Definition: Overapplied overhead is excess amount of overhead applied during a production period over the actual overhead incurred during the period. In other words, it’s the amount that the estimated overhead exceeds the actual overhead incurred for a production period.
What Does Over-Applied Overhead Mean?
Since overhead costs contribute to the production of inventory and are incurred throughout the production process, they must be allocated to each job. In a perpetual inventory system, inventory costs are updated in real time. This means management can’t wait until the end of the period to add up all of the overhead costs incurred and allocate them to each job. Instead, management needs to estimate the future overhead costs and allocate them throughout the production process.
This process is done by estimating a predetermined overhead rate that can be used to split costs between jobs and departments. At the end of the period, the estimated costs and the actual costs incurred are compared.
As with any estimation, the predetermined overhead rate isn’t always accurate. Sometimes the estimate is more than the actual amount and sometimes it’s less than the actual amount. Overapplied overhead happens when the estimated overhead that was allocated to jobs during the period is actually more than the actual overhead costs that were incurred during the production process. In a sense, the production managers came in “under budget” and achieved a lower overhead than the cost accountants estimated.
A journal entry must be made at the end of the period to reconcile the difference between the estimated amount and the actual overhead costs. In this case we would, debit the factory overhead account and credit the cost of goods sold account for the difference.