What is Underapplied Overhead?

Underapplied overhead occurs when the overhead rate used to apply overhead to production jobs is too low. This means that the total overhead applied to the job is less than the total overhead incurred. This can occur if the overhead rate used is based on an estimate, and that estimate is too low. For example, let’s say that a company estimated their overhead rate to be 5%, but the actual overhead rate ended up being 8%. If this company applied 5% overhead to all of their jobs, then they would have underapplied overhead to each job.

What is Overapplied Overhead?

Overapplied overhead occurs when the overhead rate used to apply overhead to production jobs is too high. This means that the total overhead applied to the job is more than the total overhead incurred. This can occur if the overhead rate used is based on an estimate, and that estimate is too high. For example, let’s say that a company estimated their overhead rate to be 10%, but the actual overhead rate ended up being 8%. If this company applied 10% overhead to all of their jobs, then they would have overapplied overhead to each job.

What are the Implications of Underapplied and Overapplied Overhead?

The implications of underapplied or overapplied overhead depend on the magnitude of the difference between the estimated and the actual overhead rate. If the difference is minor, then the implications may not be significant. However, if the difference is significant, then the implications may be more severe. For example, if a company applied a 5% overhead rate to all of their jobs, but the actual overhead rate was 8%, then this would result in the company underapplying overhead to each job. This could result in the company not recovering all of the overhead costs incurred, and thus, the company’s profits would be lower than they otherwise would have been.

How Can Underapplied and Overapplied Overhead be Avoided?

Underapplied and overapplied overhead can be avoided by accurately estimating the overhead rate. This means that a company must have accurate information about their overhead costs and the amount of production that will be done. Additionally, it is important to periodically review the overhead rate to ensure that it is still accurate. If changes have occurred in the overhead costs or the amount of production, then the overhead rate may need to be adjusted.

How is Underapplied and Overapplied Overhead Handled?

Underapplied and overapplied overhead is typically handled by adjusting the income statement at the end of the accounting period. If there is underapplied overhead, then the amount of underapplied overhead will be added to the cost of goods sold. If there is overapplied overhead, then the amount of overapplied overhead will be deducted from the cost of goods sold. This will ensure that the cost of goods sold is accurate and that the company is not overstating or understating its profits.

Conclusion

In conclusion, underapplied or overapplied overhead is a common problem faced by many companies. It occurs when the overhead rate used to apply overhead to production jobs is either too high or too low. The implications of underapplied or overapplied overhead can be significant, so it is important for companies to accurately estimate their overhead rate and periodically review it to ensure that it is still accurate. Additionally, underapplied and overapplied overhead is typically handled by adjusting the income statement at the end of the accounting period.