What is Overapplied Overhead?
Definition: Overapplied overhead refers to the amount of money that goes unused despite being assigned to finance the production of units for a given accounting period. Such costs are synonymous with companies with robust manufacturing operations. Such companies allocate overhead expenses at the beginning of each accounting period on an estimated basis.
However, at the end of the accounting period, a situation arises whereby the charged amount is slightly higher than the sum incurred thus leading to overapplied overhead.
Companies incur different types of costs as part of the production process. Direct material costs go towards the purchase of raw materials used in the manufacturing process. Direct labor costs, on the other hand, cater to wages paid to workers that enable the production process.
Overheads, on the other hand, are costs that cannot be allocated in a satisfactory manner. In this case, companies are forced to make estimates on some of the costs they are likely to incur. Such costs can include wages paid to employees who aren’t part of the manufacturing process or expenses incurred on the purchase of disposable tools or protective devices.
Conversely, the allocation of overhead expenses is done on an estimated basis. Likewise, at the end of an accounting period, it may emerge that the costs charged are slightly lower than what was estimated at the start of the accounting period. Overapplied overhead occurs when there is some amount that is left unspent despite being allocated.
Overapplied Overhead Examples
Company ABC allocates overheads based on the machine hours used in production. Similarly, at the beginning of a quarter, it estimates that its machines will run for a total of 6,000 hours; consequently, it allocates overhead costs amounting to $60,000, which is $10 per hour.
However, at the end of the quarter, it emerges that the machines ran for 7,000 hours resulting in $70,000 worth of costs. The Overapplied overhead cost, in this case, would be $10,000.
Causes of Overapplied Overhead
In big manufacturing settings, it is impossible to avoid overapplied overhead, given that there are indirect costs that will always come into play. The fact that such costs cannot be traced to results means they have to be estimated at the start of each accounting period. For that reason, overapplied overhead is the overhead cost that is allocated to a specific department or production unit based on expected overhead costs.
Below are some of the reasons why Overapplied overhead come about
Labor costs
Overhead costs that firms take into account include costs of labor that are not directly used in the production of goods and services. Some of these costs include costs for building a new facility, as it is impossible to pinpoint the exact task that would be completed in future.
Facility Costs
Facility costs, especially those for financing renovations or renting facilities, also account for a big share of overapplied overhead. Managers must estimate at the beginning of the year the costs they are likely to be charged for the renovation of the production facility or for renting new facilities. Similarly, they may have to allocate funds for fixing a production units or equipment.
Resources
A buyer finding strong deals for goods and materials could lead to a reduction in overhead costs. By making new connections with vendors of raw materials, a business could end up spending much less than initially anticipated leading to overapplied overhead costs. This is especially the case when a business is testing new cost-saving production methods.
Increased Production
Plans to ramp up production can lead to an increase in overhead costs leading to overapplied overhead. For instance, a firm may have to estimate some of the costs needed to facilitate a much bigger production process.
Summary
Overapplied overhead in its purest form is the difference between the estimated overhead cost of a given manufacturing process and the manufacturing overhead cost actually incurred.