Chapter 3

Systems Design: Job-Order Costing

Solutions to Questions

3-1 By definition, manufacturing cost sheet. The job cost sheet, in turn, is
overhead consists of costs that cannot be used to summarize the various production
practically traced to jobs. Therefore, if costs incurred to complete the job. These
these costs are to be assigned to jobs, they costs are entered on the job cost sheet
must be allocated rather than traced. from materials requisition forms, direct
labor time tickets, and by applying
3-2 Job-order costing is used in overhead.
situations where many different products or
services are produced each period. Process 3-6 Some production costs such as a
costing is used in situations where a single, factory manager’s salary cannot be traced
homogeneous product, such as cement, to a particular product or job, but rather are
bricks, or gasoline, is produced for long incurred as a result of overall production
periods. activities. In addition, some production
costs such as indirect materials cannot be
3-3 The job cost sheet is used to record easily traced to jobs. If these costs are to
all costs that are assigned to a particular be assigned to products, they must be
job. These costs include direct materials allocated to the products.
costs traced to the job, direct labor costs
traced to the job, and manufacturing 3-7 If actual manufacturing overhead
overhead costs applied to the job. When a cost is applied to jobs, the company must
job is completed, the job cost sheet is used wait until the end of the accounting period
to compute the unit product cost. to apply overhead and to cost jobs. If the
company computes actual overhead rates
3-4 A predetermined overhead rate is more frequently to get around this problem,
used to apply overhead cost to jobs. It is the rates may fluctuate widely due to
computed before a period begins by seasonal factors or variations in output. For
dividing the period’s estimated total this reason, most companies use
manufacturing overhead by the period’s predetermined overhead rates to apply
estimated total amount of the allocation manufacturing overhead costs to jobs.
base. Thereafter, overhead cost is applied
to jobs by multiplying the predetermined 3-8 The measure of activity used as the
overhead rate by the actual amount of the allocation base should drive the overhead
allocation base that is recorded for each cost; that is, the allocation base should
job. cause the overhead cost. If the allocation
base does not really cause the overhead,
3-5 A sales order is issued after an then costs will be incorrectly attributed to
agreement has been reached with a products and jobs and product costs will be
customer on quantities, prices, and distorted.
shipment dates for goods. The sales order
forms the basis for the production order. 3-9 Assigning manufacturing overhead
The production order specifies what is to be costs to jobs does not ensure a profit. The
produced and forms the basis for the job units produced may not be sold and if they

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 77
are sold, they may not be sold at prices some of the overhead may be fixed and the
sufficient to cover all costs. It is a myth that actual amount of the allocation base may
assigning costs to products or jobs ensures be less than estimated at the beginning of
that those costs will be recovered. Costs the period. In this situation, the amount of
are recovered only by selling to customers overhead applied to inventory will be less
—not by allocating costs. than the actual overhead cost incurred.

3-10 The Manufacturing Overhead 3-13 Underapplied overhead implies that

account is credited when overhead cost is not enough overhead was assigned to jobs
applied to Work in Process. Generally, the during the period and therefore cost of
amount of overhead applied will not be the goods sold was understated. Therefore,
same as the amount of actual cost incurred underapplied overhead is added to cost of
because the predetermined overhead rate goods sold. On the other hand, overapplied
is based on estimates. overhead is deducted from cost of goods
sold.
3-11 Underapplied overhead occurs when
the actual overhead cost exceeds the 3-14 A plantwide overhead rate is a single
amount of overhead cost applied to Work in overhead rate used throughout a plant. In a
Process inventory during the period. multiple overhead rate system, each
Overapplied overhead occurs when the production department may have its own
actual overhead cost is less than the predetermine overhead rate and its own
amount of overhead cost applied to Work in allocation base. Some companies use
Process inventory during the period. multiple overhead rates rather than
Underapplied or overapplied overhead is plantwide rates to more appropriately
disposed of by either closing out the allocate overhead costs among products.
amount to Cost of Goods Sold or by Multiple overhead rates should be used, for
allocating the amount among Cost of Goods example, in situations where one
Sold and ending inventories in proportion to department is machine intensive and
the applied overhead in each account. The another department is labor intensive.
adjustment for underapplied overhead
increases Cost of Goods Sold (and 3-15 When automated equipment
inventories) whereas the adjustment for replaces direct labor, overhead increases
overapplied overhead decreases Cost of and direct labor decreases. This results in
Goods Sold (and inventories). an increase in the predetermined overhead
rate—particularly if it is based on direct
3-12 Manufacturing overhead may be labor.
underapplied for several reasons. Control
over overhead spending may be poor. Or,

© The McGraw-Hill Companies, Inc., 2010

78 Managerial Accounting, 13th Edition
Exercise 3-1 (10 minutes)

a. Process costing g. Job-order costing

b. Job-order costing h. Process costing*
c. Process costing i. Job-order costing
d. Process costing j. Process costing*
e. Process costing k. Job-order costing
f. Job-order costing l. Job-order costing

* Some of the listed companies might use either a process

costing or a job-order costing system, depending on the nature
of their operations and how homogeneous the final product is.
For example, a chemical manufacturer would typically operate
with a process costing system, but a job-order costing system
might be used if products are manufactured in relatively small
batches. The same thing might be true of the tire
manufacturing plant in item j.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 79
Exercise 3-2 (15 minutes)

1. The direct materials and direct labor costs listed in the exercise
would have been recorded on four different documents: the
materials requisition form for Job W456, the time ticket for
Jamie Unser, the time ticket for Melissa Chan, and the job cost
sheet for Job W456.

2. The costs for Job W456 would have been recorded as follows:
Materials requisition form:
Quan- Unit Total
tity Cost Cost
Blank 20 $15.00 $300
s
Nibs 480 $1.25 600
$900
Time ticket for Jamie Unser
Time
Com- Amoun Job Num-
Started Ended pleted Rate t ber
11:00 2:45 3.75 $9.60 $36.00 W456
AM PM
Time ticket for Melissa Chan
Time
Starte Com- Amoun Job Num-
d Ended pleted Rate t ber
8:15 11:30 3.25 $12.20 $39.65 W456
AM AM
Job Cost Sheet for Job W456
Direct materials....... $900.00
Direct labor:
Jamie Unser........... 36.00
Melissa Chan.......... 39.65
$975.65

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

80 Managerial Accounting, 13th Edition
Exercise 3-3 (10 minutes)

The predetermined overhead rate is computed as follows:

Estimated total manufacturing overhead. . $134,000
÷ Estimated total direct labor hours
(DLHs)..................................................... 20,000 DLHs
= Predetermined overhead rate................ $6.70 per DLH

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 81
Exercise 3-4 (15 minutes)

a. Raw Materials................. 80,000

Accounts Payable...... 80,000

b. Work in Process.............. 62,000

Manufacturing Over-
head............................... 9,000
Raw Materials............ 71,000

c. Work in Process.............. 101,000

Manufacturing Over-
head............................... 11,000
Wages Payable.......... 112,000

Manufacturing Over-
d. head............................... 175,000
Various Accounts....... 175,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

82 Managerial Accounting, 13th Edition
Exercise 3-5 (10 minutes)

Actual direct labor-hours....................... 10,800

× Predetermined overhead rate............ $23.40
= Manufacturing overhead applied....... $252,720

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 83
Exercise 3-6 (20 minutes)
1 Cost of Goods Manufactured
.
Direct materials:
Raw materials inventory, beginning....... $12,00
0
Add: Purchases of raw materials............ 30,000
Total raw materials available.................. 42,000
Deduct: Raw materials inventory,
ending................................................... 18,000
Raw materials used in production.......... 24,000
Less indirect materials included in $ 19,00
manufacturing overhead...................... 5,000 0
Direct labor................................................. 58,000
Manufacturing overhead applied to work in 87,00
process inventory..................................... 0
Total manufacturing costs.......................... 164,00
0
Add: Beginning work in process inventory.. 56,00
0
220,00
0
Deduct: Ending work in process inventory. 65,00
0
Cost of goods manufactured....................... $155,0
00

2 Cost of Goods Sold

.
Finished goods inventory, beginning.......... $ 35,00
0
Add: Cost of goods manufactured.............. 155,00
0
Goods available for sale............................. 190,00
0
Deduct: Finished goods inventory, ending.. 42,00
0
Unadjusted cost of goods sold.................... 148,00
0

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

84 Managerial Accounting, 13th Edition
 Add: Underapplied overhead...................... 4,00
0
Adjusted cost of goods sold........................ $152,0
00

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 85
Exercise 3-7 (20 minutes)

Parts 1 and 2.

