Over-applied Overhead

Definition

Over-applied overhead refers to a situation where the actual overhead costs incurred by a business exceed the predetermined overhead rate used to allocate overhead to production. This results in a surplus or credit balance in the overhead control account, indicating that more overhead was applied to production than was actually incurred.

5 Must Know Facts For Your Next Test

1. Over-applied overhead can occur when the actual level of production activity is higher than the estimated level used to calculate the predetermined overhead rate.
2. The surplus or credit balance in the overhead control account due to over-applied overhead is typically closed out at the end of the accounting period by reducing the cost of goods sold.
3. Over-applied overhead can also happen when the predetermined overhead rate is set too high, resulting in more overhead being applied to production than is actually incurred.
4. In a job order cost system, over-applied overhead is allocated to the cost of goods sold, work in process, and finished goods inventory accounts.
5. In a nonmanufacturing environment, such as a service-based business, over-applied overhead may be allocated to the appropriate revenue or expense accounts.

Review Questions

• Explain how over-applied overhead is calculated and its impact on the overhead control account.
  • Over-applied overhead is calculated as the difference between the actual overhead costs incurred and the overhead applied to production using the predetermined overhead rate. This difference results in a credit balance in the overhead control account, indicating that more overhead was applied to production than was actually incurred. The surplus or credit balance in the overhead control account is typically closed out at the end of the accounting period by reducing the cost of goods sold.
• Describe how over-applied overhead is treated in a job order cost system.
  • In a job order cost system, the over-applied overhead is allocated to the cost of goods sold, work in process, and finished goods inventory accounts. This means that the surplus or credit balance in the overhead control account is distributed across these accounts, effectively reducing the cost of goods sold and increasing the value of the work in process and finished goods inventory accounts.
• Analyze the implications of over-applied overhead in a nonmanufacturing environment, such as a service-based business.
  • In a nonmanufacturing environment, such as a service-based business, over-applied overhead may be allocated to the appropriate revenue or expense accounts, rather than to inventory accounts. This can impact the reported profitability of the business, as the surplus or credit balance in the overhead control account is used to reduce expenses or increase revenue, depending on the specific accounting practices and the nature of the business. Managers must carefully monitor the over-applied overhead and make adjustments to the predetermined overhead rate to ensure accurate financial reporting and decision-making.

Related terms

Predetermined Overhead Rate: The predetermined overhead rate is an estimated rate used to apply overhead costs to production, calculated by dividing the estimated total overhead costs by the estimated activity base (such as direct labor hours or machine hours).

Overhead Control Account: The overhead control account is a general ledger account that records the actual overhead costs incurred and the overhead applied to production based on the predetermined overhead rate.

Underapplied Overhead: Underapplied overhead occurs when the actual overhead costs incurred are greater than the overhead applied to production using the predetermined overhead rate, resulting in a debit balance in the overhead control account.