COST

ACCOUNTING
B Y: U J A L A S H A H R A S H D I
ABSORPTION COSTING

• Absorption costing is a costing system that is used in valuing inventory. It not only includes
the cost of materials and labor, but also both variable and fixed manufacturing overhead costs.
Absorption costing is also referred to as full costing. This guide will show you what’s included,
how to calculate it, and the advantages or disadvantages of using this accounting method.
COMPONENTS OF ABSORPTION COSTING

• Under the absorption method of costing (aka “full costing”), the following costs go into the product:
• Direct material (DM)
• Direct labor (DL)
• Variable manufacturing overhead (VMOH)
• Fixed manufacturing overhead (FMOH)
• Under absorption costing, the costs below are considered period costs and do not go into the cost of
a product. They are, instead, expensed in the period occurred:
• Variable selling and administrative
• Fixed selling and administrative
• Example of Absorption Costing
• Company A is a manufacturer and seller of a single product. In 2016, the company reported the
following costs:
• Variable costs per unit:
• Direct materials cost: $25
• Direct labor cost: $20
• Variable manufacturing overhead cost: $10
• Variable selling and administrative cost: $5
•  
• Fixed costs:
• Fixed manufacturing overhead of $300,000
• Fixed selling and administrative of $200,000
•  
• Over the year, the company sold 50,000 units and produced 60,000 units, with a unit selling price
of $100 per unit.
•  
• Using the absorption method of costing, the unit product cost is calculated as follows:
• Direct materials + Direct labor + Variable overhead + Fixed manufacturing overhead
allocated = $25 + $20 + $10 + $300,000 / 60,000 units = $60 unit product cost under
absorption costing
•  
• Recall that selling and administrative costs (fixed and variable) are considered period costs and
are expensed in the period occurred. Those costs are not included in the product costs.
ADVANTAGES

• There are several advantages to using full costing. Its main advantage is that it is 
GAAP-compliant. It is required in preparing reports for financial statements and stock
valuation purposes.
• In addition, absorption costing takes into account all costs of production, such as fixed costs of
operation, factory rent, and cost of utilities in the factory. It includes direct costs such as direct
materials or direct labor and indirect costs such as plant manager’s salary or property taxes. It
can be useful in determining an appropriate selling price for products.
•  
DISADVANTAGES
• Since absorption costing includes allocating fixed manufacturing overhead to the product cost, it is
not useful for decision-making. Absorption costing provides a poor analysis of the actual cost of
manufacturing a product. Therefore, variable costing is used instead to help management make
product decisions.
• Absorption costing can skew a company’s profit level due to the fact that all fixed costs are not
subtracted from revenue unless the products are sold. By allocating fixed costs into the cost of
producing a product, the costs can be hidden from a company’s income statement. Hence, absorption
costing can be used as an accounting trick to temporarily increase a company’s profitability by
moving fixed manufacturing overhead costs from the income statement to the balance sheet.
• For example, recall in the example above that the company incurred fixed manufacturing overhead
costs of $300,000. If a company produces 100,000 units (allocating $3 in FMOH to each unit) and
only sells 10,000, a significant portion of manufacturing overhead costs would be hidden in the
balance sheet. If the manufactured products are not all sold, the income statement would not show the
full expenses incurred during the period.
JOB-ORDER COSTING: AN OVERVIEW
Job-order costing systems are used
when:
1. Many different products are produced each period.
2. Products are manufactured to order.
3. The unique nature of each order requires tracing or
allocating costs to each job, and maintaining cost
records for each job.
JOB-ORDER COSTING: AN OVERVIEW

Examples of companies that

would use job-order costing include:
1. Boeing (aircraft manufacturing)
2. Bechtel International (large scale construction)
3. Walt Disney Studios (movie production)
JOB-ORDER COSTING – AN EXAMPLE
Direct Costs

