Question

Platinum Tracks, Inc., is a small audio recording studio located in Los Angeles. The company handles work for advertising agencies—primarily for radio ads—and has a few singers and bands as clients. Platinum Tracks 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 Los Angeles 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 follow: Last Year This Year Estimated hours of studio service 1,400 1,150 Estimated studio overhead cost $ 110,000 $ 110,000 Actual hours of studio service provided 1,300 1,050 Actual studio overhead cost incurred $ 110,000 $ 110,000 Hours of studio service at capacity 2,200 2,200 The company applies studio overhead to recording jobs on the basis of the hours of studio service provided. For example, 41 hours of studio time were required to record, edit, and master the Verde Baja music CD for a local Latino band. All of the studio overhead cost is fixed, and the actual overhead cost incurred was exactly as estimated at the beginning of the year in last year and this year. Required: 1. Platinum Tracks computes its predetermined overhead rate at the beginning of each year based on the estimated studio overhead cost and the estimated hours of studio service for the year. Using this approach, how much overhead would have been applied to the Verde Baja job last year? How about this year? 2. The president of Platinum Tracks has heard that some companies in the industry have changed to a system of computing the predetermined overhead rate based on 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 Verde Baja job if it had been done last year? This year? 3. If Platinum Tracks computes its predetermined overhead rate based on the hours of studio service that could be provided at capacity as in (2) above, how much unused capacity cost would the company have incurred last year? This year?

Answer 1

Part 1

	Last year	This year
Estimated studio overhead cost (a)	110000	110000
Estimated hours of studio service (b)	1400	1150
Predetermined overhead rate (a) ÷ (b)	$78.57	$95.65
Verde Baja job’s studio hours	41	41
Overhead applied to the Verde Baja job	$3221	$3922

Part 2

	Last year	This year
Estimated studio overhead cost (a)	110000	110000
Estimated hours of studio service (b)	2200	2200
Predetermined overhead rate (a) ÷ (b)	$50	$50
Verde Baja job’s studio hours	41	41
Overhead applied to the Verde Baja job	$2050	$2050

Part 3

	Last year	This year
Amount of the allocation base at capacity (a)	2200	2200
Actual amount of the allocation base (b)	1300	1050
Unused capacity in hours (a) – (b)	900	1050
Unused capacity in hours (a)	900	1050
Predetermined overhead rate (b)	50	50
Cost of unused capacity (a) × (b)	$45000	$52500