E3-1

Predetermined overhead rate:

Driver: Direct labor hours (DLH)

Est. DLH 40,000
Total estimated manufacturing overhead:
Fixed 466,000
Variable/DLH 3 120,000
Total 586,000

Predetermined overhead rate: 14.65 per DLH

E3-2

Predetermined overhead rate:

Driver: Direct labor hours (DLH)

Rate 277,200/12,000 23.10
Applied 12,600x23.10 291,060

E3-3

Predetermined overhead rate: 18 per DLH

Driver: Direct labor hours (DLH)
Cost Hours
Direct materia 200
Direct labor 120 120/12 10
Applied overhead:
10X18 180
Total manufacturing cost 500
Units 50 10
Exercise 3-14: Varying Predetermined Overhead Rates

Given:
Javadi Company makes a single product that is subject to wide seasonal variations
in demand. Javadi uses a job-order costing system and computes predetermined
overhead rates on a quarterly basis using the number of units to be produced as the
allocation base. Its estimated costs, by quarter, for the coming year are given below:

Quarter
First Second Third Fourth
Direct Materials $240,000 $120,000 $60,000 $180,000
Direct Labor 96,000 48,000 24,000 72,000
Manufacturing Overhead 228,000 204,000 192,000 ?
Total Manufacturing Costs $564,000 $372,000 $276,000 ?

Number of units to be produced 80,000 40,000 20,000 60,000

Estimated unit product cost $7.05 $9.30 $13.80 ?

Management finds the variation in quarterly unit product costs to be confusing and
difficult to work with. It has been suggested that the problem lies with manufacturing
overhead, since it is the largest element of total manufacturing cost. Accordingly,
you have been asked to find a more appropriate way of assigning manufacturing
overhead cost to units of product.

Required:
1. Using the high-low method, estimate the fixed manufacturing overhead cost per
quarter and the variable manufacturing overhead cost per unit. Creat a cost
formula to estimate the total manufacturing overhead cost for the fourth quarter.
Compute the total manufacturing cost and unit product cost for the fourth quarter.

Manufacturing
Dollars Units
High Values $228,000 80,000 $228,000
Low Values 192,000 20,000 Minus variable MO 48,000
Change in Costs $36,000 60,000 Fixed MOH $180,000
Variable MOH cost per unit $0.60
Fixed MOH cost per quarter $180,000 $180,000

Cost Formula for 4th Q MOH: Y = $180,000 + $.60(4th quarter units)

Y = $180,000 + $.60 (60,000) = $180,000 + $36,000 = $216,000

 Fourth
Direct Materials $180,000
Direct Labor 72,000
Manufacturing Overhead 216,000
Total Manufacturing Costs $468,000
60,000
$7.80

2. What is causing the estimated unit product cost to fluctuate from one quarter
to the next?

The fixed portion of the MOH cost is causing the unit product costs to fluctuate.
The unit product cost increases as the level of production decreases because
fixed overhead is being spread over fewer units.

3. How would you recommend stabilizing the company's unit product cost?
Support your answer with computations that adapt the cost formula you
created in requirement 1.

The unit product cost can be stabalized by using a predetermined overhead

rate that is based on expected activity for the entire year (200,000 units).

The cost formula created in requirement 1 can be adapted to compute the

annual predetermined overhead rate as follows:

Fixed cost for the year can be estimated as 4 times the quarterly
value of $180,000 or $720,000.

The variable portion would still be $.60 per unit produced.

Therefore the cost formula would be: $720,000 + $.60(units produced)

Since the yearly production is expected to be 200,000 the estimated MOH

cost is expected cost is $720,000 + ($.60 X 200,000) or $720,000 + $120,000
or $840,000. Thus, the stable yearly predetermined overhead would be
$840,000/200,000 = $4.20 per unit produced.
E3-4
Debit Credit
a Raw materials inventory Accounts pyable
Raw materials inventory 86,000 a 86,000 84,000 b 86,000 a
Accounts pyable 86,000

