Question

Jack is reviewing the predetermined overhead rate used to estimate the welding overhead cost Year 1. The estimated total welding overhead cost is $ 300,000 and the estimated level of activity is 6,000 machine-hours.

By the end of the year, Fridges-R-Fun incurred actual total manufacturing overhead cost for welding of $320,000 and 5,800 total machine hours.

Required

1. Determine the amount of underapplied or overapplied manufacturing overhead for Year 1.

2. What is the implication of having large overapplied or underapplied overhead to the management planning and product costing?

Answer 1

1.Calculation of Predetermined Overhead rate :

Predetermined Overhead rate = Estimated Overheads / Estimated activity

Predetermined Overhead rate per Machine Hour = $ 3,00,000/6000

= 50 per Machine Hour

Actual manufacturing Overheads applied into the production = 5800 Machine Hours * 50 per Hour

= $ 2,90,000

Actual manufacturing Overheads incurred for the Production = $ 3,20,000

It is observed that Actual manufacturing overheads incurred is higher than the Overheads applied with an amount of $ 30,000.

Therefore it is called the scenario of Under absorption of Overheads with the amount of $ 30,000.

2.Under or Over absorption of Overheads will occur due to defective planning or Increase/Decrease in the Prices during current year.

In the Present scenario due to Underabsorption of Overheads, Product Costing will be affected as Total Cost per unit worked out will shows lesser than the actual cost incurred for its Production and for the management it leads to variation in Planned profits and Taxes.