Underapplied Overhead
Candlefocus EditorThe impact of underapplied overhead will vary depending on the level of expenses incurred. Additionally, any underapplied overhead that is not caught can lead to an inconsistency in the reporting of actual expenses when compared to the budget. The most common way of dealing with underapplied overhead is to report it on the balance sheet as a prepaid expense or short-term asset, offset by a debit to the cost of goods sold before the end of the fiscal year and a credit to prepaid expenses.
Underapplied overhead should not be viewed as a negative figure as it may indicate something positive, such as a change in the business environment or economic cycle. It may also be caused due to a period of exceptionally high demand, meaning the underapplied overhead is justified. Analysts and managers therefore watch out for patterns and monitor the growth of the company to decide whether the underapplied overhead is a result of excessive spending or return of higher profits.
Overall, underapplied overhead should be viewed as a useful measure to gain insight into the business environment and assist a company in making more informed decisions regardless of whether it is favorable or unfavorable. By monitoring their expenditure and noting any discrepancies, a business can gain a better understanding of what needs to be adjusted or improved to increase profits and remain competitive.