b Work in process 72,000

Manufacturing overhead 12,000
Raw materials inventory 84,000

c Work in process 105,000 Work in process Wages payable

Manufacturing overhead 3,000 b 72,000 108,000 c
Wages payable 108,000 c 105,000

d Manufacturing overhead 197,000

Various accounts 197,000

Manufacturing overhead
b 12,000
c 3,000
d 197,000
E3-5
Debit Credit
a Raw materials inventory Cash
Raw materials inventory 75,000 a 75,000 73,000 b
Cash 75,000 75,000 a
126,000 d
b Work in process inventory 67,000
Manufacturing overhead 6,000
Raw materials inventory 73,000

c Work in process inventory 134,000 Work in process inventory Wages payable

Manufacturing overhead 18,000 b 67,000 152,000 c
Wages payable 152,000 c 134,000
e 178,000 379,000 f
d Manufacturing overhead 126,000
Cash 126,000

e Work in process inventory 178,000

Manufacturing overhead 178,000 Manufacturing overhead Accounts payable
b 6,000 178,000 d
f Finished goods inventory 379,000 c 18,000
Work in process inventory 379,000 d 126,000
h 28,000
g Cost of goods sold 379,000
Finished goods inventory 379,000
Finished goods inventory Cost of goods sold
h Manufacturing overhead 28,000 f 379,000 379,000 g g 379,000 28,000 h
Cost of goods sold 28,000
Exercise 3-6 Schedules of Cost of Goods Manufacrtured and Cost of Goods Sold

Given:
Parmitan Corporation hyas provided the following data concerning last month's manufacturing
operations.

Purchases of raw materials $53,000

Indirect materials included in manufacturing overhead 8,000
Direct labor 62,000
Manufacturing overhead applied to work in process 41,000
Underapplied overhead 8,000

Beginning Ending
Raw materials inventory $24,000 $6,000
Work in process inventory 41,000 38,000
Finished goods inventory 86,000 93,000

Required:

1. Prepare a schedule of Cost of Goods Manufactured Schedule

Parmitan Corporation
Schedule of Cost of Goods Manufactured
For the month just completed year

Direct materials used:

Raw materials inventory, beginning $24,000
Add: Purchases of raw materials 53,000
Raw materials available for use $77,000
Less: Raw materials inventory, ending (6,000)
Raw materials used in production $71,000
Less: Indirect materials used 8,000
Direct Material Used $63,000
Direct labor incurred: 62,000
Manufacturing overhead applied 41,000
Total manufacturing costs added this period $166,000
Beginning work-in-process 41,000
Total work in process $207,000
Less: Work in process inventory, ending 38,000
Cost of goods manufactured $169,000

2. Prepare an income statement for the just completed year.

Parmitan Corporation
Cost of Goods Sold
For the month just completed year

Cost of goods sold:

Finished goods inventory, beginning $86,000
Add: Cost of goods manufactured 169,000
Cost of goods available for sale $255,000
Less: Finished goods inventory, ending 93,000
Unadjusted cost of goods sold $162,000
Add: Underapplied overhead 8,000
Adjusted cost of good sold $170,000
E3-7

Estimated total manufacturing overhead 171,200

Estimate activity level 8,000 Direct labor hours
Predtermined overhead rate 21.4 per direct labor hour

Applied manufacturing overhead 8,250 x 21.4 = 176,550

Actual manufacturing overhead 172,500
Overapplied manufacturing overhead 4,050

Cost of goods sold Will be reduced by 4,050

Gross margin (profit) Will be increased by 4,050
Problem 3-25: Comprehensive Problem -- J/Es, T-Accounts, Financial Statements

Given:
Southworth Company uses a job-order costing system and applies manufacturing
cost to jobs on the basis of the cost of direct materials used in production. At the
beginning of the current year, the following estimates were made for the purpose
of computing the predetermined overhead rate:
Estimated Actual
Manufacturing overhead cost $248,000 $243,000
Direct materials cost $155,000 $150,000
MOH rate $1.60 160% $1.62

The following transactions took place during the year (all purchases and services
were acquired on account):
a. Raw materials purchased $142,000
b. Raw materials requisitioned for use in production (all DM) $150,000
c. Utility bills incurred in the factory $21,000 $21,000

d. Costs for salaries and wages were incurred as follows:

