Question

HOW WOULD I RESPOND TO THESE?

- The predetermined overhead rate is based on the relationship between estimated annual overhead costs and estimated annual operating activity, expressed in terms of a common activity base. The company may state the activity in terms of direct labor costs, direct labor hours, machine hours, or any other measure that provides an equitable basis for applying overhead costs to jobs. Companies establish the predetermined overhead rate at the beginning of the year. The formula of the predetermined overhead rate is estimated annual overhead costs divided by estimated annual operating activity. Using an estimated predetermined overhead rate enables a cost to be determined for the job immediately and identifies when actual costs may be different than planned. The use of a predetermined overhead rate enables the company to determine the approximate total cost of each job when it completes the job. Once the formula mentioned above is computed it shows you for every dollar of direct labor, machine hours, etc. how much of manufacturing overhead will be assigned to each job.

- Underapplied manufacturing overhead is when applied overhead is less than the actual overhead, were as overapplied manufacturing overhead is when applied overhead is greater than the actual overhead. Overapplied overhead means that the overhead applied to work in process (WIP) is greater than the overhead incurred. When it comes to manufacturing overhead you have your actual (costs incurred) and your applied (costs assigned).  When manufacturing overhead has a debit balance, overhead is underapplied. If there is a credit balance, overhead is overapplied. For example, you may have WIP, finished goods, and cost of goods sold reflecting in the debit column of your balance sheet while manufacturing overhead has a credit. This is overhead being underapplied. For overapplied you may have manufacturing overhead with debit and WIP, finished goods, and cost of goods sold with credits.

Answer 1

The allocation of overhead to various jobs can be done using traditional method or activity-based costing method. In traditional method allocation of manufacturing overhead applied is done on the basis of single allocation base. Whereas in case of activity-based costing method different cost pools are developed for the overhead allocation.

In the traditional method, the predetermined overhead is calculated to determine manufacturing overhead applied. Predetermined overhead rate is always calculated using budgeted values and not actual values incurred. It is calculated by dividing estimated manufacturing overhead costs by estimated allocation base. This allocation base may direct labor hours, direct labor cost, machine hours, etc.

The overhead applied calculated may be higher than or lower than actual manufacturing overhead

In case, overhead applied > actual overhead, it is termed as overapplied overhead.

In case, overhead applied < actual overhead, it is termed as underapplied overhead.

This underapplied or overapplied overhead is transferred to only cost of goods sold, if the difference is immaterial. However, if the difference is material, it is transferred to working in process inventory, finished inventory and cost of goods sold according to the pro-rata basis. In case of underapplied overhead, manufacturing overhead account is credited and vice versa in case of overapplied overhead.