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 $900,000 of total manufacturing overhead for an estimated activity level of 75,000 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		60,000
Manufacturing overhead cost	$	850,000
Inventories at year-end:
Raw materials	$	30,000
Work in process (includes overhead applied of $36,000)	$	100,000
Finished goods (includes overhead applied of $180,000)	$	500,000
Cost of goods sold (includes overhead applied of $504,000)	$	1,400,000

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) Overhead rate = 900000/7500 = 12 per machine hour

Overhead applied = 60000*12 = 720000

Actual overhead = 850000

Under applied overhead = 130000

2) Adjusting entry

Date	account and explanation	Debit	Credit
	Cost of goods sold	130000
	Manufacturing overhead		130000
	(To record under applied overhead)

3) Adjusting entry

Date	account and explanation	Debit	Credit
	Work in process (130000*5%)	6500
	Finished goods	32500
	Cost of goods sold	91000
	Manufacturing overhead		130000
	(To record under applied overhead)

4) Net operating income increase by (6500+32500) = 39000