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Sawyer Manufacturing Corporation uses a predetermined overhead rate based on direct labor-hours to apply manufacturing overhead to jobs. Last year, the Corporation worked 49,000 actual direct labor-hours and incurred $658,000 of actual manufacturing overhead cost. The Corporation had estimated that it would work 47,000 direct labor-hours during the year and incur $611,000 of manufacturing overhead cost. The Corporation's manufacturing overhead cost for the year was: underapplied by $21,000.

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The calculation of manufacturing overhead costs is a crucial aspect of cost accounting, providing insights into the efficiency of manufacturing processes and informing pricing, budgeting, and financial analysis decisions. In managerial accounting, the use of a predetermined overhead rate simplifies the allocation of manufacturing overhead to individual jobs, especially when actual overhead costs and actual direct labor-hours are known at the fiscal year’s end. This case involving Sawyer Manufacturing Corporation exemplifies the application of these concepts, highlighting the importance of understanding applied overhead, actual costs incurred, and the resulting over- or under-applied overhead.

In this scenario, Sawyer Manufacturing utilizes a predetermined overhead rate based on direct labor-hours to assign manufacturing overhead costs. The data provided indicates that the company worked 49,000 actual direct labor-hours and incurred $658,000 of actual overhead costs. The initial estimates for the year projected 47,000 direct labor-hours and $611,000 of overhead costs. The key observation is that the company’s actual overhead costs exceeded the amount that was applied based on their predetermined rate, resulting in an underapplied overhead of $21,000.

Calculating the Predetermined Overhead Rate

The predetermined overhead rate is calculated using estimated costs and activity levels before the fiscal year begins, providing a basis for applying overhead throughout the year. The rate is computed as follows:

• Estimated Overhead Cost: $611,000
• Estimated Direct Labor-Hours: 47,000 hours
• Predetermined Overhead Rate: $611,000 / 47,000 hours ≈ $13 per direct labor-hour

This rate indicates that for every direct labor-hour worked, approximately $13 of overhead is allocated to jobs.

Applying Overhead to Jobs

Throughout the year, the applied overhead is calculated by multiplying the actual direct labor-hours by the predetermined rate:

Applied Overhead = 49,000 hours × $13/hour = $637,000

This figure represents the overhead allocated to jobs based on the actual labor-hours worked, using the predetermined rate. The actual overhead incurred during the year was $658,000, which exceeds the applied overhead, resulting in an underapplication of overhead:

Underapplied Overhead = Actual Overhead – Applied Overhead = $658,000 – $637,000 = $21,000

This confirms the company’s statement of an underapplied overhead of $21,000, meaning more overhead costs were incurred than expected and allocated based on the standard rate.

Implications of Underapplied Overhead

The presence of underapplied overhead signals a discrepancy that may affect the company’s financial statements and managerial decisions. It indicates that the actual costs are higher than those allocated, which can lead to understated production costs if not adjusted. In practice, companies may choose to close the under- or overapplied overhead to cost of goods sold at the end of the period or allocate it among work-in-process, finished goods, and cost of goods sold, depending on their accounting policies.

Conclusion

In summary, Sawyer Manufacturing’s actual overhead costs of $658,000, when compared to the applied overhead of $637,000, reveal an underapplication of $21,000. The calculation hinges on the predetermined overhead rate based on estimated activity levels, emphasizing the importance of accurate estimates and the need for adjustments at period-end. Effective management of overhead costs and precise application rates are vital for accurate product costing, financial reporting, and operational decision-making.

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