Question

"At the end of the year, all manufacturing overhead transactions are complete. There is no further opportunity for offsetting events to occur. At this point, Wallace Company eliminates any balance in Manufacturing Overhead by an adjusting entry. It considers under‐ or overapplied overhead to be an adjustment to cost of goods sold. Thus, Wallace debits underapplied overhead to Cost of Goods Sold. It credits overapplied overhead to Cost of Goods Sold.

After Wallace posts this entry, Manufacturing Overhead has a zero balance. In preparing an income statement for the year, Wallace reports cost of goods sold after adjusting it for either under‐ or overapplied overhead.

Conceptually, some argue that under‐ or overapplied overhead at the end of the year should be allocated among ending work in process, finished goods, and cost of goods sold. The discussion of this possible allocation approach is left to more advanced courses." If the over or underapplied overhead is material, explain why this allocation approach would be preferable.

Hey, I have trouble figuring this question out.

Answer 1

This allocation approach will be preferable if the over or the under applied overhead is material because of the fact that there are three different inventory accounts i.e. raw materials, work-in-progress and finished goods. While doing calculations for these accounts overhead is added during the calculation of work in progress. It means that overhead is applied to work-in-progress, finished goods and cost of goods sold.

Thus when a variance (over or under) is computed, that variance exists for each of these accounts and not just cost of goods sold. Thus in order to ensure that these accounts are accurate the variance in the form of over or the under applied overhead should be allocated among ending work in progress, finished goods and cost of goods sold.