Problems of Overhead Application

Problems of Overhead Application - McGraw-Hill's Connect -...

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9/11/09 7:22 PM McGraw-Hill's Connect - Ebook Page 1 of 6 http://connect.mcgraw-hill.com/connect/hmEBook.do?setTab=sectionTabs Managerial Accounting EBook 13/e Content Chapter3: Systems Design: Job-Order Costing Problems of Overhead Application We need to consider two complications relating to overhead application: (1) underapplied and overapplied overhead; and (2) the disposition of any balance remaining in the Manufacturing Overhead account at the end of a period. Learning Objective 8 Compute underapplied or overapplied overhead cost and prepare the journal entry to close the balance in Manufacturing Overhead to the appropriate accounts. Underapplied and Overapplied Overhead Because the predetermined overhead rate is established before the period begins and is based entirely on estimated data, the overhead cost applied to Work in Process will generally differ from the amount of overhead cost actually incurred. In the case of Ruger Corporation , for example, the predetermined overhead rate of $6 per hour was used to apply $90,000 of overhead cost to Work in Process, whereas actual overhead costs for April proved to be $95,000 (see Exhibit 3-8 ). The difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is called either underapplied or overapplied overhead. For Ruger Corporation , overhead was underapplied by $5,000 because the applied cost ($90,000) was $5,000 less than the actual cost ($95,000). If the situation had been reversed and the company had applied $95,000 in overhead cost to Work in Process while incurring actual overhead costs of only $90,000, then the overhead would have been overapplied. What is the cause of underapplied or overapplied overhead? The causes can be complex, and a full explanation will have to wait for later chapters. Nevertheless, the basic problem is that the method of p. 109
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9/11/09 7:22 PM McGraw-Hill's Connect - Ebook Page 2 of 6 http://connect.mcgraw-hill.com/connect/hmEBook.do?setTab=sectionTabs applying overhead to jobs using a predetermined overhead rate assumes that actual overhead costs will be proportional to the actual amount of the allocation base incurred during the period. If, for example, the predetermined overhead rate is $6 per machine-hour, then it is assumed that actual overhead costs incurred will be $6 for every machine-hour that is actually worked. There are at least two reasons why this may not be true. First, much of the overhead often consists of fixed costs that do not change as the number of machine-hours incurred goes up or down. Second, spending on overhead items may or may not be under control. If individuals who are responsible for overhead costs do a good job, those costs
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Problems of Overhead Application - McGraw-Hill's Connect -...

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