Question

Could a manager increase the company's operating income by allocating over-or underapplied overhead allocation to work in process, finished goods and cost of goods sold?

Answer 1

Yes, manager can increase the company's operating income.

This can be done in two ways ............

(1) In the case of Under-applied overhead - allocating the underapplied overhead to work in process, finished goods and cost of goods sold.

(2) In the case of over - applied overhead - allocating total over-applied overhead directly to cost of goods sold.

Under applied overhead is a situation where lower amount of overhead is charged to production. If such under - recovery is charged directly to cost of goods sold, it will increase the expenses account and operating income decreases. Hence management may prefer to allocate such under-applied overhead to all the three accounts i.e WIP, FG and COGS. This will decrease the cost allocated to COGS and lower expenses leads to increase.

In the case of over-applied, there is already higher overhead charged into production. Management prefers to reduce it directly from cost of goods sold, so that expenses account decreases and income increases.