Entry For Manufacturing Overhead Cost Applied To Jobs

Manufacturing overhead, a critical component of production costs, often requires meticulous tracking and allocation. Understanding the journal entries associated with the application of manufacturing overhead to jobs is essential for accurate cost accounting and financial reporting. This article will provide a comprehensive guide to recording these entries, ensuring clarity and precision in your accounting practices.

Understanding Manufacturing Overhead

Manufacturing overhead encompasses all indirect costs incurred in the production process. These costs are not directly traceable to specific products or services, making their allocation a crucial step in cost accounting. Common examples include:

• Indirect Labor: Wages paid to factory supervisors, maintenance staff, and other personnel who do not directly work on products.
• Indirect Materials: Consumables used in the production process, such as lubricants, cleaning supplies, and small tools.
• Factory Rent and Utilities: Costs associated with the factory building, including rent, electricity, water, and gas.
• Depreciation on Factory Equipment: The allocation of the cost of factory equipment over its useful life.
• Factory Insurance and Taxes: Property taxes and insurance premiums related to the factory building and equipment.

Unlike direct materials and direct labor, which are easily assigned to individual jobs, manufacturing overhead must be allocated using a predetermined overhead rate. This rate is calculated based on an estimated overhead cost and an allocation base, such as direct labor hours, machine hours, or direct material costs.

The Predetermined Overhead Rate

The predetermined overhead rate is calculated at the beginning of the accounting period and used to apply overhead costs to jobs as they are completed. The formula for calculating the predetermined overhead rate is:

Predetermined Overhead Rate = Estimated Total Manufacturing Overhead Costs / Estimated Total Allocation Base

For example, if a company estimates total manufacturing overhead costs for the year to be $500,000 and expects to use 25,000 direct labor hours, the predetermined overhead rate would be $20 per direct labor hour ($500,000 / 25,000 hours).

Using a predetermined overhead rate allows companies to apply overhead costs consistently throughout the year, regardless of fluctuations in actual overhead costs or production volume. This provides a more accurate and timely picture of job costs, which is essential for pricing decisions and profitability analysis.

Journal Entries for Manufacturing Overhead

The process of applying manufacturing overhead to jobs involves several key journal entries. These entries track the accumulation of actual overhead costs, the application of overhead to work-in-process inventory, and the eventual disposition of any over- or underapplied overhead. Let's explore these entries in detail:

1. Recording Actual Manufacturing Overhead Costs

As manufacturing overhead costs are incurred throughout the period, they are recorded as debits to various expense accounts and credits to the corresponding cash, accounts payable, or other asset accounts. A summary entry is typically made at the end of each month to consolidate these individual transactions.

Example:

Assume a company incurs the following manufacturing overhead costs during the month:

• Indirect Labor: $20,000
• Indirect Materials: $5,000
• Factory Rent: $10,000
• Factory Utilities: $3,000
• Depreciation on Factory Equipment: $7,000

The journal entry to record these costs would be:

In this entry, the individual expense accounts (Indirect Labor, Indirect Materials, etc.) are debited to increase their balances. The total amount of actual overhead costs is then credited to the Manufacturing Overhead Control account. This account acts as a holding account for all actual overhead costs incurred during the period.

2. Applying Manufacturing Overhead to Work-in-Process

As jobs are worked on, manufacturing overhead is applied to them using the predetermined overhead rate. The amount of overhead applied is calculated by multiplying the predetermined overhead rate by the actual amount of the allocation base used by the job.

Formula:

Applied Overhead = Predetermined Overhead Rate x Actual Allocation Base

Example:

Using the previous example, assume the predetermined overhead rate is $20 per direct labor hour. If a job requires 50 direct labor hours, the amount of overhead applied to that job would be $1,000 ($20/hour x 50 hours).

The journal entry to record the application of manufacturing overhead to work-in-process inventory is:

In this entry, Work-in-Process Inventory is debited to increase the value of the partially completed goods. The Manufacturing Overhead Applied account is credited to recognize the amount of overhead that has been allocated to production.

Important Considerations:

• The Manufacturing Overhead Applied account is a contra-account to the Manufacturing Overhead Control account. It represents the amount of overhead that has been applied to jobs, while the Manufacturing Overhead Control account represents the actual overhead costs incurred.
• This entry is typically made periodically, such as daily or weekly, as jobs are completed or as the allocation base is used.
• The specific allocation base used (e.g., direct labor hours, machine hours) will depend on the company's cost accounting system and the nature of its operations.

3. Transferring Completed Goods to Finished Goods Inventory

When jobs are completed, their costs, including direct materials, direct labor, and applied manufacturing overhead, are transferred from Work-in-Process Inventory to Finished Goods Inventory.

Example:

Assume a job with the following costs is completed:

• Direct Materials: $500
• Direct Labor: $800
• Applied Manufacturing Overhead: $1,000

The journal entry to record the transfer of these costs to finished goods inventory would be:

In this entry, Finished Goods Inventory is debited to increase the value of the completed goods. Work-in-Process Inventory is credited to reduce the value of the partially completed goods.

4. Recording the Cost of Goods Sold

When finished goods are sold, their costs are transferred from Finished Goods Inventory to Cost of Goods Sold.

Example:

Assume the job from the previous example is sold for $3,000. The journal entries to record the sale would be:

a. To record the revenue:

b. To record the cost of goods sold:

In these entries, Accounts Receivable is debited and Sales Revenue is credited to record the sale. Cost of Goods Sold is debited and Finished Goods Inventory is credited to record the cost of the goods sold.

