Measuringandrecordingmanufacturingoverheadcost

Posted in: Job-order costing system

Manufacturing costs other than direct materials and direct labor are known as manufacturing overhead (also known as factory overhead). It usually consists of both
variable and fixed components. Examples of manufacturing overhead cost include indirect materials, indirect labor, depreciation, salary of production manager,
property taxes, fuel, electricity, grease used in machines, and insurance etc.
Unlike direct materials and direct labor, manufacturing overhead is an indirect cost that cannot be directly assigned to each individual job. This problem is solved by
using a rate that is computed at the beginning of each period. This rate is known as predetermined overhead rate.
Application of manufacturing overhead:
As stated earlier, the predetermined overhead rate is computed at the beginning of the period and is used to apply manufacturing overhead cost to jobs throughout
the period.
Manufacturing overhead cost is applied to jobs as follows:

Example:
Suppose the GX company has completed a job order. The time tickets show that the workers have worked for 27 hours to complete the job. The predetermined
overhead rate computed at the beginning of the year is $8 per direct labor hour. The manufacturing overhead cost would be applied to this job as follows:

= $8.00 27 DLH
= $216
The manufacturing overhead cost assigned to the job is recorded on the job cost sheet of that particular job.
Journal entry to record manufacturing overhead cost:
The manufacturing overhead cost applied to the job is debited to work in process account. The journal entry for the applied manufacturing overhead cost, computed
in the above example, would be made as follows:
Work in process
216
Manufacturing overhead
216
The reason of using a predetermined overhead rate rather than actual overhead costs:
Notice that the procedure of manufacturing overhead application described above is based on an estimated overhead rate (predetermined overhead rate). The
manufacturing overhead cost applied to the job is, therefore, not actual manufacturing overhead cost incurred by the job. The reason is that the total actual
manufacturing overhead costs are usually not known to managers before the end of the year. The application of manufacturing overhead based on a predetermined
overhead rate helps in computing cost of goods sold of a particular job before it is shipped to the customer.
The use of predetermined overhead rate to apply manufacturing overhead cost to products or job orders is known as normal cost system.
Overorunder-appliedmanufacturingoverhead
Posted in: Job-order costing system
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. 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.

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. 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.
The procedure of computing predetermined overhead rate and its use in applying manufacturing overhead has been described in measuring and recording
manufacturing overhead cost article.
Recording actual and applied overhead cost in manufacturing overhead account:
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. Actual overhead costs
are debited as they are incurred and applied overhead costs are credited as they are applied to work in process. At the end of a period, if manufacturing overhead
account shows a debit balance, it means the overhead is under-applied. On the other hand; if it shows a credit balance, it means the overhead is over-applied. For
further explanation of the concept, consider the following example:

1.
2.

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.
Disposition of over or under-applied manufacturing overhead:
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. These two methods have been discussed below:
Allocation among work in process, finished goods and 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. The following journal entry is made to dispose off an over or under-applied overhead:
When overhead is under-applied:
Work in process
xxxx
Finished goods
xxxx
Cost of goods sold
xxxx
Manufacturing overhead
xxxx
When overhead is over-applied:
Manufacturing overhead
xxxx
Work in process
xxxx
Finished goods
xxxx
Cost of goods sold
xxxx
This method is more accurate than second method. The only disadvantage of this method is that it is more time consuming.
Transferring the entire amount of over or under-applied to cost of goods sold:
Under this method the entire amount of over or under applied overhead is transferred to cost of goods sold. The following entry is made for this purpose:
When overhead is under-applied:
Cost of goods sold
xxxx
Manufacturing overhead
xxxx
When overhead is over-applied:
Manufacturing overhead
xxxx
Cost of goods sold
xxxx
This method is not as accurate as first method. Companies use this method because it is less time consuming and easy to use.
Example:
During the year 2012, Beta company started two jobs job A and job B . Job A consisted of 1000 units and job B consisted of 500 units. At the end of the year 2012, job A was completed
but job B was in process. The information about manufacturing overhead cost applied to job A and B was as follows:
Job A:
$
65,000
Job B:
35,000

Total
$
100,000

The actual manufacturing overhead cost incurred by the company during 2012 was $108,000. Out of 1,000 units in job A, 750 units had been sold before the end of 2012.
Required: Calculate over or under applied manufacturing overhead and make journal entries required to dispose off over or under applied manufacturing overhead assuming:
It is disposed off by allocating between inventory and cost of goods sold accounts.
It is disposed off by transferring to cost of goods sold.
Solution:
Calculation of over or under-applied manufacturing overhead:
Total manufacturing overhead applied to work in process
$
100,000
Total manufacturing overhead cost actually incurred
108,000

Under-applied manufacturing overhead

$
8,000

Journal entries to dispose off under-applied overhead:

Allocation among work in process finished goods, and cost of goods sold accounts:
Work in process
2,800
finished goods
1,300
cost of goods sold
3,900
Manufacturing overhead
8,000
Amount
Percentage
Work in process
$
35,000
35.00%
Finished goods ($65,000 250 units)/1,000 units
16250
16.25%
Cost of goods sold ($65,000 750 units)/1000 units
48750
48.75%

Total overhead applied

100,000
100%

Transfer of entire under-applied overhead to cost of goods sold account:

Cost of goods sold
8,000
Manufacturing overhead
8,000