During 2012, a company incurs $500,000 of manufacturing overhead costs and allocates out $460,000 of manufacturing overhead costs. At year-end, the adjustment entry needed to clear the overhead balance to zero will include a debit to Cost of goods sold.

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If only $460,000 of manufacturing overhead costs were allocated, then there is an underallocated amount of $40,000 ($500,000 - $460,000). To clear this balance, an adjustment entry is needed, which will include a debit to Cost of goods sold. This is because underallocated overhead means that actual overhead costs were higher than allocated overhead costs, which means that more manufacturing costs should be recorded as an expense in the income statement.

During 2012, a Company Incurs $500,000 of Manufacturing Overhead Costs