Compute The Underallocated Or Overallocated Overhead And Pro

Compute the underallocated or overallocated overhead and prorate it to the appropriate accounts in the most

The Clash Company uses job-order costing with normal costing to allocate overhead based on direct labor cost. For 2014, the estimated direct labor cost was $60,000, and the estimated overhead was $72,000. Actual overhead incurred during 2014 was $70,000. The company begins with certain balances in Materials Control, Work in Process, and Finished Goods inventory, and has specific data on direct materials, direct labor costs, and units for various jobs. The task involves calculating the underallocated or overallocated overhead for the year, prorating it accurately to the relevant accounts, determining the actual overhead rate based on actual data, and comparing the actual and corrected Work in Process balances under different costing methods.

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To address the comprehensive overhead allocation issues faced by The Clash Company, an in-depth analysis of the year's costing data is essential. The objective is to compute the underallocated or overallocated overhead, prorate it correctly, determine the actual overhead rate, and compare the ending Work in Process (WIP) balances under different costing methods—normal costing and actual costing. This analysis not only ensures accurate financial reporting but also provides insights into the costing efficiency and precision of budget estimates against actual results.

Overhead Allocation and Proration

At the core of job-order costing lies the allocation of overhead based on a predetermined rate, which in this case is based on direct labor costs. The estimated overhead rate can thus be calculated as:

Estimated Overhead Rate = Estimated Overhead / Estimated Direct Labor Cost = $72,000 / $60,000 = 1.2 or 120%

Using this rate, the applied overhead for 2014 based on actual direct labor costs ($60,000) is:

Applied Overhead = Actual Direct Labor Cost x Predetermined Overhead Rate = $60,000 x 1.2 = $72,000

Given that the actual overhead incurred was only $70,000, the company experienced an overapplication of overhead, calculated as:

Overapplied Overhead = Applied Overhead - Actual Overhead = $72,000 - $70,000 = $2,000

Since all under or overapplied overhead was previously charged to Cost of Goods Sold, the next step involves properly prorating the $2,000 overapplied overhead to Work in Process, Finished Goods, and Cost of Goods Sold proportionally based on their respective overhead allocations.

Proportional Distribution of Overapplied Overhead

Calculate total overhead costs assigned to all jobs during the year, considering direct materials, direct labor, and applied overheads. Based on data for each job, the overhead allocated is derived from the predetermined rate applied to direct labor costs. For instance, Job 111 with $10,000 direct labor costs would have overhead of:

Overhead = $10,000 x 1.2 = $12,000

This process is repeated for all jobs, summing up to total applied overhead. The proportion of each account's overhead to the total helps in distributing the $2,000 overapplication accordingly.

Actual Overhead Rate and Work in Process Balance using Actual Costing

The actual overhead rate reflects the real overhead costs incurred relative to direct labor costs:

Actual Overhead Rate = Actual Overhead / Actual Direct Labor = $70,000 / $60,000 ≈ 1.17 or 117%

This rate would be used if actual costing was employed, and applying it to the actual direct labor costs when jobs are completed would give the actual total cost, including direct materials, direct labor, and actual overhead.

The total balance in ending Work in Process under actual costing considers the actual overhead for completed jobs, remaining costs for unfinished jobs, and the closing balances in inventory. Comparing this with the corrected normal costing balance reveals if both methods produce consistent results. Typically, they should be closely aligned if costs are accurately allocated and prorated, although minor discrepancies may occur due to proration methods or timing of overhead application.

Conclusion

Efficient overhead allocation requires precise calculations, especially when actual costs differ from estimations. By accurately prorating overapplied overhead and understanding the differences between normal and actual costing, The Clash Company can ensure its financial statements accurately reflect its costs and profitability. Proper proration methods, grounded in sound theoretical principles, enhance the accuracy of cost control and managerial decision-making. Ultimately, accurate costing methods support more reliable financial analysis and strategic planning, emphasizing the importance of meticulous overhead management in job-order costing systems.

References

• Drury, C. (2018). Management and Cost Accounting (10th ed.). Springer.