The Management Of Rathburn Corporation Would Like To Invent
The Management Of Rathburn Corporation Would Like Toinve
The management of Rathburn Corporation is exploring the possibility of basing its predetermined overhead rate on activity at capacity rather than on estimated activity for the year. The company's controller has provided an example involving machine-hours, where the estimated annual machine-hours are 43,000, capacity is 47,000 machine-hours, and actual activity is 42,600 machine-hours. All manufacturing overhead is fixed at $848,820 per year, which is also the estimated overhead for the year, overhead at capacity, and the actual overhead.
Given this scenario, the following tasks are to be completed:
- Determine the predetermined overhead rate based on estimated activity.
- Calculate the overhead applied to a specific job using the estimated rate.
- Compute the underapplied or overapplied overhead for the year.
- Determine the new predetermined overhead rate based on capacity.
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Paper For Above instruction
Introduction
In managerial accounting, the allocation of manufacturing overhead is critical for accurate product costing and profitability analysis. Traditionally, overhead is allocated based on estimated activity levels for the upcoming year. However, some firms consider adopting a capacity-based approach, which allocates overhead based on actual capacity rather than expected activity, providing a potentially more stable and reflective measure of fixed overhead costs. This paper discusses the implications of switching from an estimated activity base to a capacity-based system for Rathburn Corporation, details the calculations involved in both approaches, and analyzes their impact on overhead application and cost management.
Determining the Predetermined Overhead Rate Based on Estimated Activity
The first step involves calculating the predetermined overhead rate using estimated activity. Given the estimated machine-hours of 43,000 for the upcoming year and a total fixed overhead of $848,820, the rate is calculated as:
\[
\text{Predetermined Overhead Rate} = \frac{\text{Estimated Total Overhead}}{\text{Estimated Activity Base}} = \frac{848,820}{43,000} \approx \$19.73 \text{ per machine-hour}
\]
This rate establishes a standard cost per machine-hour, which will be used to allocate overhead to jobs throughout the year.
Overhead Applied to Job F31I Using Estimated Activity Base
For Job F31I, which required 310 machine-hours, the overhead applied is calculated as:
\[
\text{Overhead Applied} = \text{Machine-hours for Job} \times \text{Predetermined Rate} = 310 \times 19.73 \approx \$6,119.30
\]
This application method ensures that overhead costs are assigned to jobs based on the estimated activity levels.
Calculating Underapplied or Overapplied Overhead
At the end of the year, it's crucial to compare the actual overhead incurred with the overhead applied to determine if there is underapplied or overapplied overhead. Actual overhead is given as $848,820, and the actual activity was 42,600 machine-hours, so the applied overhead is:
\[
\text{Applied Overhead} = 42,600 \times 19.73 \approx \$840,198
\]
The difference is:
\[
\text{Underapplied Overhead} = \text{Actual} - \text{Applied} = 848,820 - 840,198 = \$8,622
\]
This indicates that overhead was underapplied by approximately $8,622, meaning actual costs exceeded allocated costs.
Determining the Predetermined Overhead Rate Based on Capacity
Alternatively, the company might base its rate on capacity rather than estimated activity. Using the capacity of 47,000 machine-hours, the rate is:
\[
\text{Predetermined Overhead Rate at Capacity} = \frac{848,820}{47,000} \approx \$18.07 \text{ per machine-hour}
\]
This approach spreads fixed overhead costs over the maximum possible activity, potentially leading to different overhead allocations for jobs and more consistent overhead rates, especially in environments with fluctuating activity levels.
Implications and Analysis
Choosing between an estimated activity-based rate and a capacity-based rate affects how overhead costs are assigned and how managers interpret cost data. The capacity-based rate tends to smooth out fluctuations caused by varying activity levels, providing a more stable overhead allocation. This can facilitate better pricing decisions and performance evaluation as it reduces the distortions associated with short-term activity variations.
However, reliance on capacity-based overhead can sometimes lead to overcosting when actual activity is below capacity, which may be problematic for decision-making and cost control. Conversely, the estimated activity rate aligns closer to actual costs incurred during normal operation but can result in fluctuating overhead rates, making cost management and comparison across periods more complex.
In Rathburn's context, adopting a capacity-based approach would ensure consistent overhead rates, particularly if the company frequently experiences fluctuations in activity levels. It also aligns with the fixed nature of overhead costs, ensuring that these costs are recovered regardless of activity variability. Nevertheless, this necessitates careful consideration of how to handle differences between allocated and actual overhead.
Conclusion
The decision to base predetermined overhead rates on estimated activity or capacity influences cost accuracy, managerial decision-making, and financial reporting. For Rathburn Corporation, utilizing the capacity-based rate provides a stable overhead allocation, facilitating consistent costing and budgeting. However, it is essential for management to understand the implications regarding overcosting or undercosting and to implement appropriate cost control measures. Ultimately, the choice depends on the company's operational environment, cost structure, and managerial priorities.
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