Compute the manufacturing overhead rate and under- or overapplied overhead
Ikerd Company applies overhead to jobs on the basis of machine hours used. Overhead costs are expected to total
$300,000 for the year, and machine usage is estimated at 125,000 hours. For the year, $322,000 of overhead costs
are incurred and 130,000 hours are used.
Instructions
(a)
Compute the manufacturing overhead rate for the year.
(b)
What is the amount of under-or overapplied overhead at December 31?
(c )
Prepare the adjusting entry to assign the under- or overapplied overhead for the year to cost of goods sold.
NOTE: Enter a number in cells requesting a value; enter either a number or a formula in cells with a “?” .
After you have completed E2-5, consider the following additional question.
1.
Assume that the estimated total overhead for the year changed to $350,000. Determine
the impact on this change on the overhead rate, the amount of manufacturing overhead
over(under) applied. Revise the journal to dispose of over (under) applied overhead.
The Correct Answer and Explanation is:
(a) Compute the manufacturing overhead rate for the year
Overhead Rate=Estimated OverheadEstimated Machine Hours=300,000125,000=2.40 per machine hour\text{Overhead Rate} = \frac{\text{Estimated Overhead}}{\text{Estimated Machine Hours}} = \frac{300,000}{125,000} = \boxed{2.40 \text{ per machine hour}}
(b) Compute under- or overapplied overhead at December 31
Applied Overhead=130,000 hours×2.40=312,000\text{Applied Overhead} = 130,000 \text{ hours} \times 2.40 = 312,000 Actual Overhead Incurred=322,000\text{Actual Overhead Incurred} = 322,000 Underapplied Overhead=322,000−312,000=10,000 underapplied\text{Underapplied Overhead} = 322,000 – 312,000 = \boxed{10,000 \text{ underapplied}}
(c) Adjusting journal entry to assign underapplied overhead
Since overhead was underapplied, we increase Cost of Goods Sold (COGS):
Journal Entry:
Dr. Cost of Goods Sold 10,000
Cr. Manufacturing Overhead 10,000
(1) Impact of revised estimated overhead to $350,000
New Overhead Rate: 350,000125,000=2.80 per machine hour\frac{350,000}{125,000} = \boxed{2.80 \text{ per machine hour}}
Applied Overhead at New Rate: 130,000×2.80=364,000130,000 \times 2.80 = 364,000
Overapplied Overhead: 364,000−322,000=42,000 overapplied364,000 – 322,000 = \boxed{42,000 \text{ overapplied}}
Revised Journal Entry:
Because overhead is overapplied, we reduce COGS:
Dr. Manufacturing Overhead 42,000
Cr. Cost of Goods Sold 42,000
Explanation)
Manufacturing overhead includes indirect costs like maintenance, utilities, and depreciation related to production. Since these costs cannot be directly traced to specific jobs, companies allocate them using a predetermined overhead rate, often based on machine hours, labor hours, or units produced.
In this case, Ikerd Company uses machine hours to allocate overhead. Initially, the company estimated $300,000 in total overhead and 125,000 machine hours. This resulted in a rate of $2.40 per machine hour. When applied to the actual usage of 130,000 hours, the company applied $312,000 of overhead. However, actual overhead incurred was $322,000. The difference—$10,000—is considered underapplied, meaning not enough overhead was allocated compared to what was actually spent. This must be adjusted by increasing COGS, because costs were understated.
If estimates are revised mid-year (e.g., increasing expected overhead to $350,000), the new rate becomes $2.80 per hour. Applying this to actual usage results in $364,000 of applied overhead. Now, actual overhead is lower than applied, creating a $42,000 overapplied balance. This suggests the company charged too much overhead to production. To correct this, the adjustment reduces COGS, reflecting lower actual expenses.
Such adjustments ensure financial statements accurately reflect production costs. Regularly reviewing estimates helps maintain accurate costing and profitability analysis, especially in manufacturing environments with fluctuating overhead.
