The journal entry to dispose of a small amount of overapplied or underapplied overhead, if overhead is applied based on direct labor hours, would be charged to: Multiple Choice Cost of Goods Sold. Materials Inventory. Work-in-Process Inventory. Finished Goods Inventory. Factory Overhead Control.
The Correct Answer and Explanation is:
The correct answer is Cost of Goods Sold.
When overhead is applied based on direct labor hours, it is common for companies to either overapply or underapply the overhead costs. Overapplied overhead occurs when the applied overhead exceeds the actual overhead incurred, while underapplied overhead happens when the applied overhead is less than the actual overhead.
At the end of the period, if there is a small amount of overapplied or underapplied overhead, companies typically dispose of this variance by making an adjusting journal entry. The common practice is to charge this variance to the Cost of Goods Sold (COGS) account. This is because COGS represents the total cost of goods that have been sold during the period, and the slight discrepancy in overhead application is typically considered a minor fluctuation that doesn’t require adjustments to inventory accounts.
Explanation:
- Overapplied or Underapplied Overhead:
- Overapplied overhead occurs when more overhead is applied than was actually incurred during production. It reflects an excess amount of applied costs.
- Underapplied overhead occurs when the applied overhead is less than what was actually incurred, resulting in a shortfall.
- Why Charge to Cost of Goods Sold (COGS):
The reason the variance is typically disposed of in the COGS account is that it affects the profitability of the period. Since overhead is applied to the cost of production, any adjustments in the overhead amounts should ultimately affect the expense associated with the goods sold. A minor fluctuation in overhead can be directly charged to COGS without distorting the accuracy of the balance in Work-in-Process or Finished Goods inventories. - Other Accounts:
- Materials Inventory, Work-in-Process Inventory, Finished Goods Inventory: These accounts are more appropriate for the allocation of costs related to production, labor, and materials. Adjustments for overhead would typically be made to these accounts during the normal course of production, but for small variances, COGS is more appropriate.
- Factory Overhead Control: This account is used for recording actual overhead expenses and applied overhead amounts. Once the variance is determined, it is transferred out, typically to COGS for minor adjustments.
Therefore, Cost of Goods Sold is the best option for disposing of a small amount of overapplied or underapplied overhead.
