Underapplied Overhead

  

Categories: Accounting

That one secretary handles servicing three lawyers. She costs $90,000 a year all in ($20,000 for benefits, her 225 square feet of office space, insurance, phone, and whatnot...$5,000 for IRA matching thing, and $65,000 in salary). Her costs are then applied to those three lawyers as $30,000 a year in their overhead. That would be "fair" reporting of overhead.

So then...what would be the "under" for overhead? Well, if in calculating the costs of those lawyers to the firm, the firm's accountant just looked at the secretary's salary in applying her real costs, that would be underapplied overhead. Politicians do this all the time when they quote various public servants' salaries or "costs," conveniently omitting the costs of their pensions and benefits and all the other stuff.

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00:00

and finance Allah shmoop properly accounting for overhead And yes

00:08

it's an important question for very tail Giants and N

00:11

BA centers are also key question for business owners Will

00:15

you run a business that makes candles scented like particular

00:18

cities You know for people who have moved away and

00:21

gotten homesick You have your Brooklyn coffee shop model your

00:25

Dubai Lamborghini dealership model there your Paris and San Francisco

00:29

St Urine model Each candle cost you twelve bucks to

00:33

make and they sell for thirty each That twelve dollars

00:36

represents what's called any accounting world Caw gse Nora cost

00:40

of goods sold well It encompasses the direct expenses that

00:44

go into making the candles You know the wax the

00:46

wick the glass holder the artificial and natural ingredients needed

00:50

Teo make the smell It also includes things like direct

00:53

labor and all the other costs that you Khun directly

00:55

attribute to each candle But those CAW GSE expenses don't

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account for everything You've got a whole set of other

01:02

costs that get incurred for things outside of the production

01:05

process You've got the accounting in HR departments You've got

01:08

the R and D lab constantly trying to match smell

01:12

combinations with different cities You've got the fleet of executive

01:15

private jets and a small island in the Caribbean where

01:18

you hold your annual too weak you know think sessions

01:21

These things cost the company money but you can't assign

01:25

the expenses to any particular candle thes air known as

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Yes overhead costs Yeah because a while to get to

01:30

the title there But we did in accounting speak They

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get a special name They're known as SG any expenses

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or sales general and administrative expenses So we're talking stuff

01:41

related to sales or admin obviously plus anything that applies

01:44

to the company in general I eat not to any

01:46

particular product So like for your candle company these overhead

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costs Mike total five million bucks a month You have

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to pay those expenses those overhead expenses whether you sell

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one candle or yourself five million the overhead does not

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change based on your sales volume But you have to

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sell enough candles to reach that five million dollar mark

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Otherwise well you post a loss for that month enough

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losses in a row and well you'LL run out of

02:10

money and then the b word bankruptcy Remember you're selling

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candles for thirty bucks that cost twelve bucks to make

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The thirty represents your revenue That twelve represents your cog

02:20

which leaves eighteen left Poor candle for everything else So

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that eighteen dollars is known is the gross profit It's

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the prophet you earn from each candle net not counting

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the overhead cost The gross profit represents the first off

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along the income statement You started revenue and go through

02:36

COGSA and then you end up at the gross profit

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right there Well the next step takes care of the

02:41

S g N A Expenses You sell half a million

02:44

candles in a month Each one is worth a gross

02:46

profit of eighteen bucks there That's nine million dollars in

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total gross profit for that month Well you have five

02:53

million in overhead right It's sixty million a year to

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run your business Those DNA expenses all told five million

02:59

a month So what does that get you while you

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got nine million gross there minus the five million and

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overhead and that gives you four million bucks after overhead

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Well that four million dollars number represents what's called your

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operating profit or pretax profit If you want to know

03:12

you're operating margin Well you just relate that number to

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the revenue figure like that So you sold five hundred

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thousand candles at thirty bucks each Total revenue fifteen million

03:21

dollars With that sales lovely ended up with four million

03:23

in operating profit and four million divided by fifteen million

03:26

gives you an operating margin about twenty six point seven

03:29

Some like that So when you sold five hundred thousand

03:31

candles you paid all the expenses needed to make the

03:33

product Then he paid all your overhead which left you

03:36

with four million dollars over twenty six point seven percent

03:39

of your total revenue wealth To figure out your break

03:41

even point you just have to work through the process

03:44

backwards You have five million dollars in overhead you have

03:46

to pay for well Each candle gives you a gross

03:49

profit of eighteen dollars So the question How many eighteen

03:52

dollars bits of gross profit do you need to pay

03:55

for five million in overhead We just divide that five

03:58

million by eighteen and that gets you roughly two hundred

04:00

seventy seven thousand eight hundred seventy eight thousand candles That's

04:04

your break even production level Sell that many candles and

04:07

you'LL pay your overhead All sales beyond that point Well

04:10

generally fall to the bottom line like through that n

04:13

ba center Yeah you need to make sure all the

04:15

door jams and ceilings in your house or at least

04:17

eight feet tall Then you don't have to worry about 00:04:19.614 --> [endTime] you know bumping into that overhead

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