Dispose off those Overheads!

What are overheads?

Manufacturing Overhead is the indirect factory related cost incurred by a manufacturer at the time of production. It is also called factory overhead, factory manufacturing cost. 

What does overheads include?

Manufacturing overheads include those costs which are directly related to factory equipment such as depreciation of factory equipment, factory supplies and overheads, factory personnel etc.

The General Accepted Accounting Principle mandates that overheads

must be included in the cost of Work in Progress and Finished Goods. In

work in progress account, the overheads have to be debited on

applied basis.

The work in progress account does not consider actual manufacturing overhead incurred. Disposing off over and under applied overheads is a must because it considers the effect of difference between the actual and applied overheads.

1. Overheads are estimated on the basis of predetermined overhead rates.

2. The overheads applied to work in progress and actual manufacturing overhead incurred always maintains a difference between them. This difference is what is called Overhead Over-Applied or Under-applied manufacturing overhead.

Overhead Over-Applied 

Over applied manufacturing overhead is the situation where actual manufacturing overhead is less than overheads applied to the production.

Under-Applied Overhead 

When applied overheads are less than the actual overheads incurred, the term is referred to as Under-applied manufacturing overhead.

Now, let us come to the original 

question that was how to dispose 

off under-applied or over-applied 

overhead?

There are two methods of disposing over 

applied and under applied overhead:

•Cost of Goods Sold Method

•Allocating Cost between Work in Progress and Finished Goods

Reasons for Over & Under Applied 

Overheads•The main reason for occurrence of over & under applied overheads is the method of applying overheads to jobs by using predetermined overhead rate. •Predetermined overhead rate is assumed to be same as actual cost whereas in actual the two rates differ. •There are 2 reasons of difference:a) Overhead includes fixed part which does not vary with the

machine hours or direct labor hours.b) O erheads may or may not be under control.

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