Direct Materials Charge

Job No. 1 direct
material and
Direct Labor
Job No. 2 direct labor
costs to each
Job No. 3 job as work
is performed.
JOB-ORDER COSTING – AN EXAMPLE
Manufacturing
Direct Costs
Overhead,
Direct Materials including
Job No. 1 indirect
materials and
Direct Labor indirect labor,
Job No. 2
Indirect Costs are allocated to
Manufacturing all jobs rather
Job No. 3
Overhead than directly
traced to each
job.
THE JOB COST SHEET
PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-14
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Units Shipped

Direct Materials Date Number Balance
Direct Labor
Manufacturing Overhead
Total Cost
Unit Product Cost
MEASURING DIRECT MATERIALS
COST PearCo Materials Requisition Form
Requisition No. X7 - 6890 Date 3-4-14
Job No. A - 143
Department B3

Description Quantity Unit Cost Total Cost

2 x 4, 12 feet 12 $ 3.00 $ 36.00
1 x 6, 12 feet 20 4.00 80.00
$ 116.00

Authorized
Signature Will E. Delite
MEASURING DIRECT MATERIALS
COST PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-14
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
X7-6890 $ 116

Cost Summary Units Shipped

Direct Materials $ 116 Date Number Balance
Direct Labor
Manufacturing Overhead
Total Cost
Unit Product Cost
MEASURING DIRECT LABOR COSTS
PearCo Employee Time Ticket

Time Ticket No. 36 Date 3-5-14

Employee I. M. Skilled Station 42

Starting Ending Hours Hourly

Time Time Completed Rate Amount Job No.
0800 1600 8.00 $ 11.00 $ 88.00 A-143

Totals 8.00 $ 11.00 $ 88.00 A-143

Supervisor C. M. Workman
JOB-ORDER COST ACCOUNTING
PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-14
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
X7-6890 $ 116 36 8 $ 88

Cost Summary Units Shipped

Direct Materials $ 116 Date Number Balance
Direct Labor $ 88
Manufacturing Overhead
Total Cost
Unit Product Cost
LEARNING OBJECTIVE 1

Compute a predetermined
overhead rate.
WHY USE AN ALLOCATION BASE?
An allocation base, such as direct labor hours, direct
labor dollars, or machine hours, is used to assign
manufacturing overhead to individual jobs.
We use an allocation base because:
a. It is impossible or difficult to trace overhead costs to particular
jobs.
b. Manufacturing overhead consists of many different items
ranging from the grease used in machines to the production
manager’s salary.
c. Many types of manufacturing overhead costs are fixed even
though output fluctuates during the period.
MANUFACTURING OVERHEAD
APPLICATION
The predetermined overhead rate (POHR)
used to apply overhead to jobs is determined
before the period begins.
Estimated total manufacturing
overhead cost for the coming period
POHR =
Estimated total units in the
allocation base for the coming period

Ideally, the allocation base is

a cost driver that causes
overhead.
THE NEED FOR A POHR
Predetermined overhead rates that rely upon estimated data are often used
because:
1. Actual overhead for the period is not
known until the end of the period, thus inhibiting the ability to
estimate job costs during the period.
2. Actual overhead costs can fluctuate seasonally, thus misleading
decision makers.
COMPUTING PREDETERMINED OVERHEAD
RATES
The predetermined overhead rate is computed before the period begins
using a four-step process.
1. Estimate the total amount of the allocation base (the denominator)
that will be required for next period’s estimated level of production.
2. Estimate the total fixed manufacturing overhead cost for the coming
period and the variable manufacturing overhead cost per unit of the
allocation base.
3. Use the following equation to estimate the total amount of
manufacturing overhead:
Y = a + bX
Where,
Y = The estimated total manufacturing overhead cost
a = The estimated total fixed manufacturing overhead cost
b = The estimated variable manufacturing overhead cost
per unit of the allocation base
X = The estimated total amount of the allocation base.

