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 $900,000 of total manufacturing overhead for an estimated activity level of 75,000 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: 60,000

Manufacturing Overhead cost: $850,000

Inventories at year-end:

Raw Materials  $30,000

Work in Process (includes overhead applied of $36,000) $100,000

Finished goods (includes overhead applied of $180000) $500,000

Cost of goods sold (includes overhead applied of $504,000) $1,400,000

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. Compute the underapplied or overapplied overhead.

Overhead applied = 900,000 / 75000 * 60000 = 720000

Overhead cost incurred = 850000

Under applied overhead = 850000 - 720000 = 130,000

2. Assume that the company closes any underapplied or overapplied overhead to Cost of Goods sold

Journal entry

	Debit	Credit
Cost of goods sold a/c	130000
Manufacturing overhead a/c		130000

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.

Under applied amount of 130000 will be divided among the three things .. i.e WIP, Finished goods and Cost of goods sold in the ratio of their amounts before this adustment. Such ratio = 1/20, 5/20 and 14/20 .......

	Debit	Credit
Cost of goods sold a/c (130000 * 14/20)	91000
Finished goods a/c (130000*5/20)	32500
Work in process a/c (130000 * 1/20)	6500
To Manufacturing Overhead a/c		130000

Question - 4

When allocation is done over these three elements, instead of direct charge to COGS, we will have higher net operating income.