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 $651,000 of total manufacturing overhead for an estimated activity level of 93,000 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 $ 618,000 Inventories at year-end: Raw materials $ 11,000 Work in process (includes overhead applied of $41,440) $ 146,400 Finished goods (includes overhead applied of $98,420) $ 347,700 Cost of goods sold (includes overhead applied of $378,140) $ 1,335,900

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. Computation of the underapplied or overapplied overhead.

Predetermined overhead rate = Total Manufacturing Overhead/ Machine Hours

= $651,000 / 93,000 Machine hours = $7 per Machine hour

Total manufacturing overhead cost actually incurred	618,000
Total manufacturing overhead applied to work in process ($7 * 74,000) (Predetermined overhead rate x Actual Machine Hours)	518,000
Under-applied manufacturing overhead	100,000

2. journal entry.

General Journal	Debit ($)	Credit ($)
Cost of goods sold	100,000
Manufacturing overhead		100,000

3.

Computation of Proportion of Overhead applied during the year to Work in Process, Finished Goods, and Cost of Goods Sold-

	Amount ($)	Percent (%)
Work in process	41,440	8% (41440*100/518000)
Finished goods	98,420	19% (98420*100/518000)
Cost of goods sold	378,140	73% (378140*100/518000)
Total	518,000	100%

Journal Entry

General Journal	Debit ($)	Credit($)
Work in process (8% of $100,000)	8,000
Finished goods (19% of $100,000)	19,000
Cost of goods sold (73% of $100,000)	73,000
Manufacturing overhead		100,000

4.

Cost of goods sold if the underapplied overhead is closed directly to cost of goods sold (S1,335,900 + $100,000)	$1,435,900
Cost of goods sold if the underapplied overhead is allocated among the Work in Process, Finished Goods, and Cost of Goods Sold Proportionally (S1,335,900 + $73,000)	$1,408,900
Difference in cost of goods sold	$27,000

Thus, net operating income will be $27,000 greater if the underapplied overhead is allocated among work in process, finished goods, and cost of goods sold rather than closed directly to cost of goods sold.

it is due to the amount of $8000 and $19000 transfered to work in Progress and Finished Goods becomes part of Closing inventory and therefore cost of goods sold decrease by $27000, Which increases income of $27000.