If manufacturing overhead is under-applied, then:
a. actual overhead is greater than applied overhead.
b. estimated overhead is greater than actual overhead.
c. actual overhead is less than applied overhead.
d. applied overhead is less than budgeted overhead.
The correct answer and explanation is :
The correct answer is:
a. actual overhead is greater than applied overhead.
Explanation:
In manufacturing, overhead costs are the indirect costs associated with production, such as factory rent, utilities, and maintenance. These costs are not directly tied to a specific product but must be allocated to units produced. Companies estimate overhead costs at the beginning of the period and apply them based on a predetermined rate, often calculated using labor hours, machine hours, or another allocation base.
Understanding Under-Applied Overhead
When a company applies less overhead to products than the actual overhead incurred, it results in under-applied overhead. This means that the actual costs of production were higher than the company originally estimated.
Mathematically, this can be expressed as:
[
\text{Applied Overhead} < \text{Actual Overhead}
]
Since applied overhead is determined based on estimated rates, variations can occur due to:
- Higher actual expenses – Costs such as factory rent, utilities, or maintenance may exceed budgeted amounts.
- Lower production volume – If fewer units are produced than expected, overhead is spread over a smaller number of products, causing under-application.
Implications of Under-Applied Overhead
- Financial Statements – If under-applied, the company’s actual expenses are higher than reported, which could lower net income.
- Cost Adjustments – Businesses may need to adjust product pricing or re-evaluate overhead allocation methods.
- End-of-Year Adjustments – Companies adjust their accounts by transferring under-applied overhead to the cost of goods sold (COGS) to reflect true costs.
In contrast, over-applied overhead occurs when applied overhead exceeds actual overhead, meaning the company estimated costs too high.
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