Cash Raw Materials

(a) 94,000 (a) 94,000 (b) 89,000
(c) 132,00 Bal.
0 5,000
(d) 143,00
0

Work in Process Finished Goods

(b) (f) 342,00 342,00
78,000 0 (f) 0
(c) 112,000 Bal. 0
(e) 342,00
152,000 (f) 0
Bal
. 0

Manufacturing Overhead Cost of Goods Sold

(b) 152,00 (f) 342,00
11,000 (e) 0 0
(c) 20,000 (g) 22,000
(d) 22,000 Bal. 364,00
143,000 (g) 0
Bal
. 0

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

86 Managerial Accounting, 13th Edition
Exercise 3-8 (10 minutes)

1. Actual direct labor-hours..................... 11,500

× Predetermined overhead rate.......... $18.20
= Manufacturing overhead applied..... $209,300
Less: Manufacturing overhead in-
curred............................................... 215,000
$ (5,700
)
Manufacturing overhead underap-
plied.................................................. $5,700

2. Because manufacturing overhead is underapplied, the cost of

goods sold would increase by $5,700 and the gross margin
would decrease by $5,700.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 87
Exercise 3-9 (10 minutes)

Yes, overhead should be applied to value the Work in Process

inventory at year-end.
Because $6,000 of overhead was applied to Job V on the basis of
$8,000 of direct labor cost, the company’s predetermined
overhead rate must be 75% of direct labor cost.
Job W direct labor cost............................................... $4,000
× Predetermined overhead rate................................ × 0.75
= Manufacturing overhead applied to Job W at year-
end.......................................................................... $3,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

88 Managerial Accounting, 13th Edition
Exercise 3-10 (15 minutes)

1. Predetermined overhead rates:

Company X:

Company Y:

Company Z:

$530,00
2. Actual overhead costs incurred....................... 0
Overhead cost applied to Work in Process:
522,60
$6.70 per hour × 78,000* actual hours........ 0
$
Underapplied overhead cost............................ 7,400
*12,000 hours + 36,000 hours + 30,000 hours = 78,000 hours

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 89
Exercise 3-11 (15 minutes)

1 Item (a): Actual manufacturing overhead costs for the year.

Item (b): Overhead cost applied to work in process for the

year.
Item (c): Cost of goods manufactured for the year.
Item (d): Cost of goods sold for the year.

70,00
2. Cost of Goods Sold.................................... 0
70,00
Manufacturing Overhead...................... 0

3. The underapplied overhead will be allocated to the other

accounts on the basis of the amount of overhead applied
during the year in the ending balance of each account:
Work in Process........ $ 19,500 5%
Finished Goods......... 58,500 15
Cost of Goods Sold.... 312,000 80
Total cost.................. $390,000 100 %
Using these percentages, the journal entry would be as follows:
Work in Process (5% × $70,000)........... 3,500
10,50
Finished Goods (15% × $70,000).......... 0
56,00
Cost of Goods Sold (80% × $70,000).... 0
70,00
Manufacturing Overhead.................. 0

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

90 Managerial Accounting, 13th Edition
Exercise 3-12 (30 minutes)

1. The predetermined overhead rate is computed as follows:

2. The amount of overhead cost applied to Work in Process for the

year would be: 75,000 machine-hours × $2.40 per machine-
hour = $180,000. This amount is shown in entry (a) below:

Manufacturing Overhead
(Maintenance) 21,000 (a) 180,00
0
(Indirect materi- 8,000
als)
(Indirect labor) 60,000
(Utilities) 32,000
(Insurance) 7,000
(Depreciation) 56,000
Balance 4,000

Work in Process
(Direct materials) 710,00
0
(Direct labor) 90,000
(Overhead) (a) 180,00
0

3. Overhead is underapplied by $4,000 for the year, as shown in

the Manufacturing Overhead account above. The entry to close
out this balance to Cost of Goods Sold would be:
Cost of Goods Sold................................. 4,000
Manufacturing Overhead.................. 4,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 91
Exercise 3-12 (continued)

4. When overhead is applied using a predetermined rate based on

machine-hours, it is assumed that overhead cost is proportional
to machine-hours. When the actual machine-hours turn out to
be 75,000, the costing system assumes that the overhead will
be 75,000 machine-hours × $2.40 per machine-hour, or
$180,000. This is a drop of $12,000 from the initial estimated
manufacturing overhead cost of $192,000. However, the actual
manufacturing overhead did not drop by this much. The actual
manufacturing overhead was $184,000—a drop of $8,000 from
the estimate. The manufacturing overhead did not decline by
the full $12,000 because of the existence of fixed costs and/or
because overhead spending was not under control. These
issues will be covered in more detail in later chapters.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

92 Managerial Accounting, 13th Edition
Exercise 3-13 (10 minutes)

Direct material.................... $10,000

Direct labor......................... 12,000
Manufacturing overhead:
$12,000 × 125%............... 15,000
Total manufacturing cost.... $37,000
Unit product cost:
$37,000 ÷ 1,000 units...... $37

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 93
Exercise 3-14 (30 minutes)

1. a. Raw Materials Inventory..................... 210,00

0
Accounts Payable............................ 210,000
b. Work in Process.................................. 178,00
0
Manufacturing Overhead.................... 12,000
Raw Materials Inventory.................. 190,000
c. Work in Process.................................. 90,000
Manufacturing Overhead.................... 110,00
0
Salaries and Wages Payable............ 200,000
d. Manufacturing Overhead.................... 40,000
Accumulated Depreciation............... 40,000
e. Manufacturing Overhead.................... 70,000
Accounts Payable............................ 70,000
f. Work in Process.................................. 240,00
0
Manufacturing Overhead................. 240,000
30,000 MH × $8 per MH =
$240,000.
g. Finished Goods................................... 520,00
0
Work in Process............................... 520,000
h. Cost of Goods Sold............................. 480,00
0
Finished Goods................................ 480,000
Accounts Receivable.......................... 600,00
0
Sales................................................ 600,000
$480,000 × 1.25 = $600,000.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

94 Managerial Accounting, 13th Edition
Exercise 3-14 (continued)

2.
Manufacturing Overhead Work in Process
(b) 240,00 Bal 520,00
12,000 (f) 0 . 42,000 (g) 0
(c) 110,000 (b) 178,000
(d) 40,000 (c) 90,000
(e) 70,000 (f) 240,000
8,000 Bal
. 30,000
(Overapplied
overhead)

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 95
Exercise 3-15 (30 minutes)

1. Because $120,000 of studio overhead was applied to Work in

Process on the basis of $75,000 of direct staff costs, the
predetermined overhead rate was 160%:

2. The Lexington Gardens Project is the only job remaining in

Work in Process at the end of the month; therefore, the entire
$35,000 balance in the Work in Process account at that point
must apply to it. Recognizing that the predetermined overhead
rate is 160% of direct staff costs, the following computation can
be made:
Total cost in the Lexington Gardens
Project..................................................... $35,000
Less Direct staff costs..............................
: $ 6,500
Studio overhead cost ($6,500 ×
160%)............................................ 10,400 16,900
Costs of subcontracted work..................... $18,100
With this information, we can now complete the job cost sheet
for the Lexington Gardens Project:
Costs of subcontracted work. $18,100
Direct staff costs.................... 6,500
Studio overhead.................... 10,400
Total cost to January 31......... $35,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

96 Managerial Accounting, 13th Edition
Exercise 3-16 (30 minutes)

1. a. Raw Materials.................................... 325,000

Accounts Payable......................... 325,000
b. Work in Process................................. 232,000
Manufacturing Overhead................... 58,000
Raw Materials............................... 290,000
c. Work in Process................................. 60,000
Manufacturing Overhead................... 120,000
Wages and Salaries Payable........ 180,000
d. Manufacturing Overhead................... 75,000
Accumulated Depreciation........... 75,000
e. Manufacturing Overhead................... 62,000
Accounts Payable......................... 62,000
f. Work in Process................................. 300,000
Manufacturing Overhead.............. 300,000

15,000 MH × $20 per MH = $300,000

Manufacturing Overhead Work in Process

(b) 58,000 (f) 300,000 (b) 232,000

(c) 120,000 (c) 60,000
(d) 75,000 (f) 300,000
(e) 62,000

3. The cost of the completed job is $592,000 as shown in the

Work in Process T-account above. The journal entry is:
Finished Goods............................ 592,000
Work in Process...................... 592,000

4. The unit product cost on the job cost sheet would be:
$592,000 ÷ 16,000 units = $37 per unit
© The McGraw-Hill Companies, Inc., 2010. All rights reserved.
Solutions Manual, Chapter 3 97
Exercise 3-17 (15 minutes)

$473,00
1. Actual manufacturing overhead costs. 0
Manufacturing overhead cost applied: 485,00
19,400 MH × $25 per MH................. 0
$
Overapplied overhead cost................. 12,000

2. Chang Company
Schedule of Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning. $ 20,000
Add purchases of raw materials........ 400,000
Raw materials available for use........ 420,000
Deduct raw materials inventory,
ending............................................ 30,000
Raw materials used in production..... 390,000
$375,00
Less indirect materials...................... 15,000 0
Direct labor......................................... 60,000
Manufacturing overhead cost applied
to work in process............................. 485,000
Total manufacturing costs................... 920,000
Add: Work in process, beginning......... 40,000
960,000
Deduct: Work in process, ending......... 70,000
$890,00
Cost of goods manufactured............... 0

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

98 Managerial Accounting, 13th Edition
Exercise 3-18 (30 minutes)

1. As suggested, the costing problem does indeed lie with

manufacturing overhead cost. Because manufacturing
overhead is mostly fixed, the cost per unit increases as the
level of production decreases. This apparent problem can be
“solved” by using a predetermined overhead rate, which should
be based on expected activity for the entire year. Some
students will use units of product in computing the
predetermined overhead rate, as follows:

The predetermined overhead rate could also be set on the

basis of either direct labor cost or direct materials cost. The
computations are:

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 99
Exercise 3-18 (continued)

2. Using a predetermined overhead rate, the unit product costs

would be:

Quarter
First Second Third Fourth
$240,00 $120,00 $ $180,00
Direct materials............ 0 0 60,000 0
Direct labor................... 128,000 64,000 32,000 96,000
Manufacturing over-
head:
Applied at $4.80 per
unit, 300% of direct
labor cost, or 160% of
direct materials cost... 384,000 192,000 96,000 288,000
$752,00 $376,00 $188,00 $564,00
Total cost...................... 0 0 0 0
Number of units pro-
duced.......................... 80,000 40,000 20,000 60,000
Unit product cost........... $9.40 $9.40 $9.40 $9.40

