Chap 003

Chapter 3
Systems Design: Job-Order Costing
Solutions to Questions
3-1 By definition, manufacturing overhead forms, direct labor time tickets, and by applying
consists of costs that cannot be practically traced overhead.
to jobs. Therefore, if these costs are to be
assigned to jobs, they must be allocated rather 3-6 Some production costs such as a factory
than traced. manager’s salary cannot be traced to a particular
product or job, but rather are incurred as a result
3-2 Job-order costing is used in situations of overall production activities. In addition, some
where many different products or services are production costs such as indirect materials cannot
produced each period. Process costing is used in be easily traced to jobs. If these costs are to be
situations where a single, homogeneous product, assigned to products, they must be allocated to
such as cement, bricks, or gasoline, is produced the products.
for long periods.
3-7 If actual manufacturing overhead cost is
3-3 The job cost sheet is used to record all applied to jobs, the company must wait until the
costs that are assigned to a particular job. These end of the accounting period to apply overhead
costs include direct materials costs traced to the and to cost jobs. If the company computes actual
job, direct labor costs traced to the job, and overhead rates more frequently to get around this
manufacturing overhead costs applied to the job. problem, the rates may fluctuate widely due to
When a job is completed, the job cost sheet is seasonal factors or variations in output. For this
used to compute the unit product cost. reason, most companies use predetermined
overhead rates to apply manufacturing overhead
3-4 A predetermined overhead rate is used to costs to jobs.
apply overhead cost to jobs. It is computed
before a period begins by dividing the period’s 3-8 The measure of activity used as the
estimated total manufacturing overhead by the allocation base should drive the overhead cost;
period’s estimated total amount of the allocation that is, the allocation base should cause the
base. Thereafter, overhead cost is applied to jobs overhead cost. If the allocation base does not
by multiplying the predetermined overhead rate really cause the overhead, then costs will be
by the actual amount of the allocation base that is incorrectly attributed to products and jobs and
recorded for each job. product costs will be distorted.
3-5 A sales order is issued after an 3-9 Assigning manufacturing overhead costs
agreement has been reached with a customer on to jobs does not ensure a profit. The units
quantities, prices, and shipment dates for goods. produced may not be sold and if they are sold,
The sales order forms the basis for the production they may not be sold at prices sufficient to cover
order. The production order specifies what is to all costs. It is a myth that assigning costs to
be produced and forms the basis for the job cost products or jobs ensures that those costs will be
sheet. The job cost sheet, in turn, is used to recovered. Costs are recovered only by selling to
summarize the various production costs incurred customers—not by allocating costs.
to complete the job. These costs are entered on
the job cost sheet from materials requisition 3-10 The Manufacturing Overhead account is
credited when overhead cost is applied to Work in
© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Solutions Manual, Chapter 3 77
Process. Generally, the amount of overhead 3-13 Underapplied overhead implies that not
applied will not be the same as the amount of enough overhead was assigned to jobs during the
actual cost incurred because the predetermined period and therefore cost of goods sold was
overhead rate is based on estimates. understated. Therefore, underapplied overhead is
added to cost of goods sold. On the other hand,
3-11 Underapplied overhead occurs when the overapplied overhead is deducted from cost of
actual overhead cost exceeds the amount of goods sold.
overhead cost applied to Work in Process
inventory during the period. Overapplied 3-14 A plantwide overhead rate is a single
overhead occurs when the actual overhead cost is overhead rate used throughout a plant. In a
less than the amount of overhead cost applied to multiple overhead rate system, each production
Work in Process inventory during the period. department may have its own predetermine
Underapplied or overapplied overhead is disposed overhead rate and its own allocation base. Some
of by either closing out the amount to Cost of companies use multiple overhead rates rather
Goods Sold or by allocating the amount among than plantwide rates to more appropriately
Cost of Goods Sold and ending inventories in allocate overhead costs among products. Multiple
proportion to the applied overhead in each overhead rates should be used, for example, in
account. The adjustment for underapplied situations where one department is machine
overhead increases Cost of Goods Sold (and intensive and another department is labor
inventories) whereas the adjustment for intensive.
overapplied overhead decreases Cost of Goods
Sold (and inventories). 3-15 When automated equipment replaces
direct labor, overhead increases and direct labor
3-12 Manufacturing overhead may be decreases. This results in an increase in the
underapplied for several reasons. Control over predetermined overhead rate—particularly if it is
overhead spending may be poor. Or, some of the based on direct labor.
overhead may be fixed and the actual amount of
the allocation base may be less than estimated at
the beginning of the period. In this situation, the
amount of overhead applied to inventory will be
less than the actual overhead cost incurred.
© The McGraw-Hill Companies, Inc., 2010

78 Managerial Accounting, 13th Edition
Exercise 3-1 (10 minutes)
a. Process costing g. Job-order costing
b. Job-order costing h. Process costing*
c. Process costing i. Job-order costing
d. Process costing j. Process costing*
e. Process costing k. Job-order costing
f. Job-order costing l. Job-order costing
* Some of the listed companies might use either a process costing or a

job-order costing system, depending on the nature of their operations
and how homogeneous the final product is. For example, a chemical
manufacturer would typically operate with a process costing system, but
a job-order costing system might be used if products are manufactured
in relatively small batches. The same thing might be true of the tire
manufacturing plant in item j.

