Definition of Underapplied overhead:
Before looking at how underapplied overhead works, it's important to define overhead costs. The term overhead is used to describe the costs associated with running a business. More specifically, these are expenses that a business incurs for its day-to-day operations but are not directly linked to the creation of a product or service. Overhead is important for businesses for a number of reasons including budgeting and how much to charge their customers in order to realize a profit.
The term underapplied overhead refers to a situation that arises when overhead expenses amount to more than what a company actually budgets for in order to run its operations. Underapplied overhead is normally reported as a prepaid expense on a company's balance sheet and is balanced by inputting a debit to the cost of goods sold (COGS) section by the end of the year. Costs of goods sold are the direct cost associated with the production of goods sold by a company. The amount of underapplied overhead is referred to as an unfavorable variance.
A situation in which the overhead applied to a work in progress (WIP) product is less than the overhead that the WIP actually incurs. This results in the manufacturing overhead having a debit balance. Underapplied overhead is reported on the balance sheet as a prepaid expense. At the end of the year, underapplied overhead is balanced by creating a debit to Cost of Goods Sold. Opposite of overapplied overhead.
How to use Underapplied overhead in a sentence?
- Underapplied overhead is an unfavorable variance because a business goes over budget.
- Underapplied overhead occurs when overhead expenses are more than what a company actually budgets.
- It is generally not considered negative because analysts and managers look for patterns that may point to changes in the business environment or economic cycle.
- This figure reported on a company's balance sheet as a prepaid expense or short-term asset as a credit, then offset by a debit to the cost of goods sold before the end of the fiscal year.
Meaning of Underapplied overhead & Underapplied overhead Definition