What is Overhead Under Absorption and Over Absorption?
When a company uses standard costing, it derives a standard amount of overhead cost that should be incurred in an accounting period, and applies it to cost objects [usually produced goods]. If the actual amount of overhead turns out to be different from the standard amount of overhead, then the overhead is said to be either under absorbed or over absorbed. If overhead is under absorbed, this means that more actual overhead costs were incurred than expected, with the difference being charged to expense as incurred. This usually means that the recognition of expense is accelerated into the current period, so that the amount of profit recognized declines.
If overhead is over absorbed, this means that fewer actual overhead costs were incurred than expected, so that more cost is applied to cost objects than were actually incurred. This means that the recognition of expense is reduced in the current period, which increases profits. For example, if the overhead rate is predetermined to be $20 per direct labor hour consumed, but the actual amount should have been $18 per hour, then the $2 difference is considered to be over absorbed overhead.
Reasons for Overhead Under Absorption and Over Absorption
There can be several reasons for overhead under absorption or over absorption, including the following:
The amount of overhead incurred is not the same as the amount expected.
The basis upon which overhead is applied is in an amount different than expected. For example, if there is $100,000 of standard overhead to be applied and 2,000 hours of direct labor expected to be incurred in the period, then the overhead application rate is set at $50 per hour. However, if the number of hours actually incurred is only 1,900 hours, then the $5,000 of overhead associated with the missing 100 hours will not be applied.
There may be seasonal differences in the amount of overhead actually incurred or in the basis of application, versus a standard rate that is based on a longer-term average.
The basis of allocation may be incorrect, perhaps due to a data entry or calculation error.
How to Deal with Overhead Under Absorption or Over Absorption
When under or over absorption is encountered, it is normally dealt with in one of two ways. Either the difference [either positive or negative] is charged to the cost of goods sold at once, or the difference [either positive or negative] is applied to the relevant cost objects. The first approach is easier to accomplish, but less precise. Consequently, an immediate write-off is usually limited to smaller variances, while the latter method is used for larger variances.
The entire issue of overhead absorption can be reduced by using just-in-time systems to reduce the amount of inventory on hand at the end of an accounting period. By doing so, a case can be made to charge all overhead costs to expense as incurred.
Nonmanufacturing cost
administrative cost advertising cost also known as period cost.
The direct materials required to manufacture each unit of product are listed on a ________.
bill of materials
In the cost formula [Y = a + bX] that is used to estimate the total manufacturing overhead cost for a given period, the letter “a” refers to the estimated ________.
total fixed manufacturing overhead cost
predetermined overhead rate =
Estimated total manufacturing overhead cost / estimated total amount of the allocation base.
Predetermined overhead rates
- Depreciation - Utilities - Indirect labor. - Indirect materials.
Allocation base
-Direct labor - hours - Direct labor cost - machine hours - Units of product. - manufacturing overhead cost.
Predetermined overhead rates 4 steps :
Step 1: Estimate the total amount of the allocation base [the denominator] Step 2: Estimate the total fixed manufacturing overhead cost for the coming period and the variable manufacturing overhead cost per unit of the allocation base. Step 3: Use the cost formula [Y = a + bX] to estimate the total manufacturing overhead cost for the coming period. [the numerator] Step 4: Compute the predetermined overhead rate by diving the numerator by the monitor.
[Y = a + bX]
Y = estimated total manufacturing overhead cost. a = estimated total fixed manufacturing overhead cost. b = estimated Variable manufacturing overhead cost per unit of allocation base. X= Estimated Total amount of allocation base.
The management of Blue Ocean Company estimates that 50,000 machine-hours will be required to support the production planned for the year. It also estimates $300,000 of total fixed manufacturing overhead cost for the coming year and $4 of variable manufacturing overhead cost per machine-hour. What is the predetermined overhead rate?
$10.00 per machine hour. [Y = a + bX] a= $300,000 b= $4 X = 50,000 Y= 300,000 + 4[50,000] = 500,000 Estimated total manufacturing overhead cost / estimated total amount of the allocation base. 500,000 / 50,000 = 10
Spartan Corporation estimates that it will incur $200,000 of total manufacturing overhead cost at an estimated activity level of 10,000 direct labor-hours. What is the amount of manufacturing overhead that would be applied to a job that required 200 direct labor-hours?
$4,000 Predetermined overhead rate = $200,000 ÷ 10,000 DLHs = $20 per DLH For 200 DLHs, the manufacturing overhead that would be applied is = $20 per DLH × 200 DLHs = $4,000
Overhead applied to a particular job =
Predetermined Overhead Rate X Amount of the allocation base incurred by the job.
Overhead cost applied to jobs =
predetermined overhead rate X actual amount of the allocation base incurred by the jobs
A normal cost system applies overhead to jobs ________.
by multiplying a predetermined overhead rate by the actual amount of the allocation base incurred by the job
Wilson Products uses a plantwide predetermined overhead rate of $10 per direct labor-hour. Direct material and direct labor associated with Job X23 are $4,000 and $1,200 respectively. If Job X23 used 100 direct labor-hours, what is the total cost assigned to this job?
