead account.
Here's the actual ledger page for our factory overhead account.
Job A was allocated to 15,000 of overhead so
we debited work in process for Job A and credited factory overhead for 15,000.
For Job B, we debited working process and
here's the credit to Job B working process.
And here is the credit for Job C, D and so forth.
Those are the allocations and there's the actual cost,
the offsetting debit that we saw a moment ago.
Notice the account is zeroed, or balanced out.
Here's a T-account, it's probably clearer to show how this works.
In this case, we have our 100,000 overhead incurred,
crediting our various payables and so forth and debiting factory overhead.
And there's the allocation, crediting overhead and
debiting our various work in process accounts.
That sweeps it out or zeroes out the overhead account.
Of course, you might consider that we have underapplied overhead.
Here in the middle, I show there's 100,000 that was actually incurred,
but we only applied 90,000 to production.
That left us with 10,000 of unapplied or underapplied overhead.
We're going to close out, or zero out, the factory overhead account by
crediting factory overhead and debiting cost of goods sold.
Underapplied, as I've shown, is also deemed to be unfavorable.
Perhaps it occurred because not enough jobs were produced to absorb
all of the costs based on the allocation rate.
Or maybe we had overruns in the actual costs that inccurred.
Whatever, it's an unfavorable situation.
As we zero out the factory overhead account,
we're gonna increase our expenses for costs of goods sold.
So I'm gonna place that cost into costs of goods sold.
Overapplied is the alternative situation.
I've applied 110,000 to my various jobs, but only incurred 100,000.
Now I need a $10,000 debit to balance out my factory overhead account and
I'm going to credit our reduced cost of goods sold since I didn't spend as much
as I allocated.
Overapplied overhead is a favorable situation.
Less has been spent then anticipated for the level of output achieved.
And the balance I've shown is transferred out of factory overhead and
reduces cost of goods sold.
Now, I took all of the underapplied or
overapplied overhead to cost of goods sold.
Perhaps theoretically a more appropriate approach would be to allocate the under or
overapplied overhead to work in process,
to finished goods and cost of goods sold on some kind of pro-rata basis.
I mean the cost related to all of those goods weather still in production or not.
However if it's not a largely material amount
many companies will simply choose to charge or credit cost of goods
sold to dispose of that amount rather than going through the allocation process.
GAAP also addresses this by the way.
Generally accepted accounting principles require that under applied overhead
relating to facilities.
Wasted material, the allocation of fixed production overhead, and so
forth, be charged to current period as was illustrated.
So there is some basis for supporting the allocation of cost of goods sold.
So in closing let me again indicate,
because this is often a confusing subject for students.
When we allocate overhead to production,
we'll debit the inventory account work in process and credit factory overhead.
As we incur the actual cost, we'll be debiting factory overhead.
If there's a perfect allocation of everything that was actually spent,
there will be no balance left in the overhead account, it goes away.
If there's any balance and they're underapplied or
overapplied, we transfer that balance to the cost of goods sold account,
as part of our process for completing or
adjusting and closing financial statements at the end of a period.
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