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Lecture 11

ADMS 1000 Lecture Notes - Lecture 11: Financial Statement, Finished Good, Electronic Data InterchangePremium


Department
Administrative Studies
Course Code
ADMS 1000
Professor
Keith Lehrer
Lecture
11

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ADMS 1000 Lecture 11 Notes Disposition of Under applied or Over applied Overhead,
Balances, A General Model of Product Cost Flows, Variations from the General Model of
Product Cost Flow, Multiple Predetermined Overhead Rates, Job-order costing in service
companies and Use of information technology
Introduction
What disposition should be made of any under applied or over applied balance
remaining in the Manufacturing Overhead account at the end of a period?
Under current accounting standards applicable in Canada (IAS 2)
Unallocated overheads are recognized as an expense in the period in which they are
incurred. In periods of abnormally high production, the amount of fixed overhead
allocated to each unit of production is decreased so that inventories are not measured
above cost.
Note that IAS 2 is a financial reporting standard that is not necessarily required to be
followed for internal purposes.
Even so, most companies treat accounting for inventory costs consistently for both
financial reporting and internal management decision making for simplicity’s sake.
Thus, the balance in the account must be treated in one of two ways depending on
whether it was under- or over applied during the year
If overhead was under applied, the remaining balance is closed out to Cost of Goods
Sold.
If overhead was over applied, the remaining balance is allocated among Work in
Process, Finished Goods, and Cost of Goods Sold in proportion to the overhead applied
during the current period in the ending balances of these accounts.
Close out Under applied Overhead to Cost of Goods Sold
o As mentioned above, closing out the balance in Manufacturing Overhead to Cost of
Goods Sold is simpler than the allocation method.
Allocate Over applied Overhead among Accounts

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o Allocation of over applied overhead assigns overhead costs to where they would
have gone in the first place had it not been for the errors in the estimates going into
the predetermined overhead rate.
o Note that the first step in the allocation was to determine the amount of overhead
applied in each account.
o For Finished Goods, for example, the total amount of overhead applied to Job A,
$60,000, was divided by the total number of units in Job A, 1,000 units, to arrive at
the average overhead applied of $60 per unit.
o Since 250 units from Job A were still in ending finished goods inventory, the amount
of overhead applied in the Finished Goods Inventory account was $60 per unit
multiplied by 250 units, or $15,000 in total.
o An alternative but less accurate way to allocate over applied overhead among Work
in Process, Finished Goods, and Cost of Goods Sold is to use the entire cost of
manufacturing in each account.
o A comparison of the percentages above with those using only overhead suggests
that total manufacturing costs and overhead were not in the same proportions in
each account.
o This difference is the inaccuracy in the problem resulting from using total
manufacturing costs to conduct the allocation.
o The rationale for deducting the beginning work in process and finished goods
inventories from the cost of goods sold is to permit the allocation to be based on
costs from the current period.
o By doing so, the 39.25% in the Rand Company example reflects only total
manufacturing costs from April and thus corresponds to the period in which the over
applied overhead occurred.
o Without this adjustment, cost of goods sold would be assigned the overhead
difference based on costs carried over from March and thus bear a disproportionate
amount of the over applied overhead.
A General Model of Product Cost Flows
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