Howdy! Let's take a closer look at the
treatment of manufacturing overhead. KA
catering uses a job order costing system
to assign cost to its catering jobs.
Overhead is allocated to each job based
on direct labor-hours. Listed below is
data for the current year: Budgeted
overhead cost $90,000, actual overhead
cost incurred $77,000, budgeted labor
$100,000 for 10,000 hours, actual labor
$95,000 for 9000 hours. So here we have
a case where we know what the company
thought would happen at the beginning of
the year, and then what actually did
happen throughout the year. So we've got
a complete picture. First we'll determine
the amount of overhead applied to work
in process during the period. In order to
do that, you have to first compute the
predetermined overhead rate. Notice the
word predetermined. This means that the
overhead rate is going to be based on
budgeted information. The formula we
learned previously is: you take the
budgeted overhead costs and you divide
by the budgeted activity. Now you'll
notice that it says the overhead is
allocated to each job based on direct
labor-hours. This is important
information because it tells us what our
denominator is going to be. It's going to
be direct labor-hours. So, we were given
that budgeted overhead costs were
$90,000 and budgeted labor was $100,000
for 10,000 hours and, of course, we're
going to use the hours since that's how
the company applies overhead. So plugging
in we will take $90,000 divided by 10,000
hours and we'll get $9 per direct
labor-hour.
So this company believes that for every
labor hour worked they incur labor costs,
but they also incur overhead costs.
Electricity is used, a space needs to be
rented, there needs to be a supervisor, so
they believe this occurs at a rate of
nine dollars for every direct labor-hour
worked.Now that we have the overhead
rate we can use that to assign overhead
costs to inventory. Now remember, we do
that by taking the predetermined rate,
that multiplied by actual activity. So
the formula is overhead applied is equal
to the overhead rate times actual
activity. So as labor hours are worked
throughout the period we assign cost to
the jobs. Alright, we were given the
actual labor cost were ninety five
thousand dollars for nine thousand hours.
But since our overhead rate is nine
dollars per labor hour we're going to
multiply by the nine thousand hours and
that's going to give us overhead applied
of eighty one thousand dollars. So this
is how we would assign cost to the work
in process inventory account. Eighty one
thousand dollars.
We will show the adjusting entry to close
the overhead account at the end of the
period. So companies will calculate a
predetermined rate, assign overhead cost
to inventory throughout the period and
then they will close this overhead
account to zero at the end of the period,
before they prepare financial statements
So anytime you're asked to close out the
overhead account, a good thing to do is
just to set that t-account up. And
remember, actual overhead costs are
recorded on the debit side and applied
overhead costs are recorded on the
credit side. That way you have...you're
keeping track of what overhead costs
were actually incurred and what overhead
costs were assigned to inventory. So we
were given the actual overhead cost, or
seventy seven thousand dollars. So we'll
put that into our t-account. Notice that
we did not use the budgeted overhead
cost. The only place that is used is in
the predetermined overhead rate
calculation. Now in our first calculation
we determined that applied overhead is
eighty one thousand dollars. So we can
see based on this that we have a four
thousand dollar credit balance. That
means that we assigned eighty one
thousand dollars to...to inventory
but we only incurred seventy seven
thousand dollars of cost. So we have
overapplied overhead--we've over assigned
cost to our inventory account. So the
journal entry to close that out, if we
have a credit balance in overhead, we
are going to need to debit manufacturing
overhead for four thousand dollars. This
will get this account to zero. We will
assume this amount is insignificant or
immaterial in amount, so we will close it
to cost of goods sold. We will always
close the overhead account to cost of
goods sold in this class. This
essentially reduces the cost of goods
sold account since it is an expense
account. Assume two jobs were sold during
the period: Job 10-A costing two hundred
thousand dollars and Job-12B
costing one hundred thousand dollars.
What is the cost of goods sold before
adjustment? What is the cost of goods
sold after adjustment? So before
adjustment, we take the cost of the two
jobs: two hundred thousand and one
hundred thousand dollars. So cost of
goods sold before adjustment is three
hundred thousand dollars. Now, after
adjustment, we will have to consider the
four thousand dollars of overapplied
overhead. Since we over-assigned cost to
our inventory, we will reduce our cost of
goods sold. So cost of goods sold after
adjustment is two hundred ninety six
thousand dollars. This is what will go to
our income statement for cost of goods
sold. That's the end of this problem so
make sure that you do your homework
related to overhead and bring questions
to class. See you then!
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