Final answer:
The spreading of underallocated or overallocated overhead among different inventory accounts is called the proration approach, which allocates the variance based on the relative sizes of the ending balances in each account.
Step-by-step explanation:
The process of spreading underallocated or overallocated overhead among ending work-in-process, finished goods, and cost of goods sold is known as the proration approach. This method is used to adjust the cost accounts after the actual overhead costs have been determined to be different from the estimated costs used during the period. Under this approach, any overhead variance is proportionally allocated among the ending balances of work-in-process inventory, finished goods inventory, and cost of goods sold based on their relative sizes.
To apply the proration approach, first calculate the total of the ending balances of the three inventory accounts, then determine the percentage of the total that each account represents. The underallocated or overallocated overhead amount is then prorated across the three categories by these percentages. This method ensures a more equitable distribution of overhead costs and provides a more accurate reflection of the actual cost of production.