Question

E18-25 Developing and Using a Predetermined Overhead Rate: Hight-Low Cost Estimation.

For years, Mattoon Components Company has used an actual plantwide overhead rate and based its prices on cost plus a markup of 30 percent. Recently the marketing manager, Holly Adams, and the production manager, Sue Walsh, confronted the controller with a common problem. The marketing manager expressed a concern that Mattoon’s prices seem to vary widely throughout the year. According to Adams, “It seems irrational to charge higher prices when business is bad and lower prices when business is good. While we get a lot of business during high-volume months because we are raising prices while our competitors are lowering them.” Walsh also believed that it was “folly to be so pushed that we have to pay overtime in some months and then lay employees off in others.” She commented, “while there are natural variations in customer demand, the accounting system seems to amplify this variation.”

Required

1. Evaluate the arguments by Adams and Walsh. What suggestions do you have for improving the accounting and pricing procedures?

2. Assume that the Mattoon components Company had the following total manufacturing overhead costs and direct labor in 2016 and 2017:

	2016	2017
Total manufacturing overhead	$210,000	$248,000
Direct labor hours	20,000	28,000

Use the high-low method (see Module 15) to develop a cost estimating equation for total manufacturing overhead.

3. Develop a predetermined rate for 2018, assuming 25,000 direct labor hours are budgeted for 2018.

4. Assume that the actual level of activity in 2018 was 30,000 direct labor hours and that the total 2018 manufacturing overhead was $250,000. Determine the underapplied or overapplied manufacturing overhead at the end of 2018.

5. Describe two ways of handling any underapplied or overapplied manufacturing overhead at the end of the year.

Answer 1

	2016	2017	Difference
Total MOH	210,000	248,000	38,000
Direct Labor Hours	20,000	28,000	8,000
Variable Portion - As per High Low Method = $38,000 / 8,000 DLH = $4.75
Fixed Portion - As per High Low Method = $210,000 - (20,000 X $4.75) = $115,000
Cost Estimation Equation for Total MOH:
Total Costs = $115,000 + $4.75 x
Answer c.
Predetermined Overhead Rate = ($115,000 + 25,000 X $4.75) / 25,000 DLH
Predetermined Overhead Rate = $233,750 / 25,000
Predetermined Overhead Rate = $9.35 per DLH
Answer d.
Applied Overhead - $9.35 X 30,000 DLH	280,500
Actual Overhead	250,000
Overapplied Overhead	30,500