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In: Accounting

Terri computed the pre-determined overhead rate. She estimated that 440,000 direct labor hours were going to...

Terri computed the pre-determined overhead rate. She estimated that 440,000 direct labor hours were going to be used for the upcoming year. Her boss wanted her to change the estimate to 420,000 direct labor hours even though he knows that this amount is probably going to be wrong. 1) What is the effect of changing the estimated direct labor hours on the pre-determined overhead rate computation? 2) Should Terri change the estimated direct labor hours to 420,000? Why or why not?

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Expert Solution

1) Estimated labor hours play a significant role in computing pre-determined overhead rate. It is directly related to the pre-determined overhead rate, i.e, when labour hours are decreased, the overhead rate will also decrease. Therefore by changing the labor hours from 440,000 to 420,000 the pre-determined overhead rate will also decrease. This will look favourably on the estimated cost of production for the year.

2) The choice to change the labor hours friom 440,000 to 420,000 will depend upon Terri's intention. If she believes her estimation to be correct and the company will in fact utilize 440,000 labor hours in the coming year, she should stand her ground and not change it to 420,000.

However, if she wants to submit a more favourable cost estimation to her superiors, she should change it to 420,000. But she will also have to take necessary steps to ensure that the total labor hours utilised during the year comes to around 420,000 by employing skilled labourers and encouraging them to perform efficiently.

In my opinion, the second alternative saves cost for the company and is therefore preferable from the management's point of view.

(I'm assuming Terri in question is a woman.) :)

ekkarill92 answered 1 year ago
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