5. Analyzing and Disposing of Over- or Underapplied Overhead

At the end of the accounting period, the Manufacturing Overhead Control and Manufacturing Overhead Applied accounts are compared to determine if overhead was over- or underapplied.

• Overapplied Overhead: Occurs when the amount of overhead applied to jobs is greater than the actual overhead costs incurred (Manufacturing Overhead Applied > Manufacturing Overhead Control). This results in a credit balance in the Manufacturing Overhead Applied account.
• Underapplied Overhead: Occurs when the amount of overhead applied to jobs is less than the actual overhead costs incurred (Manufacturing Overhead Applied < Manufacturing Overhead Control). This results in a debit balance in the Manufacturing Overhead Applied account.

The over- or underapplied overhead must be disposed of at the end of the period. There are two common methods for disposing of this balance:

a. Write-Off to Cost of Goods Sold: This is the simplest method and is often used when the amount of over- or underapplied overhead is immaterial. The entire balance is written off to Cost of Goods Sold.

Example:

Assume the company has underapplied overhead of $2,000 at the end of the period. The journal entry to write off this balance to cost of goods sold would be:

If the overhead was overapplied, the entry would be reversed, with a debit to Manufacturing Overhead Applied and a credit to Cost of Goods Sold.

b. Allocation to Work-in-Process, Finished Goods, and Cost of Goods Sold: This method is more accurate and is used when the amount of over- or underapplied overhead is material. The balance is allocated to Work-in-Process Inventory, Finished Goods Inventory, and Cost of Goods Sold based on the proportion of overhead included in each account.

Example:

Assume the company has underapplied overhead of $2,000 and the following balances:

• Work-in-Process Inventory: $50,000 (includes $5,000 of applied overhead)
• Finished Goods Inventory: $100,000 (includes $10,000 of applied overhead)
• Cost of Goods Sold: $500,000 (includes $50,000 of applied overhead)

Total Applied Overhead in Ending Balances: $5,000 + $10,000 + $50,000 = $65,000

Allocation percentages:

• Work-in-Process Inventory: $5,000 / $65,000 = 7.69%
• Finished Goods Inventory: $10,000 / $65,000 = 15.38%
• Cost of Goods Sold: $50,000 / $65,000 = 76.92%

Amount of underapplied overhead allocated to each account:

• Work-in-Process Inventory: $2,000 x 7.69% = $153.80
• Finished Goods Inventory: $2,000 x 15.38% = $307.60
• Cost of Goods Sold: $2,000 x 76.92% = $1,538.40

The journal entry to allocate the underapplied overhead would be:

This method provides a more accurate allocation of overhead costs and ensures that the financial statements reflect the true cost of goods sold and inventory values.

Example: Comprehensive Overhead Application

To illustrate the entire process, let's consider a comprehensive example:

Scenario:

XYZ Company uses a job-order costing system. At the beginning of the year, the company estimates the following:

• Total Manufacturing Overhead Costs: $800,000
• Total Direct Labor Hours: 40,000 hours

During the year, the company incurs the following actual costs:

• Indirect Labor: $250,000
• Indirect Materials: $80,000
• Factory Rent: $150,000
• Factory Utilities: $50,000
• Depreciation on Factory Equipment: $200,000
• Other Factory Overhead: $70,000

Total Direct Labor Hours Worked: 38,000 hours

Calculations:

1. Predetermined Overhead Rate: $800,000 / 40,000 hours = $20 per direct labor hour

2. Total Actual Manufacturing Overhead Costs: $250,000 + $80,000 + $150,000 + $50,000 + $200,000 + $70,000 = $800,000

3. Total Applied Manufacturing Overhead: $20/hour x 38,000 hours = $760,000

4. Over- or Underapplied Overhead: $760,000 (Applied) - $800,000 (Actual) = $40,000 Underapplied

Journal Entries:

1. To record actual manufacturing overhead costs:

2. To record manufacturing overhead applied to work-in-process:

3. To dispose of underapplied overhead (assuming write-off to Cost of Goods Sold):

This example demonstrates the complete cycle of recording, applying, and disposing of manufacturing overhead costs.

Key Considerations for Accurate Overhead Application

• Accurate Estimation: The accuracy of the predetermined overhead rate depends on the accuracy of the estimated overhead costs and allocation base. Companies should use reliable historical data and forecasting techniques to develop these estimates.
• Appropriate Allocation Base: The allocation base should be chosen based on the driver of overhead costs. For example, if overhead costs are primarily driven by machine usage, machine hours would be a more appropriate allocation base than direct labor hours.
• Regular Monitoring: Companies should regularly monitor actual overhead costs and the allocation base to identify any significant variances from the estimated amounts. This allows for timely adjustments to the predetermined overhead rate, if necessary.
• Consistent Application: Overhead costs should be applied consistently throughout the period to ensure accurate and comparable job costs.
• Materiality: The method used to dispose of over- or underapplied overhead should be based on the materiality of the balance. If the balance is immaterial, writing it off to cost of goods sold is acceptable. However, if the balance is material, it should be allocated to work-in-process, finished goods, and cost of goods sold.

Conclusion

The accurate application of manufacturing overhead is crucial for effective cost accounting and financial reporting. By understanding the journal entries involved and following best practices for estimating, allocating, and disposing of overhead costs, companies can ensure that their job costs are accurate and reliable. This, in turn, supports informed decision-making, accurate pricing strategies, and improved profitability analysis. Mastering these accounting principles is essential for anyone involved in manufacturing cost management.