 In this presentation, we will take a look at the Journal Entry for Under or Overapplied Overhead. First, let's take a look at the sequence of events related to overhead. Support Accounting Instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Generally, at the start of the period, at the start of the month, we set up the predetermined overhead rate, that overhead rate, the thing that we will use to allocate the overhead from the bucket of overhead to individual jobs. Throughout the month, then we're going to record actual overhead, the actual things that we're going to put into overhead. Remember that those things are the things that we cannot apply to a specific job in a job cost system. And therefore, we put it into overhead and are going to apply it to a job using an estimate, that estimated being the predetermined overhead rate is going to be part of the estimate process. Then we're going to apply the estimated overhead to the jobs. Now note that here we have these two items are happening one, we have the recorded overhead, the actual overhead, and then we have the applied overhead. And of course, because the recorded overhead or the applied overhead is an estimate, it's not going to match the recorded overhead. So we're going to have then this problem of over or under applied overhead. And it could be either one, we might have over applied or under applied, whatever is the case, we're going to have to then deal with that over or under applied overhead by the end of the time period so that next month we basically start with zero. So there's three things that can happen with an estimate. One is, you know, we can have we can be under applied, we can be over applied, or we can be right on our estimate could be perfect. That's not going to happen in real life. So we're almost always going to be under or over applied, and we'll have to compensate for that in some way. In our problem here, we see that overhead was under applied by the 300 and 80. We have the 300 and 80. Now we need to know the terminology and we also need to know what to do with this 300 and 80. And they're often two different things because obviously what are we going to do with this 300 and 80 at the end of the time period, we're going to make it zero, whatever it is, whether it be a debit or a credit, we're going to make it to go to zero because we need to start this process over in the next month. So although this factory overhead is kind of like a permanent account, it's kind of like part of the inventory. It's acting like a temporary account, not because it's closing out to retain earnings, but because we're going to close it out to basically cost of goods sold. We're going to force it to go back to zero so that we're going to start all over in the next time period. And the reason we, so that means that this number here, the 300 and 80, whether it be a debit or a credit from a journal entry standpoint, we're going to do whatever we need to do to make it go to zero. So this is a debit. So we're going to credit it 300 and 80. If it were a credit, we would debit it by 300 and 80. From a practical standpoint, that's all we need to do. We need to see what's there and we need to do whatever we need to do to make it go down to zero at the end of the time period. From a book problem perspective and just from a communication perspective and knowing what's going on, we need to understand the terms under or over applied. If we look at what actually happened in factory overhead, we're going to say, okay, this is the stuff, all the debits that happened. That's the stuff that's going into factory overhead. And you can think about this by thinking about, okay, what would the debit journal entries be related to factory overhead? When would we debit factory overhead? Let's think about the journal entries. Well, one would be indirect labor. And so the indirect labor would be crediting wages, payable or cash and debiting factory overhead because we didn't know which job to assign it to. And we're not expensing it because it's not part of this period's cost as part of the inventory. Indirect materials is going to be the same thing. We took materials out in order to make inventory. It didn't know which job to put it to. So we debited factory overhead and credited the raw materials. Any other thing that's on the factory that we paid for, such as rent on the factory or utilities in the factory, those are going to be things we're going to credit cash and we're going to debit not the expense of utilities expense and whatnot, but part of inventory, not working process because we don't know which job to put it to, but factory overhead. So all these debits are what actually happened. And then this credit is us taking it out. If we think of that journal entry, that's us reducing the factory overhead with a credit and putting it into the working process. It's only one journal entry here and going into just the working process account there, but it's going to be going to multiple jobs that support this working process account. And that's why we had to do it in this process. That's why it had to go in and out of the factory overhead in the first place. Now, as that happens, we can say, okay, well, and also note that this amount that we apply out, we did it all at one time to all the jobs at one time, like at the end of the month. It's quite possible that we do that as we go, meaning we might start the job and as we finish the job, apply out a factory overhead as we finish the job. So we may have credits in here as we go. It's not always the case, in other words, that we will incur all the factory overhead and then apply it out at the end of the time period. We're going to apply it out based on our predetermined overhead rate as we go. So we want to keep that in mind. But as we look at this at the end of the time period, we can say, okay, well, these are the debits. There's the credits. There's more debits than credits because we're left with a debit balance. In other words, the debits are winning. If I add up all the debits and subtract out all the credits, the debits are winning by 380, meaning we had more actual costs than we applied out. And that would mean that from our terminology standpoint, that's going to be under-applied. So we have under-applied because we had more costs than we applied out. We applied out less than or under what the actual was. Now, that leaves us with a debit balance, which kind of makes sense for us because it's always a debit balance. You would think factory overhead being kind of like an inventory account would always be a debit balance. But it could have been over-applied. And over-applied would look funny to us because it would mean