Problem 4 - Accounting

Question

The chief cost accountant for Mountain Glade Beverage Co. estimated that total factory overhead cost for the Blending Department for the coming fiscal year beginning March 1 would be \(\$ 546,000\), and total direct labor costs would be \(\$ 420,000\). During March, the actual direct labor cost totaled \(\$ 36,000\), and factory overhead cost incurred totaled \(\$ 45,000\). a. What is the predetermined factory overhead rate based on direct labor cost? b. Journalize the entry to apply factory overhead to production for March. c. What is the March 31 balance of the account Factory Overhead-Blending Department? d. Does the balance in part (c) represent overapplied or underapplied factory overhead?

Step-by-Step Solution

Answer

a. 130%. b. Debit Work in Process $46,800; Credit Factory Overhead $46,800. c. Balance is -$1,800. d. Overapplied.

Step 1: Calculate the Predetermined Overhead Rate

The predetermined overhead rate is calculated by dividing the estimated total factory overhead by the estimated total direct labor cost for the upcoming year. \[\text{Predetermined Overhead Rate} = \frac{\text{Estimated Total Factory Overhead}}{\text{Estimated Total Direct Labor Costs}} = \frac{546,000}{420,000}\]So, the predetermined overhead rate is calculated as \[1.3 \text{ or } 130\%\].

Step 2: Apply Factory Overhead

To apply the factory overhead for March, multiply the actual direct labor cost of March by the predetermined overhead rate:\[\text{Applied Factory Overhead} = \text{Actual Direct Labor Costs} \times \text{Predetermined Overhead Rate} = 36,000 \times 1.3 = 46,800\]This is the factory overhead to apply to the production for March.

Step 3: Journalize Application of Factory Overhead

Record the application of factory overhead in the company's journal. The entry involves:- **Debit:** Work in Process - Blending Department- **Credit:** Factory Overhead - Blending DepartmentThe amounts to be recorded are \[46,800\, \text{for both debit and credit on March 31.}\]

Step 4: Calculate the March 31 Balance of Factory Overhead

Calculate the balance by subtracting the applied factory overhead from the actual overhead cost incurred during March:\[\text{Balance} = \text{Actual Factory Overhead Incurred} - \text{Applied Factory Overhead} = 45,000 - 46,800 = -1,800\]Therefore, the balance is \(-1,800\).

Step 5: Determine Overapplied or Underapplied Overhead

Since the balance is negative (\(-1,800\) ), it indicates that more overhead was applied than actually incurred. This results in overapplied factory overhead.

Key Concepts

Factory Overhead Rate Calculation

Calculating the factory overhead rate is a fundamental aspect of cost accounting. This rate is an estimation that helps businesses allocate overhead costs efficiently, based on various bases such as direct labor costs.
In this case, the Mountain Glade Beverage Co. needs to determine the predetermined overhead rate to predict how much overhead should be applied per dollar of direct labor costs. The formula used is:

• Predetermined Overhead Rate = Estimated Total Factory Overhead / Estimated Total Direct Labor Costs

Plugging in the numbers from the exercise, we have: \[\text{Predetermined Overhead Rate} = \frac{546,000}{420,000} = 1.3 \]This result means that for every dollar spent on direct labor, the company needs to apply $1.30 as overhead.
This approach ensures that all products are accounted for with the associated overhead cost, maintaining accurate costing across production.

Journal Entry for Overhead Application

Once the predetermined overhead rate is calculated, it's applied to the actual direct labor costs to determine the applied overhead for a specific period—in this case, March.
To apply the overhead, multiply the actual direct labor costs by the predetermined rate:

• Applied Factory Overhead = Actual Direct Labor Costs x Predetermined Overhead Rate

In the exercise, this calculation is:\[36,000 \times 1.3 = 46,800\]Thus, $46,800 is the factory overhead applied to production.
The journal entry ensures accurate accounting of how overhead costs impact production costs. It involves:

• Debit: Work in Process - Blending Department
• Credit: Factory Overhead - Blending Department

This systematic recording helps in monitoring and managing production expenses seamlessly, ensuring correct financial documentation.

Overapplied and Underapplied Overhead

Comparing the actual overhead incurred with applied overhead is crucial in determining overapplied or underapplied overhead. Overapplied overhead occurs when the applied amount exceeds the actual overhead costs; underapplied is the opposite.
For March, Mountain Glade Beverage Co. recorded an actual overhead of \(45,000 but applied \)46,800. The difference is calculated as:\[\text{Balance} = \text{Actual Overhead} - \text{Applied Overhead} = 45,000 - 46,800 = -1,800 \]With a negative balance of $1,800, the overhead is considered overapplied.
Overapplied overhead suggests that the company applied more costs than incurring, indicating an excess allocation. This can impact financial statements and often requires adjustment at the fiscal year-end to align realized costs with applied ones, ensuring true financial performance is reflected.

Direct Labor Cost in Cost Accounting

Direct labor cost plays a pivotal role in the overhead application process. These costs encompass wages paid to employees directly involved in the manufacturing process. Properly accounting for direct labor costs helps determine a product's total manufacturing cost.
In many cost accounting systems, direct labor costs serve as a base for applying factory overhead costs. The reason is that labor activity often correlates closely with the consumption of overhead resources.
The proportionate allocation of overhead through direct labor costs ensures a fair distribution of expenses across various production units. This tactic helps in accurate pricing, budgeting, and strategic financial planning.
Ensuring meticulous documentation and management of direct labor costs thus bolsters efficient overhead allocation, contributing substantially to accurate cost control and financial governance within a manufacturing setting.