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

100 Managerial Accounting, 13th Edition
Exercise 3-19 (30 minutes)

1. Harris Chan James

Designer-hours...................... 120 100 90
Predetermined overhead
rate..................................... × $90 × $90 × $90
Manufacturing overhead ap-
plied.................................... $10,800 $9,000 $8,100

2. Harris Chan
Direct materials..................... $ 4,500 $ 3,700
Direct labor........................... 9,600 8,000
Overhead applied.................. 10,800 9,000
Total cost.............................. $24,900 $20,700
Completed Projects......................... 45,600*
Work in Process.......................... 45,600*
* $24,900 + $20,700 = $45,600

3. The balance in the Work in Process account consists entirely of

the costs associated with the James project:
$
Direct materials................................. 1,400
Direct labor........................................ 7,200
8,10
Overhead applied.............................. 0
$16,70
Total cost in work in process............. 0

4. The balance in the Overhead account can be determined as

follows:
Overhead
Actual overhead 30,000 27,900 Applied overhead
costs costs
Underapplied over- 2,100
head
As indicated above, the debit balance in the Overhead account
is called underapplied overhead.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 101
Exercise 3-20 (15 minutes)

1. Cutting Department:

Finishing Department:

2. Overhead Ap-
plied
Cutting Department: 80 MHs × $7.50 per
MH............................................................. $600
Finishing Department: $150 × 180%.......... 270
Total overhead cost applied........................ $870

3. Yes; if some jobs require a large amount of machine time and

little labor cost, they would be charged substantially less
overhead cost if a plantwide rate based on direct labor cost
were used. It appears, for example, that this would be true of
Job 203 which required considerable machine time to complete,
but required only a small amount of labor cost.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

102 Managerial Accounting, 13th Edition
Problem 3-21 (60 minutes)

1. and 2.

Cash Accounts Receivable

Bal 63,000 (m) 785,000 Bal 102,000 850,00
. . (l) 0
(l) 850,000 (k) 925,000
Bal 128,000 Bal 177,000
. .

Raw Materials Prepaid Insurance

Bal 30,000 (b) 200,000 Bal 9,000 (g) 7,000
. .
(a) 185,00 Bal
0 . 2,000
Bal 15,000
.

Videos in Process Finished Goods

Bal 45,000 550,000 Bal 600,00
. (j) . 81,000 (k) 0
(b) 170,00 (j)
0 550,000
(f) 82,000 Bal
. 31,000
(i) 290,00
0
Bal 37,000
.

Studio and Equipment Accumulated Depreciation

Bal 730,00 Bal
. 0 . 210,000
(d) 84,000
Bal 294,000
.

Studio Overhead Depreciation Expense

(b) 30,000 * (i) 290,000 (d) 21,000
© The McGraw-Hill Companies, Inc., 2010. All rights reserved.
Solutions Manual, Chapter 3 103
 (c) 72,000
(d) 63,000
(f) 110,00
0
(g) 5,600 Insurance Expense
(n) 9,400 Bal. 9,400 (g) 1,400
* $280,000 ÷ 7,000 hours = $40 per hour;
7,250 hours × $40 per hour = $290,000

Advertising Expense Miscellaneous Expense

(e) 130,00 (h)
0 8,600

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

104 Managerial Accounting, 13th Edition
Problem 3-21 (continued)

Administrative Salaries Sales

Expense
(f) 95,000 925,00
(k) 0

Cost of Goods Sold Accounts Payable

(k) 600,00 9,400 (m) 500,000 Bal 160,000
0 (n) .
(a) 185,000
Bal 590,60 (c) 72,000
. 0
(e) 130,000
(h) 8,600
Bal 55,600
.

Salaries & Wages Payable

(m) 285,00 287,000
0 (f)
Bal. 2,000

Capital Stock Retained Earnings

420,000 Bal 270,000
Bal. .

3. Overhead is overapplied for the year by $9,400. Entry (n)

above records the closing of this overapplied overhead balance
to Cost of Goods Sold.

4.
Supreme Videos, Inc.
Income Statement
For the Year Ended December 31
Sales of videos...................................... $925,000
Cost of goods sold ($600,000 – $9,400) 590,600
Gross margin......................................... 334,400
Selling and administrative expenses:
© The McGraw-Hill Companies, Inc., 2010. All rights reserved.
Solutions Manual, Chapter 3 105
 Depreciation expense......................... $ 21,000
Advertising expense............................ 130,000
Administrative salaries........................ 95,000
Insurance expense.............................. 1,400
Miscellaneous expense....................... 8,600 256,000
Net operating income............................ $ 78,400

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

106 Managerial Accounting, 13th Edition
Problem 3-22 (60 minutes)

1. a. Raw Materials.................................... 275,000

Cash............................................. 275,000
b. Work in Process................................. 220,000
Manufacturing Overhead................... 60,000
Raw Materials............................... 280,000
c. Work in Process................................. 180,000
Manufacturing Overhead................... 72,000
Sales Commissions Expense............. 63,000
Salaries Expense............................... 90,000
Cash............................................. 405,000
d. Manufacturing Overhead................... 13,000
Rent Expense.................................... 5,000
Cash............................................. 18,000
e. Manufacturing Overhead................... 57,000
Cash............................................. 57,000
f. Advertising Expense.......................... 140,000
Cash............................................. 140,000
g. Manufacturing Overhead................... 88,000
Depreciation Expense....................... 12,000
Accumulated Depreciation........... 100,000
h. Work in Process................................. 297,000
Manufacturing Overhead.............. 297,000

Rmb180,000 actual direct labor cost × 165% = Rmb297,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 107
Problem 3-22 (continued)

i. Finished Goods.................................. 675,000

Work in Process............................ 675,000
j. Cash.................................................. 1,250,000
Sales............................................. 1,250,000
Cost of Goods Sold............................ 700,000
Finished Goods............................. 700,000

2.
Raw Materials Work in Process
Bal 280,00 Bal 675,00
. 25,000 (b) 0 . 10,000 (i) 0
(a) 275,000 (b) 220,000
Bal (c)
. 20,000 180,000
(h) 297,000
Bal
. 32,000

Finished Goods Manufacturing Overhead

Bal 40,000 (j) 700,00 (b) 60,000 (h) 297,00
. 0 0
(i) 675,000 (c) 72,000
Bal 15,000 (d) 13,000
.
(e) 57,000
(g) 88,000
Bal 7,000
.

Cost of Goods Sold

(j) 700,000

3. Manufacturing overhead is overapplied by Rmb7,000 for the

year. The entry to close this balance to Cost of Goods Sold
would be:

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

108 Managerial Accounting, 13th Edition
 Manufacturing Overhead.............................. 7,000
Cost of Goods Sold................................... 7,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 109
Problem 3-22 (continued)

4.
Gold Nest Company
Income Statement
Rmb1,250,00
Sales.................................................. 0
Cost of goods sold
(Rmb700,000 - Rmb7,000).............. 693,000
Gross margin..................................... 557,000
Selling and administrative expenses:
Sales commissions.......................... Rmb63,000
Administrative salaries.................... 90,000
Rent expense.................................. 5,000
Advertising expense........................ 140,000
Depreciation expense..................... 12,000 310,000
Rmb 247,00
Net operating income........................ 0

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

110 Managerial Accounting, 13th Edition
Problem 3-23 (60 minutes)

1. a. Raw Materials.................................. 170,000

Accounts Payable....................... 170,000
b. Work in Process............................... 144,000
Manufacturing Overhead................. 36,000
Raw Materials............................. 180,000
c. Work in Process............................... 200,000
Manufacturing Overhead................. 82,000
Salaries Expense............................. 90,000
Salaries and Wages Payable....... 372,000
d. Manufacturing Overhead................. 65,000
Accounts Payable....................... 65,000
e. Advertising Expense........................ 100,000
Accounts Payable....................... 100,000
f. Manufacturing Overhead................. 18,000
Insurance Expense.......................... 2,000
Prepaid Insurance....................... 20,000
g. Manufacturing Overhead................. 153,000
Depreciation Expense...................... 27,000
Accumulated Depreciation......... 180,000
h. Work in Process............................... 350,000
Manufacturing Overhead............ 350,000
$200,000 actual direct labor cost × 175% = $350,000 overhead
applied
i. Finished Goods................................ 700,000
Work in Process.......................... 700,000
j. Accounts Receivable....................... 1,000,000
Sales........................................... 1,000,000
Cost of Goods Sold.......................... 720,000
Finished Goods........................... 720,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 111
Problem 3-23 (continued)

2.
Raw Materials Finished Goods
Bal 32,000 (b) 180,00 Bal 48,000 (j) 720,00
. 0 . 0
(a) 170,000 (i) 700,000
Bal 22,000 Bal 28,000
. .

Work in Process Manufacturing Overhead

Bal 20,000 (i) 700,00 (b) 36,000 (h) 350,00
. 0 0
(b) 144,000 (c) 82,000
(c) 200,000 (d) 65,000
(h) 350,000 (f) 18,000
Bal 14,000 (g) 153,000
.
Bal 4,000
.