1. The direct materials and direct labor costs listed in the exercise would
have been recorded on four different documents: the materials
requisition form for Job W456, the time ticket for Jamie Unser, the time
ticket for Melissa Chan, and the job cost sheet for Job W456.
2. The costs for Job W456 would have been recorded as follows:
Materials requisition form:
Quantit Unit Total Cost
y Cost
Blanks 20 $15.00 $300
Nibs 480 $1.25 600
$900
Time ticket for Jamie Unser
Time
Started Ended Completed Rate Amount Job Number
11:00 AM 2:45 PM 3.75 $9.60 $36.00 W456
Time ticket for Melissa Chan
Starte Time
d Ended Completed Rate Amount Job Number
8:15 AM 11:30 AM 3.25 $12.20 $39.65 W456
Job Cost Sheet for Job W456
Direct materials............ $900.00
Direct labor:
Jamie Unser.............. 36.00
Melissa Chan............. 39.65
$975.65

The predetermined overhead rate is computed as follows:
Estimated total manufacturing overhead........... $134,000
÷ Estimated total direct labor hours (DLHs)...... 20,000 DLHs
= Predetermined overhead rate........................ $6.70 per DLH

a. Raw Materials..................... 80,000
Accounts Payable.......... 80,000
b. Work in Process.................. 62,000

Manufacturing Overhead..... 9,000
Raw Materials............... 71,000
c. Work in Process.................. 101,000

Manufacturing Overhead..... 11,000
Wages Payable.............. 112,000
d. Manufacturing Overhead..... 175,000

Various Accounts........... 175,000

Actual direct labor-hours.............................. 10,800
× Predetermined overhead rate................... $23.40
= Manufacturing overhead applied............... $252,720

1. Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning............... $12,000
Add: Purchases of raw materials.................... 30,000
Total raw materials available......................... 42,000
Deduct: Raw materials inventory, ending....... 18,000
Raw materials used in production.................. 24,000
Less indirect materials included in
manufacturing overhead............................. 5,000 $ 19,000
Direct labor...................................................... 58,000
Manufacturing overhead applied to work in
process inventory............................................ 87,000
Total manufacturing costs................................. 164,000
Add: Beginning work in process inventory.......... 56,000
220,000
Deduct: Ending work in process inventory.......... 65,000
Cost of goods manufactured.............................. $155,000
2. Cost of Goods Sold

Finished goods inventory, beginning.................. $ 35,000
Add: Cost of goods manufactured...................... 155,000
Goods available for sale.................................... 190,000
Deduct: Finished goods inventory, ending.......... 42,000
Unadjusted cost of goods sold........................... 148,000
Add: Underapplied overhead............................. 4,000
Adjusted cost of goods sold............................... $152,00
0

Parts 1 and 2.
Cash Raw Materials

(a) 94,000 (a) 94,000 (b) 89,000
(c) 132,000 Bal. 5,000
(d) 143,000
Work in Process Finished Goods

(b) 78,000 (f) 342,000 (f) 342,000
(c) 112,000 Bal. 0
(e) 152,000 (f) 342,000
Bal. 0
Manufacturing Overhead Cost of Goods Sold

(b) 11,000 (e) 152,000 (f) 342,000
(c) 20,000 (g) 22,000
(d) 143,000 (g) 22,000 Bal. 364,000
Bal. 0

1. Actual direct labor-hours........................... 11,500
× Predetermined overhead rate................. $18.20
= Manufacturing overhead applied............. $209,300
Less: Manufacturing overhead incurred...... 215,000
$ (5,700)
Manufacturing overhead underapplied........ $5,700
2. Because manufacturing overhead is underapplied, the cost of goods sold

would increase by $5,700 and the gross margin would decrease by
$5,700.

