Question

Luzadis Company makes furniture using the latest automated technology. The company uses a job-order costing system and applies manufacturing overhead cost to products on the basis of machine-hours. The predetermined overhead rate was based on a cost formula that estimates $1,068,000 of total manufacturing overhead for an estimated activity level of 89,000 machine-hours. During the year, a large quantity of furniture on the market resulted in cutting back production and a buildup of furniture in the company’s warehouse. The company’s cost records revealed the following actual cost and operating data for the year: Machine-hours 74,000 Manufacturing overhead cost $ 1,029,000 Inventories at year-end: Raw materials $ 10,000 Work in process (includes overhead applied of $44,400) $ 91,000 Finished goods (includes overhead applied of $150,960) $ 309,400 Cost of goods sold (includes overhead applied of $692,640) $ 1,419,600 Required: 1. Compute the underapplied or overapplied overhead. 2. Assume that the company closes any underapplied or overapplied overhead to Cost of Goods Sold. Prepare the appropriate journal entry. 3. Assume that the company allocates any underapplied or overapplied overhead proportionally to Work in Process, Finished Goods, and Cost of Goods Sold. Prepare the appropriate journal entry. 4. How much higher or lower will net operating income be if the underapplied or overapplied overhead is allocated to Work in Process, Finished Goods, and Cost of Goods Sold rather than being closed to Cost of Goods Sold?

Answer 1

Requirement 1:- Compute the underapplied or overapplied overhead.

Solution:- Underapplied overhead = $141,000

Predetermined overhead rate = Estimated manufacturing overhead / Estimate machine hours

Predetermined overhead rate = $1,068,000 / 89,000

Predetermined overhead rate = $12

Calculation of Underapplied or overapplied overhead

Total manufacturing overhead cost actually incurred	$1,029,000
Total manufacturing overhead applied to work in process (74,000 * 12)	$888,000
Underapplied manufacturing overhead	$141,000

Requirement 2:- Assume that the company closes any underapplied or overapplied overhead to Cost of Goods Sold. Prepare the appropriate journal entry.

Solution:- Journal entry would be -

Account Titles and Explanation	Debit	Credit
Cost of Goods sold	$141,000
Manufacturing Overhead		$141,000

Requirement 3:- Assume that the company allocates any underapplied or overapplied overhead proportionally to Work in Process, Finished Goods, and Cost of Goods Sold. Prepare the appropriate journal entry.

Solution:- Journal entry would be -

Account Titles and Explanation	Debit	Credit
Work in process (141,000 * 5%)	$7,050
Finished Goods (141,000 * 17%)	$23,970
Cost of Goods sold (141,000 * 78%)	$109,980
Manufacturing Overhead		$141,000

Calculation of Overhead applied during the year

	Amount	Percentage	Calculation
Work in process	$44,400	5%	44,400 / 888,000
Finished Goods	$150,960	17%	150,960 / 888,000
Cost of Goods sold	$692,640	78%	692,640 / 888,000
Total	$888,000	100%

Requirement 4:- How much higher or lower will net operating income be if the underapplied or overapplied overhead is allocated to Work in Process, Finished Goods, and Cost of Goods Sold rather than being closed to Cost of Goods Sold?

Solution:- Cost of goods sold if the underapplied overhead is closed directly to the cost of goods sold = $1,419,600 + $141,000 = $1,560,600

Cost of goods sold if the underapplied overhead is allocated amount the accounts = $1,419,600 + $109,980 = $1,529,580

Difference in cost of goods sold = $1,560,600 - $1,529,580 = $31,020

Conclusion:- Net operating income will be $31,020 greater if underapplied overhead is allocated among work in process, finished goods and cost of goods sold rather than closed directly to cost of goods sold.

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