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 $1,615,000 of total manufacturing overhead for an estimated activity level of 85,000 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: 77,000 $ 1,574,000 Machine-hours Manufacturing overhead cost Inventories at year-end: Raw materials Work in process (includes overhead applied of $73, 150) Finished goods (includes overhead applied of $277,970) Cost of goods sold (includes overhead applied of $1,111, 880) $ 14,000 $ 94,000 $ 357,200 $ 1,428,800 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

Solution: Overhead allocation rate = Total estimated mfg. overhead / Machine hours

   = $1,615,000 / 85,000 = $19 per MH

So, applied mfg. overhead = $19×77,000 = $1,463,000

1. Underapplied Overhead = Actual mfg. OH cost - Applied mfg. OH

= $1,574,000 - 1,463,000

= $111,000

2. & 3.

Credit No. 2 Accounts Title Cost of Goods sold Factory Overhead Debit $ 111,000 $ 111,000 3 $ Work in Process Finished Goods Cost of Goods sold Factory Overhead 5,550 21,090 84,360 $ 111,000

4. Net operating income will be higher by = 111,000 - $84,360 = $26,640

Since, there would be lower COGS (by $26,640) if underapplied overhead is allocated to WIP, Finished goods, and COGS.

Workings:

Underapplied mfg. OH allocated to WIP = $94,000×111,000 / (94,000 + 327,200 + 1,428,800)

   = $94,000 ×$111,000 / $1,880,000

   = $5,550

Underapplied mfg. OH allocated to finished goods = $327,200 ×$111,000/ $1,880,000 = $21,090

Underapplied mfg. OH allocated to COGS = $1,428,800 ×$111,000 / $1,880,000 = $84,360

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