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 $651,000 of total manufacturing overhead for an estimated activity level of 93,000 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: $ 74,000 618,000 Machine-hours Manufacturing overhead cost Inventories at year-end: Raw materials Work in process (includes overhead applied of $41,440) Finished goods (includes overhead applied of $98, 420) Cost of goods sold (includes overhead applied of $378,140) 11,000 146,400 347,700 $ 1,335,900 $ 34 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

Required 1 :
Predetermined overhead rate = Estimated manufacturing overhead / Estimated machine hours = 651000 / 93000	7
Manufacturing Overhead applied = Actual machine hours * Predetermined overhead rate = 74000 * 7	518000
Actual manufacturing overhead cost	618000
As the manufacturing overhead applied is less than the actual manufacturing cost, the overhead is underapplied by 100000 ( i.e. 618000 - 518000 )

Underapplied overhead cost

100000

Required 2 :
	Debit	Credit
Cost of goods sold	100000
Manufacturing overhead		100000

Required 3 :
	Debit	Credit
Work in process ( 100000 * 41440 / 518000 )	8000
Finished goods ( 100000 * 98420 / 518000 )	19000
Cost of goods sold ( 100000 * 378140 / 518000 )	73000
Manufacturing overhead		100000

Required 4 :

The net operating income will be 27000 greater if the underapplied overhead is allocated rather than closed entirely to cost of goods sold.

Reason : Because the cost of goods sold in the allocation method will be lower by 27000 [ i.e. 100000 - 73000 ] than the cost of goods sold when the entire underapplied is closed to cost of goods sold.