that this credit here had been higher than the debits. And that's possible. It would just flip the account from a debit balance account to a credit balance account. So if the credits were winning, we would have a credit balance in the factory overhead. And that's okay because it's just an estimate. It could be over-applied. It could be under-applied. We don't know. We do our best to make an estimate as close as possible. And it's possible to be under or over. Whatever the case may be, we need to do something with this 380. We need to make it go down. In this case, it's a debit. We're going to make it go down doing the opposite thing to it, which is a credit. Now, the other side we're going to put that to is like, where are we going to go with that, the other side? Because we don't know which job to put it to. That's the whole problem of us putting into factory overhead in the first place. And we're going to use, as we can see here, the cost of goods sold number. And our rationale for that is basically going to be that, eventually it's going to go to cost of goods sold. Because if we go through this process, we would hope it's going to go to factory overhead. If everything was done perfectly, it would have then go into work and process. And then we're going to sell that, and then it's going to go into finished goods. And then we're going to sell this inventory and expense it in the form of cost of goods sold. So this 380, we don't know where it really should be. Should it still be in work and process? Should it still be in finished goods? Or should it be in cost of goods sold? It could be either one of those if we had done things perfectly, if we knew exactly where to post everything out. Why then would we choose cost of goods sold? If it's in material, if it's small amount in relation to decision making, cost of goods sold is the easiest place to go. Because cost of goods sold will then roll out to net income. And then net income will roll out or roll into retained earnings. In other words, it'll go away after this first time period. So that's the easiest thing to do. If we want to make this zero and not have to worry about this number, then we can put it to a income statement account. The most logical one being cost of goods sold because it's related to inventory, which will then roll out to retained earnings at the end of the time period. And we won't have to worry about it. We'll start all over. So again, the question here often is, well, what happens to net income? You're distorting net income possibly by this 380. Because maybe it shouldn't be in cost of goods sold. Maybe it still should be in work and process or finished goods. And that could be the case, but usually and hopefully, it's immaterial to decision-making and it won't affect people's decision-making process. And therefore, it's OK. It's justifiable to do the easy thing and write it off to cost of goods sold, given the fact that it is an estimate. Now, if it is material, then we would want to go back through if it's going to affect decision-making. If this is a big number in relation to the other numbers that would affect what we think about the financial statements. Then we'd want to go through and say, OK, we should go back and try to figure out which job it should be applied to. Is it still in work and process finished goods or have those jobs been sold and try to allocate in some fashion to the jobs and properly allocated out as best we can? Again, there's no perfect way because it's an estimate. This bucket is just an estimated number. So we can try to do a reallocation and figure out where it should go. If we think the number would be material. If not, we'll do the easy thing here. And just record it to cost of goods sold. So that's what we do here. Now, note also that if this number happened to be a credit, then we would just do the opposite of this journal entry, meaning we would if this was a credit here, we'd have to do the opposite thing to make it go down. We would debit it and then we would credit cost of goods sold. And that might seem a little funny because you might say, why would we ever credit cost of goods sold? And because it's an expense account should only go up in the debit direction. And again, it's not about cost of goods sold. It's really about just getting this number to zero. We already know this number is wrong. It's only wrong because it's an estimate. If it's close enough, then that estimate is close enough. And all we're trying to do is make this zero. And we're kind of abandoning the normal rule to cost of goods sold, which is that it typically only goes up in the debit direction. In this case, we'll make it go down just to clear out this account. And because it's low, it's a low amount. So that's kind of our exception to the rule that I have said a few times that expenses typically only go up. So there's a few exceptions to the rule. This would be kind of an exception to that rule. If this amount happened to be a credit at the end of the year, meaning we had overapplied factory overhead, we would do the same journal entry, but of course the reverse of it to make factory overhead go down, we would have to debit it. And then the other side would have to go to cost of goods sold. We're not going to change the account. It's going to go to, and it would look funny because we would be crediting cost of goods sold. But again, that's okay because it's just an estimate. Okay, so if we do that, then our journal entry is going to be a debit to cost of goods sold, going from zero up by 380 to 380. And that's going to be this posting or posting to the general edger. Then we're going to post the factory overhead. It's going to go from 380 down in the credit direction in this case to zero. So if we look at our accounts over here, we've got the factory overhead at zero. That's the point. And then we have the 380 here which brought net income down. Now in our problem here, we haven't recorded the sales for the month yet. So the sales are going to be recorded in the next process. We wanted to keep the factory overhead journal entries kind of in the same place. So you can see them side by side of what happens. So remember that this really happens at the end of the time period, generally at the end of the month, we would clear out the factory overhead. And that's going to be after typically, hopefully we're going to have sales happening throughout the month. What we're going to record now is the next process that's within the flow of inventory, which is to move the work and process in the next presentations to the finished goods. And then some of those jobs will be sold recording sales and the cost of goods related to those jobs.