Question

Matt Litkee is confused about under- and overapplied manufacturing overhead. Define the terms for Matt, and indicate the balance in the manufacturing overhead account applicable to each term.

Answer 1

Overhead is applied to jobs using a predetermined rate based on volume based measures e.g. direct labor hours, direct labor cost, machine hours, units produced etc.

Predetermined overhead rate = Estimated Total Manufacturing Overhead / Estimated Volume of Cost Driver.

But the actual overhead incurred may be more or less than the applied overhead. It may happen if either the numerator or the denominator is wrongly estimated.

When the overhead applied is less than the overhead costs actually incurred, it is under-applied overhead. It means that the amount underapplied needs to be charged to production or the cost of goods sold.

On the other hand, overhead applied might exceed actual overhead incurred. This is overapplied overhead. In other words, too much overhead cost has been charged to jobs / products. It needs to be reduced.

If overhead is overapplied, it would appear as a credit balance in manufacturing overhead account, as the credit side ( overhead applied) is heavier than the debit side ( overhead incurred ) . The opposite would be true for underapplied overhead.