When overhead costs are incurred they are recorded in an Account titled Manufacturing Overhead Control Account. The account is debited for each overhead expense billed and an appropriate account such as Cash or Accounts Payable is credited. Since overhead costs cannot be traced directly to a cost object or to a Job, the total annual overhead cost for the coming year are estimated at the end of the preceeding year and a formula is used to estimate the amount of overhead that should be charged to each job or product. The amount charged to jobs or products is credited to the MOH account and debited to the Work In Process Account. This estimated amount is a surrogate for the actual overhead costs that are incurred during the year. At the end of the accounting period, the estimated amounts charged to all jobs or products may be higher or lower than the actual overhead costs incurred during the year. This situation gives rise to the phenomenon of Under /Over applied overhead. Since overhead expenses are just like ordinary expenses except for the fact that they are incorporated in the cost of product, then the MOH account is like any other temporary account and therefore it must be closed at the end of the accounting period.
Applied overhead is calculated using the following formula: Predetermined Overhead Application Rate (POHAR) x Actual consumption of the Activity Base. For example, if the POHAR is $10 per direct labor hour consumed by a product and the product consumes 5 direct labor hours, then Applied Overhead would be: 10 X 5 = $50. Under/ Over applied overhead is calculated as: Actual Overhead costs – Applied Overhead. If Actual is greater than applied then Overhead is described as under applied and if the Applied is greater than Actual then it is described as over applied.
The estimated overhead costs of Abel Furniture were $2,200,000and the estimated basis used for charging overhead to production is direct labor hours estimated at 500,000. The actual overhead incurred during the year was $2,800,000 and the amount charged to production was $2,400,000. Calculate the amount of Under/Over applied overhead and close the balance to Cost of Goods sold.