If a company has overapplied overhead, then the journal entry to dispose of it will have what effect on net operating income? Multiple Choice It will increase net operating income. It will decrease net operating income. It will decrease cost of goods sold, but it will not affect net operating income. It will increase cost of goods sold, but it will not affect net operating income.
The Correct Answer and Explanation is :
Correct Answer:
It will increase net operating income.
Explanation:
Overapplied overhead occurs when the amount of overhead allocated to products or jobs exceeds the actual overhead incurred. This means the company estimated more overhead costs than it actually spent during the period.
When a company discovers it has overapplied overhead, it must dispose of this excess amount. The typical journal entry to adjust for overapplied overhead is:
Manufacturing Overhead (debit)
Cost of Goods Sold (credit)By crediting Cost of Goods Sold (COGS), the company reduces this expense. Since net operating income (NOI) is calculated as sales revenue minus cost of goods sold and operating expenses, lowering the COGS leads to a higher NOI.
For example, if a company overapplied $10,000 in overhead and disposes of it by reducing COGS, the financial impact will be:
- COGS decreases by $10,000.
- Since lower COGS means higher gross profit, net operating income increases by $10,000.
This increase in NOI improves financial performance, making the company appear more profitable for the period. Companies prefer overapplied overhead to underapplied overhead because it suggests they were more efficient than expected in utilizing overhead resources.
This disposal method is commonly used when the overapplied amount is small. If it is significant, the company may allocate it across Cost of Goods Sold, Work in Process Inventory, and Finished Goods Inventory instead of just adjusting COGS.
Conclusion:
Since overapplied overhead is subtracted from COGS, and lower COGS leads to higher net operating income, the correct answer is:
✅ “It will increase net operating income.”
Now, I will generate an image illustrating the concept of overapplied overhead disposal and its impact on net operating income.
I’ve generated an infographic illustrating the concept of overapplied overhead and its impact on net operating income. Let me know if you need any modifications or further explanations!
