Question

At the end of the year, overhead applied was 3,737,000. Actual overhead was3,379,000. Closing over/underapplied overhead into cost of goods sold would cause net income to ________?

1) increase
2) decrease
3) remain unchanged
4) cannot be determined

Answer 1

Closing overapplied overhead into cost of goods sold decreases cost of goods sold and increases net income. Overapplied overhead occurs when applied overhead exceeds actual overhead costs. Spreading the overhead correlates to reducing average fixed cost per unit by increasing production.

Step-by-step explanation:

When overhead is applied to products during the year, the company estimates the amount of overhead that will be incurred. At the end of the year, these estimates are reconciled with the actual overhead costs. In this scenario, the overhead applied was $3,737,000 and the actual overhead was $3,379,000. There is an overapplied overhead situation because less overhead was actually incurred than was applied to the products. Therefore, closing the overapplied overhead into the cost of goods sold would result in a decrease in the cost of goods sold, thereby causing net income to increase.

Using the concept of spreading the overhead, the fixed cost such as the supposed $1,000 overhead is allocated across the units produced. The average fixed cost curve typically slopes downward as production increases because fixed costs are spread over more units, reducing the cost per unit. Therefore, 'spreading the overhead' refers to allocating the fixed cost over the produced units to determine their share of the overhead cost.