Question

Scenario: You were recently hired as comptroller for a division in a prominent manufacturing company. You have been asked to calculate the predetermined overhead rate for your division to use in the upcoming year. It is important that the rate be accurate because any resulting over-applied or under-applied overhead is closed out to Cost of Goods Sold at the end of the year. The allocation base for your division is machine hours. You began by estimating the total manufacturing overhead costs you expected the division to incur in the upcoming year. Then you divided that figure by the estimate of the total machine hours that the production manager thought would be required to produce the division’s product and arrived at the pre-determined overhead rate for the division.

But when you took the rate to the General Manager, he asked you to rework the calculations and reduce the machine hours estimated by the production manager from 505,000 to 484,800. He explained that it has always been done that way and at the end of the year, when adjusting entries are made, the division appears to have had a large increase in net operating income.

Your initial post is due by 11:59 p.m. Tuesday, March 20, 2018 and provide your response to:

1. BRIEFLY explain why reducing the estimated machine hours in the base for the predetermined overhead rate results in a large increase of the net operating income at the end of the fiscal year? (Include discussion about how how such a change affects the rate, and what happens to product costs if that rate is applied throughout the year, and any adjustment needed at the end of the fiscal year, and then use this information in your explanation.)

2. BRIEFLY explain why you should or should not comply with the manager’s request? (Your response should recognize and explain an ethical dilemma.)

Answer 1

Reducing estimated machine hour in the base for the predetermined overhead rate increased applied overhead rate.

Thus the costs are reported higher than the actual costs.

Hence, at the end of the year the Overhead account shown over-applied overhead.

Then it is adjusted in the costing profit and loss account with a credit. This increases the net income at year end.

In this case, assume that the estimated overhead for the year is=$10,100,000

The machine hour rate for overhead application should be==$10,100,000/505000=$20 per machine hour.

If we reduce the machine hour from the budget to 484,800, the applied overhead rate will be calculated as=$10,100,000/484,800=$20.83

This will increase the overhead application rate and hence the costs of goods sold . It will artificially reduce net income.

At the end of the year, the applied overhead will be =20.83*505000= $   10,520,833 and actual overhead will be $10,100,000

The difference will be over -applied overhead=(10520833-10100000)= $              420,833

This amount will be credited to Profit and loss account and net income will increase by this amount.

2.According to the “Standards for Ethical conduct of Management Accountants (published by IMA),management accountants are required to provide information which are accurate and clear.

They are also required to maintain credibility by communicating information fairly and objectively and disclose deficiencies in information.

In this case the accountant faces ethical dilemma . he is coerced to provide inaccurate information for decision support.

He should not succumb to coercion and take up the issue at higher level in the organization