 Hello, and welcome to the session. This is Professor Farhad in which we would look at an actual exercise that could be considered a simulation that deals with overhead. How do we compute the predetermined overhead rate for various jobs? And what do we do when we have an overapplied, compute that amount or underapplied overhead and what do we do with it? As always before we start, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1,900 plus accounting, marketing, tax, finance, as well as Excel tutorials. If you like my lectures, please like them and share them. If they benefit you, it means they might benefit other people as well. I do have a website, and on my website I do have additional resources, especially for CPA candidate, as well as accounting students. But if you're a CPA candidate and you are taking a Becker, Roger, a Wiley, a Glyme, I don't replace those courses. I can't replace those courses. What I can do is I can make the material on those courses much more interesting and much more beneficial to you. So if you use my resources to study, then Becker, Roger, and all these courses, then you can use them to their max efficiency. So I strongly suggest if you're a CPA candidate to check out my website. So let's take a look at this problem. Northern Rim Parts estimates, so the first word is important. It's manufacturing overhead to be 495, and its direct labor cost to be 900,000. That's all estimates for year one. The first three jobs that Northern Rim worked on had an actual direct labor cost of 20,000 for job 301, 30,000 for job 302, and 40,000 for job 303. So we have the job 301, 302, and 303. And 301, we spent 20,000, 302, we spent 30,000. That's easy, and 303, we spent 40,000. This is how much we actually spend. For the year, actual manufacturing overhead was 479,000. This is another important term. Here is the actual. Notice we have actual numbers and we have estimates. So you have to know when to use the actual, when to use the estimate. The actual was 479, and the actual direct labor cost was 850. Manufacturing overhead is applied to jobs on the basis of direct labor hour constants. Although we are giving, there's no other method here using predetermined rate. Okay, how much overhead was assigned to each of the three jobs? Well, to know how much you assign, you need to have a predetermined overhead rate. To know the predetermined overhead rate, you need to know how do you allocate your overhead? Well, I allocate my overhead based on my direct labor cost, based on the estimate that I make at the beginning of the year. My estimate is based on 495,000. So notice these are all from the estimate divided by total of 900,000. If I do this, I'm gonna find the rate of 55%. It means I am for every job, for every dollar I spend in, for every dollar I spend in direct labor cost, I allocate an additional 55% to that job in manufacturing overhead. Well, let me change my pen here and see how much I allocated for each of these jobs. Well, 20,000 times 0.55, 30,000 times 0.55, 40,000 times 0.55. And that's gonna give me 11,000, 16,500 and 22,000. In total, I allocated to these jobs 49,500. This is how much I allocated. That's good. What was the over-applied or under-applied manufacturing overhead for year one? Now it's a different question. They're asking us for the whole year, how much was overhead over-applied or under-applied? How do I know whether overhead is under-applied or over-applied? I have to compare two numbers. I have to look at my actual, how much my actual was versus my applied. How much did I estimate I will spend? Well, I have the actual right here. My actual overhead was 479,000. That's easy peasy versus applied. Well, how do I apply it? I applied based on direct labor hours. What was my direct labor hours? My direct labor hours were 850,000 and I'm gonna apply 0.55 and that's gonna give me 467,500. Therefore my applied is 467,500. What does that mean? Well, I actually spend 479,000. I applied, applied another word for applied is estimate. I estimate the spent on overhead based on my rate of 55% of direct labor cost, 467. Well, guess what? I underestimated. I underestimated my overhead. I under, let's use the technical word, under-applied by 11,500. So I answered this question. What do we do with any under-applied or over-applied? We have to close it. How do we close it? That's gonna be in the next question. Let's take a look at this question. Prepare an entry to allocate the under-applied or over-applied overhead. We already know it's 11,500. Overhead applied to each, overhead applied in each of the inventory accounts. So what they want us to do, they want us to take this 11,500 and allocate it to working process, finished goods and cost of goods sold. Now, how do we allocate? Sorry. Since they want us to allocate, for example, in most textbooks, or when you first learn this in managerial accounting, you allocate this to manufacture to cost of goods sold. Now, let's allocate it only to cost of goods sold. So