Micro Enterprises planned to produce 120,000 lerts per year. Annual overheads, of which 32.5% are variable, are estimated at $320,400. Each lert takes 1.2 machine hours and 3 labor hours to produce. The firm allocates overhead by direct labor hours. You review the accounting records at the end of the year. You learn that Micro made 125,000 lerts in the year, using 356,000 direct labor hours. Actual overhead expenditures totaled $333,333.

Question

Quizplus · Accepted Answer

To calculate the under or over-applied overhead, we need to compare the actual overhead expenditure with the overhead cost allocated based on the predetermined overhead rate.

The predetermined overhead rate can be calculated as follows:

Variable overhead = 32.5% of $320,400 = $104,130
Fixed overhead = $320,400 - $104,130 = $216,270

Total overhead = $104,130 + $216,270 = $320,400
Predetermined overhead rate = Total overhead / Direct labor hours
Predetermined overhead rate = $320,400 / 356,000 = $0.90 per direct labor hour

Now, let's calculate the overhead cost allocated:

Overhead cost allocated = Predetermined overhead rate x Actual direct labor hours
Overhead cost allocated = $0.90 x 356,000 = $320,400

Since the overhead cost allocated matches the actual overhead expenditure, there is no over or under application of overhead.

However, if we were to allocate overhead based on the planned level of production (120,000 lerts), the allocated overhead would be as follows:

Variable overhead = 32.5% of $320,400 = $104,130
Fixed overhead per unit = $216,270 / 120,000 = $1.80 per lert

Predetermined overhead rate = Variable overhead + Fixed overhead per unit
Predetermined overhead rate = $104,130 + $1.80 = $105,910 / 120,000 = $0.88 per lert

Overhead cost allocated = Predetermined overhead rate x Actual production level
Overhead cost allocated = $0.88 x 125,000 = $110,000

Actual overhead expenditure = $333,333

Under-applied overhead = Actual overhead expenditure - Overhead cost allocated
Under-applied overhead = $333,333 - $110,000 = $223,333

Since under-applied overhead is a debit balance, it should be charged to Cost of Goods Sold. Therefore, option C is the correct answer.

Micro Enterprises Planned to Produce 120,000 Lerts Per Year