Journal entries for over and under applied overhead
Overview
As the manufacturing overhead costs that are applied to the production are based on the estimation, it rarely is equal to the actual overhead cost that really occurs during the period. Likewise, the company usually needs to make the journal entry for overapplied overhead or underapplied overhead in order to make an adjustment to reflect the actual cost that actually occurs before it can prepare the financial statements at the end of the accounting period.
This is due to the company needs to prepare the financial statements with the actual costs that really occur during the accounting period rather than the estimation that is based on the predetermined standard rate. Likewise, it needs to compare the applied manufacturing overhead cost with the actual cost that occurs during the period to determine whether the overhead has been overapplied or underapplied before making an adjusting entry.
Overapplied overhead is the result of the manufacturing overhead costs that are applied to the production process is more than the actual overhead cost that actually incurs during the accounting period.
On the other hand, the underapplied overhead is the result of the applied manufacturing overhead cost is less than the actual overhead cost that incurs during the accounting period.
Journal entry for overapplied overhead
The company can make the journal entry for overapplied overhead by debiting the manufacturing overhead account and crediting the cost of goods sold account at the period end adjusting entry.
| Account | Debit | Credit |
|---|---|---|
| Manufacturing overhead | 000 | |
| Cost of goods sold | 000 |
As the applied overhead is more than the actual overhead, the company needs to make an adjustment for variance between the applied overhead cost and the actual overhead cost by deducting the excess amount from the applied overhead. Likewise, it needs to debit the manufacturing overhead account as in the journal entry above.
After this journal entry, the balance in the manufacturing overhead account will be zero as it should be our goal to make it zero at the end of the accounting period. If it is not zero, it is probably not correct.
For example, based on estimation, we credit $10,000 into the manufacturing overhead account to assign the overhead cost to the work in process. However, the actual overhead cost which is debited to the manufacturing overhead account is only $9,500.
This means that without the adjustment, the manufacturing overhead account will have a credit balance of $500 at the end of the period. Hence, we need to make the journal entry for the overapplied overhead of $500 by debiting that amount into the manufacturing overhead account to zero it out.
If we look at the journal entry from the perspective of the cost of goods sold, we can view it as deducting the excess amount of cost from the cost of goods sold as the actual overhead cost that has occurred is less than the amount we have applied to the production during the period.
Journal entry for underapplied overhead
On the other hand, the company can make the journal entry for underapplied overhead by debiting the cost of goods sold account and crediting the manufacturing overhead account.
| Account | Debit | Credit |
|---|---|---|
| Cost of goods sold | 000 | |
| Manufacturing overhead | 000 |
This journal entry is the opposite of the overapplied overhead as the remaining balance of the manufacturing overhead, in this case, will be on the debit side at the end of the accounting period instead. Hence, we need to credit the manufacturing overhead account instead to zero it out.
Of course, we can also look at it from the perspective of cost of goods sold where we need to add more cost with the debit of the cost of goods sold as the applied overhead cost is less than the cost that actually occurs.
Overapplied overhead example
For example, on December 31, the company ABC which is a manufacturing company finds out that it has incurred the actual overhead cost of $9,500 during the accounting period. However, the manufacturing overhead costs that it has applied to the production based on the predetermined standard rate is $10,000 for the period.
In this case, the manufacturing overhead is overapplied by $500 ($10,000 – $9,500) as the applied overhead cost is $500 more than the actual overhead cost that have occurred during the period.
Likewise, at the period-end adjusting entry, the company ABC can make the journal entry for overapplied overhead by debiting the $500 into the manufacturing overhead account and crediting the same amount into the cost of goods sold account.
| Account | Debit | Credit |
|---|---|---|
| Manufacturing overhead | 500 | |
| Cost of goods sold | 500 |
This journal entry will remove the remaining balance of $500 in the manufacturing overhead account in order to reflect its actual cost of $9,500. Likewise, after this journal entry, the balance of manufacturing overhead will become zero.
Underapplied overhead example
For another example, assuming the actual overhead cost that has occurred during the period is $11,000 instead while the applied overhead cost is $10,000, the same as the above example.
In this case, the manufacturing overhead is underapplied by $1,000 ($11,000 – $10,000) as the applied overhead cost is $1,000 less than the actual overhead cost that has occurred during the accounting period.
Likewise, the company ABC can make the journal entry for underapplied overhead of $1,000 at the period end adjusting in order to zero it out as below:
| Account | Debit | Credit |
|---|---|---|
| Cost of goods sold | 1,000 | |
| Manufacturing overhead | 1,000 |