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 $560,000 of total manufacturing overhead for an estimated activity level of 70,000 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		61,000
Manufacturing overhead cost	$	514,000
Inventories at year-end:
Raw materials	$	14,000
Work in process (includes overhead applied of $48,800)	$	188,000
Finished goods (includes overhead applied of $92,720)	$	357,200
Cost of goods sold (includes overhead applied of $346,480)	$	1,334,800

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. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

3. Assume that the company allocates any underapplied or over appliedoverhead proportionally to Work in Process, Finished Goods, and Cost of Goods Sold. Prepare the appropriate journal entry. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field.)

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

The predetermined overhead rate was based on a cost formula that estimates $560,000 of total manufacturing overhead for an estimated activity level of 70,000 machine-hours.

= Total Manufacturing overhead / Machine hours = 560,000 / 70000 = 8 per hour

Required - 1

Underabsorbed Overhead = Overhead incurred - Overhead applied

= 514000 - ( 61000 * 8 per hour) = 514000 - 488,000 = 26000

Required - 2

	Debit	Credit
Cost of goods sold	26000
Manufacturing Overhead		26000

Previously, we have overhead of 488,000 being included in cost of goods sold. Above entry will adjust the cost of goods sold to its true value.

Requirement - 3

Work in process	2600
Finished goods	4940
Cost of goods sold	18460
Manufacturing overhead		26000

In this model, adjustment to cost of goods sold shall be proportionate. Thus some part of the overhead is shared to WIP and Finished goods ........ i.e Inventory.

Required - 4

Amount of profit shall be higher by 7540

Under applied overhead which is debited to WIP and FG Shall be carried forward to next accounting period. Thus instead of total being debited to cost of goods sold, only a portion of under absorption is debited, thus decrease in cost and increase in profit if we compare with the practice of adjustment only to cost of goods sold.