4. Compute the predetermined overhead rate.

LEARNING OBJECTIVE 2

Apply overhead cost to jobs

using a predetermined
overhead rate.
OVERHEAD APPLICATION RATE
PearCo estimates that it will require 160,000 direct labor-hours to meet the
coming period’s estimated production level. In addition, the company
estimates total fixed manufacturing overhead at $200,000, and variable
manufacturing overhead costs of $2.75 per direct labor hour.
Y = a + bX
Y = $200,000 + ($2.75 per direct labor-hour × 160,000 direct labor-hours)
Y = $200,000 + $440,000
Y = $640,000

$640,000 estimated total manufacturing overhead

POHR =
160,000 estimated direct labor hours (DLH)

POHR = $4.00 per direct labor-hour

JOB-ORDER COST ACCOUNTING
PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-14
Date Completed 3-5-14
Department B3 Units Completed 2
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
X7-6890 $ 116 36 8 $ 88 8 $ 4 $ 32

Cost Summary Units Shipped

Direct Materials $ 116 Date Number Balance
Direct Labor $ 88
Manufacturing Overhead $ 32
Total Cost
Unit Product Cost
LEARNING OBJECTIVE 3

Compute the total cost and

average cost per unit of a
job.
JOB-ORDER COST ACCOUNTING
PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-14
Date Completed 3-5-14
Department B3 Units Completed 2
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
X7-6890 $ 116 36 8 $ 88 8 $ 4 $ 32

Cost Summary Units Shipped

Direct Materials $ 116 Date Number Balance
Direct Labor $ 88
Manufacturing Overhead $ 32
Total Cost $ 236
Unit Product Cost
JOB-ORDER COST ACCOUNTING
PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-14
Date Completed 3-5-14
Department B3 Units Completed 2
Item Wooden cargo crate
Direct Materials Direct Labor Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount
X7-6890 $ 116 36 8 $ 88 8 $ 4 $ 32

Cost Summary Units Shipped

Direct Materials $ 116 Date Number Balance
Direct Labor $ 88
Manufacturing Overhead $ 32
Total Cost $ 236
Unit Product Cost $ 118
QUICK CHECK 
Job WR53 at NW Fab, Inc. required $200 of direct
materials and 10 direct labor hours at $15 per hour.
Estimated total overhead for the year was $760,000
and estimated direct labor hours were 20,000. What
would be recorded as the cost of job WR53?
a. $200.
b. $350.
c. $380.
d. $730.
QUICK CHECK 
Job WR53 at NW Fab, Inc. required $200 of direct
materials and 10 direct labor hours at $15 per hour.
Estimated total overhead for the year was $760,000
and estimated direct labor hours were 20,000. What
would be recorded as the cost of job WR53?
a. $200. POHR = $760,000/20,000 hours $38
b. $350.
Direct materials $200
c. $380.
Direct labor $15 x 10 hours $150
d. $730. Manufacturing overhead $38 x 10 hours $380
Total cost $730
LEARNING OBJECTIVES 4 AND 5
Learning Objective 4 is to understand
the flow of costs in the job-order
costing system and prepare
appropriate journal entries to record
costs.

Learning Objective 5 is to use T-

accounts to show the flow of costs in a
job-order costing system.
KEY DEFINITIONS
1. Raw materials include any materials that go
into the final product.
2. Work in process consists of units of production
that are only partially complete and will require
further work before they are ready for sale to
customers.
3. Finished goods consist of completed units of
product that have not been sold to customers.
4. Cost of goods manufactured include the
manufacturing costs associated with the goods
that were finished during the period,
FLOW OF COSTS: A CONCEPTUAL
OVERVIEW Balance Sheet Income
Costs Inventories Statement
Expenses
Material Purchases Raw Materials

