Most
businesses overcome these variations and the waiting by using a predetermined
(or estimated) overhead rate. Applied overhead, which is the amount of
manufacturing overhead that’s assigned to the goods that are produced, is typically done by using a
predetermined rate. None of the manufacturing overhead items listed above can be
traced directly to a job. And these costs are not always encountered equally
throughout the year.

• Applied overhead is not considered appropriate in many decision-making situations.
• A manager would be more likely to keep selling the widget based on its profit before overhead application, and less likely to do so after the overhead application.
• He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
• To calculate indirect labor costs, all the expenses related
  to the salaries of these employees are added together.

If Creative Printers had used actual overhead, the company
would not have determined the costs of its July work until August. It is better to have a good estimate of costs when doing the work
instead of waiting a long time for only a slightly more accurate
number. Manufacturing companies hope the differences will not be significant at the end of the accounting period. Applied overhead is the amount of actual overhead that has been applied to goods produced.

Definition of Applied Overhead

The two amounts can then be compared afterward
which is known as Under- or Overapplied Manufacturing Overhead. When Manufacturing Overhead has a DEBIT balance, overhead is said
to be UNDERAPPLIED, meaning that the overhead applied to work in
process or to the certain job is LESS than the overhead incurred. On the contrary, when manufacturing overhead has a CREDIT balance,
overhead is OVERAPPLIED, meaning that the overhead assigned to work
in process or to the certain job is GREATER than the overhead
incurred. 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.

• Connie’s Candy used fewer direct labor hours and less variable overhead to produce 1,000 candy boxes (units).
• For example, the electric bill for July will probably not arrive until August.
• However, the variable standard cost per unit is the same per unit for each level of production, but the total variable costs will change.
• The company estimates these overheads based on a level activity of 1,000 units.
• At this stage, companies estimate that amount and allocate it to every job or project individually.

The overhead that has been applied to the jobs will either be too much or too little. The accounting for applied overheads may differ from one company to another. Usually, companies credit the factory overhead account for the amount that the company expects to absorb. 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.

Chapter 2: Job Order Cost System

Although those jobs are still in Work in Process or Finished Goods Inventory, companies usually adjust the Cost of Goods Sold account instead of each inventory account. Adjusting each inventory account for a small overhead adjustment is usually not a good use of managerial and accounting time and effort. All jobs appear in Cost of Goods Sold sooner or later, so companies simply adjust Cost of Goods Sold instead of the inventory accounts. In this case, two elements are contributing to the favorable outcome.

Determination and Evaluation of Overhead Variance

It is better to have a good estimate of costs when doing the work instead of waiting a long time for only a slightly more accurate number. •Predetermined rates make it possible
for companies to estimate job costs sooner. Using a predetermined
rate, companies can assign overhead costs to production when they
assign direct materials and direct labor costs. Without a
predetermined rate, companies do not know the costs of production
until the end of the month or even later when bills arrive. For
example, the electric bill for July will probably not arrive until
August.

How to record the journal entries for Actual and Applied Overheads?

However, applied overheads require estimations at the beginning of an accounting period. Over that period, companies will incur expenses that become a part of their overheads. 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. Kraken Boardsports had 6,240 direct labor hours for the year and assigns overhead to the various jobs at the rate of $33.50 per direct labor hour. So, in this example, you can see how applied overhead and actual overhead can differ and why it’s necessary to adjust for any variance at the end of the accounting period.

To calculate indirect labor costs, all the expenses related
to the salaries of these employees are added together. Looking at Connie’s Candies, the following table shows the variable overhead rate at each of the production capacity levels. These illustrations of the disposition of under- and overapplied overhead are typical, but not the only solution. A more theoretically correct approach would be to reduce cost of goods sold, work in process inventory, and finished goods inventory on a pro-rata basis. However, this approach is cumbersome and occasionally runs afoul of specific accounting rules discussed next.

If too much overhead has been applied to the jobs, we say that overhead is overapplied. If too little overhead has been applied to the jobs, we say that overhead is underapplied. I like to figure this out before I even calculate the dollar figure. Remember that applied overhead is what is in cost of goods sold right now. We need to adjust cost of goods sold to actual at the end of the year.

The predetermined rate, on the other hand, is constant
from month to month. 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. Using a predetermined overhead rate allows companies to accurately
and quickly estimate their job costs by assigning overhead costs immediately
along with direct materials and labor. Manufacturing overhead costs are indirect costs that cannot
be traced directly to the manufacturing of products, unlike direct material and
labor costs. Rather, the overhead costs are incurred for auxiliary goods and
services that support the manufacturing process, e.g. facility rent, utilities,
salaries of non-production staff, etc.

For example, the amount of corporate overhead applied to a subsidiary reduces its profits, even though the activities of the corporate headquarters staff do not assist the subsidiary in earning a higher profit. Similarly, the application of factory overhead to a product may obscure its actual cost for the purposes of establishing a short-term price for a specific customer order. Consequently, applied overhead may be stripped away from a cost object for the purposes of some types of decision making. Actual and applied overheads are a part of the accounting process for production companies.

5 Under- or Over-applied Overhead

Adding applied manufacturing overhead calculates the cost of goods manufactured to be $13,500 to complete the work on this project. Applied overhead, on the other hand, is the estimated amount of overhead costs that should be allocated to the production of goods or services, based on a certain allocation base. The allocation base could describe how credit cards affect the following: your personal budget be direct labor hours, machine hours, or any other measure that is deemed appropriate for the business. This applied overhead is calculated before the production process and is used to assign overhead costs to products during the production process. •Predetermined rates make it possible for companies to estimate job costs sooner.

In summary, actual overhead is the real, incurred overhead cost, while applied overhead is the estimated overhead cost allocated to the production of goods or services. In cost accounting, overhead refers to indirect costs that are incurred in the production of goods or services, but cannot be directly traced to a specific product or service. Applied overhead is not considered appropriate in many decision-making situations.