Question

Pat Miranda, the new controller of Vault Hard Drives, Inc., has just returned from a seminar on the choice of the activity level in the predetermined overhead rate. Even though the subject did not sound exciting at first, she found that there were some important ideas presented that should get a hearing at her company. After returning from the seminar, she arranged a meeting with the production manager, J. Stevens, and the assistant production manager, Marvin Washington Pat: Patt Marvin: Pati I ran across an idea that I wanted to check out with both of you. It's about the way we compute predetermined overhead rates We're all ears, We compute the predetermined overhead rate by dividing the estimated total factory overhead for the coming year, which is all a fixed cost, by the estimated total units produced for the coming year. We've been doing that as long as I've been with the company. And it has been done that way at every other company I've worked at, except at most places they divide by direct labor-hours. We use units because it is simpler and we basically make one product with minor variations. But, there's another way to do it. Instead of basing the overhead rate on the estimated total units produced for the coming year, we could base it on the total units produced at capacity. Oh, the Marketing Department will love that. It will drop the costs on all of our products. They'll go vild over there cutting prices. That is a worry, but I wanted to talk to both of you first before going over to Marketing Aren't you always going to have a lot of unused capacity costs? That's correct, but let me show you how we would handle it. Here's an example based on our budget for next year. Marvin: Pati J. Pat: Budgeted (estimated) production Budgeted sales Capacity Selling price Variable manufacturing cost Total manufacturing overhead cost (all fixed) Selling and administrative expenses (all fixed) Beginning inventories 79.000 units 79.000 units 100,000 units $74 per unit $17 per unit $1,975,000 $ 2,245,000 $0 Traditional Approach to Computation of the Predetermined Overhead Rate Estimated total manufacturing overhead co 9 1.975,000 Estimated total units produced, 79,000 $25.00 unit $ 5,846,000 Budgeted Income Statement Revenue (79.000 units X $74 per unit) Cost of goods soldi Variable manufacturing (79.000 units $17 per unit) Manufacturing overhead applied (79.000 units $25 per unit) Crossargin Selling and administrative expenses Net operating income $1,363.000 1.915.000 3.318.000 2,528,000 2.245.000 283,000 New Approach to Computation of the Predetermined Overhead Rate Using Capacity in the Denominator

Answer 1

Requirement 2
Statement of computation of units to be produced
Particulars	Amount
Expected operating Income	283000
(+) Selling and admin expenses	2245000
Gross margin	2528000
(+)Variable manuf. Overhead (73000 * 17)	1241000
(-)Expected Revenue (73000 * 74)	5402000
Therefore, balance, Manufacturing overhead applied	1633000
Now:
Total Fixed Manuf. Overhead	1975000
Let the number of units to be manufactured be	x
Therefore, estimated cost per unit	(1975000 / x)
Total no of units sold	73000
Total applied Manufacturing overhead required to earn desired profit	1633000
Therfeore, number of units to be manufactured is (i.e x)	(1975000 / x) * 73000 = 1633000
therefore x	88288.43
Rounded off to	88289

Requirement 3
Revised Budgeted Income statement
Particulars	Amount
Revenue (73000 * 74)	5402000
(-) Cost of goods sold
Variable manuf. Overhead (73000 * 17)	1241000
Manufacturing overhead applied (73000 * 19.75)	1441750
Gross margin	2719250
(-) Selling and admin expenses	2245000
Balance available for Cost of unused capacity & operating Income	474250
Expected operating Income	283000
Therefore, Cost of unused capacity (Balancing figure)	191250
Note:
Total Cost of unused capacity	191250
Cost per unit of unused capacity	19.75
Therefore, estimated unused capacity units	9683.544
Total Capacity	100000
Therefore, number of units to be manufactured is	90316.46
Rounded off to	90317