When overhead is overapplied or underapplied, there are two different ways to allocated the variance. In the previous post, we allocated all of the variance to cost of goods sold. However, that is not a very accurate way to allocate the variance.

Think back to the calculation of cost of goods sold in our discussion of inventory. There are three different inventory accounts: Raw materials, work-in-progress, and finished goods. If you think back to the calculations for these accounts, overhead was added during the calculation of work-in-progress.

That means that overhead is applied to work-in-progress, finished goods, and cost of goods sold. When the variance is calculated, that variance exists in each of these accounts, not just cost of goods sold. Therefore, in order to make sure that each of these accounts is accurate, the variance should be allocated to each of these accounts.

In order to do this, we need to look at what percentage of the applied overhead is in each of the accounts and allocate the variance based on those percentages.

Let’s look at an example.

Example #1

K’s Kustom Furniture has applied overhead of $1,300,000. The $1,300,000 is allocated to the following accounts:

Work-in-progress $200,000
Finished goods $150,000
Cost of goods sold $950,000

The balances in the accounts are as follows:

Work-in-progress $675,000
Finished goods $525,000
Cost of goods sold $3,500,000

Actual overhead is $1,450,000

Calculate the amount of the overhead variance and allocate the variance to work-in-progress, finished goods, and cost of goods sold.

We have $1,300,000 in applied overhead currently sitting in the three accounts. We need to determine what percentage of the applied overhead is in each of the accounts. Divide the applied overhead balance in each account by the total amount of applied overhead.

Work-in-progress $200,000 / $1,300,000 = 15.38%
Finished goods $150,000 / $1,300,000 = 11.54%
Cost of goods sold $950,000 / $1,300,000 = 73.08%

Now calculate the variance. We know that overhead is underapplied because the applied overhead is lower than the actual overhead. Not enough overhead has been applied to the accounts. The variance is:

$1,300,000 – $1,450,000 = $150,000 underapplied.

Multiply the $150,000 by each of the percentages.

Work-in-progress $200,000 / $1,300,000 = 15.38% X $150,000 = $23,070 underapplied in work-in-progress
Finished goods $150,000 / $1,300,000 = 11.54% X $150,000 = $17,310 underapplied in finished goods
Cost of goods sold $950,000 / $1,300,000 = 73.08% X $150,000 = $109,620 underapplied in cost of goods sold

We know how much overhead has been underapplied in each account, so we now must adjust each of the account. When overhead is underapplied, there is not enough overhead in each of the accounts. We must add the variance to each of the account balances. Add the variance to the total amount in each account.

Work-in-progress $675,000 + $23,070 variance = $698,070 adjusted Work-in-progress
Finished goods $525,000 + $17,310 variance = $542,310 adjusted Finished goods
Cost of goods sold $3,500,000 + $109,620 = $3,609,620 adjusted Cost of goods sold

Final Thoughts

When allocating the overhead variance among multiple accounts, look at the amount of applied overhead in each of the accounts: work-in-progress, finished goods, and cost of goods sold. Calculate the percentage of total applied overhead in each of the accounts. Then use that percentage to calculate the amount of the variance that should be allocated to each account. If the overhead is underapplied, add the amount of variance to each of the accounts. If the overhead is overapplied, add the amount of variance to each of the accounts.

Related Videos

Allocating overhead using a predetermined overhead rate

Share This:


Related pages


lifo and fifo methodsdepreciation journal entry exampletwo categories of adjusting entriessemi annual annuity formulaprice taker and price makerunearned revenues areoverhead calculation formulajournalizing notes payablecontra account journal entryhow to calculate variable costingtotal asset turnover calculationformula for contribution marginwrite off of accounts receivablemanagement accounting variancesassembly line workers wages are period costshow to calculate direct materials costbudgeting in managerial accountingmoh costjournal entry for prepaid rentaccount receivable aginglifo accounting methodjournal entry accrued interesthow to calculate total fixed cost formulavariable cost examples in manufacturingprepare a correct bank reconciliationbad debt expense journal entriespresent value of ordinary annuitygross margin absorption costingaccountant pay per hourcogs journal entrydouble declining balance method formulahow to calculate income tax payable on balance sheethow to calculate machine depreciationjournal entry for prepaid incomevariances in budgetscredit sales balance sheetcalculate variable cost per unitcalculating sales tax ratenet paye calculatora post closing trial balance will showusing accrual accounting revenue is recorded and reported onlyperpetual formulaactual manufacturing overhead ratefactory overhead variancewhat accounts appear on the post closing trial balanceaccrued expense journal entrywriting off accounts receivableexample of an accelerated depreciation methodinventory turnover calculator onlinedeclining balance depreciation calculatorschedule of costs of goods manufacturedformat of marginal costingdeferred revenue journal entriesmanufacturing overhead cost calculationfifo calculatorinterest accrual journal entryprepaid income journal entrypurchase returns and allowancesbad debt and doubtful debthow to calculate direct materials costformula for manufacturing overheadaccounts payable would appear on which financial statementexample indirect cash flow statementunpaid salaries adjusting entrysalaries and wages payable on balance sheetdouble entry records for depreciationjob order costing system exampleshow much is a premium bond worthis manufacturing overhead a fixed costunder absorption costingan important purpose of closing entries is toperiodic and perpetual inventory definition