Underapplied and Overapplied Overhead

Overview

As the manufacturing overhead applied during the period is an estimate, there is usually an underapplied or overapplied overhead that needs to be reconciled at the end of the accounting period. Likewise, the journal entry will be required to reconcile the underapplied or overapplied overhead based on whether the company has the debit balance or credit balance of manufacturing overhead at the end of the period.

In this case, if the manufacturing overhead has a debit balance it means that that the applied overhead is less than the actual overhead. This will result of the underapplied overhead.

Applied overhead < Actual overhead => Underapplied overhead

On the other hand, if the manufacturing overhead has a credit balance it means that that the applied overhead is more than the actual overhead. This will result of the overapplied overhead.

Applied overhead > Actual overhead => Overapplied overhead

Underapplied overhead journal entry

At the end of the accounting period, when the company has a debit balance of manufacturing overhead, it can make the journal entry to reconcile the overhead cost by debiting the cost of goods sold account and crediting the manufacturing overhead account.

Account	Debit	Credit
Cost of goods sold	$$$
Manufacturing overhead		$$$

Overapplied overhead journal entry

On the other hand, when the applied overhead is more than the actual overhead, the company can make the journal entry to reconcile the overhead cost by debit the manufacturing overhead account and crediting the cost of goods sold account.

Account	Debit	Credit
Manufacturing overhead	$$$
Cost of goods sold		$$$

Example

For example, the manufacturing company ABC finds that it has a $2,000 debit balance of the manufacturing overhead at the end of the accounting period.

In this case, it means that the company has underapplied overhead. Hence, it can make the journal entry in order to reconcile the underapplied overhead as below:

Account	Debit	Credit
Cost of goods sold	2,000
Manufacturing overhead		2,000

After this journal entry, the balance of manufacturing overhead will become zero.

It is useful to note that some companies may use the more accurate method, but more time-consuming, to reconcile the underapplied or overapplied overhead. That method will not only allocate the overhead to the cost of goods sold but also to the work in process inventory account and the finished goods inventory account.

In that case, the underapplied overhead journal entry will include two more accounts as below:

Account	Debit	Credit
Work in process inventory	$$$
Finished goods inventory	$$$
Cost of goods sold	$$$
Manufacturing overhead		$$$

Similarly, the work in process inventory account and finished goods inventory account will also be added in the overapplied overhead journal entry.

Account	Debit	Credit
Manufacturing overhead	$$$
Work in process inventory		$$$
Finished goods inventory		$$$
Cost of goods sold		$$$