Direct labor $216,000
Indirect labor $90,000 $90,000
Selling and Administrative Salaries $145,000

e. Maintenance costs incurred in the factory $15,000 $15,000

f. Advertising costs incurred $130,000
g. Depreciation recorded for the year $50,000
90% relates to factory assets $45,000 $45,000
10% relates to Selling & Administrative $5,000
h. Rental cost incurred on buildings $90,000
80% is factory related $72,000 $72,000
20% is selling & administrative related $18,000
i. Misc. selling & administrative costs $17,000
j. Manufacturing overhead cost applied to jobs ?
k. Cost of goods manufactured for the year $590,000
l. Sales for the year on account $1,000,000
Cost of goods sold (from job cost sheets) $600,000

Inventory balances at the beginning of the year

Raw materials $18,000
Work in Process $24,000
Finished Goods $35,000

Required:
Debit Credit
1. Prepare journal entries to record the above data.

a. Raw Materials Inventory 142,000

Accounts Payable 142,000
To record purchase of direct materials

b. Work In Process Inventory, Job #???? 150,000

Raw Materials Inventory 150,000
To record materials requisitions
 c. Manufacturing Overhead 21,000
Accounts Payable 21,000
To record factory utilities

d. Work-in-Process Inventory, Jobs #???? 216,000

Manufacturing Overhead 90,000
Selling and Administrative Salaries Expense 145,000
Wages and Salaries Payable 451,000
To record payroll

e. Manufacturing Overhead 15,000

Accounts Payable 15,000
To record factory maintenance

f. Advertising Expense 130,000

Accounts Payable 130,000
To record advertising expense incurred

g. Manufacturing Overhead 45,000

Depreciation Expense, Selling & Administrative 5,000
Accumulated Depreciation, Selling & Administrative 5,000
Accumulated Depreciation, Factory 45,000
To record depreciation

h. Manufacturing Overhead 72,000

Rental Expense 18,000
Accounts Payable 90,000
To record cost of rent

i. Misc. Selling and Administrative Expense 17,000

Accounts Payable 17,000
To record misc. selling & administrative expense

j. Work In Process Inventory, Job #???? 240,000

Manufacturing Overhead 240,000
To record the application of MOH

k. Finished Goods Inventory 590,000

Work In Process Inventory, Job #???? 590,000
To record completed goods transferred to FG

l. Accounts Receivable, Name??? 1,000,000

Sales 1,000,000
To record sales on account

Cost of Goods Sold 600,000

Finished Goods 600,000
To record cost of goods sold

4. Prepare a journal entry to close any balance in the Manufacturing

Overhead account to COGS.

m. Cost of Goods Sold 3,000

Manufacturing Overhead 3,000
 To close the Manufacturing Overhead Account

2. Post entries to T-accounts. Determine the ending balances in the

inventory accounts and in the manufacturing overhead account.

Raw Materials Inventory Manufacturing Overhead

BB 18,000 BB 0
a. 142,000 c. 21,000
b. 150,000 d. 90,000
EB 10,000 e. 15,000
g. 45,000
h. 72,000
243,000 j. 240,000
B 3,000
m. 3,000
EB 0

Work In Process Inventory Accounts Payable

BB 24,000 BB ??
b. 150,000 a. 142,000
d. 216,000 c. 21,000
j. 240,000 e. 15,000
k. 590,000 f. 130,000
40,000 h. 90,000
i. 17,000
415,000

Finished Goods Inventory Wages & Salaries Payable

BB 35,000 BB 0
k. 590,000 d. 451,000
l. 600,000
25,000

Accounts Receivable Sales

BB ?? BB 0
l. 1,000,000 l. 1,000,000

Cost of Goods Sold S & A. Salaries Expense

BB 0 BB 0
l. 600,000 d. 145,000
m. 3,000
603,000

Advertising Expense Depreciation Exp., S & A

BB 0 BB 0
f. 130,000 g. 5,000

Acc. Depr., Selling & Admin. Acc. Depreciation, Factory

BB 0 BB 0
 g. 5,000 g. 45,000

Rental Expense Misc. Selling & Admin. Exp.

