Question

The management of Bullinger Corporation would like to investigate the possibility of basing its predetermined overhead rate on activity at capacity. The company's controller has provided an example to illustrate how this new system would work. In this example, the allocation base is machine-hours and the estimated amount of the allocation base for the upcoming year is 20,000 machine-hours. Capacity is 23,000 machine-hours and the actual level of activity for the year is assumed to be 18,700 machine-hours. All of the manufacturing overhead is fixed and both the estimated amount at the beginning of the year and the actual amount at the end of the year are assumed to be $29,000 per year. For simplicity, it is assumed that this is the estimated manufacturing overhead for the year as well as the manufacturing overhead at capacity. It is further assumed that this is also the actual amount of manufacturing overhead for the year.

If the company bases its predetermined overhead rate on capacity, what would be the cost of unused capacity reported on the income statement prepared for internal management purposes? (Round intermediate calculations to 2 decimal places.)

Answer 1

Cost of unused capacity reported on the income statement = $5418

Explanation;

Capacity is given = 23000 machine hours

Manufacturing overhead is given = $29000

Predetermined overhead rate on the basis of capacity will be ($29000 / 23000) = $1.26 per machine hour

Now let’s calculate unused capacity;

Actual level of activity is given = 18700 machine hours

Capacity is given = 23000 machine hours

Thus, unused capacity (23000 – 18700) = 4300 machine hours

So, Cost of unused capacity reported on the income statement (4300 * $1.26) = $5418 (Approx.)