What adjustment is made for underapplied overhead on the schedule of cost of goods sold? What adjustment is made for overapplied overhead?
The Correct Answer and Explanation is :
In accounting, underapplied overhead and overapplied overhead refer to situations where the actual overhead costs differ from the applied overhead costs based on a predetermined rate. Adjustments are made on the Schedule of Cost of Goods Sold (COGS) to account for these discrepancies.
Adjustment for Underapplied Overhead:
When overhead is underapplied, it means that the company applied less overhead to the products than it actually incurred. This occurs when the actual overhead costs exceed the applied overhead, and the company needs to recognize the additional cost. To adjust for underapplied overhead, the company will increase the Cost of Goods Sold (COGS) by the amount of the underapplied overhead.
For example, if the actual overhead was $10,000, but the applied overhead was $8,000, the underapplied overhead is $2,000. The journal entry would increase the COGS by $2,000, reflecting the additional costs that were not originally included.
Adjustment for Overapplied Overhead:
When overhead is overapplied, it means that the company applied more overhead than it actually incurred. This occurs when the applied overhead exceeds the actual overhead costs. To adjust for overapplied overhead, the company will decrease the Cost of Goods Sold (COGS) by the amount of the overapplied overhead.
For instance, if the actual overhead was $8,000, but the applied overhead was $10,000, the overapplied overhead is $2,000. The company would reduce the COGS by $2,000, reflecting the fact that they allocated more overhead to products than was actually necessary.
Importance of Adjusting for Underapplied and Overapplied Overhead:
The purpose of adjusting for underapplied or overapplied overhead is to ensure that the financial statements reflect the true cost of goods sold. If these adjustments were not made, the cost of goods sold could be misstated, leading to inaccurate profitability and potentially misleading financial reporting. Properly adjusting these figures allows for more accurate financial analysis and decision-making.