BB 0 BB 0
h. 18,000 i. 17,000

3. Prepare a schedule of cost of goods manufactured

Southworth Company
Schedule of Cost of Goods Manufactured
For the Period ended on ___________

Raw Material Inventory, Beginning $18,000

Plus: Purchases of raw materials during period 142,000
Raw material available for use during period $160,000
Less: Raw Material Inventory, Ending 10,000
Raw material used in production $150,000
Direct labor incurred during period 216,000
Manufacturing overhead applied to work in process 240,000
Total Manufacturing Costs Added to Production $606,000
Plus: Work-in-Process Inventory, Beginning Balance 24,000
Total manufacturing costs to account for $630,000
Less: Work-in-Process Inventory, Ending Balance 40,000
Cost of Goods Manufactured $590,000

4. Prepare a journal entry (J/E) to close any balance in the Manufacturing

Overhead account to Cost of Goods Sold.

See J/E " m." above.

Prepare a schedule of cost of goods sold.

Southworth Company
Schedule of Cost of Goods Sold
For the Period ended on ___________

Finished Goods Inventory, beginning $35,000

Plus: Cost of Goods Manufactured 590,000
Cost of Goods Available for Sale $625,000
Less: Finished Goods Inventory, ending (25,000)
Unadjusted Cost of Goods Sold $600,000
Plus: Underapplied manufacturing overhead 3,000
Adjusted Cost of Goods Sold $603,000

5. Prepare an income statement for the year.

Southworth Company
Statement of Income
For the Period ended on ___________

Sales $1,000,000
Less: Adjusted Cost of Goods Sold 603,000
 Gross Margin $397,000
Selling and Administrative Expenses:
Salaries Expense $145,000
Advertising Expense 130,000
Depreciation Expense 5,000
Rent Expense 18,000
Miscellaneous Expense 17,000 315,000
Net Operating Income $82,000

6. Job 218 was one of the many jobs started and completed during the
year. The job required $3,600 in DMs and 400 hours of DL time at a
rate of $11 per hour. If the job contained 500 units and the company
billed at 75% above the unit product cost on the job cost sheet, what
price per unit would have been charged to the customer?

Cost assigned to Job 218:

Direct materials $3,600
Direct labor 4,400
Applied manufacturing overhead ($1.60/DM$) 5,760 5,760
Total manufacturing costs $13,760
Add: Markup based on 75% of TMC 10,320
Anticipated sales billings for Job 218 $24,080
Divided units produced 500
Price Per Unit Produced $48.16
Exercise 3-16: Applying Overhead; J/Es; Disposition of Underapplied or Overapplied Overhead

Given:
The following information is taken from the accounts of FasGrow Company. The entries in the
T-accounts are summaries of the transaction that affected those accounts during the year.

Manufacturing Overhead Work In Process Inventory

a. 380,000 Bal. 105,000
b. 410,000 c. 760,000
210,000
Bal. 30,000 115,000
b. 410,000
80,000

Finished Goods Inventory Cost of Goods Sold

Bal. 160,000 d. 820,000
c. 760,000
d. 820,000

Bal. 100,000

The overhead that had been applied to production during the year is distributed among the
ending balances in the accounts as follow:

Work in Process, ending $32,800

Finished Goods, ending 41,000
Cost of Goods Sold 336,200
$410,000

For example, of the $80,000 ending balance in WIP, $32,800 was overhead that had been
applied during the year.

Required:

1. Identify the reasons for entries (a) through (d).

(a) To record the actual MOH incurred during the current time period.
(b) To record applied MOH assigned to production during the current time period.
(c) To record cost of goods manufactured for the current time period.
(d) To record the cost of goods sold for the current time period.

2. Assume that the company closes any balance in the MOH directly to COGS.
Prepare the necessary journal entry.
Debit Credit
Manufacturing Overhead 30,000
Cost of Goods Sold 30,000
To close the Manufacturing Overhead Account

3. Assume instead that the company allocates any balance in the MOH account to the
other accounts in proportion to the overhead applied during the year that is in the
ending balance in each account. Prepare the necessary journal entry, with
supporting computations.
Debit Credit
Manufacturing Overhead 30,000
Work in Process Inventory 2,400
Finished Goods Inventory 3,000
Cost of Goods Sold 24,600
To close the Manufacturing Overhead Account
Case 3-29: Plantwide versus Departmental MOH Rates; Under/Overapplied Overhead

Given:
"Don't tell me we've lost another bid!" exclaimed Sandy Kovallas, president of Lenko Products,
Inc. "I'm afraid so," replied Doug Martin, the operations vice president. "One of our competitors
underbid us by about $10,000 on the Hastings job." "I just can't figure it out," said Kovallas. "It
seems we're either too high to get the job or too low to make any money on half the jobs we bid
any more. What's happened?"

