Predetermined Overhead Rate and Capacity [L0l, L02, L07, L08]
Skid Road Recording, Inc., is a small audio recording studio located in Seattle. The company handles work for advertising agencies—primarily for radio ads—and has a few singers and bands as clients. Skid Road Recording handles all aspects of recording from editing to making a digital master from which CDs can be copied. The competition in the audio recording industry in Seattle has always been tough, but it has been getting even tougher over the last several years. The studio has been losing customers to newer studios that are equipped with more up-to-date equipment and that are able to offer very attractive prices and excellent service. Summary data concerning the last two years of operations follow:
| 2010 | 2011 |
Estimated hours of studio service | 1,000 | 750 |
Estimated studio overhead cost | $90,000 | $90,000 |
Actual hours of studio service provided | 900 | 600 |
Actual studio overhead cost incurred | $90,000 | $90,000 |
Hours of studio service at capacity | 1,800 | 1,800 |
The company applies studio overhead to recording jobs on the basis of the hours of studio service provided. For example, 30 hours of studio time were required to record, edit, and master the Slug Fest music CD for a local band. All of the studio overhead is fixed, and the actual overhead cost incurred was exactly as estimated at the beginning of the year in both 2010 and 2011.
Required:
1. Skid Road Recording computes its predetermined overhead rate at the beginning of each year based on the estimated studio overhead and the estimated hours of studio service for the year. How much overhead would have been applied to the Slug Fest job if it had been done in 2010? In 2011? By how much would overhead have been underapplied or overapplied in 2010? In 2011?
2. The president of Skid Road Recording has heard that some companies in the industry have changed to a system of computing the predetermined overhead rate at the beginning of each year based on the hours of studio service that could be provided at capacity. He would like to know what effect this method would have on job costs. How much overhead would have been applied using this method to the Slug Fest job if it had been done in 2010? In 2011? By how much would overhead have been underapplied or overapplied in 2010 using this method? In 2011?
3. How would you interpret the underapplied or overapplied overhead that results from using studio hours at capacity to compute the predetermined overhead rate?
4. What fundamental business problem is Skid Road Recording facing? Which method of computing the predetermined overhead rate is likely to be more helpful in facing this problem? Explain.
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