it's just the easy way. So this way, once you understand it, it will be easy for you. So you have an overhead account. That's what you have. And in that overhead account, you have a debit. On the debit, you have the actual. And on the credit, you have the applied. Now, let's see. Our actual was 479,000 and our applied was 467,500 as computed earlier. Therefore, we had a debit balance of 11,500. In managerial accounting, what you did is basically, you said, okay, I'm gonna close this account to cost of goods sold. That's assume I already have a million in cost of goods sold. How do I close it? Well, I will credit 11,500 of manufacturing overhead to make it down, go down to zero. So I credit and I debit 11,500. Therefore, my cost of goods sold becomes 1,011,500. So I closed my overhead. I closed the two cost of goods sold. Now they want us to close it to not only the cost of goods sold, to spread it out, to spread it out. But this is basically what happened. Well, if we're gonna spread it out, we're gonna have to allocate it. How do we do so? We'll do so based on the relative value. What does it mean relative value? It means I'm gonna add up all these figures, then allocate for each one separately. If I add up all these figures, they're gonna add up to 467,500. Then what I do, the figures are working process, finished goods and cost of goods sold. The reason I spell out everything is because I have some blind viewers on make sure I want to make sure they follow what I'm saying. So what I do is I'm gonna take 37,400 divided by 467,500 and that's gonna give me 8%. It means I'm gonna allocate of the 11,500 of the 11,500, I'm gonna allocate 8% to finished goods. I will do the same thing for the 102,850 which is finished goods inventory divided by 467,500 and that's gonna give me 22%. Then I divide cost of goods sold by the total and without even doing the computation which is 327,250 divided by the total 467,500 it must be 70% because the first two percentages were eight and 22, what's left is 70 because they all have to add up to 100%. Now I'm ready to allocate of the 11,500 to each of these accounts. So let me show you the computation first. So this is basically exactly what I just stated. I will take the total and I will divide each account work in process finished goods and cost of goods sold by the total to get the percentages. Then now I need to prepare the journal entry. What I have again, I have, let me show you the journal entry then I will explain it. So if you remember what I showed you earlier, I showed you the overhead account and I said there are two sides on the debit side I have 479,000 and on the credit side I have 467,500 and what I said, I said I have a credit balance of 11,000. What I need to do now, I need to close these accounts. I need to basically not these accounts I need to close this account, overhead has to go away. So I have to close it, how do I close it? Well, I'm gonna credit basically I don't have to credit 479 because it's technically, you know, but let's do it. So I'm gonna credit this account 479,000, debit this account 467,500 and debit this account also, I'm sorry, then credit this account. So 467,500, this amount canceled. Well, let's not do it this way. Okay. I already have 479 and overhead is 467,500. Basically those two accounts, if you know, one is applied, one is actual and one is applied. So basically those two accounts as I showed you earlier they net out to 11,500. Now all what I have to do is credit this account 11,500 which is, that's what I did here, credit this account 11,500, debit work and process, debit finish goods and debit cost of goods sold. And now, you know, you understand why I showed you the simple entry, credit overhead debit cost of goods sold. Here they kind of, they show it to you and like little bit more involved which is it's not much then taken the 11,500 and spreading that number over three accounts, 920, 2530 and 8,050. And notice what happened overall, all the accounts are down to zero. So after I have 11,500, I credited 11,500, my overhead is zero whether it's debit or credit now it's zero. So I allocated all the overhead. So basically the overhead is gone. The overhead is gone. So simply put, how would I, how would I journalize this entry? What I would do, I would say, I will debit work and process basically what it boils down to, 920, debit finished goods, 2530, debit cost of goods sold, 8,050 and credit the total manufacturing overhead, 11,500. So as long as you have those two accounts, the 479 and the 467,500, the debit and the credit in the overhead, this entry will close everything. But in this entry here, they're telling us you are, you are also closing the other two accounts. We already kind of closed them. Hopefully you'll see both journal entries and you understand both. As always, before I'm done, I would like to remind you to check out farhatlatchers.com for additional resources, whether you are studying for your CPA exam or if you're taking cost account.