Lenko Products manufactures specialized goods to customers' specifications and operates a job-
order costing system. Manufacturing overhead cost is applied to jobs on the basis of direct labor
cost. The following estimates were made at the beginning of the year:

Department
Cutting Machining Assembly Total Plant
Direct labor $300,000 $200,000 $400,000 $900,000
Manufacturing overhead $540,000 $800,000 $100,000 $1,440,000

Jobs require varying amounts of work in the three departments. The Hastings job, for
example, would have required manufacturing costs in the three departments as follows:

Department
Cutting Machining Assembly Total Plant
Direct materials $12,000 $900 $5,600 $18,500
Direct labor $6,500 $1,700 $13,000 $21,200
Manufacturing overhead ? ? ? $0

The company uses a plantwide overhead rate to apply manufacturing overhead costs
to jobs.

Required:
1. Assuming the use of a plantwide rate:
a. Calculate the MOH rate for the current year

Predetermined MOH Rate = Estimated TMOH $/ Estimated total amount of the allocation base

Predetermined MOH Rate = $1,440,000 / $900,000 = $1.60 160%

b. Determine the amount of MOH $ that would have been applied to the Hastings job.

Applied MOH = MOH Rate X Actual use of the allocation based used to the determine rate

Applied MOH = $1.60 X $21,200 = $33,920

2. Suppose that instead of using a plantwide overhead rate, the company had used a
separate predetermined overhead rate in each department. Under these conditions:
a. Compute the MOH rate for each department for the current year.

Predetermined MOH Rate = Estimated TMOH $/ Estimated total amount of the allocation base

Department
Cutting Machining Assembly Total Plant
Manufacturing overhead $540,000 $800,000 $100,000 $1,440,000
Direct labor cost $300,000 $200,000 $400,000 $900,000
MOH Rate per DL $ $1.80 $4.00 $0.25 $1.60
MOH Rate as a % of DL $ 180% 400% 25% 160%

b. Determine the amount of MOH cost that would have been applied to the Hastings job.

Department
Cutting Machining Assembly Total Plant
Direct materials $12,000 $900 $5,600 $18,500
Direct labor $6,500 $1,700 $13,000 $21,200
Manufacturing overhead $11,700 $6,800 $3,250 $21,750

3. Explain the difference between the MOH that would have been applied to the Hastings
job using the plantwide rate in question 1 (b) above and using the departmental rates
in question 2 (b).

The bulk of the labor cost on the Hastings job is in the Assembly Department, which incurs
very little overhead cost. The department has an overhead rate of only 25% of direct labor
 cost as compared to much higher rates in the other two departments.

As indicated above, use of departmental MOH overhead rates results in a much smaller
amount of overhead cost charged to the Hastings job than if a plantwide rate is used.

The use of a plantwide overhead rate redistributes MOH costs proportionally between the
three departments (at the rate of 160% of DL costs) and results in a larger amount of MOH
cost being charged to the Hastings job, as shown in Part 1. Use of the plantwide MOH rate
may help explain why the company bid too high and lost the job.

If a plantwide MOH rate is being used, the company will tend to charge too little MOH cost
to jobs that require a large amount of labor in the Cutting or Machining Departments. The
reason is that the plantwide overhead rate (160%) is much lower than the rates if these
departments were considered separately (180% and 400%).

4. Assume that it is customary in the industry to bid jobs at 150% of total manufacturing
cost (direct materials, direct labor, and applied MOH). What was the company's bid
price on the Hastings job? What would the bid price have been if departmental MOH
rates had been used to apply MOH costs?

