Question

Fastraq Inc. is in the business of design and manufacture of bike chains for both professional and amateur cyclists. Two new titanium chain sets were introduced during the year – the Smooth and Extreme. They are currently selling for $110 and $155 respectively. The following data summarise the cost structure for the two chain sets:

		Smooth	Extreme
	Number of sets budgeted and produced	43,000	55,000
	Number of sets sold	40,000	52,000
	Direct labour hours per set	2	3
	Direct labour cost per hour	$22	$22
	Direct materials per set	$45	$61

The company adopts an absorption costing system. Overhead is applied to the two products based on direct labour hours using a flexible budget to calculate the overhead rate prior the commencement of the financial year.

Fastraq budgeted (and produced) 43,000 Smooth and 55,000 Extreme chain sets. Fixed manufacturing overhead was budgeted at $1,650,000 and variable manufacturing overhead was estimated to be $1.75 per direct labour hour. Actual overhead incurred for the year amounted to $2,100,000. Any over- or under-absorbed overhead is written off to cost of goods sold.

(e) Calculate how much of manufacturing overhead will be charged to the income statement if in the following year, Fastraq incurs total manufacturing overhead of $2,300,000 and sells off all of the brought forward inventory from the current year, under (i) absorption costing and (ii) variable costing.

Answer 1

			Smooth	Extreme
	A	Number of sets budgeted and produced	43,000	55,000	Total
	B	Number of sets sold	40,000	52,000
	C	Direct labour hours per set	2	3
	D	Direct labour cost per hour	$22	$22
	E	Direct materials per set	$45	$61
	F=A*C	Total Direct labor hours budgeted	86000	165000	251000
	G	Budgeted Fixed manufacturing overhead			$1,650,000
	H=G/F	Fixed manufacturing overhead per hour			$6.57	(1650000/251000)
	I	Variable manufacturing overhead per hour			$1.75
	J=H+I	Manufacturing overhead rate per hour			$8.32
			Smooth	Extreme	Total
	K=J*F	Applied Manufacturing Overhead	$715,839	$1,373,411	$2,089,250
	L	Actual Manufacturing Overhead			$2,100,000
	M=L-K	Under absorbed overhead charged to Cost of goods sold			$10,750
	(i)	ABSORPTION COSTING
		Current year :
		Manufacturing overhead in Finished goods Inventory
			Number of Sets	Manufacturing Overhead
		Product Smooth	3000	$49,942	715839*(3000/43000)
		Product Extreme	3000	$74,913	1373411*(3000/55000)
		Total manufacturing Overhead in Inventory		$124,856	(49942+74913)
		ActualManufacturing Overhead incurred		$2,300,000
		Total manufacturing Overhead Charged to income		$2,424,856	(124856+2300000)
	(ii)	VARIABLE COSTING
		Under this system all Fixed Costs are charged toincome of the Year
		Only Variable Costs are part of inventory
			Smooth	Extreme
		Variable Cost Per Unit:
		Direct Material	$45	$61
		Direct labor	$44	$66
		Variable Overhead	$3.50	$5.25	(1.75*2)=$3.50	(1.75*3)=$5.25
		Total Variable cost per unit	$93	$132
		Manufacturing overhead in Finished goods Inventory
			Number of Sets	Manufacturing Overhead
		Product Smooth	3000	$10,500	(3000*3.50)
		Product Extreme	3000	$15,750	(3000*5.25)
		Total manufacturing Overhead in Inventory		$26,250	(10500+15750)
		ActualManufacturing Overhead incurred		$2,300,000
		Total manufacturing Overhead Charged to income		$2,326,250	(26250+2300000)