what is underapplied overhead 
the term underapplied overhead refers to a situation that arises when overhead expenses amount to more than what a company actually budgets for in order to run its operations underapplied overhead is normally reported as a prepaid expense on a company s balance sheet and is balanced by inputting a debit to the cost of goods sold cogs section by the end of the year costs of goods sold are the direct cost associated with the production of goods sold by a company the amount of underapplied overhead is referred to as an unfavorable variance understanding underapplied overheadbefore looking at how underapplied overhead works it s important to define overhead costs the term overhead is used to describe the costs associated with running a business more specifically these are expenses that a business incurs for its day to day operations but are not directly linked to the creation of a product or service overhead is important for businesses for a number of reasons including budgeting and how much to charge their customers in order to realize a profit underapplied overhead occurs when a business doesn t budget enough for its overhead costs this means the budgeted amount is less than the amount the business actually spends on its operations for example when a company incurs 150 000 in overhead after budgeting only 100 000 it has an underapplied overhead of 50 000 this is referred to as an unfavorable variance because it means that the budgeted costs were lower than actual costs put simply the business went over budget making the cost of goods sold more than expected as noted above underapplied overhead is reported on a company s balance sheet as a prepaid expense or a short term asset this debit item on the balance sheet must be offset at a future date in order to reconcile this the company s accounting department generally inputs a debit by the end of the year to the cogs section and a credit to the prepaid expenses section 