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 $1,068,000 of total manufacturing overhead for an estimated activity level of 89,000 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		74,000
Manufacturing overhead cost	$	1,029,000
Inventories at year-end:
Raw materials	$	10,000
Work in process (includes overhead applied of $44,400)	$	91,000
Finished goods (includes overhead applied of $150,960)	$	309,400
Cost of goods sold (includes overhead applied of $692,640)	$	1,419,600

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)

Predetermined Overhead Rate	Estimated Manufacturing Overhead / Estimated Machine Hours = $1,068,000 / 89,000 Machine Hours = $12 per Machine Hour
Applied Overhead	Predetermined Overhead Rate x Actual Machine Hours = $12 per Machine Hour x 74,000 Machine Hours = $888,000
Actual Overhead	$1,029,000
Under applied Overhead	Actual Overhead – Applied Overhead = $1,029,000 - $888,000 = $141,000

2)

Account Titles and Explanation	Debit($)	Credit($)
Cost of Goods Sold	141,000
Manufacturing Overhead		141,000
(Record of Under applied Overhead)

3)

Account Titles and Explanation	Debit($)	Credit($)
Work in Process	7,050
Finished Goods	23,970
Cost of Goods Sold	109,980
Manufacturing Overhead		141,000

Note: Overhead underapplied to Work in Process = Total Underapplied Overhead x (Overhead Applied to WIP / Total Overhead Applied)

= $141,000 x ($44,400 / $888,000)

= $141,000 x 0.05

= $7,050

Overhead underapplied to Finished Goods = Total Underapplied Overhead x (Overhead Applied to FG / Total Overhead Applied)

= $141,000 x ($150,960 / $888,000)

= $141,000 x 0.17

= $23,970

Overhead underapplied to Cost of Goods = Total Underapplied Overhead x (Overhead Applied to COGS / Total Overhead Applied)

= $141,000 x ($692,640 / $888,000)

= $141,000 x 0.78

= $109,980

4)

Net Operating will be higher by an amount of:

= Work-in-Process + Finished Goods

= $7,050 + $23,970

= $31,020