Cost of Goods Sold

(j) 720,000

3. Overhead is underapplied by $4,000 for the year. The entry to

close this balance to Cost of Goods Sold would be:
Cost of Goods Sold................................ 4,000
Manufacturing Overhead................. 4,000

4.
Almeda Products, Inc.
Income Statement
For the Year Ended March 31
$1,000,00
Sales........................................................ 0
Cost of goods sold ($720,000 + $4,000). 724,000
Gross margin........................................... 276,000
Selling and administrative expenses:
Salary expense...................................... $ 90,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

112 Managerial Accounting, 13th Edition
 Advertising expense.............................. 100,000
Insurance expense................................ 2,000
Depreciation expense........................... 27,000 219,000
Net operating income.............................. $ 57,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 113
Problem 3-24 (60 minutes)

1. and 2.

Cash Accounts Receivable

Bal 7,000 (m) 234,000 Bal 18,000 245,00
. . (l) 0
(l) 245,000 (k) 250,000
Bal 18,000 Bal 23,000
. .

Raw Materials Prepaid Insurance

Bal 9,000 (b) 38,000 Bal 4,000 (g) 3,000
. .
(a) 40,000 Bal
. 1,000
Bal 11,000
.

Work in Process Finished Goods

Bal 20,000 140,00 Bal 130,00
. (j) 0 . 32,000 0
(b) 32,300 (j) 140,000 (k)
(f) 45,000 Bal
. 42,000
(i) 60,000
Bal 17,300
.

Plant and Equipment Accumulated Depreciation

Bal Bal
. 210,000 . 53,000
(d) 36,000
Bal 89,000
.

Manufacturing Overhead Depreciation Expense

(b) 5,700 * (i) 60,000 (d) 9,000
(c) 19,100
(d) 27,000
© The McGraw-Hill Companies, Inc., 2010. All rights reserved.
114 Managerial Accounting, 13th Edition
 (f) 10,000
(g) 2,400 Insurance Expense
Bal 4,200 (n) 4,200 (g) 600
.
*7,500 MH × $8 per MH = $60,000

Advertising Expense Miscellaneous Expense

(e) 48,000 (h) 9,500

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 115
Problem 3-24 (continued)

Administrative Salaries Sales

Expense
(f) 30,000 250,00
(k) 0

Cost of Goods Sold Accounts Payable

(k) (m) 150,000 Bal 38,000
130,000 .
(n) 4,200 (a) 40,000
Bal (c) 19,100
. 134,200
(e) 48,000
(h) 9,500
Bal 4,600
.

Salaries & Wages Payable

(m) 84,000 (f) 85,000
Bal. 1,000

Capital Stock Retained Earnings

160,00 Bal 49,000
Bal. 0 .

3. Overhead is underapplied by $4,200. Entry (n) above records

the closing of this underapplied overhead balance to Cost of
Goods Sold.

4.
Hudson Company
Income Statement
For the Year Ended December 31
Sales........................................................ $250,000
Cost of goods sold ($130,000 + $4,200). 134,200
Gross margin........................................... 115,800
Selling and administrative expenses:
Depreciation expense........................... $ 9,000
Advertising expense.............................. 48,000
© The McGraw-Hill Companies, Inc., 2010. All rights reserved.
116 Managerial Accounting, 13th Edition
 Administrative salaries expense........... 30,000
Insurance expense................................ 600
Miscellaneous expense......................... 9,500 97,100
Net operating income.............................. $ 18,700

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 117
Problem 3-25 (45 minutes)

1. Research & Documents predetermined overhead rate:

Litigation predetermined overhead rate:

2. Research & Documents overhead applied:

26 hours × $35 per hour............................. $ 910
Litigation overhead applied: $5,700 × 40%. . 2,280
Total overhead cost....................................... $3,190

3. Total cost of Case 418-3:

Departments
Research
& Docu- Litiga-
ments tion Total
Legal forms and sup-
plies............................ $ 80 $ 40 $ 120
Direct attorney cost...... 350 5,700 6,050
Overhead cost applied. . 910 2,280 3,190
Total cost...................... $1,340 $8,020 $9,360

4. Research &
Documents Litigation
Departmental overhead cost in-
curred............................................. $870,000 $315,000
Departmental overhead cost ap-
plied:
26,000 hours × $35 per hour.......... 910,000
$750,000 × 40%............................. 300,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

118 Managerial Accounting, 13th Edition
 Underapplied (or overapplied) over-
head................................................ $ (40,000) $ 15,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 119
Problem 3-26 (60 minutes)

1.
Raw Materials Work in Process
Bal. 30,000 (a) 16,800 Bal 41,000 (e) 38,300
. *
(a) 13,200
(b) 20,000
(d) 28,000
Bal 63,900
.

Finished Goods Manufacturing Overhead

Bal. 50,000 (a) 3,600 (d) 28,000
(e) 38,300 (b) 7,000
(c) 19,400

Salaries & Wages Payable Accounts Payable

(b) 27,000 (c) 19,400

Job 208 materials, labor, and overhead at

* May 31......................................................... RUR28,700
Job 209 materials, labor, and overhead at
May 31......................................................... 12,300
Total Work in Process inventory at May 31... . RUR41,000

13,20
2. a. Work in Process............................... 0 *
Manufacturing Overhead................. 3,600
Raw Materials............................. 16,800
*RUR6,000 + RUR7,200 = RUR13,200.
This entry is posted to the T-accounts as entry (a) above.
b. Work in Process............................... 20,000 *
Manufacturing Overhead................. 7,000
Salaries and Wages Payable....... 27,000
*RUR4,000 + RUR7,500 + RUR8,500 = RUR20,000.
This entry is posted to the T-accounts as entry (b) above.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

120 Managerial Accounting, 13th Edition
Problem 3-26 (continued)

19,40
c. Manufacturing Overhead................. 0
Accounts Payable....................... 19,400
This entry is posted to the T-accounts as entry (c) above.

3. The company uses a predetermined overhead rate of 140% of

direct labor cost. This figure can be determined by relating the
May applied overhead cost on the job cost sheets to the May
direct labor cost shown on these sheets. For example, in the
case of Job 208:

The overhead cost applied to each job during June was:

RUR 5,60
Job 208: RUR4,000 × 140%..... 0
Job 209: RUR7,500 × 140%..... 10,500
Job 210: RUR8,500 × 140%..... 11,900
RUR28,00
Total applied overhead............ 0

The entry to record the application of overhead cost to jobs

would be [recorded as entry (d) in the T-accounts above]:
Work in Process........................... 28,000
Manufacturing Overhead........ 28,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 121
Problem 3-26 (continued)

4. The total cost of job 208 was:

RUR 9,50
Direct materials...................................................... 0
Direct labor (RUR8,000 + RUR4,000)..................... 12,000
Manufacturing overhead applied (RUR12,000 ×
140%).................................................................. 16,800
RUR38,30
Total cost................................................................ 0
The entry to record the transfer of the completed job is
[recorded as entry (e) in the T-accounts above]:
Finished Goods............................ 38,300
Work in Process...................... 38,300

5. As shown in the above T-accounts, the balance at June 30 was

RUR63,900. The breakdown of this amount between Jobs 209
and 210 is:
Job 209 Job 210 Total
Direct materials........... RUR11,100 RUR7,200 RUR18,300
Direct labor.................. 10,500 8,500 19,000
Manufacturing over- 14,70 11,90
head applied............. 0 0 26,600
Total cost..................... RUR36,300 RUR27,600 RUR63,900

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

122 Managerial Accounting, 13th Edition
Problem 3-27 (60 minutes)

1. a.

b. Before the underapplied or overapplied overhead can be

computed, we must determine the amount of direct
materials used in production for the year.
Raw materials inventory, beginning.............. $ 20,000
Add, Purchases of raw materials................... 510,000
Raw materials available................................ 530,000
Deduct: Raw materials inventory, ending..... 80,000
Raw materials used in production................. $450,000

Actual manufacturing overhead costs:

Indirect labor.............................................. $170,000
Property taxes............................................ 48,000
Depreciation of equipment......................... 260,000
Maintenance............................................... 95,000
Insurance.................................................... 7,000
Rent, building............................................. 180,000
Total actual costs.......................................... 760,000
Applied manufacturing overhead costs:
$450,000 × 160%....................................... 720,000
Underapplied overhead................................. $ 40,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 123
Problem 3-27 (continued)

2. Gitano Products
Schedule of Cost of Goods Manufactured

Direct materials:
$
Raw materials inventory, beginning....... 20,000
Add purchases of raw materials............. 510,000
Total raw materials available.................. 530,000
Deduct raw materials inventory, ending. 80,000
$ 450,00
Raw materials used in production............. 0
Direct labor............................................... 90,000
Manufacturing overhead applied to work
in process............................................... 720,000
Total manufacturing costs......................... 1,260,000
Add: Work in process, beginning............... 150,000
1,410,000
Deduct: Work in process, ending.............. 70,000
$1,340,00
Cost of goods manufactured..................... 0

3. Cost of goods sold:

Finished goods inventory, beginning.......... $ 260,000
Add: Cost of goods manufactured............... 1,340,000
Goods available for sale.............................. 1,600,000
Deduct: Finished goods inventory, ending. . 400,000
$1,200,00
Cost of goods sold....................................... 0
The underapplied overhead can either be closed out to Cost of
Goods Sold or allocated between Work in Process, Finished
Goods, and Cost of Goods Sold based on the overhead applied
during the year in the ending balance in each of these
accounts.

