Exercise 3-8 Underapplied and Overapplied Overhead [LO8]
Osborn Manufacturing uses a predetermined overhead rate of $18.20 per direct labor-hour. This predetermined rate was based on 12,000 estimated direct labor-hours and $218,400 of estimated total manufacturing overhead.
The company incurred actual…
The correct answer and explanation is:
To calculate underapplied or overapplied overhead, let’s analyze the given data step by step:
Step 1: Gather Key Information
- Predetermined Overhead Rate: $18.20 per direct labor-hour
- Estimated Direct Labor-Hours: 12,000 hours
- Estimated Total Manufacturing Overhead: $218,400
- Formula for Predetermined Overhead Rate: Predetermined Overhead Rate=Estimated Manufacturing OverheadEstimated Direct Labor-Hours\text{Predetermined Overhead Rate} = \frac{\text{Estimated Manufacturing Overhead}}{\text{Estimated Direct Labor-Hours}} Validation: 218,40012,000=18.20\frac{218,400}{12,000} = 18.20 (correct).
- Actual Direct Labor-Hours: Not specified here; you’ll need to use the value given in the complete exercise.
- Actual Manufacturing Overhead: Not provided; should be in the details.
Step 2: Calculate Applied Overhead
Applied Overhead=Predetermined Overhead Rate×Actual Direct Labor-Hours\text{Applied Overhead} = \text{Predetermined Overhead Rate} \times \text{Actual Direct Labor-Hours}
Step 3: Determine Overapplied or Underapplied Overhead
Overapplied/Underapplied Overhead=Applied Overhead−Actual Manufacturing Overhead\text{Overapplied/Underapplied Overhead} = \text{Applied Overhead} – \text{Actual Manufacturing Overhead}
Explanation
Overhead application in a manufacturing setting uses a predetermined overhead rate, calculated based on estimated data at the start of the period. This approach simplifies cost accounting during production. However, the difference between estimated and actual values results in overapplied or underapplied overhead.
Overapplied Overhead occurs when the applied overhead exceeds the actual overhead incurred. This implies the company estimated too high for its activity or incurred lower costs than expected. Underapplied Overhead, conversely, means the applied overhead is less than the actual overhead, indicating underestimation of activity levels or higher-than-expected costs.
To resolve this discrepancy, the company must adjust its financial records. The difference is typically closed to the Cost of Goods Manufactured or directly to Cost of Goods Sold (COGS). For instance:
- Overapplied overhead reduces COGS, increasing profitability.
- Underapplied overhead increases COGS, reducing profitability.
Accurate estimation ensures better cost control, pricing, and decision-making. Mismanagement can distort financial statements and lead to mispricing of products.
Let me know the actual values of direct labor-hours and manufacturing overhead to complete the calculation.