Proration Approach

The proration approach spreads under- or overallocated overhead among ending work-in-process inventory, finished-goods inventory, and cost of goods sold. No overhead costs are prorated to the materials inventory account because no manufacturing overhead costs have been allocated to it. We illustrate end-of-year proration in the Robinson Company example. Assume the following actual results for Robinson Company in 2020:

A spreadsheet screenshot shows the actual results for Robinson Company in 2020 that illustrates end-of-year proration. The categories that have been illustrated for three types of account are account balance before proration and manufacturing overhead in each account balance allocated in the current year before proration.

The details of the spreadsheet screenshot are as follows:

  1. Account: Work-in-process control

    • Account balance before proration: $50,000
    • Manufacturing overhead in each account balance allocated in the current year before proration: $16,200

  2. Account: Finished goods control

    • Account balance before proration: $75,000
    • Manufacturing overhead in each account balance allocated in the current year before proration: $31,320

  3. Account: Cost of goods sold

    • Account balance before proration: $2,375,000
    • Manufacturing overhead in each account balance allocated in the current year before proration: $1,032,480

  4. Total

    • Account balance before proration: $2,500,000
    • Manufacturing overhead in each account balance allocated in the current year before proration: $1,080,000

How should Robinson prorate the underallocated $135,000 of manufacturing overhead at the end of 2020?

On the basis of the total amount of manufacturing overhead allocated in 2020 (before proration) included in the ending balances of Work-in-Process Control, Finished Goods Control, and Cost of Goods Sold accounts. In the following table, the $135,000 underallocated overhead is prorated over the three accounts in proportion to the total amount of manufacturing overhead allocated (before proration) in column 2, resulting in the ending balances (after proration) in column 5.

A spreadsheet screenshot shows the actual results for Robinson Company in 2020 that illustrates end-of-year proration under various categories for three types of account such as work-in-process control, finished goods control, and cost of goods sold.

The details of the spreadsheet screenshot are as follows:

  1. Manufacturing overhead in each account balance allocated in the current year as a percent of total is equal to manufacturing overhead in each account balance allocated in the current year before proration divided by $1,080,000.

  2. Proration of $135,000 of under-allocated manufacturing overhead is equal to manufacturing overhead in each account balance allocated in the current year as a percent of total multiplied by $135,000.

  3. Account balance after proration is equal to account balance before proration plus proration of $135,000 of under-allocated manufacturing overhead.

The details of the various categories illustrated in the spreadsheet screenshot are as follows:

  1. Account: Work-in-process control

    • Account balance before proration: $50,000

    • Manufacturing overhead in each account balance allocated in the current year before proration: $16,200

    • Manufacturing overhead in each account balance allocated in the current year as a percent of total: 1.5%

    • Proration of $135,000 of under-allocated manufacturing overhead: $2,025

    • Account balance after proration: $52,025

  2. Account: Finished goods control

    • Account balance before proration: $75,000

    • Manufacturing overhead in each account balance allocated in the current year before proration: $31,320

    • Manufacturing overhead in each account balance allocated in the current year as a percent of total: 2.9%

    • Proration of $135,000 of under-allocated manufacturing overhead: $3,915

    • Account balance after proration: $78,915

  3. Account: Cost of goods sold

    • Account balance before proration: $2,375,000

    • Manufacturing overhead in each account balance allocated in the current year before proration: $1,032,480

    • Manufacturing overhead in each account balance allocated in the current year as a percent of total: 95.6%

    • Proration of $135,000 of under-allocated manufacturing overhead: $129,060

    • Account balance after proration: $2,504,060

  4. Total

    • Account balance before proration: $2,500,000

    • Manufacturing overhead in each account balance allocated in the current year before proration: $1,080,000

    • Manufacturing overhead in each account balance allocated in the current year as a percent of total: 100.0%