4. Direct materials............................................. $ 8,500

Direct labor.................................................... 2,700
Overhead applied ($8,500 × 160%).............. 13,600
Total manufacturing cost............................... $24,800

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

124 Managerial Accounting, 13th Edition
 $24,800 × 125% = $31,000 price to the customer

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 125
Problem 3-27 (continued)

5. The amount of overhead cost in Work in Process was:

$24,000 direct materials cost × 160% = $38,400
The amount of direct labor cost in Work in Process is:
Total ending work in process......... $70,000
Deduct: Direct materials............... $24,000
Manufacturing overhead... 38,400 62,400
Direct labor cost............................ $ 7,600
The completed schedule of costs in Work in Process was:
Direct materials............................. $24,000
Direct labor.................................... 7,600
Manufacturing overhead................ 38,400
Work in process inventory............. $70,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

126 Managerial Accounting, 13th Edition
Problem 3-28 (45 minutes)

1. Molding Department predetermined overhead rate:

Painting Department predetermined overhead rate:

2. Molding Department overhead applied:

110 machine-hours × $8.60 per ma-
chine-hour................................................ $ 946
Painting Department overhead applied:
$680 direct labor cost × 175%................. 1,190
Total overhead cost....................................... $2,136

3. Total cost of Job 205:

Molding Painting
Dept. Dept. Total
Direct materials..................... $ 470 $ 332 $ 802
Direct labor............................ 290 680 970
Manufacturing overhead ap-
plied.................................... 946 1,190 2,136
Total cost............................... $1,706 $2,202 $3,908

Unit product cost for Job 205:

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 127
Problem 3-28 (continued)

4. Molding Painting
Dept. Dept.
Manufacturing overhead incurred..... $570,000 $750,000
Manufacturing overhead applied:
65,000 MHs × $8.60 per MH........... 559,000
$436,000 direct labor cost × 175% 763,000
Underapplied (or overapplied) over-
head................................................ $ 11,000 ($ 13,000)

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

128 Managerial Accounting, 13th Edition
Problem 3-29 (60 minutes)

1. a.

b. $9,500 × 140% = $13,300

Fabricat- Machining Assembly

ing De- Depart- Depart-
2. a. partment ment ment
Estimated manufac-
turing overhead
cost (a)..................... $350,000 $400,000 $ 90,000
Estimated direct la-
bor cost (b)............... $200,000 $100,000 $300,000
Predetermined over-
head rate (a) ÷ (b).... 175% 400% 30%

b. Fabricating Department:
$2,800 × 175%......................... $4,900
Machining Department:
$500 × 400%............................ 2,000
Assembly Department:
$6,200 × 30%........................... 1,860
Total applied overhead................ $8,760

3. The bulk of the labor cost on the Koopers job is in the Assembly
Department, which incurs very little overhead cost. The
department has an overhead rate of only 30% of direct labor
cost as compared to much higher rates in the other two
departments. Therefore, as shown above, use of departmental
overhead rates results in a relatively small amount of overhead
cost being charged to the job.
Use of a plantwide overhead rate in effect redistributes
overhead costs proportionately between the three departments
(at 140% of direct labor cost) and results in a large amount of

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 129
 overhead cost being charged to the Koopers job, as shown in
Part 1. This may explain why the company

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

130 Managerial Accounting, 13th Edition
Problem 3-29 (continued)

bid too high and lost the job. Too much overhead cost was
assigned to the job for the kind of work being done on the job
in the plant.
On jobs that require a large amount of labor in the Fabricating
or Machining Departments the opposite will be true, and the
company will tend to charge too little overhead cost to the jobs
if a plantwide overhead rate is being used. The reason is that
the plantwide overhead rate (140%) is much lower than the
rates would be if these departments were considered
separately.

4. The company’s bid was:

Direct materials..................................... $ 4,600
Direct labor............................................ 9,500
Manufacturing overhead applied
(above)................................................ 13,300
Total manufacturing cost....................... $27,400
Bidding rate........................................... × 1.5
Total bid price........................................ $41,100
If departmental overhead rates had been used, the bid would
have been:
Direct materials..................................... $ 4,600
Direct labor............................................ 9,500
Manufacturing overhead applied
(above)................................................ 8,760
Total manufacturing cost....................... $22,860
Bidding rate........................................... × 1.5
Total bid price........................................ $34,290
Note that if departmental overhead rates had been used,
Teledex Company would have been the low bidder on the
Koopers job because the competitor underbid Teledex by only
$2,000.

5. a. Actual overhead cost................................. $864,000

Applied overhead cost ($580,000 ×
140%)..................................................... 812,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 131
 Underapplied overhead cost...................... $ 52,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

132 Managerial Accounting, 13th Edition
Problem 3-29 (continued)

b. Department
Fabricat- Machin- Assem- Total
ing ing bly Plant
Actual overhead
cost..................... $360,000 $420,000 $84,000 $864,000
Applied overhead
cost:....................
$210,000 ×
175%................ 367,500
$108,000 ×
400%................ 432,000
$262,000 ×
30%.................. 78,600 878,100
Underapplied
(overapplied) ($ 12,000
overhead cost..... ($ 7,500) ) $ 5,400 ($ 14,100)

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 133
Problem 3-30 (45 minutes)

1. The cost of raw materials put into production was:

Raw materials inventory, 1/1........... $ 15,000
Debits (purchases of materials)....... 120,000
Materials available for use............... 135,000
Raw materials inventory, 12/31....... 25,000
Materials requisitioned for produc-
tion................................................ $110,000

2. Of the $110,000 in materials requisitioned for production,

$90,000 was debited to Work in Process as direct materials.
Therefore, the difference of $20,000 was debited to
Manufacturing Overhead as indirect materials.

3. Total factory wages accrued during the year (cred-

its to the Factory Wages Payable account)........... $180,000
Less direct labor cost (from Work in Process).......... 150,000
Indirect labor cost.................................................... $ 30,000

4. The cost of goods manufactured was $470,000—the credits to

the Work in Process account.

5. The Cost of Goods Sold for the year was:

Finished goods inventory, 1/1.................................... $ 40,000
Add: Cost of goods manufactured (from Work in
Process)................................................................... 470,000
Goods available for sale............................................. 510,000
Finished goods inventory, 12/31................................ 60,000
$450,00
Cost of goods sold..................................................... 0

6. The predetermined overhead rate was:

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

134 Managerial Accounting, 13th Edition
Problem 3-30 (continued)

7. Manufacturing overhead was overapplied by $10,000,

computed as follows:
Actual manufacturing overhead cost for the year
(debits).................................................................. $230,000
Applied manufacturing overhead cost (from Work
in Process—this would have been the credits to
the
Manufacturing Overhead account)........................ 240,000
$(10,000
Overapplied overhead............................................. )

8. The ending balance in Work in Process is $30,000. Direct

materials make up $9,200 of this balance, and manufacturing
overhead makes up $12,800. The computations are:
Balance, Work in Process, 12/31............................. $30,000
Less: Direct labor cost (given)................................ (8,000)
Manufacturing overhead cost ($8,000 ×
160%)........................................................... (12,800)
Direct materials cost (remainder)........................... $ 9,200

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 135
Problem 3-31 (120 minutes)

1. a. Raw Materials............................... 200,000

Accounts Payable..................... 200,000
b. Work in Process............................ 185,000
Raw Materials........................... 185,000
c. Manufacturing Overhead.............. 63,000
Utilities Expense........................... 7,000
Accounts Payable..................... 70,000
d. Work in Process............................ 230,000
Manufacturing Overhead.............. 90,000
Salaries Expense........................... 110,000
Salaries and Wages Payable.... 430,000
e. Manufacturing Overhead.............. 54,000
Accounts Payable..................... 54,000
f. Advertising Expense..................... 136,000
Accounts Payable..................... 136,000
g. Manufacturing Overhead.............. 76,000
Depreciation Expense................... 19,000
Accumulated Depreciation....... 95,000
h. Manufacturing Overhead.............. 102,000
Rent Expense................................ 18,000
Accounts Payable..................... 120,000
i. Work in Process............................ 390,000
Manufacturing Overhead......... 390,000

975 actual DLH × Nkr400 per DLH = Nkr390,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

136 Managerial Accounting, 13th Edition
Problem 3-31 (continued)

j. Finished Goods.............................. 770,000

Work in Process........................ 770,000
k. Accounts Receivable..................... 1,200,000
1,200,00
Sales......................................... 0
Cost of Goods Sold........................ 800,000
Finished Goods......................... 800,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 137
Problem 3-31 (continued)

2.
Accounts Receivable Sales
(k) 1,200,00 (k) 1,200,000
0

Raw Materials Cost of Goods Sold

Bal. 30,000 185,000 (k) 800,000
(a) 200,000 (b)
Bal. 45,000

Work in Process Manufacturing Overhead

Bal. 21,000 (j) 770,000 (c) 63,000 (i) 390,000
(b) 185,000 (d) 90,000
(d) 230,000 (e) 54,000
(i) 390,000 (g) 76,000
Bal. 56,000 (h) 102,000
Bal. 5,000

Finished Goods Advertising Expense

Bal. 60,000 (k) 800,000 (f) 136,000
(j) 770,000
Bal. 30,000

Accumulated Depreciation Utilities Expense

(g) 95,000 (c) 7,000

Accounts Payable Salaries Expense

(a) 200,000 (d) 110,000
(c) 70,000
(e) 54,000 Depreciation Expense
(f) 136,000 (g) 19,000
(h) 120,000

