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 $880,000 of total manufacturing overhead for an estimated activity level of 88,000 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: 79,000 836,000 $ Machine-hours Manufacturing overhead cost Inventories at year-end: Raw materials Work in process (includes overhead applied of $71,100) Finished goods (includes overhead applied of $134,300) Cost of goods sold (includes overhead applied of $584,600) $ 15,000 $ 171,900 $ 324,700 $ 1,413,400 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 = 880000 / 88000	10
Manufacturing Overhead applied = Actual machine hours * Predetermined overhead rate = 79000 * 10	790000
Actual manufacturing overhead cost	836000
As the manufacturing overhead applied is less than the actual manufacturing cost, the overhead is underapplied by 46000 ( i.e. 836000 - 790000 )
Underapplied overhead cost	46000

Required 2 :
	Debit	Credit
Cost of goods sold	46000
Manufacturing overhead		46000

Required 3 :
	Debit	Credit
Work in process ( 46000 * 71100 / 790000 )	4140
Finished goods ( 46000 * 134300 / 790000 )	7820
Cost of goods sold ( 46000 * 584600 / 790000 )	34040
Manufacturing overhead		46000

Required 4 :

The net operating income will be 11960 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 11960 [ i.e. 46000 - 34040 ] than the cost of goods sold when the entire underapplied is closed to cost of goods sold.