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

aging account receivablejournal entry for reserve for bad debtscontra asset examplehow to find retained earningbank reconciliation statement overdraftstandard overhead ratecalculate contributed capitalcost recovery method journal entriesjournal entry for payroll taxeshow much is ss and medicare taxprepaid explifo perpetual inventory methodmerchandising formulapurpose of retained earnings statementhow to solve weighted average problemspremium bonds repaymentrights of common stockholderspv lump sum tablewhat is the double declining balance methodresidual value depreciationcalculating fifomeaning of prepaid expensesformula for average fixed costweighted average costinghow to compute sales revenuedifference between perpetual and periodiccollected accounts receivablelifo costaccrual adjusting entrieswhen to depreciate an assetfica taxes calculatoraging of accounts receivabletreatment of prepaid expensescontribution margin at the break-even pointdefinition of variable expenseaccounting closing entries processhow to calculate cost of merchandise soldpv annuity factor tabless wage base 2014how to find the cost of goods manufacturedtax provision accounting entriesinventory costing methodnotes payable journal entrytraditional absorption costing examplefixed cost and variable cost examples for manufacturingactivity based depreciation formulatabel present value annuitydividends declared income statementinterest receivable journal entryincome statement approach to estimating uncollectiblesaccounts receivable balance sheet examplelifo fifo accountingreturn on investment measureshow to make post closing trial balanceaccounting inventory systemscalculate variable expensesexamples of merchandising businessescost of goods purchased equationfederal withheld tax percentagecogs formula income statementunearned service revenue still unearned journal entrysocial security tax withholding tablesample chart of accounts for llcmerchandise inventory adjusting entrywhat is straight line method of calculating depreciationfixed and variable expenses definitionannual straight line depreciation formulawhat is the correct sequence for closing the temporary accountscalculate tax deductions paycheckstraight line depreciation calculation formulathe direct write off method of accounting for bad debtst accounts journal entrieshow to calculate variable cost per unit