Direct Labor Work in

Process
Manufacturing
Overhead Cost of
Finished
Goods
Goods
Sold

Selling and Period Costs Selling and

Administrative Administrative
JOB-ORDER COSTING: THE FLOW OF
COSTS The transactions (in
T-account and journal
entry form) that capture
the flow of costs in a
job-order costing
system are illustrated on
the following slides.
THE PURCHASE AND ISSUE OF RAW
MATERIALS: T-ACCOUNT FORM
Raw Materials Work in Process
Material  Direct (Job Cost Sheet)
Purchases Materials Direct
 Indirect Materials
Materials

Mfg. Overhead
Actual Applied
 Indirect

Materials
COST FLOWS – MATERIAL
PURCHASES
On October 1, Smith Corporation had $5,000 in raw materials on hand.
During the month, the company purchased $45,000 in raw materials.

(1)
Raw Materials 45,000
Accounts Payable 45,000
ISSUE OF DIRECT AND INDIRECT
MATERIALS
On October 3, Smith had $43,000 in raw materials requisitioned from the
storeroom for use in production. These raw materials included $40,000 of
direct and $3,000 of indirect materials.

(2)
Work in Process 40,000
Manufacturing Overhead 3,000
Raw Materials 43,000
THE RECORDING OF LABOR COSTS
Salaries and Work in Process
Wages Payable (Job Cost Sheet)
 Direct  Direct
Labor
 Indirect
Materials
 Direct

Labor Labor

Mfg. Overhead
Actual Applied
 Indirect

Materials
 Indirect

Labor
THE RECORDING OF LABOR COSTS
During the month the employee time tickets included $35,000 of direct labor
and $12,000 for indirect labor.

(3)
Work in Process 35,000
Manufacturing Overhead 12,000
Salaries and Wages Payable 47,000
RECORDING ACTUAL
MANUFACTURING
Salaries and OVERHEAD COSTS
Work in Process
Wages Payable (Job Cost Sheet)
 Direct  Direct
Labor
 Indirect
Materials
 Direct

Labor Labor
Mfg. Overhead
Actual Applied
 Indirect

Materials
 Indirect

Labor
 Other

Overhead
RECORDING ACTUAL
MANUFACTURING OVERHEAD COSTS
During the month the company incurred the following actual overhead costs:
1. Utilities (heat, water, and power) $1,700
2. Depreciation of factory equipment $2,900
3. Property taxes payable on factory $1,000

(4)
Manufacturing Overhead 5,600
Utilities Payable 1,700
Accumulated Depreciation 2,900
Property Taxes Payable 1,000
APPLYING MANUFACTURING
OVERHEAD
Salaries and Work in Process
Wages Payable (Job Cost Sheet)
 Direct  Direct
Labor
 Indirect
Materials
 Direct

Labor Labor
 Overhead
Mfg. Overhead
Actual Applied Applied
 Indirect
If actual and applied
Materials  Overhead
 Indirect
manufacturing overhead
Applied to are not equal, a year-end
Labor Work in adjustment is required.
 Other
Process
Overhead
APPLYING MANUFACTURING
OVERHEAD
Smith uses a predetermined overhead rate of $3.50 per machine-hour.
During the month, 5,000 machine-hours were worked on jobs.

(5)
Work in Process 17,500
Manufacturing Overhead 17,500
(5,000 machine hours × $3.50 = $17,500)
ACCOUNTING FOR
NONMANUFACTURING COST
Nonmanufacturing costs are not assigned to
individual jobs, rather they are expensed in the
period incurred.

Examples:
1. Salary expense of employees
who work in a marketing, selling,
or administrative capacity.
2. Advertising expenses are expensed
in the period incurred.
ACCOUNTING FOR
NONMANUFACTURING COST
During the month, Smith incurred but has not paid sales salaries of $2,000,
and advertising expense of $750.

