Applied Overhead Predetermined Rate

Applied overhead is the amount of manufacturing overhead allocated to a particular job. The normal method for doing this is to use a predetermined overhead rate.

Predetermined Rate

The process of deciding on the predetermined rate is done in three steps:

  1. First of all determine the basis on which overhead is to be applied, this is usually machine hours or labor hours but could be another method more suitable to the business.
  2. Estimate the number of hours and the manufacturing overhead for the period.
  3. Divide the manufacturing overhead by the number of hours to give a predetermined rate per hour to be used for the period.

Suppose as an example, the business chooses to use labor hours as the applied cost allocation base, and estimates 36,000 production hours and 324,000 manufacturing overhead for the year. The overhead rate is determined as follows.

Overhead rate = Manufacturing overhead / Labor hours
Overhead rate = 324,000 / 36,000 = 9.00 per labor hour

So on a particular job which involved say 100 hours of labor, the applied over-head would be 100 x 9.00 = 900

The journal to post the applied overhead is as follows:

To transfer predetermined overhead to work in process
Account Debit Credit
Work in process inventory 900
Manufacturing overhead clearing account 900
Total 900 900

The amount of 900 has been debited to the work in process for the job at the predetermined rate. The manufacturing overhead clearing account is a temporary account to hold the predetermined applied overhead credit until the actual manufacturing overhead is allocated to it.

Actual Manufacturing Overhead

The actual manufacturing overhead will be made up from indirect labor, indirect materials, and other costs such as depreciation, maintenance costs, insurance. When the actual manufacturing overhead is known, this is transferred to the manufacturing overhead clearing account with the following journal:

To transfer actual manufacturing overhead to manufacturing overhead account
Account Debit Credit
Manufacturing overhead clearing account 1,000
Indirect materials 200
Indirect labor wages 400
Depreciation 100
Utilities 250
Other costs 50
Total 1,000 1,000

Under Applied Overhead

If we look at the manufacturing overhead clearing account in the above example, the actual overhead was 1,000 debit, and the applied overhead at the predetermined rate was 900 credit, this leaves a debit balance on the account of 100 which represents under applied overhead. The overhead should have been 1,000 but the amount applied was actually 900.

Providing the amount is not significant, the normal process for clearing the temporary account is to charge the under applied overhead to cost of goods sold.

To transfer under applied overhead to cost of goods sold
Account Debit Credit
Cost of goods sold 100
Manufacturing overhead clearing account 100
Total 100 100

Over Applied Overhead

The opposite situation occurs when there is over applied overhead. Suppose in the above example the actual overhead was 700, the manufacturing overhead clearing account would have shown a debit of 700 and a credit of 1,000 representing the predetermined applied overhead. The balance on the account would be a credit of 300. The overhead should have been 700, but the job was charged with 1,000, there is over applied manufacturing overhead of 300.

Again the journal to correct this would take the over applied overhead as a credit to the cost of goods sold.

To transfer over applied overhead to cost of goods sold
Account Debit Credit
Manufacturing overhead clearing account 300
Cost of goods sold 300
Total 300 300
Applied Overhead Predetermined Rate October 9th, 2017Team

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