 In this presentation, we will take a look at the adjustment for over or under applied overhead. First, let's take a look at the recap of the process of overhead. What goes through the process or what steps we need to have. 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 through the processing and recording of overhead. First we typically set up the predetermined overhead rate based on last year's information. We set up the predetermined overhead rate. We then record actual overhead. We know what the actual overhead is. We're going to record the overhead, but we probably don't know which department that it needs to go to. So we have the actual overhead, therefore not going into work and process, but to the departments within apply estimated overhead to specific processes. And this is going to be the estimate of us applying out the overhead to the processes. It is only an estimate. So therefore, these two items will not match often times and note that in a perfect world, this would be in a linear situation. We would do this first, then this and then this. If we had that kind of ordering, it may be possible for us to apply out the actual overhead, but in the case where there isn't perfect ordering, we have to use of course some type of estimate. That estimate means that the actual overhead will not be the same as the amount that will be applied out. And therefore, we will have to deal with in that case, what happens now where we have an under or over applied overhead and we'll have to adjust for that. We're going to have some amount then, in other words, left in overhead, which is either under applied or over applied, which will now have to make zero because we want to be able to start this process over without having anything in the overhead account. So in this case, in this example, you can see what actually happened. If you consider the factory overhead account, you're going to consider what side of it is the actual and what side of it is applied. Overhead is basically, we can think of it as an asset type account or goes up with debit or has a normal debit balance and then it goes down with a credit. So in this case, the actual items, these items on the left, the debit, are going to be the increases in overhead. All the stuff that we had a cost for, but we didn't know where to apply it to. Therefore put it into the factory overhead, indirect labor, indirect materials, other depreciation of the factory, utilities on the factory, anything on the factory that we couldn't apply out, those are the actual. And then this number must be what we applied out. That's what we took out. So you can see this happened in kind of linear fashion. It went up, up, up, up, increasing the balance for all the activity. And then we applied out, out to the actual work and process account in this case. But the amount we applied out is not the same as the actual cost. Notice the actual was at 700, 7,100 and the amount we applied out was less 6,720. Therefore we under applied. And notice if you see it in this format, you can kind of work it out in your head and say, what does it mean to be under or over applied. In a lot of test type questions, they may not give you all this detail and they may just tell you it was under or applied or over applied. And what you want to do is write down a T account or something like this and actually kind of jot this down, jot down the debits and the credits and then think about what does it mean to be under applied or over applied. In this case, this is how much the actual was, this is how much was applied out. It's less than the actual and therefore we under applied. We applied less than the actual and we're left with a debit balance because we're left with some of the actual that wasn't applied out because it was under applied. Once we know that, once we know that we have a debit balance then it's pretty easy to know what we need to do. We need to get rid of that debit balance. And usually if it's immaterial, we just take it to the cost of good sold account meaning we're just going to debit the cost of good sold and credit this account just to make it go to zero. Why? Because the cost of good sold is really where the end process will be meaning after it goes through all of the inventory accounts it'll clear out the cost of good sold when it is sold. And what we want to do is have it go to a temporary account because it's immaterial. We don't want to see it again. We want it to go away. If we put it into another one of these inventory accounts or a permanent account, a balance sheet account it won't go away once we clear out the closing process but if we put it into the cost of good sold then it's through the closing process this whatever is in net income at the end of the time period will roll in to retained earnings and we won't see it anymore. So it'll kind of wash out in cost of good sold and because of course we're hoping it's small, it's immaterial then it would be appropriate for us to do that and basically put it into cost of good sold that being the easiest thing to do so then it will then close out in the closing process and we'll be okay to just start over in the next month. So that process then we're gonna say cost of good sold is gonna be increased and then the other side is gonna be taking down the factory overhead. So our cost of good sold then goes up and then the factory overhead is gonna go down to zero. So now we're at zero, that's what we want so that we can then start over from a fresh start in the next time period. Now note that the reverse could have happened here. It could quite well be that we over applied what if this number was bigger than this number? If this number was bigger than this number then we would end up with a credit balance. Let's just say it was bigger by $1,000. We would end up with a credit balance in the factory overhead, which shouldn't happen because notice it's kind of a debit balance account. It's kind of like a clearing account in that it goes up and then it goes down to zero in the time period. So a temporary account or a clearing account but it usually has a debit balance because it goes up and then we apply out, you would think if it was a perfect world it would increase and then we would apply out that increase. It shouldn't go negative, that would be funny. That means we applied out more or in other words we over applied. That would be the case where we over applied. Now if we over applied then all we would do is just say okay I know this has a credit balance so I'm gonna do whatever I need to do to make it go to zero to start over next time. And in this case it would be the same journal entry but we would have to debit the factory overhead by a thousand in our example, a thousand and credit 1,000 to the cost of goods sold because we're gonna do whatever we need to do to make this go down to zero. And this looks a little bit funny because normally cost of goods sold is an expense account and it doesn't normally go down. So usually it only goes up. This is an exception to the rule. The rule typically being cost of goods sold only goes up. In this case we're gonna say it goes down. Why does it go down? Because it's immaterial and we need to do this to correct for an estimate basically. So because it's a small amount, because we know it's an estimate, because it's immaterial, we're gonna break the rule and say we're gonna decrease an expense account here and do what we need to do, whatever we need to do to make this small amount, this estimated amount small in comparison to everything else, hopefully that's gonna be the idea, go down to zero. So we do whatever we do, we need to do to get the factory overhead to zero and typically the other side goes to the cost of goods sold. That's the easiest thing to do and that's okay typically if it is immaterial to do so.