Salaries & Wages Payable Rent Expense

(d) 430,000 (h) 18,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

138 Managerial Accounting, 13th Edition
Problem 3-31 (continued)

3. Froya Fabrikker A/S

Schedule of Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning. Nkr 30,000
Purchases of raw materials............... 200,000
Materials available for use................ 230,000
Raw materials inventory, ending...... 45,000
Nkr185,00
Materials used in production............. 0
Direct labor.......................................... 230,000
Manufacturing overhead applied to
work in process................................. 390,000
Total manufacturing costs................... 805,000
Add: Work in process, beginning......... 21,000
826,000
Deduct: Work in process, ending......... 56,000
Nkr770,00
Cost of goods manufactured............... 0

4. Manufacturing Overhead..................... 5,000

Cost of Goods Sold......................... 5,000

Schedule of cost of goods sold:

Finished goods inventory, beginning Nkr 60,000
Add: Cost of goods manufactured..... 770,000
Goods available for sale.................... 830,000
Deduct finished goods inventory,
ending............................................ 30,000
Unadjusted cost of goods sold.......... 800,000
Deduct: Overapplied overhead......... 5,000
Nkr795,00
Adjusted cost of goods sold.............. 0

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 139
Problem 3-31 (continued)

5. Froya Fabrikker A/S

Income Statement
Sales.................................................. Nkr1,200,000
Cost of goods sold............................. 795,000
Gross margin..................................... 405,000
Selling and administrative ex-
penses:
Advertising expense....................... Nkr136,000
Utilities expense............................. 7,000
Salaries expense............................. 110,000
Depreciation expense..................... 19,000
Rent expense.................................. 18,000 290,000
Net operating income........................ Nkr 115,000

6. Direct materials................................................... Nkr 8,000

Direct labor.......................................................... 9,200
Manufacturing overhead applied
(39 hours × Nkr400 per hour)........................... 15,600
Total manufacturing cost..................................... 32,800
Add markup (60% × Nkr32,800)......................... 19,680
Total billed price of Job 412................................. Nkr52,480
Nkr52,480 ÷ 4 units = Nkr13,120 per unit

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

140 Managerial Accounting, 13th Edition
Problem 3-32 (30 minutes)

1. The predetermined overhead rate is:

Sfr850,00
2. Actual manufacturing overhead cost.............. 0
Manufacturing overhead cost applied to
Work in Process during the year: 60,000 720,00
actual MHs × Sfr12 per MH........................... 0
Sfr130,00
Underapplied overhead cost........................... 0

3. Cost of Goods Sold.............................. 130,000

Manufacturing Overhead................ 130,000

4. The underapplied balance would be allocated using the

following percentages:
Overhead applied during the year
in:
Sfr 36,00
Work in process............................. 0 5%
Finished goods.............................. 180,000 25 %
504,00
Cost of goods sold......................... 0 70 %
Sfr720,00
Total................................................ 0 100 %
The entry to record the allocation of the underapplied overhead
would be:
Work in Process (5% × Sfr130,000)... 6,500
Finished Goods (25% × Sfr130,000).. 32,500
Cost of Goods Sold (70% ×
Sfr130,000)..................................... 91,000
Manufacturing Overhead........... 130,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 141
Problem 3-32 (continued)

5. Cost of goods sold if the underapplied over-

head is closed directly to cost of goods sold
(Sfr1,400,000 + Sfr130,000)......................... Sfr1,530,000
Cost of goods sold if the underapplied over-
head is allocated among the accounts
(Sfr1,400,000 + Sfr91,000)........................... 1,491,000
Difference in cost of goods sold...................... Sfr 39,000
Thus, net operating income will be Sfr39,000 greater if the
underapplied overhead is allocated rather than closed directly
to cost of goods sold.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

142 Managerial Accounting, 13th Edition
Case 3-33 (45 minutes)

1. Shaving 5% off the estimated direct labor-hours in the

predetermined overhead rate will result in an artificially high
overhead rate. The artificially high predetermined overhead
rate is likely to result in overapplied overhead for the year. The
cumulative effect of overapplying the overhead throughout the
year is all recognized in December when the balance in the
Manufacturing Overhead account is closed out to Cost of Goods
Sold. If the balance were closed out every month or every
quarter, this effect would be dissipated over the course of the
year.

2. This question may generate lively debate. Where should Terri

Ronsin’s loyalties lie? Is she working for the general manager of
the division or for the corporate controller? Is there anything
wrong with the “Christmas bonus”? How far should Terri go in
bucking her boss on a new job?
While individuals can certainly disagree about what Terri
should do, some of the facts are indisputable. First,
understating direct labor-hours artificially inflates the overhead
rate. This has the effect of inflating the Cost of Goods Sold in all
months prior to December and overstating the costs of
inventories. In December, the huge adjustment for overapplied
overhead provides a big boost to net operating income.
Therefore, the practice results in distortions in the pattern of
net operating income over the year. In addition, because all of
the adjustment is taken to Cost of Goods Sold, inventories are
still overstated at year-end. This means, of course, that the net
operating income for the entire year is also overstated.
While Terri is in an extremely difficult position, her
responsibilities under the IMA’s Statement of Ethical
Professional Practice seem to be clear. The Credibility Standard
states that management accountants have a responsibility to
“disclose all relevant information that could reasonably be
expected to influence an intended user’s understanding of the
reports, analyses or recommendations.” In our opinion, Terri
should discuss this situation with her immediate supervisor in
the controller’s office at corporate headquarters. This step may

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 143
 bring her into direct conflict with the general manager of the
division, so it would be a very difficult decision for her to make.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

144 Managerial Accounting, 13th Edition
Case 3-33 (continued)

In the actual situation that this case is based on, the corporate
controller’s staff were aware of the general manager’s
accounting tricks, but top management of the company
supported the general manager because “he comes through
with the results” and could be relied on to hit the annual profit
targets for his division. Personally, we would be very
uncomfortable supporting a manager who will resort to
deliberate distortions to achieve “results.” If the manager will
pull tricks in this area, what else might he be doing that is
questionable or even perhaps illegal?

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 145
Case 3-34 (75 minutes)

1. The revised predetermined overhead rate is determined as

follows:
Original estimated total manufacturing $3,402,00
overhead.................................................... 0
Plus: Lease cost of the new machine............ 348,000
Plus: Cost of new technician/programmer.... 50,000
$3,800,00
Estimated total manufacturing overhead..... 0
Original estimated total direct labor-hours... 63,000
Less: Estimated reduction in direct labor-
hours.......................................................... 6,000
Estimated total direct labor-hours................ 57,000

The revised predetermined overhead rate is higher than the

original rate because the automated milling machine will
increase the overhead for the year (the numerator in the rate)
and will decrease the direct labor-hours (the denominator in
the rate). This double-whammy effect increases the
predetermined overhead rate.

2. Acquisition of the automated milling machine will increase the

apparent costs of all jobs—not just those that use the new
facility. This is because the company uses a plantwide
overhead rate. If there were a different overhead rate for each
department, this would not happen.

3. The predetermined overhead rate is now considerably higher

than it was. This will penalize products that continue to use the
same amount of direct labor-hours. Such products will now
appear to be less profitable and the managers of these
products will appear to be doing a poorer job. There may be
© The McGraw-Hill Companies, Inc., 2010. All rights reserved.
146 Managerial Accounting, 13th Edition
 pressure to increase the prices of these products even though
there has in fact been no increase in their real costs.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 147
Case 3-34 (continued)

4. While it may have been a good idea to acquire the new

equipment because of its greater capabilities, the calculations
of the cost savings were in error. The original calculations
implicitly assumed that overhead would decrease because of
the reduction in direct labor-hours. In reality, the overhead
increased because of the additional costs of the new
equipment. A differential cost analysis would reveal that the
automated equipment would increase total cost by about
$316,000 a year if the labor reduction is only 2,000 hours.
Cost consequences of leasing the automated equipment:
Increase in manufacturing overhead cost:
$348,00
Lease cost of the new machine......................... 0
Cost of new technician/programmer.................. 50,000
398,000
Less: labor cost savings (2,000 hours × $41 per
hour).................................................................. 82,000
$316,00
Net increase in annual costs................................ 0
Even if the entire 6,000-hour reduction in direct labor-hours
had happened, that would have added only $164,000 (4,000
hours × $41 per hour) in cost savings. The net increase in
annual costs would have been $152,000 and the machine
would still be an unattractive proposal. The entire 6,000-hour
reduction may ultimately be realized as workers retire or quit.
However, this is by no means automatic.
There are two morals to this tale. First, predetermined
overhead rates should not be misinterpreted as variable costs.
They are not. Second, a reduction in direct labor requirements
does not necessarily lead to a reduction in direct labor hours
paid. It is often very difficult to actually reduce the direct labor
force and may be virtually impossible except through natural
attrition in some countries.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

148 Managerial Accounting, 13th Edition
Research and Application 3-35

1. Toll Brothers succeeds first and foremost because of its product

leadership customer value proposition. The annual report
mentions in numerous places that Toll Brothers focuses on
Luxury Homes and Communities and high quality construction.
Page 8 of the 10-K says ‘We believe our marketing strategy,
which emphasizes our more expensive “Estate” and
“Executive” lines of homes, has enhanced our reputation as a
builder-developer of high-quality upscale housing.” Page 2 of
the 10-K says “We are the only publicly traded national home
builder to have won all three of the industry’s highest honors:
America’s Best Builder (1996), the National Housing Quality
Award (1995), and Builder of the Year (1988).” Toll Brothers
seeks to realize manufacturing efficiencies for the benefit of its
shareholders, but its customers choose Toll Brothers for its
leadership position in the luxury home market.