Bid Based On Plantwide MOH Rate Department

Cutting Machining Assembly Total Plant
Direct materials $12,000 $900 $5,600 $18,500
Direct labor 6,500 1,700 13,000 21,200
Manufacturing overhead 10,400 2,720 20,800 33,920
Total Manufacturing Costs $28,900 $5,320 $39,400 $73,620
Customary markup 50% 36,810
Bid price on Hastings job (TMC X $1.50) $110,430

Bid Based On Departmental MOH Rate Department

Cutting Machining Assembly Total Plant
Direct materials $12,000 $900 $5,600 $18,500
Direct labor 6,500 1,700 13,000 21,200
Manufacturing overhead 11,700 6,800 3,250 21,750
Total Manufacturing Costs $30,200 $9,400 $21,850 $61,450
Customary markup 50% 30,725
Bid price on Hastings job (TMC X $1.50) $92,175

Difference in Bid price if departmental MOH rates are used $18,255

5. At the end of the year, the company assembled the following actual cost data relating
to all jobs worked on during the year:

Actual manufacturing costs Department

Cutting Machining Assembly Total Plant
Direct materials $760,000 $90,000 $410,000 $1,260,000
Direct labor 320,000 210,000 340,000 870,000
Manufacturing overhead 560,000 830,000 92,000 1,482,000 1.7034483
Total Manufacturing Costs $1,640,000 $1,130,000 $842,000 $3,612,000

Compute the underapplied or overapplied for the year

(a) assuming that a plantwide overhead rate is used

Department
Cutting Machining Assembly Total Plant
Actual MOH Incurred $560,000 $830,000 $92,000 $1,482,000
Applied MOH 512,000 336,000 544,000 1,392,000
Underapplied Overhead $48,000 $494,000 ($452,000) $90,000

(b) assuming that departmental overhead rates are used

Department
Cutting Machining Assembly Total Plant
Actual MOH Incurred $560,000 $830,000 $92,000 $1,482,000
Applied MOH 576,000 840,000 85,000 1,501,000
Overapplied Overhead ($16,000) ($10,000) $7,000 ($19,000)
Problem 3A-3: Predetermined Overhead Rate and Capacity

Given:
Skid Road Recording, Inc., is a small audio recording studio located in Seattle. The company handles
work for advertising agencies -- primarily for radio ads -- and has a few singers and bands as clients.
Skid Road Recording handles all aspects of recording from editing to making a digital master from
which CDs can be copied. The competition in the audio recording industry in Seattle has always been
tough, but it has been getting even tougher over the last several years. The studio has been losing
customers to newer studios that are equipped with more-up-to-date equipment and that are able to
offer very attractive prices and excellent service. Summary data concerning the last two years of
operations follows:
2010 2011
Estimated hours of studio services 1,000 750
Estimated studio overhead cost $90,000 $90,000
Actual hours of studio service provided 900 600
Actual studio overhead cost incurred $90,000 $90,000
Hours of studio service at capacity 1,800 1,800

The company applies studio overhead to recording jobs on the basis of the hours of studio service
provided. For example, 30 hours of studio time were required to record, edit, and master the Slug
Fest music CD for a local band. All the studio overhead is fixed, and the actual overhead cost
incurred was exactly as estimated at the beginning of the year in both 2010 and 2011.

Required:
1. Skid Road Recording computes its predetermined overhead rate at the beginning of each year
based on the estimated studio overhead and the estimated hours of studio service for the year.
How much overhead would have applied to the Slug Fest job if it had been done in 2010? In
2011? By how much would overhead have been underapplied or overapplied in 2010? In 2011?

Predetermined overhead rate = Estimated studio overhead cost/Estimated hours of studio services

2010 2011
Predetermined rate
Estimated studio overhead cost $90,000 $90,000
Estimated hours of studio services 1,000 750
Predetermined overhead rate $90 $120
Studio time used on Slug Fest job 30 30
Applied overhead to Slug Fest job $2,700 $3,600

2010 2011
Calculation of Under/Overapplied Overhead
Actual hours of studio service provided 900 600
Predetermined overhead rate $90 $120
Applied overhead $81,000 $72,000
Actual studio overhead cost incurred $90,000 $90,000
Underapplied overhead ($9,000) ($18,000)

2. The president of Skid Road Recording has heard that some companies in the industry have
changed to a system of computing the predetermined overhead rate at the beginning of each
year based on the estimated studio overhead for the year and the hours of studio service that
could be provided at capacity. He would like to know what effect this method would have on
job costs. How much overhead would have been applied using this method to the Slug Fest
job if it had been done in 2010? In 2011? By how much will overhead have been underapplied
 or overapplied in 2010 using this method? In 2011?

