Question

There are two methods for disposing of overapplied and underapplied overhead. What are they? Why would a company use one method over another? What effect does overapplied overhead have on Cost of goods sold (increase/decrease)? What about underapplied overhead?

Answer 1

1) There are two method to close over-applied or under-applied overhead :

a)Close to cost of goods sold

b)Allocate to work in process inventory , finished goods inventory and cost of goods sold

2)

When the amount of under-applied /over-applied overhead is not significant or is negligible ,then same should be directly closed to cost of goods sold .However this method does not provide accurate results .

Since overhead is applied to work in process inventory ,finished goods inventory and inventory that is sold ,therefore amount of under-applied /over-applied overhead should not be directly closed to cost of goods sold rather should be proportionately closed to all of these accounts based on their closing balance or some other criteria.Thus this method provides accurate results .

3)

Over-applied overhead means Applied overhead is greater than Actual overhead thus it means charging of extra cost to inventory .Therefore in order to reduce the same ,cost of goods sold is credited (as normal balance of expense is Debit).

And credit of cost of goods sold means decrease of same .

Under-applied overhead means Applied overhead is less than Actual overhead thus it means charging of less cost to inventory .Therefore in order to increase the same ,cost of goods sold is Debited (as normal balance of expense is Debit).

And Debit of cost of goods sold means Increase of same .