Yes, overhead should be applied to value the Work in Process inventory at
year-end.
Because $6,000 of overhead was applied to Job V on the basis of $8,000 of
direct labor cost, the company’s predetermined overhead rate must be
75% of direct labor cost.
Job W direct labor cost..................................................... $4,000
× Predetermined overhead rate......................................... × 0.75
= Manufacturing overhead applied to Job W at year-end.... $3,000

1. Predetermined overhead rates:
Company X:
Predetermined = Estimated total manufacturing overhead cost
overhead rate Estimated total amount of the allocation base
$536,000
= = $6.70 per DLH
80,000 DLHs
Company Y:
$315,000
= = $4.50 per MH
70,000 MHs
Company Z:
$480,000
= = 160% of direct
$300,000 direct materials cost materials cost
2. Actual overhead costs incurred............................... $530,000

Overhead cost applied to Work in Process:
$6.70 per hour × 78,000* actual hours................ 522,600
Underapplied overhead cost................................... $ 7,400
*12,000 hours + 36,000 hours + 30,000 hours = 78,000 hours

1. Item (a): Actual manufacturing overhead costs for the year.
Item (b): Overhead cost applied to work in process for the year.
Item (c): Cost of goods manufactured for the year.
Item (d): Cost of goods sold for the year.
2. Cost of Goods Sold.......................................... 70,000

Manufacturing Overhead............................. 70,000
3. The underapplied overhead will be allocated to the other accounts on

the basis of the amount of overhead applied during the year in the
ending balance of each account:
Work in Process............ $ 19,500 5%
Finished Goods............. 58,500 15
Cost of Goods Sold........ 312,000 80
Total cost..................... $390,000 100 %
Using these percentages, the journal entry would be as follows:
Work in Process (5% × $70,000)................. 3,500
Finished Goods (15% × $70,000)................. 10,500
Cost of Goods Sold (80% × $70,000)........... 56,000
Manufacturing Overhead........................ 70,000

1. The predetermined overhead rate is computed as follows:
$192,000
= = $2.40 per MH
80,000 MHs
2. The amount of overhead cost applied to Work in Process for the year
would be: 75,000 machine-hours × $2.40 per machine-hour =
$180,000. This amount is shown in entry (a) below:
Manufacturing Overhead
(Maintenance) 21,000 (a) 180,000
(Indirect materials) 8,000
(Indirect labor) 60,000
(Utilities) 32,000
(Insurance) 7,000
(Depreciation) 56,000
Balance 4,000
Work in Process
(Direct materials) 710,000
(Direct labor) 90,000
(Overhead) (a) 180,000
3. Overhead is underapplied by $4,000 for the year, as shown in the

Manufacturing Overhead account above. The entry to close out this
balance to Cost of Goods Sold would be:
Cost of Goods Sold...................................... 4,000
Manufacturing Overhead......................... 4,000

Exercise 3-12 (continued)
4. When overhead is applied using a predetermined rate based on
machine-hours, it is assumed that overhead cost is proportional to
machine-hours. When the actual machine-hours turn out to be 75,000,
the costing system assumes that the overhead will be 75,000 machine-
hours × $2.40 per machine-hour, or $180,000. This is a drop of $12,000
from the initial estimated manufacturing overhead cost of $192,000.
However, the actual manufacturing overhead did not drop by this much.
The actual manufacturing overhead was $184,000—a drop of $8,000
from the estimate. The manufacturing overhead did not decline by the
full $12,000 because of the existence of fixed costs and/or because
overhead spending was not under control. These issues will be covered
in more detail in later chapters.

Direct material......................... $10,000
Direct labor............................. 12,000
Manufacturing overhead:
$12,000 × 125%................... 15,000
Total manufacturing cost.......... $37,000
Unit product cost:
$37,000 ÷ 1,000 units........... $37

1. a. Raw Materials Inventory........................... 210,000
Accounts Payable.................................. 210,000
b. Work in Process....................................... 178,000
Manufacturing Overhead.......................... 12,000
Raw Materials Inventory........................ 190,000
c. Work in Process....................................... 90,000
Manufacturing Overhead.......................... 110,000
Salaries and Wages Payable................... 200,000
d. Manufacturing Overhead.......................... 40,000
Accumulated Depreciation..................... 40,000
e. Manufacturing Overhead.......................... 70,000
Accounts Payable.................................. 70,000
f. Work in Process....................................... 240,000
Manufacturing Overhead....................... 240,000
30,000 MH × $8 per MH = $240,000.
g. Finished Goods........................................ 520,000
Work in Process.................................... 520,000
h. Cost of Goods Sold.................................. 480,000
Finished Goods..................................... 480,000
Accounts Receivable................................ 600,000
Sales.................................................... 600,000
$480,000 × 1.25 = $600,000.