2. Toll Brothers faces numerous business risks as described in

pages 10-11 of the 10-K. Students may mention other risks
beyond those specifically mentioned in the 10-K. Here are four
risks faced by Toll Brothers with suggested control activities:
 Risk: Downturns in the real estate market could adversely
impact Toll Brothers’ sales. Control activities: Diversify geo-
graphic markets served so that a downturn in one region of
the country will not cripple the company.
 Risk: Large sums of money may be spent buying land that,
geologically speaking, cannot support home construction.
For example, soil conditions may be too unstable to support
the weight of a home. Control activities: Pay engineers to
certify that targeted properties can support home construc-
tion.
 Risk: Raw material costs may increase thereby depressing
profit margins. Control activities: Vertically integrate by op-
erating manufacturing facilities (see page 12 of the 10-K for
a discussion of Toll Brothers’ manufacturing facilities). Buy-
ing raw materials at wholesale prices cuts out a middleman
in the value chain. In addition, Toll Brothers can purchase
raw materials in large volumes to realize purchase price dis-
counts.
© The McGraw-Hill Companies, Inc., 2010. All rights reserved.
Solutions Manual, Chapter 3 149
Research and Application 3-35 (continued)

 Risk: Subcontractors may perform substandard work result-

ing in warranty claims and dissatisfied customers. Control
activities: Employ a project manager within each community
who serves in a quality assurance capacity.

3. Toll Brothers would use job-order costing because its homes

are unique rather than homogeneous. Each home being built
would be a considered a job. Toll Brothers’ standard floor plans
differ from one another particularly across its main product
lines such as Move-Up, Empty Nester, Active Adult, Urban In-
Fill, High-Density Suburban, and Second Homes (see pages 5
and 9 of the annual report). In 2004, Toll Brothers introduced
87 new home models (see page 4 of the 10-K).
Beyond the fact that Toll Brothers offers a wide variety of floor
plans, homes are further distinguished from one another by
customer upgrades that add an average of $103,000 to the
price of a home (see page 1 of the annual report). Upgrades in-
clude items such as additional garages, guest suites, extra fire-
places, and finished lofts (see page 4 of 10-K).

4. Examples of direct materials used in Toll Brothers’

manufacturing facilities include lumber and plywood for wall
panels, roofs, and floor trusses, as well as other items such as
windows and doors (see page 12 of the 10-K). Examples of
direct materials used at the home sites include shingles,
exterior finishes such as stone, stucco, siding, or brick, kitchen
cabinets, cement for the foundation, bathroom fixtures, etc.
The standard bill of materials (e.g., prior to considering a spe-
cific customer’s upgrade requests) for each home would differ.
For example, differences in the square footage of homes would
drive numerous differences in their bills of materials. Bigger
homes would require more lumber, sheet rock, electrical
wiring, etc. Bills of materials are also likely to differ across geo-
graphic regions of the country. For example, homes in Florida
typically do not have basements whereas homes in New Eng-
land are likely to have basements. Front porches may be more
prevalent in South Carolina than in Ohio. Different grades of

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

150 Managerial Accounting, 13th Edition
 windows and insulation may be used in homes in the North
than in the South.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 151
Research and Application 3-35 (continued)

5. Toll Brothers incurs two types of direct labor costs. The

company employs its own direct laborers in its manufacturing
facilities in Morrisville, Pa. and Emporia, Va. The costs of these
workers can be traced to specific items such as roof trusses
that can in turn be traced to particular houses. Work at the
home sites is performed by subcontractors. The labor cost
embedded in a subcontractor’s fixed price contract is directly
traceable to the home being built. However, the direct laborers
are not employed by Toll Brothers. Toll Brothers would not use
employee time tickets at its home sites because the
subcontractors are not employees of Toll Brothers, Inc. and
they are paid a fixed price that is unaffected by the amount of
hours worked.

6. There are numerous examples of overhead costs mentioned in

the annual report and 10-K. Some examples are: land
acquisition costs, land development costs (e.g., grading and
clearing), road construction costs, underground utility
installation costs, swimming pools, golf courses, tennis courts,
marinas, community entrances, model home costs (including
construction, furnishing and staffing), and project manager
salaries. These costs are incurred to create housing
communities but they cannot be easily and conveniently traced
to specific homes.

7. It appears that Toll Brothers does not use cost-plus pricing to

establish selling prices for its base models. Page 8 of the 10-K
says “In determining the prices for our homes, we utilize, in
addition to management’s extensive experience, an internally
developed value analysis program that compares our homes
with homes offered by other builders in each local marketing
area.” In other words, the value to the customer and
competitive conditions determine prices—not the cost of
building a particular home.
Page 5 of the annual report says “When there is strong
demand, we benefit from exceptional pricing power because
we have greater ability to raise prices than those builders who
target buyers on tight budgets: it’s easier to hit doubles, triples
© The McGraw-Hill Companies, Inc., 2010. All rights reserved.
152 Managerial Accounting, 13th Edition
 and home runs selling to luxury buyers.” This quote implies
that pricing is driven by the customers’ willingness and ability
to pay and not by the cost of building a particular house.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 153
Research and Application 3-35 (continued)

8. Based on information contained in the 10-K, it appears that Toll

Brothers assigns overhead to cost objects in two ways. First,
page 16 of the 10-K says “Land, land development and related
costs (both incurred and estimated to be incurred in the future)
are amortized to the cost of homes closed based upon the total
number of homes to be constructed in each community.” In
other words, each home is assigned an equal share of
overhead costs. Page 16 also says, “The estimated land,
common area development and related costs of master
planned communities (including the cost of golf courses, net of
their estimated residual value) are allocated to individual
communities within a master planned community on a relative
sales value basis.” In other words, higher priced communities
within a master planned community are assigned a greater
portion of master planned community overhead costs.
In master planned communities, the allocation of overhead
appears to take place in two stages. First, the overhead costs
common to all communities contained with the master planned
community are assigned to communities based on relative
sales value. Then, all overhead costs related to a particular
community within the master planned community are assigned
equally to each home site.
The company needs to assign overhead costs to homes so that
it can derive a cost of sales number for the income statement
and an inventory number for the balance sheet. Page 29 of the
annual report shows the components of the company’s ending
inventory balance of $3.878 billion. Inventoriable costs include
land and land development costs ($1.242 billion), construction
in progress ($2.178 billion), sample homes and sales offices
($208 million), land deposits and costs of future development
($237 million), and other ($12 million). Construction in progress
is similar to work in process for a manufacturing company.
Overhead costs (as well as direct costs) flow through the
construction in progress account and hit cost of home sales
when a customer has a closing and takes possession of the
home.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

154 Managerial Accounting, 13th Edition
Appendix 3A
The Predetermined Overhead Rate and
Capacity

Exercise 3A-1 (30 minutes)

1. The overhead applied to Mrs. Brinksi’s account would be

computed as follows:
2008 2009
$310,50 $310,50
Estimated overhead cost (a)...................... 0 0
Estimated professional staff hours (b)........ 4,500 4,600
Predetermined overhead rate (a) ÷ (b)...... $69.00 $67.50
Professional staff hours charged to Ms.
Brinksi’s account...................................... × 2.5 × 2.5
Overhead applied to Ms. Brinksi’s account. $172.50 $168.75

2. If the actual overhead cost and the actual professional hours

charged turn out to be exactly as estimated there would be no
underapplied or overapplied overhead.
2008 2009
Predetermined overhead rate (see above). $69.00 $67.50
Actual professional staff hours charged to
clients’ accounts (by assumption)............ × 4,500 × 4,600
$310,50 $310,50
Overhead applied....................................... 0 0
Actual overhead cost incurred (by as-
sumption)................................................. 310,500 310,500
Underapplied or overapplied overhead...... $ 0 $ 0

3. If the predetermined overhead rate is based on the

professional staff hours available, the computations would be:
$310,50 $310,50
Estimated overhead cost (a)........................ 0 0
Professional staff hours available (b)........... 6,000 6,000
Predetermined overhead rate (a) ÷ (b)....... $51.75 $51.75
© The McGraw-Hill Companies, Inc., 2010. All rights reserved.
Solutions Manual, Appendix 3A 155
 Professional staff hours charged to Ms.
Brinksi’s account....................................... × 2.5 × 2.5
Overhead applied to Ms. Brinksi’s account. . $129.38 $129.38

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

156 Managerial Accounting, 13th Edition
Exercise 3A-1 (continued)

4. If the actual overhead cost and the actual professional staff

hours charged to clients’ accounts turn out to be exactly as
estimated, overhead would be underapplied as shown below.
2008 2009
Predetermined overhead rate (see above)
(a).............................................................. $51.75 $51.75
Actual professional staff hours charged to
clients’ accounts (by assumption) (b)........ × 4,500 × 4,600
$232,87 $238,05
Overhead applied (a) × (b).......................... 5 0
Actual overhead cost incurred (by assump-
tion)........................................................... 310,500 310,500
Underapplied overhead............................... $ 77,625 $ 72,450
The underapplied overhead is best interpreted in this situation
as the cost of idle capacity. Proponents of this method of
computing predetermined overhead rates suggest that the
underapplied overhead be treated as a period expense that
would be disclosed separately on the income statement as Cost
of Unused Capacity.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Appendix 3A 157
Problem 3A-2 (60 minutes)

1. The overhead applied to the Verde Baja job is computed as

follows:
2008 2009
$160,00 $160,00
Estimated studio overhead cost (a).......... 0 0
Estimated hours of studio service (b)....... 1,000 800
Predetermined overhead rate (a) ÷ (b).... $160 $200
Verde Baja job’s studio hours .................. × 40 × 40
Overhead applied to the Verde Baja job .. $6,400 $8,000

