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

Estimated total manufacturing overhead Estimated total machine-hours Predetermined overhead rate per machine hour $1,068,000 89,000 $12 ($1068000 / 89000 machine hours] Actual machine hours worked 74,000 Predetermined overhead rate per machine hour $12 [As calculated in Part-1] Manufacturing overhead cost allocated $888,000 (74000 machine hours x $12] Actual Manufacturing ovehead cost incurred $1,029,000 Under-applied manufacturing overhead cost $141,000 [Difference between $1029000 & $888000] (It is under-applied because applied mfg. overhead is less than actual mfg. overhead incurred) 2) Journal entry to close under-applied overhead to cost of goods sold: Account titles Cost of goods sold Manufacturing overhead Debit $141,000 Credit (Cost of goods sold is debited as current cost of goods sold would be reported short due to under-applied mfg. OH] $141,000 [Mfg. overhead is credited as current mfg. overhead applied would show debit balance due to under-applied mfg. OH]

3) Value of ending work in process without overhead applied Value of ending finished goods without overhead applied Value of cost of goods sold without overhead applied Total cost of ending inventory reported $46,600 ($91,000 - $44,400] $158,440 ($309,400 - $150,960] $726,960 ($1,419,600 - $692,640] $932,000 Journal entry to close under-applied overhead to work-in-process, finished goods and cost of goods sold proportionately: Account titles Work in process Finished goods Cost of goods sold Manufacturing overhead Debit $7,050 $23,970 $109,980 Credit ($141000 x ($46600 / $932000)] ($141000 x ($158440 / $932000)] ($141000 x ($726960 / $932000)] $141,000 4) When under-applied mfg. overhead cost is allocated among work in process, finished goods and cost of goods sold, firm's income statement will report mfg. overhead allocated to cost of goods sold only as cost for the respective reporting period. In simple words, firm's total cost for the reporting period will not include under-applied mfg. overhead allocated to work in process and finished goods. As a result, firm's net operating income will be higher by the amount that equals to sum of amount of mfg. overhead allocated to WIP & FG. Mfg. overhead cost allocated to work in process inventory Mfg. overhead cost allocated to finished goods inventory Net operating income will be higher by $7,050 [Ref: Part-3] $23,970 [Ref: Part-3] $31,020 if underapplied overhead is allocated to WIP, FG, & Cost of Goods Sold rather than being closed to Cost of Goods Sold fully.