allocating to work-in-progress

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

cost of goods sold merchandisingmanagerial accounting and decision makingdirect and absorption costingreceived cash on account journal entrysimple interest loan payment formulacorrecting entries accountingaccounting entries for sale of businessunearned income balance sheetadministrative overheadsannuity to present valueaccounts journal entries basicswhat does y mx b stand fornotes receivable journal entryactual manufacturing overhead costspv ordinary annuity calculatorcalculating tax deductions from paycheckmanufacturing overhead is applied to each jobcost of good sold equationunearned revenue debit or creditover and under applied overheadwhat is the purpose of the retained earnings statementreclass journal entries examplecontra equity account exampleswithholding tax journal entryfinancial accounting journalsaccounting entry for unearned revenuevariable costing vs full costingcalculating pv factorhow to calculate costs of goods manufactureddebit and credit accounts examplescost of finished goods available for sale formuladirectwriteallowance method of accounting for uncollectible receivablesprepare a correct bank reconciliationfifo and lifo accountingaccrued revenue examplesadjusting trial balance examplemanufacturing variancesaverages calculatorhow to calculate declining balance methodcalculating depreciation straight line methodnet pay calculator with overtimeplastic mug manufacturing processcalculate fifowhat is the purpose of the adjusted trial balanceadvantages and disadvantages of separate legal entity2014 ss wage baseordinary annuity examplediminishing balance depreciation methodwhat is weighted average contribution marginwhat does liquidate stock meanhow do you calculate federal withholding from a paycheckstate withholding tax ratesunearned service revenue debit or creditpresent value of an ordinary annuitybond amortization schedule exampledepreciation journal entry examplerevenue and expense accounts are considered temporary accounts because theyhow to calculate total variable costaccelerated method of depreciationmanagerial accounting reports examplesthe difference between periodic and perpetual inventory systemsvariable costing unit product costfixed assets debit or creditincome statement merchandising companyjournal entry for allowance for doubtful accountsinventory valuation examplesreversing entriesdouble declining balance depreciation calculatorpreparing closing entrieswhat goes on a trial balanceaccounting cycle journal entriesexample of fifo methodsample chart of accounts for llcwhy are closing entries preparedestimating ending inventorydouble declining balance exampleformula total variable cost