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 $520,000 of total manufacturing overhead for an estimated activity level of 65,000 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		54,000
Manufacturing overhead cost	$	488,000
Inventories at year-end:
Raw materials	$	19,000
Work in process (includes overhead applied of $25,920)	$	117,000
Finished goods (includes overhead applied of $73,440)	$	331,500
Cost of goods sold (includes overhead applied of $332,640)	$	1,501,500

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

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Luzadis Company
Workings
Calculation of predetermined overhead rate
	Amount $	Note
Expected overhead	520,000.00	A
Estimated Machine hours	65,000.00	B
Predetermined overhead rate	8.00	C=A/B
Calculation of overhead applied	Amount $
Actual machine hours	54,000.00	D
Predetermined overhead rate	8.00	See C
Factory overhead amount applied	432,000.00	E=C*D
Answer 1
Calculation of under applied/ over applied overhead	Amount $
Manufacturing overhead amount applied	432,000.00	See E
Manufacturing overhead cost	488,000.00	F
Under applied	56,000.00	G=F-E
Answer 2
If overhead variance is closed through cost of good sold.
Journal Entry
Account	Debit $	Credit $
Cost of Goods Sold	56,000.00		See G
Manufacturing overhead		56,000.00
Answer 3
If overhead variance closed in the ratio of work in process, finished goods and cost of good sold.
	Work in process	Finished goods	Cost of good sold	Total
Amount	117,000.00	331,500.00	1,501,500.00	1,950,000.00
% of allocation	6.00%	17.00%	77.00%	100.00%
Over applied overhead	3,360.00	9,520.00	43,120.00	56,000.00	This is $ 56,000* % of allocation.
Journal Entry
Account	Debit $	Credit $
Work in process	3,360.00
Finished goods	9,520.00
Cost of good sold	43,120.00
Factory overhead		56,000.00
Answer 4
Under applied overhead allocated to	Amount $
Work in process	3,360.00
Finished goods	9,520.00
Total	12,880.00
Income will be higher by $ 12,880 if under applied overhead in allocated to work in process, finished goods and cost of good sold rather than being closed to Cost of Goods Sold.