(6)
Salaries Expense 2,000
Advertising Expense 750
Salaries Payable 2,000
Accounts Payable 750
TRANSFERRING COMPLETED UNITS
Work in Process Finished Goods
(Job Cost Sheet )
 Direct  Cost of
Cost of Goods
Materials
 Direct
Goods Manufactured
Manufactured
Labor
 Overhead

Applied
TRANSFERRING COMPLETED UNITS
During the period, Smith completed jobs with a total cost of $27,000.

(9)
Finished Goods 27,000
Work in Process 27,000
TRANSFERRING UNITS SOLD
Work in Process Finished Goods
(Job Cost Sheet)
 Direct  Cost of  Cost of
 Cost of Goods Goods
Materials
 Direct
Goods Mfd. Sold
Mfd.
Labor
 Overhead

Applied Cost of Goods Sold

 Cost of
Goods
Sold
TRANSFERRING UNITS SOLD
Smith sold the $27,000 in Finished Goods Inventory to customers for $43,500
on account.

(10)
Accounts Receivable 43,500
Sales 43,500

Cost of Goods Sold 27,000

Finished Goods 27,000
LEARNING OBJECTIVE 6

Prepare schedules of cost of

goods manufactured and
cost of goods sold and an
income statement.
SCHEDULE OF COST OF GOODS
MANUFACTURED: KEY CONCEPTS
This schedule contains three
types of costs, namely direct
materials, direct labor, and It calculates the
manufacturing overhead. manufacturing
costs associated
with goods that
It calculates the cost of raw
were finished
material and direct labor used in
during the period.
production and the amount of
manufacturing overhead applied to
production.
PRODUCT COST FLOWS
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials

materials inventory
+ Raw materials
purchased
= Raw materials
available for use
in production
– Ending raw materials
inventory
= Raw materials used
As items are removed from raw
in production materials inventory and placed into
the production process, they are
called direct materials.
PRODUCT COST FLOWS
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials

materials inventory + Direct labor
+ Raw materials + Mfg. overhead applied
purchased = Total manufacturing
= Raw materials costs
available for use
in production Conversion
– Ending raw materials costs are costs
inventory
= Raw materials used
incurred to
in production convert the
direct material
into a finished
product.
PRODUCT COST FLOWS
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead applied + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials
inventory All manufacturing costs added to
= Raw materials used production during the period are
in production
added to the beginning balance of
work in process.
PRODUCT COST FLOWS
Manufacturing Work
Raw Materials Costs In Process

Beginning raw Direct materials Beginning work in

materials inventory + Direct labor process inventory
+ Raw materials + Mfg. overhead applied + Total manufacturing
purchased = Total manufacturing costs
= Raw materials costs = Total work in
available for use process for the
in production period
– Ending raw materials – Ending work in
inventory process inventory
= Raw materials used = Cost of goods
Costs associated
in productionwith the goods that manufactured

are completed during the period are

transferred to finished goods
inventory.
PRODUCT COST FLOWS
Work
In Process Finished Goods

Beginning work in Beginning finished

process inventory goods inventory
+ Manufacturing costs + Cost of goods
for the period manufactured
= Total work in process = Cost of goods
for the period available for sale
– Ending work in - Ending finished
process inventory goods inventory
= Cost of goods Cost of goods
manufactured sold
QUICK CHECK 
Beginning raw materials inventory was $32,000. During the month,
$276,000 of raw material was purchased. A count at the end of the month
revealed that $28,000 of raw material was still present. What is the cost of
direct material used?

