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Exercise 3-12: Predetermined overhead rate; disposing of under-applied or over-applied overhead

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 companys warehouse. The companys 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 (included overhead applied of $180,000).. $500,000

Cost of goods sold (included overhead applied of $504,000) .. $1,400,000

Required:

1. Compute the under-applied or over-applied overhead.

2. Assume that the company closes any under-applied or over-applied overhead to COGS. Prepare the appropriate journal entry.

3. Assume that the company allocates any under-applied or over-applied overhead proportionally to Work in Process, Finished Goods, and COGS. Prepare the appropriate journal entry.

4. How much higher or lower will new operating income be if the under-applied or over-applied overhead is allocated to Work in Process, finished goods, and COGS rather than being closed to COGS?

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