Chapter 3B, Problem 3B.1E

Overhead Rate Based on Capacity LO3—6

Wixis Cabinets makes custom wooden cabinets for high-end stereo systems from specialty woods. The company uses a job-order costing system. The capacity of the plant is determined by the capacity of its constraint: which is time on the automated bandsaw that makes finely beveled cuts in wood according to the preprogrammed specifications of each cabinet. The bandsaw can operate up to 180 hours per month. The estimated total manufacturing overhead cost at capacity is $14,760 per month. The company bases its predetermined overhead rate on capacity, so its predetermined overhead rate is $82 per hour of bandsaw use.

The results of a recent month’s operations appear below:

Required:

1. Prepare an income statement following the example in Exhibit 3B—1 that records the cost of unused capacity on the income statement as a period expense.
2. Why do unused capacity costs arise when the predetermined overhead rate is based on capacity?

To determine

Introduction: Job costing is a technique of determine the cost of a manufacturing job rather than the process of the job. Manufacturing overhead is applied to product or job order is determined as predetermined overhead. Absorption costing is used to calculate the cost of product while taking indirect and direct expense into account. Activity based costing assign the cost of all the activity of the organization according to their actual consumption

To prepare: The income statement that record the cost of unused capacity.

Answer to Problem 3B.1E

Income statement given shown below:

Explanation of Solution

Cost of goods manufactured and under applied overhead

Particular	Amount $
Direct material	5,350
Direct labor	8,860
Manufacturing overhead applied	12,300
Total manufacturing cost charged to jobs	26,510
Add: Beginning work in process inventory	0
	26,510
Deduct: Ending work in process inventory	0
Cost of goods manufactured	26,510

The manufacturing overhead incurred was $14200 and the applied manufacturing overhead was $12,300. Thus, under applied overhead is:

  $\begin{array}{l}=\$12,300-\$14220\\ =\$(1920)underapplied\end{array}$

Income statement:

Particular	Amount $	Amount $
Sales		43,740
Cost of goods		26,510
Gross margin		17,230
Under applied manufacturing overhead	1920
Selling and manufacturing expense	8180	10,100
Net operating income		7,130

To determine

Introduction: Job costing is a technique of determine the cost of a manufacturing job rather than the process of the job. Manufacturing overhead is applied to product or job order is determined as predetermined overhead. Absorption costing is used to calculate the cost of product while taking indirect and direct expense into account. Activity based costing assign the cost of all the activity of the organization according to their actual consumption

The reason for unused capacity cost arises when the predetermined overhead rate is based on capacity.

Answer to Problem 3B.1E

Manufacturing overhead typically includes a significant amount of fixed cost that results in overhead being under applied when the predetermined overhead rate is based on capacity.

Explanation of Solution

Manufacturing overhead typically includes a significant amount of fixed cost that results in overhead being under applied when the predetermined overhead rate is based on capacity. If the plant never operates at full capacity, an amount less than the total fixed cost will actually be applied to each job. However, since fixed costs remain fixed the amount overhead applied to each job will typically be underapplied.