a. $276,000
b. $272,000
c. $280,000
d. $ 2,000
QUICK CHECK 
Beginning raw materials inventory was $32,000.
During the month, $276,000 of raw material
was purchased. A count at the end of the
month revealed that $28,000 of raw material
was still present. What is the cost of direct
material used? Beg. raw materials $ 32,000
+ Raw materials
a. $276,000 purchased 276,000
b. $272,000 = Raw materials available
for use in production $ 308,000
c. $280,000 – Ending raw materials
d. $ 2,000 inventory 28,000
= Raw materials used
in production $ 280,000
QUICK CHECK 
Direct materials used in production totaled $280,000. Direct labor was
$375,000, and $180,000 of manufacturing overhead was added to
production for the month. What were total manufacturing costs incurred for
the month?
a. $555,000
b. $835,000
c. $655,000
d. Cannot be determined.
QUICK CHECK 
Direct materials used in production totaled
$280,000. Direct labor was $375,000, and
$180,000 of manufacturing overhead was added
to production for the month. What were total
manufacturing costs incurred for the month?
a. $555,000
b. $835,000
c. $655,000
d. Cannot be determined.
Direct Materials $ 280,000
+ Direct Labor 375,000
+ Mfg. Overhead Applied 180,000
= Mfg. Costs Incurred
for the Month $ 835,000
QUICK CHECK 
Beginning work in process was $125,000. Manufacturing costs added to
production for the month were $835,000. There were $200,000 of
partially finished goods remaining in work in process inventory at the end
of the month. What was the cost of goods manufactured during the
month?
a. $1,160,000
b. $ 910,000
c. $ 760,000
d. Cannot be determined.
QUICK CHECK 
Beginning work in process was $125,000.
Manufacturing costs added to production for the
month were $835,000. There were $200,000 of
partially finished goods remaining in work in
process inventory at the end of the month.
What was the cost of goods manufactured
during the month? Beginning work in
a. $1,160,000 process inventory $ 125,000
+ Mfg. costs incurred
b. $ 910,000 for the period 835,000
c. $ 760,000 = Total work in process
during the period $ 960,000
d. Cannot be determined.
– Ending work in
process inventory 200,000
= Cost of goods
manufactured $ 760,000
QUICK CHECK 
Beginning finished goods inventory was $130,000. The cost of goods
manufactured for the month was $760,000. And the ending finished goods
inventory was $150,000. What was the cost of goods sold for the month?
a. $ 20,000
b. $740,000
c. $780,000
d. $760,000
QUICK CHECK 
Beginning finished goods inventory was
$130,000. The cost of goods manufactured for the
month was $760,000. And the ending finished
goods inventory was $150,000. What was the cost
of goods sold for the month?
a. $ 20,000 $130,000 + $760,000 = $890,000
b. $740,000 $890,000 - $150,000 = $740,000
c. $780,000
d. $760,000
LEARNING OBJECTIVE 7
Compute underapplied or
overapplied overhead cost
and prepare the journal
entry to close the balance in
Manufacturing Overhead to
the appropriate accounts.
UNDERAPPLIED AND OVERAPPLIED OVERHEAD―A
CLOSER LOOK
The difference between the overhead cost applied to
Work in Process and the actual overhead costs of a
period is referred to as either underapplied or
overapplied overhead.
Underapplied overhead Overapplied overhead
exists when the amount of exists when the amount of
overhead applied to jobs overhead applied to jobs
during the period using the during the period using the
predetermined overhead predetermined overhead
rate is less than the total rate is greater than the total
amount of overhead actually amount of overhead actually
incurred during the period. incurred during the period.
OVERHEAD APPLICATION EXAMPLE
PearCo’s actual overhead for the year was $650,000 with a total of 170,000
direct labor hours worked on jobs.
How much total overhead was applied to PearCo’s jobs during the year? Use
PearCo’s predetermined overhead rate of $4.00 per direct labor hour.

Overhead Applied During the Period

Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
OVERHEAD APPLICATION EXAMPLE
PearCo’s actual overhead for the year was
$650,000 with a total of 170,000 direct labor hours
worked on jobs.
HowPearCo has overhead
much total overapplied
was applied to PearCo’s
overhead for the
jobs during theyear
year? Use PearCo’s
by $30,000. overhead
predetermined What will rate of $4.00 per direct
PearCo do? labor hour.

