What does it mean when overhead is over- or underapplied? What costs are affected by this and what are the two different ways to adjust for the over- or underapplied amount?
When actual overhead costs end up being more or less than applied overhead costs, then overhead is over- or underapplied. It is "over" applied when applied overhead exceeded actual and "under" applied when applied overhead was less than actual. When this occurs, overhead applied to product costs are not correct, therefore, product costs that remain in work-in-process and finished goods, as well as cost of goods sold are incorrect. If overhead was overapplied, then there is too much overhead cost in those items and vice versa if overhead was underapplied.
The two different ways to adjust for the over- or underapplied overhead to product costs is to either:
1. Adjust the difference straight to cost of goods sold if the amount is immaterial or if all the products have been sold, or
2. Adjust the difference to ending work-in-process, ending finished goods, and cost of goods sold in proportion to the overhead that remains in each account.
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