    • Proration of $135,000 of under-allocated manufacturing overhead: $135,000

    • Account balance after proration: $2,635,000

Robinson’s actual manufacturing overhead costs ($1,215,000) in 2020 exceed its allocated manufacturing overhead costs ($1,080,000) in 2020 by 12.5%. The prorated amounts in column 4 can also be derived by multiplying the balances in column 2 by 12.5%. For example, the $3,915 prorated manufacturing overhead to Finished Goods is 12.5 % × $ 31 , 320 . Adding the prorated amounts effectively results in Robinson allocating manufacturing overhead at 112.5% of what had been allocated before, and thus in Robinson using the actual manufacturing overhead rate. (Recall that Robinson’s actual manufacturing overhead rate ($45 per direct manufacturing labor-hour) exceeds the budgeted manufacturing overhead rate ($40 per direct manufacturing labor-hour) by 12.5%.) The journal entry to record this proration is

Journal entry to record proration

Work-in-Process Control: 2,025 dollars

Finished Goods Control: 3,915 dollars

Cost of Goods Sold: 129,060 dollars

Manufacturing Overhead Allocated: 1,080,000 dollars

Manufacturing Overhead Control: 1,215,000 dollars

If manufacturing overhead had been overallocated, the Work-in-Process Control, Finished Goods Control, and Cost of Goods Sold accounts would be decreased (credited) instead of increased (debited).

This journal entry closes (brings to zero) the manufacturing overhead-related accounts and restates the 2020 ending balances for Work-in-Process Control, Finished Goods Control, and Cost of Goods Sold to what they would have been if actual manufacturing overhead rates had been used rather than budgeted manufacturing overhead rates. This method reports the same 2020 ending balances in the general ledger as the adjusted allocation-rate approach discussed above. However, unlike the adjusted allocation-rate approach, the sum of the amounts shown in the subsidiary ledgers will not match the amounts shown in the general ledger after proration because no adjustments are made to the budgeted manufacturing overhead rates used in the individual job-cost records. The objective of the proration approach is to only adjust the general ledger to actual manufacturing overhead rates for purposes of financial reporting. The increase in the cost of goods sold expense by $129,060 as a result of the proration causes Robinson’s reported operating income to decrease by the same amount.

Some companies use the proration approach, but base it on the ending balances of Work-in-Process Control, Finished Goods Control, and Cost of Goods Sold accounts prior to proration (see column 1 of the preceding table). The following table shows that prorations based on ending account balances are not the same as the more accurate prorations calculated earlier based on the amount of manufacturing overhead allocated (before proration) to the accounts because the ratios of allocated manufacturing overhead costs to total costs in these accounts are not the same.

A spreadsheet screenshot shows the prorations based on ending account balances under various categories for three types of account such as work-in-process control, finished goods control, and cost of goods sold.

The details of the spreadsheet screenshot are as follows:

  1. Account balance as a percent of total is equal to account balance before proration divided by 2,500,000 dollars.

  2. Proration of 135,000 dollars of under-allocated manufacturing overhead is equal to account balance as a percent of total multiplied by 135,000 dollars.

  3. Account balance after proration is equal to account balance before proration plus proration of 135,000 dollars of under-allocated manufacturing overhead.

The details of the various categories illustrated in the spreadsheet screenshot are as follows:

  1. Account: Work-in-process control

    • Account balance before proration: 50,000 dollars

    • Account balance as a percent of total: 2.0 percent

    • Proration of 135,000 dollars of under-allocated manufacturing overhead: 2,700 dollars

    • Account balance after proration: 52,700 dollars

  2. Account: Finished goods control

    • Account balance before proration: 75,000 dollars

    • Account balance as a percent of total: 3.0 percent

    • Proration of 135,000 dollars of under-allocated manufacturing overhead: 4,050 dollars

    • Account balance after proration: 79,050 dollars

  3. Account: Cost of goods sold

    • Account balance before proration: 2,375,000 dollars

    • Account balance as a percent of total: 95.0 percent

    • Proration of 135,000 dollars of under-allocated manufacturing overhead: 128,250 dollars

    • Account balance after proration: 2,503,250 dollars

  4. Total

    • Account balance before proration: 2,500,000 dollars

    • Account balance as a percent of total: 100.0 percent

    • Proration of 135,000 dollars of under-allocated manufacturing overhead: 135,000 dollars

    • Account balance after proration: 2,635,000 dollars

However, proration based on ending balances is frequently justified as being an expedient way of approximating the more accurate results one would obtain by using allocated manufacturing overhead costs.