Streamlining Manufacturing Costs- Mastering the Applied Overhead Journal Entry Process
Understanding and properly recording applied overhead journal entries is a crucial aspect of cost accounting for businesses. These entries help in accurately allocating overhead costs to the products or services produced, ensuring that the final cost of goods sold reflects the true expenses incurred. In this article, we will delve into the concept of applied overhead journal entries, their purpose, and how to make them correctly.
Overhead costs are the indirect expenses that cannot be directly attributed to a specific product or service. These costs include rent, utilities, salaries of administrative staff, and other expenses that are necessary for the overall operation of the business. To determine the cost of goods sold and the profitability of products, these overhead costs must be allocated to the products or services that benefit from them.
The process of allocating overhead costs is known as applying overhead. This is done using a predetermined overhead rate, which is calculated by dividing the estimated total overhead costs by the estimated total amount of the allocation base, such as direct labor hours or machine hours. Once the predetermined overhead rate is determined, it is used to calculate the applied overhead for each product or service.
An applied overhead journal entry is made to record the allocation of overhead costs to the products or services. This entry typically involves debiting the Work in Process (WIP) account and crediting the Manufacturing Overhead account. The journal entry is as follows:
Debit:
Work in Process (WIP) – Cost of Goods Manufactured
Credit:
Manufacturing Overhead
This entry reflects the increase in the cost of goods manufactured and the corresponding increase in the manufacturing overhead account. The amount debited to the WIP account is the applied overhead, which is calculated by multiplying the predetermined overhead rate by the actual amount of the allocation base used for each product or service.
It is important to note that the applied overhead journal entry is based on estimates. Since the actual overhead costs may differ from the estimated costs, a subsequent journal entry, known as the overapplied or underapplied overhead adjustment, may be required at the end of the accounting period. This adjustment is made to ensure that the actual overhead costs are allocated correctly to the products or services.
The overapplied or underapplied overhead adjustment is calculated by comparing the actual overhead costs incurred during the period with the applied overhead. If the actual overhead costs are less than the applied overhead, the difference is considered underapplied overhead, and it is credited to the Cost of Goods Sold (COGS) account. Conversely, if the actual overhead costs are greater than the applied overhead, the difference is considered overapplied overhead, and it is debited to the COGS account.
In conclusion, applied overhead journal entries play a vital role in cost accounting by accurately allocating overhead costs to products or services. Understanding how to make these entries and adjust for any discrepancies is essential for businesses to maintain accurate financial records and make informed decisions regarding pricing, production, and profitability.
