allocating to finished goods

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


traditional and contribution format income statementsbalance sheet reconciliations examplespercentage of medicare taxaccounting matching principletop side adjusting journal entrywhat is the normal balance of salescalculating net income formulaaccounts payables journal entriesunearned revenue on income statementaccrual of interest expensejournal entry for return of capitalexplain fixed and variable costspaid salaries to employees journal entryexamples of product mixfob shipping point journal entryhow to record bank overdraft in accountingcalculate asset turnover ratiopayroll accounting entriesdepreciation expense calculationmanufacturing overhead formulaschedule of cost of goods manufacturedcompute the market price present value of the bondsunit costing methodclassified balance sheet examplesthe preparation of adjusting entries isaccounting for uncollectible accountsdiscount allowed journal entrymanufacturing overhead rate formulawhat are examples of fixed expensesaccrued wages payableis common stock a current liabilitydouble entry for provision for bad debtsjournal entry for income tax refund200 db depreciation tableadjustment journal entriesexpanded accounting equation calculatorincome statement cogsstraight line balance methodwhat is fifo method in accountingchange in accounts receivable formulaaccounts receivable is a debit or creditrepurchase of treasury stockaccounting lifodepreciation expenses definitioncalculating cost varianceaverage inventory cost formulabudgeting in managerial accountingperpetual method of inventorytotal variable manufacturing cost per unit formulaformula for unit contribution marginrevenue matching principlehow to compute asset turnover ratioordinary annuity present valuebuying returned merchandiseabsorbed overheadoperating profit to sales ratiosegmented income statementunearned income entrya trial balance lists accounts in which orderoutstanding chequesinterest calculation formula per dayaccounting treatment for disposal of fixed assetsjanitor uniformshow to calculate factory overhead ratesales return and allowancesin recording an accounting transaction in a double entry systemwhy is cost behavior analysis important to managementcash flow statement accumulated depreciationbad debts entryexpense matching principledefine relevant costexpanded accounting equation calculatoris accounts payable a credit or debitreversing accrued expensesstraight line depreciation calculation