Question & Answer: Submit an Excel spreadsheet that documents the calculations made for steps 1-3 above. All ite…..

ACCT505 – Managerial Accounting

Case Study 1

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Chapter 3 – Job Order Costing

CASE 3–29 Ethics and the Manager [Course Objective B] Terri Ronsin had recently been transferred to the Home Security Systems Division of National Home Products. Shortly after taking over her new position as divisional controller, she was asked to develop the division’s predetermined overhead rate for the upcoming year. The accuracy of the rate is important because it is used throughout the year and any overapplied or underapplied over- head is closed out to Cost of Goods Sold at the end of the year. National Home Products uses direct labor-hours in all of its divisions as the allocation base for manufacturing overhead.

To compute the predetermined overhead rate, Terri divided her estimate of the total manufacturing overhead for the coming year by the production manager’s estimate of the total direct labor-hours for the coming year. She took her computations to the division’s general manager for approval but was quite surprised when he suggested a modification in the base. Her conversation with the general manager of the Home Security Systems Division, Harry Irving, went like this:

Ronsin: Here are my calculations for next year’s predetermined overhead rate. If you approve, we can enter the rate into the computer on January 1 and be up and running in the job-order costing system right away this year.

Irving:   Thanks for coming up with the calculations so quickly, and they look just fine. There is, how- ever, one slight modification I would like to see. Your estimate of the total direct labor-hours for the year is 440,000 hours. How about cutting that to about 420,000 hours?

Ronsin: I don’t know if I can do that. The production manager says she will need about 440,000 direct labor-hours to meet the sales projections for the year. Besides, there are going to be over 430,000 direct labor-hours during the current year and sales are projected to be higher next year.

Irving: Teri, I know all of that. I would still like to reduce the direct labor-hours in the base to some- thing like 420,000 hours. You probably don’t know that I had an agreement with your predecessor as divisional controller to shave 5% or so off the estimated direct labor-hours every year. That way, we kept a reserve that usually resulted in a big boost to net operating income at the end of the fiscal year in December. We called it our Christmas bonus. Corporate headquarters always seemed as pleased as punch that we could pull off such a miracle at the end of the year. This system has worked well for many years, and I don’t want to change it now.

Required:

Assume the following information:

Direct Materials $40 per unit
Direct Labor $20 per unit
Total Estimated Manufacturing Overhead $8,400,000
Manufacturing overhead is allocated based on estimated direct-labor hours.

Each unit of product requires 1 direct labor hour.

Calculate the cost of one unit of product, assuming that the overhead per unit is based on Terri Ronson’s estimate of 440,000 hours. (Round all dollar figures to two decimal places.)

If 441,000 units were produced, how much overhead was applied to work in process.

Calculate the cost of one unit of product, assuming that the overhead per unit is based on her supervisors preferred estimate of 420,000 hours. (Round all dollar figures to two decimal places.)

If 441,000 units were produced, how much overhead was applied to work in process.

During the year, the company produced and sold 441,000 units, and incurred actual overhead of $8,500,000, what is the under/overapplied overhead if:

The estimated Direct Labor Hours is 440,000.

The estimated Direct Labor Hours is 420,000.

All over-applied and under-applied overhead applied directly to cost of goods sold. Assume that the company had $1,000,000 in net operating income before the over/under applied overhead adjustment is made. What is the revised net income after the over/underapplied overhead adjustment?

Should Terri Ronson go along with the general manager’s request to reduce the direct labor hours in the predetermined overhead rate computation to 420,000 hours? Be sure to discuss the operational and ethical issues related to this decision.

Deliverables:

Submit an Excel spreadsheet that documents the calculations made for steps 1-3 above. All items should be clearly labeled, and appropriate formulas should be used to perform your calculations.

Expert Answer

 

Estimated direct labor hours 440000
Direct materials 40
Direct labor 20
Manufacturing overhead 19.09
Cost per unit $ 79.09
Estimated manufacturing overheads $ 8400000
Estimated direct labor hours 440000
Overhead rate (8400000/440000) 19.09
Direct labor hours for 441,000 units 441000
Overheads applied $ 8418690
Actual overheads $ 8500000
Overheads underapplied $ 81310
Net operating income $ 1000000
Increase in cost of goods sold after adjustment of underapplied overheads i.e. decrease in net income -81310
Revised net income $ 918690
Estimated direct labor hours 420000
Direct materials 40
Direct labor 20
Manufacturing overhead 20
Cost per unit $ 80
Estimated manufacturing overheads $ 8400000
Estimated direct labor hours 420000
Overhead rate 20
Direct labor hours for 441,000 units 441000
Overheads applied $ 8820000
Actual overheads $ 8500000
Overheads overapplied $ 320000
Net operating income $ 1000000
Decrease in cost of goods sold after adjustment of overapplied overheads i.e. increase in net income 320000
Revised net income $ 1320000

Terri Ronson should not go along with the general manager’s request to reduce the direct labour hours for computation of predetermined overhead rate. As seen from the computations above, the under-estimation of direct labor hours would result in the cost per unit being incorrect and the net operating income being overstated by $320000. This would result in operationally incorrect product costing and pricing and the overstatement of income would be unethical.

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