Exercise 15: Duggan Company Applies Manufacturing Overhead

Exercise 15 5duggan Company Applies Manufacturing Overhead To Jobs On

Exercise 15-5 involves computing the manufacturing overhead rate for Duggan Company based on machine hours, determining the amount of under- or over-applied overhead at year-end, and preparing the necessary adjusting entry. Additionally, it includes a second exercise involving cost calculations related to work-in-process inventory and transfers in a manufacturing environment. The third exercise explores overhead rate calculations using traditional and activity-based costing methods for Wilkins Inc. These problems collectively assess understanding of overhead application, inventory costing, and costing method comparisons in manufacturing accounting.

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Manufacturing overhead allocation and costing systems are fundamental components of managerial accounting, providing the foundation for determining product costs, pricing, and financial reporting. The application of manufacturing overhead involves estimating total overhead costs and apportioning them to products or jobs, typically based on a chosen cost driver such as machine hours, labor hours, or activity-based rates. Accurate application and adjustment of overhead are essential to ensure precise product costing, which directly impacts profitability analysis and decision-making in manufacturing firms.

In the case of Duggan Company, the overhead application process is based on machine hours. The company estimates total overhead costs at $353,920 and machine hours at 126,400 for the upcoming year. Using these figures, the predetermined overhead rate per machine hour is calculated by dividing the estimated overhead by estimated machine hours. This rate helps allocate overhead to individual jobs or products based on actual machine hours used. For the year, actual overhead costs incurred amount to $368,283 with 130,100 machine hours used. This deviation between estimated and actual costs leads to either under- or over-applied overhead at year-end, which must be adjusted to reflect true costs.

The first step in analyzing Duggan’s overhead application is computing the predetermined overhead rate:

Overhead Rate = Estimated Overhead / Estimated Machine Hours = $353,920 / 126,400 hours ≈ $2.80 per machine hour.

Next, the applied overhead based on actual machine hours used is:

Applied Overhead = Actual Machine Hours × Predetermined Rate = 130,100 × $2.80 ≈ $364,280.

The difference between the actual overhead incurred ($368,283) and applied overhead ($364,280) is the under-applied overhead:

Under-applied Overhead = Actual Overhead - Applied Overhead = $368,283 - $364,280 = $4,003.

To adjust the books, the following journal entry is made to allocate the under-applied overhead to cost of goods sold:

Debit: Cost of Goods Sold $4,003


Credit: Manufacturing Overhead $4,003

This adjustment ensures that the cost of goods sold accurately reflects the overhead costs incurred during the period, following the matching principle of accounting.

The second exercise involving Custer Company's work in process inventory provides insights into inventory costing and production analysis. Starting with the beginning inventory, units started during the month, and units transferred out, it discusses the calculation of equivalent units, unit materials and conversion costs, and total costs associated with ending inventory and goods transferred out. These calculations are crucial in process costing systems to allocate costs appropriately among completed and ongoing units, especially when inventory is partially complete, such as 40% completion for May 31.

The calculation of units in process at the end of May is based on the units in beginning inventory plus units started, minus units transferred out:

Units in Process = (Beginning Inventory) + (Units Started) - (Units Transferred Out) = 570 + 1,580 - 1,450 = 700 units.

The unit materials cost, given as $4.43, is derived by dividing total materials costs by units in process or completed units, adjusted for the stage of completion. Similarly, the unit conversion cost of $4.17 reflects labor and overhead costs per unit, considering the degree of completion, which affects total cost calculations.

The total cost of units transferred out combines the costs of beginning inventory plus costs added during the period, apportioned based on equivalent units. The ending inventory cost considers units remaining in process and their stage of completion. These figures help in assessing profitability and inventory valuation.

Finally, the third exercise compares traditional activity-based costing (ABC) with a plantwide overhead rate based on direct labor costs for Wilkins Inc., which produces standard and custom handbags. Under the plantwide approach, total estimated overhead ($301,100) is allocated evenly based on a single cost driver, typically direct labor costs. With ABC, overhead costs are assigned based on specific activities such as machining and setup hours, providing a more accurate reflection of the true costs associated with each product type.

Calculating the plantwide overhead rate involves dividing total overhead by the total direct labor costs, resulting in a rate per dollar of direct labor. ABC involves determining activity-specific rates by dividing estimated overhead in each activity pool by the respective activity driver quantities, such as machine hours or setup hours. This method allows more precise allocation, especially when different products consume activities at different rates.

The comparison reveals that ABC often results in different overhead allocations compared to traditional methods, especially when product lines differ significantly in their consumption of activities. This discrepancy highlights the importance of choosing an appropriate costing system for accurate product costing, pricing, and profitability analysis.

Overall, these exercises exemplify vital concepts in managerial accounting, emphasizing the significance of precise overhead application, inventory costing, and the benefits of activity-based costing. Mastery of these topics enables managers to make informed decisions, improve cost control, and enhance overall operational efficiency.

References

  • Drury, C. (2018). Management and Cost Accounting. Cengage Learning.
  • Anthony, R. N., & Govindarajan, V. (2019). Management Control Systems. McGraw-Hill Education.
  • Hilton, R. W., & Platt, D. E. (2018). Managerial Accounting: Creating Value in a Dynamic Business Environment. McGraw-Hill Education.
  • Cooper, R., & Kaplan, R. S. (1991). Measure Costs Right: Make the Right Decisions. Harvard Business Review.
  • Innes, J., & Mitchell, F. (1995). Activity-Based Costing in the UK’s Largest Companies. British Accounting Review.
  • GPK Consulting. (2022). Costing Systems and Overhead Allocation Methods. Retrieved from https://www.gpkconsulting.com

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