Overhead is underapplied for both years as computed below:

2008 2009
Predetermined overhead rate (see
above) (a).............................................. $160 $200
Actual hours of studio service provided
(b).......................................................... 750 500
$120,00 $100,00
Overhead applied (a) × (b)....................... 0 0
Actual studio cost incurred....................... 160,000 160,000
Underapplied overhead............................ $ 40,000 $ 60,000

2. If the predetermined overhead rate is based on the hours of

studio service at capacity, the computations would be:
2008 2009
Estimated studio overhead cost at capac-
ity (a)..................................................... $160,000 $160,000
Hours of studio service at capacity (b)..... 1,600 1,600
Predetermined overhead rate (a) ÷ (b).... $100 $100
Verde Baja job’s studio hours .................. × 40 × 40
Overhead applied to the Verde Baja job .. $4,000 $4,000

Overhead is underapplied for both years under this method as

well:
2008 2009
Predetermined overhead rate (see
above) (a).............................................. $100 $100
Actual hours of studio service provided 750 500
© The McGraw-Hill Companies, Inc., 2010. All rights reserved.
158 Managerial Accounting, 13th Edition
 (b)..........................................................
Overhead applied (a) × (b)....................... $ 75,000 $ 50,000
Actual studio cost incurred....................... 160,000 160,000
Underapplied overhead............................ $ 85,000 $110,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Appendix 3A 159
Problem 3A-2 (continued)

3. When the predetermined overhead rate is based on capacity,

the underapplied overhead is interpreted as the cost of idle
capacity. Indeed, proponents of this method suggest that the
underapplied overhead should be treated as a period expense
that would be disclosed separately on the income statement as
Cost of Unused Capacity.

4. Platinum Track’s fundamental problem is the competition that

is drawing customers away. The competition is able to offer the
latest equipment, excellent service, and attractive prices. The
company must do something to counter this threat or it will
ultimately face failure.
Under the conventional approach in which the predetermined
overhead rate is based on the estimated studio hours, the
apparent cost of the Verde Baja job has increased between
2008 and 2009. That happens because the company is losing
business to competitors and therefore the company’s fixed
overhead costs are being spread over a smaller base. This
results in costs that seem to increase as the volume declines.
Under this method, Platinum Track’s managers may be misled
into thinking that the problem is rising costs and they may be
tempted to raise prices to recover their apparently increasing
costs. This would almost surely accelerate the company’s
decline.

Under the alternative approach, the overhead cost of the Verde

Baja job is stable at $4,000 and lower than the costs reported
under the conventional method. Under the conventional
method, managers may be misled into thinking that they are
actually losing money on the Verde Baja job and they might
refuse such jobs in the future—another sure road to disaster.
This is much less likely to happen if the lower cost of $4,000 is
reported. It is true that the underapplied overhead under the
alternative approach is much larger than under the
conventional approach and is growing. However, if it is properly
labeled as the cost of idle capacity, management is much more
likely to draw the appropriate conclusion that the real problem
is the loss of business (and therefore more idle capacity) rather
© The McGraw-Hill Companies, Inc., 2010. All rights reserved.
160 Managerial Accounting, 13th Edition
 than an increase in costs.

While basing the predetermined rate on capacity rather than

on estimated activity will not solve the company’s basic
problems, at least this method is less likely to send managers
misleading signals.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Appendix 3A 161
Case 3A-3 (120 minutes)

1. Traditional approach:
Actual total manufacturing overhead cost in-
curred
(assumed to equal the original estimate)......... $4,000,000
Manufacturing overhead applied
(160,000 units × $25 per unit)......................... 4,000,000
Overhead underapplied or overapplied.............. $ 0

Vault Hard Drives, Inc.

Income Statement: Traditional Approach
$9,000,00
Sales (150,000 units × $60 per unit)..... 0
Cost of goods sold:
Variable manufacturing
$2,250,00
(150,000 units × $15 per unit)......... 0
Manufacturing overhead applied
3,750,00 6,000,00
(150,000 units × $25 per unit)......... 0 0
Gross margin......................................... 3,000,000
2,700,00
Selling and administrative expenses..... 0
$ 300,00
Net operating income............................ 0

New approach:
Vault Hard Drives, Inc.
Income Statement: New Approach
$9,000,00
Sales (150,000 units × $60 per unit)............ 0
Cost of goods sold:
Variable manufacturing
$2,250,00
(150,000 units × $15 per unit)................ 0
Manufacturing overhead applied
3,000,00 5,250,00
(150,000 units × $20 per unit)................ 0 0

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

162 Managerial Accounting, 13th Edition
Gross margin................................................ 3,750,000
Cost of unused capacity [(200,000 units –
160,000 units) × $20 per unit]................... 800,000
2,700,00
Selling and administrative expenses............ 0
$ 250,00
Net operating income................................... 0

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Appendix 3A 163
Case 3A-3 (continued)

2. Traditional approach:
Under the traditional approach, the reported net operating
income can be increased by increasing the production level
which then results in overapplied overhead which is deducted
from Cost of Goods Sold.

Additional net operating income required to at-

tain target net operating income ($500,000 –
$300,000) (a)....................................................... $200,000
$25 per
Overhead applied per unit of output (b)................ unit
Additional output required to attain target net
operating income (a) ÷ (b).................................. 8,000 units
Actual total manufacturing overhead cost in-
curred.................................................................. $4,000,000
Manufacturing overhead applied
[(160,000 units + 8,000 units) × $25 per unit].. . 4,200,000
Overhead overapplied............................................ $ 200,000

Vault Hard Drives, Inc.

Income Statement: Traditional Approach
$9,000,00
Sales (150,000 units × $60 per unit)........ 0
Cost of goods sold:
Variable manufacturing
$2,250,00
(150,000 units × $15 per unit)............ 0
Manufacturing overhead applied
(150,000 units × $25 per unit)............ 3,750,000
Less: Manufacturing overhead overap- 5,800,00
plied..................................................... 200,000 0
Gross margin............................................ 3,200,000
2,700,00
Selling and administrative expenses........ 0
$ 500,00
Net operating income............................... 0

Note: If the overapplied manufacturing overhead were prorated

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.
164 Managerial Accounting, 13th Edition
 between ending inventories and Cost of Goods Sold, more units
would have to be produced to attain the target net profit of
$500,000. In fact, it can be shown that the total production
level would have to be 169,014 units rather than 168,000 units.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Appendix 3A 165
Case 3A-3 (continued)

New approach:
Under the new approach, the reported net operating income can
be increased by increasing the production level. This results in
less of a deduction on the income statement for the Cost of Un-
used Capacity.

Additional net operating income required to attain

target net operating income ($500,000 –
$250,000) (a)........................................................ $250,000
Overhead applied per unit of output (b).................. $20 per unit
Additional output required to attain target net op-
erating income (a) ÷ (b)....................................... 12,500 units
160,000
Estimated number of units produced...................... units
172,500
Actual number of units to be produced................... units

Vault Hard Drives, Inc.

Income Statement: New Approach
$9,000,00
Sales (150,000 units × $60 per unit)........... 0
Cost of goods sold:
Variable manufacturing
$2,250,00
(150,000 units × $15 per unit)............... 0
Manufacturing overhead applied
3,000,00
(150,000 units × $20 per unit)............... 0 5,250,000
Gross margin............................................... 3,750,000
Cost of unused capacity [(200,000 units –
172,500 units) × $20 per unit].................. 550,000
Selling and administrative expenses........... 2,700,000
Net operating income.................................. $ 500,000

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

166 Managerial Accounting, 13th Edition
Case 3A-3 (continued)

3. Net operating income is more volatile under the new method

than under the old method. The reason for this is that the
reported profit per unit sold is higher under the new method by
$5, the difference in the predetermined overhead rates. As a
consequence, swings in sales in either direction will have a
more dramatic impact on reported profits under the new
method.

4. As the computations in part (2) above show, the “hat trick” is a

bit harder to perform under the new method. Under the old
method, the target net operating income can be attained by
producing an additional 8,000 units. Under the new method,
the production would have to be increased by 12,500 units.
Again, this is a consequence of the difference in predetermined
overhead rates. The drop in sales has had a more dramatic
effect on net operating income under the new method as noted
above in part (3). In addition, because the predetermined
overhead rate is lower under the new method, producing
excess inventories has less of an effect per unit on net
operating income than under the traditional method and hence
more excess production is required.

5. One can argue that whether the “hat trick” is unethical

depends on the level of sophistication of the owners of the
company and others who read the financial statements. If they
understand the effects of excess production on net operating
income and are not misled, it can be argued that the hat trick
is not unethical. However, if that were the case, there does not
seem to be any reason to use the hat trick. Why would the
owners want to tie up working capital in inventories just to
artificially attain a target net operating income for the period?
And increasing the rate of production toward the end of the
year is likely to increase overhead costs due to overtime and
other costs. Building up inventories all at once is very likely to
be much more expensive than increasing the rate of production
uniformly throughout the year. In this case, we assumed that
there would not be an increase in overhead costs due to the
additional production, but that is likely not to be true.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Appendix 3A 167
 In our opinion, the hat trick is unethical unless there is a good
reason for increasing production other than to artificially boost
the current period’s net operating income. It is certainly
unethical if the purpose is to fool users of financial reports such
as owners and creditors or if the purpose is to meet targets so
that bonuses will be paid to top managers.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

168 Managerial Accounting, 13th Edition