Blueprint Problem: Predetermined, overapplied, and underapplied overhead The Nat
ID: 2369193 • Letter: B
Question
Blueprint Problem: Predetermined, overapplied, and underapplied overhead
The Nature of Overhead
The overhead costs are allocated to jobs using a common measure related to each job. This measure is called an activity base, allocation base, or activity driver. The activity base or driver used to allocate overhead should reflect the consumption or use of the overhead costs. There are basically three types of drivers (or activity bases) used to compute a predetermined overhead rate: volume, cost, and time.
To calculate the predetermined overhead rate, you must first estimate the overhead costs for the year, as well as the associated level of activity that will drive these costs.
Match the type of driver with its cause.
The formula for calculating the predetermined overhead rate is the following:
Notice that the predetermined overhead rate is computed using estimated amounts at the beginning of the period. This is because managers need timely information on the product costs of each job.
APPLY THE CONCEPTS: Calculate the predetermined overhead rate
The following three companies made their overhead estimates at the beginning of the year. Complete the formula to compute the annual predetermined overhead rate for each company.
Girard Inc. estimated that overhead costs will be $440,000 and will be driven by direct labor (DL) costs estimated at $880,000.
Doherty Co. estimated that overhead costs will be $220,000 and will be driven by machine hours estimated at 25,000 hours.
Ngumi Ltd. estimated that overhead costs will be $300,000 and will be driven by the units produced, estimated at 500 units.
Application of Overhead
Now that the overhead rate has been determined, overhead can be allocated, or applied, during the year. Overhead is applied by multiplying the predetermined overhead rate by the actual units of the cost driver (time, volume, or cost). Complete the formula:
After overhead has been applied, total product costs for the period can be calculated by adding actual direct material costs and actual direct labor costs to the applied overhead. As units are sold, Cost of Goods Sold is debited for the units' product cost.
APPLY THE CONCEPTS: Apply the overhead throughout the year
During the year, each company applied overhead, using the rates previously computed (in the calculate the predetermined overhead rate section). The totals for each cost driver are provided as follows. Calculate the total overhead applied during the year.
Girard's actual direct labor cost for the year was $924,000. How much overhead was applied for the year?
Doherty used 26,500 machine hours during the year. How much overhead was applied for the year?
Ngumi produced 450 units during the year. How much overhead was applied for the year?
Reconcile the Applied and Actual Overhead
The goal is to estimate overhead as closely as possible to actual overhead costs. At the end of the year, however, it is unlikely that the two will be equal. The difference is sometimes referred to as the
1. Calculate the predetermined overhead rate.
2. Apply the overhead throughout the year.
3. Reconcile the applied and actual overhead at the end of the year.
Explanation / Answer
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VARIABLE OVERHEAD
In this section and the following section on fixed overhead, we will consider the equation approach first, followed by flexible budget diagrams and graphic illustrations. The T-account approach and the journal entries for overhead costs are presented after all four of the overhead variances have been discussed individually.
The analysis of variable overhead costs in standard costing typically includes two variances, the spending variance and the efficiency variance. The following symbols are used below to help illustrate these measurements.
SVOR = Standard variable overhead rate per direct labor hour.
AHU = Actual direct labor hours used.
SHA = Standard direct labor hours allowed for the good output.
AVO = Actual total variable overhead cost incurred.
EXAMPLE 10-3
A continuation of the Expando Company example is used to illustrate the techniques and concepts. Assume that standard overhead rates are based on 4,800 direct labor hours per month. The variable overhead rate calculation and other relevant data appear below.
SVOR = $144,000