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

Solution 1:

Overhead cost incurred = $1,029,000

Applied overhead = $44,400 + $150,960 + $692,640 = $888,000

Under applied overhead = $1,029,000 - $888,000 = $141,000

Solution 2:

Journal Entry - Underapplied overhead closed to cost of goods sold
Particulars	Debit	Credit
Cost of Goods Sold A/c Dr	$141,000.00
To Manufacturing Overhead		$141,000.00
(Being underapplied overhed transferred to COGS)

Solution 3:

Underapplied overhead to be transferred in WIP, finished goods and COGS in their proportion of overhead applied

Journal Entry - Underapplied overhead closed to WIP, Finished Goods & COGS
Particulars	Debit	Credit
WIP A/c Dr (141,000*44,400/888,000)	$7,050.00
Finished Goods A/c Dr (141,000*150,960/888,000)	$23,970.00
Cost of Goods Sold A/c Dr (141,000*692,640/888,000)	$109,980.00
To Manufacturing Overhead		$141,000.00
(Being underapplied overhed transferred to COGS, WIP and Finished Goods)

Solution 4:

If underapplied overhed allocated to WIP, finished goods and COGS proportinately rather than being closed to Cost of Goods Sold, in that situation net operating income will be higher by underapplied overhead closed to WIP & Finished Goods i.e. $31,020 ($7,050 + $23,970).