Question

A company has UNDERAPPLIED overhead for the year. If all other things remain constant, which of the following will give the company the highest net operating income?

Multiple Choice

• Allocating the underapplied overhead to the appropriate accounts

• Closing the underapplied overhead totally to Cost of Goods Sold

Answer 1

If the company has Underapplied Overhead for the year, it means that the budgeted manufacturing overhead is less than the actual manufacturing overhead spent on production. It is recorded as a prepaid expense in the financial statements and than it will be added to cost of goods sold at the end of the year.

So, it will be recorded as aprepaid expense on the accounting ledger and at the end of the year it will be added in costof goods sold, thus increasing expenses on the income statement and decreasing the net operating income of that period. Whether the business decides to record the total sum to cost of goods sold or a portion of the sum to cost of goods sold, work-in-progress,and finished goods, in both situations, the effect of underapplied overhead on the financial statements does not change.

So both the options will effect the same way.