$6,200 Total cost associated with the job = Direct material + Direct labor + Manufacturing overhead applied Total cost associated with the job = $4,000 + $1,200 + [$10 × 100 DLHs] = $6,200
Wilson Products uses a plantwide predetermined overhead rate of $10 per direct labor-hour. Direct material and direct labor associated with Job X23 are $4,000 and $1,200 respectively. If Job X23 used 100 direct labor-hours to produce 50 audio controllers, what is this job’s unit product cost [per audio controller]?
$124 total cost assigned / units = unit product cost [per audio controller]. 6,200 / 50 = 124
Companies can improve job cost accuracy by using ________.
multiple predetermined overhead rates
What is the estimated total manufacturing overhead in the Assembly Department? Assembly Packaging Direct labor-hours 5,200 62,000 Machine-hours 68,400 11,900 Total fixed manufacturing overhead cost $ 390,000 $ 419,000 Variable manufacturing overhead per DLH $ 3.75 Variable manufacturing overhead per MH $ 3.00
$595,200 Estimated total manufacturing overhead = $390,000 + [$3.00 per DLH × 68,400 MHs] = $595,200
What is the predetermined overhead rate for the Packing Department? Assembly Packaging Direct labor-hours 5,200 62,000 Machine-hours 68,400 11,900 Total fixed manufacturing overhead cost $ 390,000 $ 419,000 Variable manufacturing overhead per DLH $ 3.75 Variable manufacturing overhead per MH $ 3.00
$10.51 per DLH Predetermined overhead rate = $651,500 ÷ 62,000 DLHs = $10.51 per DLH
What is the term used when a company applies less overhead to production than it actually incurs?
Underapplied
The adjustment for overapplied overhead ________.
decreases cost of goods sold and increases net operating income.
When all of a company’s job cost sheets are viewed collectively they form what is known as a ________.
subsidiary ledger
Underapplied or overapplied overhead is the:
difference between overhead applied to work in process and actual overhead.
The adjustment for underapplied overhead :
increases cost of goods sold and decreases net income
Costs assigned to units of product under absorption costing include:
- fixed manufacturing - variable manufacturing
Companies that make many different products each period use ____ - _____ costing.
job order
True or false: Job-order costing can only be used in manfucaturing firms.
false
A measure such as direct labor-hours or machine hours used to assign overhead costs to products and services is called a cost driver or a[n] _______ ________.
allocation base.
Which of the following would not be a good allocation base for manufacturing overhead? - Direct labor hours -Machine hours - Units of product - Accounting hours
accounting hours.
To calculate a predetermined overhead rate, divide estimated manufacturing overhead by:
estimated allocation base.
The predetermined overhead rate is calculated:
before the period begins.
Overhead application is the process of:
assigning manufacturing overhead to jobs.
In the formula y=a+bX, b represents the estimated:
variable manufacturing overhead cost per unit.
The formula for applying overhead to a specific job is:
Predetermined overhead rate x Amount of allocation base incurred by job.
900.
450,000 / 150,000 = $3.00 per direct labor hour x 300 = $900.
True or false: One reason to use a predetermined overhead rate is to eliminate the effect of seasonal factors.
True
The total cost of a job is calculated by adding the total of direct labor cost, direct materials cost and
applied manufacturing overhead cost.
The process used to assign overhead costs to products is called overhead ______.
application [overhead allocation]
The predetermiend overhead rate is multipled by the actual allocation base incurred by a job to find :
overhead applied to the job.
$4000
Explanation:
The predetermined overhead rate = $100,000/5,000 direct labor hours = $20 per direct labor hour. The overhead applied to the job = $20 per direct labor hours x 200 direct labor hours = $4000
Estimated manufacturing overhead = 450,000
Estimated direct labor hours = 150,000
Actual manufacturing overhead = $405,000
Actual direct labor hours = 180,000
Based on this information, the amount of overhead allocated to a job that used 300 direct labor hours is $______.
$450,000 / 150,000 = $3.00 per direct labor hour x 300 = $900.
Manufacturing overhead costs:
- consists of many different items
- are an indirect costs.
Categories of manufacturing costs include:
- manufacturing overhead
- direct materials
- direct labor.
A bill of materials contains the
- type of each direct material needed to complete a unit of product
- quantity of each direct material needed to complete a unit of product.
Materials requisitions forms are used for:
- making journal entries in accounting records
- controlling the flow of materials into production.
A job cost sheet contains:
- labor costs changed to the job
- manufacturing overhead costs charged to the job
- materials costs charged to the job.
Direct materials costs are recorded on the job cost sheet when the:
materials are issued to the job.
The document used to record the time workers spend on each job and task is called a:
time ticket
To keep track of labor time and cost, many firms have replaced:
paper with computerized system
The type and quantity of each type of direct material needed tom complete a unit of product is listed on the:
bill of materials.
The type and quantity of materials to be drawn from the storeroom and the job that will be charged for the materials is specified on the
materials requisition form.
The document that records the materials, labor, and manufacturing overhead costs charged to a job is the:
job cost sheet.
Barcodes can be used to":
automatically record and post direct labor costs to jobs.
Labor costs that are easily traced to a job are called _________ labor costs.
direct
Manufacturing overhead:
- consists of many different types of costs
- is an indirect cost
- contains fixed costs
Typical cost drivers include:
- flight hours
- machine hours
- computer time.
Job XYZ has a total manufacturing cost of $600. If the markup percentage is 40%, the job will sell for $____.
840.