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 $612,000 of total manufacturing overhead for an estimated activity level of 68,000 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:

Machine-hours		50,000
Manufacturing overhead cost	$	570,000
Inventories at year-end:
Raw materials	$	18,000
Work in process (includes overhead applied of $22,500)	$	93,500
Finished goods (includes overhead applied of $76,500)	$	317,900
Cost of goods sold (includes overhead applied of $351,000)	$	1,458,600

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

1. Underapplied overhead: $120000

Predetermined overhead rate = $612000/68000 machine hours = $9 per machine hour

Manufacturing overheads applied = 50000 x $9 = $450000

Manufacturing overhead cost incurred = $570000

Underapplied overhead = $570000 - $450000 = $120000

2.

Event	General Journal	Debit	Credit
1	Cost of goods sold	120000
	Manufacturing overhead		120000
	(To close underapplied overhead to cost of goods sold)

3.

Event	General Journal	Debit	Credit
1	Work in process	6000
	Finished goods	20400
	Cost of goods sold	93600
	Manufacturing overhead		120000
	(To close underapplied overhead)

Working:

	Overheads applied	% of total applied	Underapplied overheads allocated
Work in process	22500	5.0%	6000
Finished goods	76500	17.0%	20400
Cost of goods sold	351000	78.0%	93600
Total $	450000	100.0%	120000

4. Net operating income will be higher by $26400 if the underapplied overhead is allocated rather than closed entirely to cost of goods sold.

If the underapplied overhead is allocated, the net operating income will be higher to the extent of the underapplied overheads deferred in the work in process and finished goods inventory. Thus, it will be higher by $6000 + $20400 = $26400.