Predetermined overhead rate = Estimated studio overhead cost/Capacity hours of studio services

2010 2011
Predetermined rate
Estimated studio overhead cost $90,000 $90,000
Capacity hours of studio services 1,800 1,800
Predetermined overhead rate $50 $50
Studio time used on Slug Fest job 30 30
Applied overhead to Slug Fest job $1,500 $1,500

2010 2011
Calculation of Under/Overapplied Overhead
Actual hours of studio service provided 900 600
Predetermined overhead rate $50 $50
Applied overhead $45,000 $30,000
Actual studio overhead cost incurred $90,000 $90,000
Underapplied overhead ($45,000) ($60,000)

3. How would you interpret the underapplied or overapplied overhead that results from using studio
hours at capacity to compute the predetermined overhead rate?

When the predetermined overhead rate is based on capacity, underapplied overhead is

interpreted as the cost of idle capacity. This underapplied overhead can be treated as a
period expense that would be separately disclosed on the Income statement as Cost of
Unused Capacity.

4. What fundamental business problem is Skid Road Recording facing? Which method of
determinimg the predetermined overhead rate is likely to be more helpful in facing this problem?
Explain.
Fundamental problem: competition is drawing customers away

Use of estimated hours as the predetermined overhead base can cause a death spiral
Lower volume causes higher cost which leads to higher prices which leads to lower
volume which leads to higher costs which leads to higher prices which leads to lower
volume, etc.

Use of capacity hours as the predetermined overhead base will avoid the death spiral.
Predetermined overhead rate is stable throughout.

While basing the predetermined rate on capacity (rather than on estimated activity) will
not solve the company's basic problem (decreasing mkt. share), at least this method
will be less likely to send managers misleading signals.
Problem 3B-5: Classification of Labor Costs

Given:
Lynn Bjorland is employed by Southern Laboratories and is directly involved in preparing
the company's leading antibiotic drug. Lynn's basic wage rate is $24 per hour. The
company pays its employees time and a half for any work in excess of 40 hours per
week.

Required:

1. Suppose that in a given week Lynn works 45 hours. Compute Lynn's total wages for
the week. How much of this cost would the company allocate to direct labor cost? To
manufacturing overhead?
Hours Rate Total
Direct labor costs 45 $24 $1,080
MOH-Overtime Premium 5 $12 60
$1,140

Regular Pay 40 $24 $960

Overtime Pay 5 $36 180
$1,140

2. Suppose in another week that Lynn works 50 hours but is idle for 4 hours during the
week due to equipment breakdowns. Compute Lynn's total wages for the week. How
much of this amount would be allocated to direct labor cost? To manufacturing
overhead?
Hours Rate Total
Direct labor costs 46 $24 $1,104
MOH idle time 4 $24 96
MOH overtime premium 10 $12 120
$1,320

Regular Pay 40 $24 $960

Overtime Pay 10 $36 360
$1,320

3. Southern Laboratories has an attractive package of fringe benefits that costs the
company $8 for each hour of employee time (either regular time or overtime).
During a particular week Lynn works 48 hours but is idle for 3 hours due to
material shortages. Compute Lynn's total wages and fringe benefits for the week.
If the company treats all fringe benefits as part of manufacturing overhead cost,
how much of Lynn's wages and fringe benefits for the week would be allocated
to direct labor cost? To manufacturing costs?

Hours Rate Total

Direct labor costs 45 $24 $1,080 $1,080
MOH idle time 3 $24 $72
MOH overtime premium 8 $12 $96
MOH fringe benefits 48 $8 384
Total MOH $552
$1,632 $1,632

Regular pay 40 $32 $1,280

Overtime pay 8 $44 352
$1,632
4. Refer to the data in (3) above. If the company treats that part of fringe benefits
relating to direct labor as added direct labor cost, how much of Lynn's wages and
fringe benefits for the week will be allocated to direct labor cost? To MOH cost?

Hours Rate Total

Direct labor costs 45 $32 $1,440 $1,440
MOH idle time 3 $24 $72
MOH fringe benefits 3 $8 24
MOH overtime premium 8 $12 $96
Total MOH $192
$1,632 $1,632

Regular pay 40 $32 $1,280

Overtime pay 8 $44 352
$1,632