Overhead Applied During the Period

Applied Overhead = POHR × Actual Direct Labor Hours
Applied Overhead = $4.00 per DLH × 170,000 DLH = $680,000
QUICK CHECK 
Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a
predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked
290,000 machine hours during the period. Tiger’s manufacturing overhead
is:
a. $50,000 overapplied.
b. $50,000 underapplied.
c. $60,000 overapplied.
d. $60,000 underapplied.
QUICK CHECK 
Tiger, Inc. had actual manufacturing overhead
costs of $1,210,000 and a predetermined
overhead rate of $4.00 per machine hour. Tiger,
Inc. worked 290,000 machine hours during the
period. Tiger’s manufacturing overhead is:
a. $50,000 overapplied.
b. $50,000 underapplied. Overhead Applied
$4.00 per hour × 290,000 hours
c. $60,000 overapplied. = $1,160,000
d. $60,000 underapplied. Underapplied Overhead
$1,210,000 - $1,160,000
= $50,000
DISPOSITION OF UNDER- OR
OVERAPPLIED OVERHEAD
PearCo’s Method

$30,000 $30,000 may be

may be allocated closed directly to
to these accounts. cost of goods sold.
OR
Work in Finished
Process Goods

Cost of Cost of
Goods Sold Goods Sold
DISPOSITION OF UNDER- OR
OVERAPPLIED OVERHEAD
PearCo’s Cost PearCo’s
of Goods Sold Mfg. Overhead
Unadjusted Actual Overhead
Balance overhead applied
costs to jobs
$30,000
$650,000 $680,000
Adjusted $30,000 $30,000
Balance overapplied
ALLOCATING UNDER- OR OVERAPPLIED
OVERHEAD BETWEEN ACCOUNTS
Assume the overhead applied in ending Work in
Process Inventory, ending Finished Goods
Inventory, and Cost of Goods Sold is shown below:

Amount
Work in process $ 68,000
Finished Goods 204,000
Cost of Goods Sold 408,000
Total $ 680,000
ALLOCATING UNDER- OR OVERAPPLIED
OVERHEAD BETWEEN ACCOUNTS
We would complete the following allocation of
$30,000 overapplied overhead:

Percent of Allocation of
Amount Total $30,000
Work in process $ 68,000 10% $ 3,000
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total $ 680,000 100% $ 30,000

$68,000 ÷ $680,000 10% × $30,000

ALLOCATING UNDER- OR OVERAPPLIED
OVERHEAD BETWEEN ACCOUNTS
Percent of Allocation of
Amount Total $30,000
Work in process $ 68,000 10% $ 3,000
Finished Goods 204,000 30% 9,000
Cost of Goods Sold 408,000 60% 18,000
Total $ 680,000 100% $ 30,000

Manufacturing Overhead 30,000

Work in Process Invenory 3,000
Finished Goods Inventory 9,000
Cost of Goods Sold 18,000
OVERAPPLIED AND UNDERAPPLIED MANUFACTURING
OVERHEAD - SUMMARY

PearCo’s
Method
Alternative 1 Alternative 2
If Manufacturing Close to Cost
Overhead is . . . of Goods Sold Allocation

UNDERAPPLIED INCREASE INCREASE

Cost of Goods Sold Work in Process
(Applied OH is less Finished Goods
than actual OH) Cost of Goods Sold

OVERAPPLIED DECREASE DECREASE

Cost of Goods Sold Work in Process
(Applied OH is greater Finished Goods
than actual OH) Cost of Goods Sold

More accurate but more complex to compute.

QUICK CHECK 

What effect will the overapplied overhead have on PearCo’s net

operating income?

a. Net operating income will increase.

b. Net operating income will be unaffected.
c. Net operating income will decrease.
QUICK CHECK 

What effect will the overapplied overhead

have on PearCo’s net operating income?
a. Net operating income will increase.
b. Net operating income will be unaffected.
c. Net operating income will decrease.