Question

Provide two reasons in detail why overhead might be underapplied in a given year.

Answer 1

Solution

Reasons for underapplied overhead cost:

Underapplied overhead cost –

Underapplied overhead cost refers to the difference between the actual manufacturing overhead cost incurred and the manufacturing overhead cost applied based on a predetermined rate during a period. When the manufacturing overhead cost applied to work in process less than the actual manufacturing overhead cost incurred, the difference is termed as underapplied overhead cost.

Applied overhead < actual overhead

Reasons –

1. Use of inaccurate overhead predetermined rate in computing applied overhead, resulting from forecasting errors, relating to budgeted manufacturing cost and budgeted information about cost drivers such as direct labor hours or machine hours. Such errors would provide inaccurate predetermined overhead rate and subsequent under applied or over applied overhead.
2. Furthermore, the adjustments of under or over applied overhead to cost of goods sold on a monthly basis would cause discrepancies in the applied overhead for a period. Hence, the suggested approach would be to make adjustments for over or underapplied overhead should be typically made at the end of year.

3. Another reason could be failure in monitoring the computations, allocations and assignment of overhead.