2.
Manufacturing Overhead Work in Process
(b) 12,000 (f) 240,000 Bal. 42,000 (g) 520,000
(c) 110,000 (b) 178,000
(d) 40,000 (c) 90,000
(e) 70,000 (f) 240,000
8,000 Bal. 30,000
(Overapplied
overhead)

1. Because $120,000 of studio overhead was applied to Work in Process on
the basis of $75,000 of direct staff costs, the predetermined overhead
rate was 160%:
Studio overhead applied $120,000
= = 160% rate
Direct staff costs incurred $75,000
2. The Lexington Gardens Project is the only job remaining in Work in
Process at the end of the month; therefore, the entire $35,000 balance
in the Work in Process account at that point must apply to it.
Recognizing that the predetermined overhead rate is 160% of direct
staff costs, the following computation can be made:
Total cost in the Lexington Gardens Project....... $35,000
Less: Direct staff costs................................... $ 6,500
Studio overhead cost ($6,500 × 160%).. 10,400 16,900
Costs of subcontracted work............................ $18,100
With this information, we can now complete the job cost sheet for the
Lexington Gardens Project:
Costs of subcontracted work....... $18,100
Direct staff costs........................ 6,500
Studio overhead......................... 10,400
Total cost to January 31............. $35,000

1. a. Raw Materials......................................... 325,000
Accounts Payable.............................. 325,000
b. Work in Process...................................... 232,000
Raw Materials.................................... 290,000
c. Work in Process...................................... 60,000
Wages and Salaries Payable............... 180,000
d. Manufacturing Overhead......................... 75,000
Accumulated Depreciation.................. 75,000
e. Manufacturing Overhead......................... 62,000
Accounts Payable.............................. 62,000
f. Work in Process...................................... 300,000
Manufacturing Overhead.................... 300,000
$4,800,000
= = $20 per MH
240,000 MHs
15,000 MH × $20 per MH = $300,000
2. Manufacturing Overhead Work in Process

(b) 58,000 (f) 300,000 (b) 232,000
(c) 120,000 (c) 60,000
(d) 75,000 (f) 300,000
(e) 62,000
3. The cost of the completed job is $592,000 as shown in the Work in

Process T-account above. The journal entry is:
Finished Goods................................. 592,000
Work in Process........................... 592,000
4. The unit product cost on the job cost sheet would be:
$592,000 ÷ 16,000 units = $37 per unit

1. Actual manufacturing overhead costs......... $473,000
Manufacturing overhead cost applied:
19,400 MH × $25 per MH....................... 485,000
Overapplied overhead cost........................ $ 12,000
2. Chang Company
Schedule of Cost of Goods Manufactured
Direct materials:
Raw materials inventory, beginning......... $ 20,000
Add purchases of raw materials............... 400,000
Raw materials available for use............... 420,000
Deduct raw materials inventory, ending... 30,000
Raw materials used in production............ 390,000
Less indirect materials............................ 15,000 $375,000
Direct labor.............................................. 60,000
Manufacturing overhead cost applied to
work in process...................................... 485,000
Total manufacturing costs......................... 920,000
Add: Work in process, beginning................ 40,000
960,000
Deduct: Work in process, ending............... 70,000
Cost of goods manufactured...................... $890,000

1. As suggested, the costing problem does indeed lie with manufacturing
overhead cost. Because manufacturing overhead is mostly fixed, the
cost per unit increases as the level of production decreases. This
apparent problem can be “solved” by using a predetermined overhead
rate, which should be based on expected activity for the entire year.
Some students will use units of product in computing the predetermined
overhead rate, as follows:
$960,000
= = $4.80 per unit
200,000 units
The predetermined overhead rate could also be set on the basis of
either direct labor cost or direct materials cost. The computations are:
$960,000
= = 300% of direct
$320,000 direct labor cost labor cost

$960,000
= = 160% of direct
$600,000 direct materials cost materials cost

2. Using a predetermined overhead rate, the unit product costs would be:
Quarter
First Second Third Fourth
Direct materials................. $240,000 $120,000 $ 60,000 $180,000
Direct labor....................... 128,000 64,000 32,000 96,000
Manufacturing overhead:
Applied at $4.80 per unit,
300% of direct labor
cost, or 160% of direct
materials cost................. 384,000 192,000 96,000 288,000
Total cost.......................... $752,000 $376,000 $188,000 $564,000
Number of units produced.. 80,000 40,000 20,000 60,000
Unit product cost............... $9.40 $9.40 $9.40 $9.40

1. Harris Chan James

Designer-hours.......................... 120 100 90
Predetermined overhead rate...... × $90 × $90 × $90
Manufacturing overhead applied. $10,800 $9,000 $8,100
2. Harris Chan
Direct materials......................... $ 4,500 $ 3,700
Direct labor............................... 9,600 8,000
Overhead applied....................... 10,800 9,000
Total cost.................................. $24,900 $20,700
Completed Projects............................... 45,600*
Work in Process............................... 45,600*
* $24,900 + $20,700 = $45,600
3. The balance in the Work in Process account consists entirely of the costs
associated with the James project:
Direct materials....................................... $ 1,400
Direct labor............................................. 7,200
Overhead applied.................................... 8,100
Total cost in work in process.................... $16,700
4. The balance in the Overhead account can be determined as follows:

Overhead
Actual overhead costs 30,000 27,900 Applied overhead costs
Underapplied overhead 2,100
As indicated above, the debit balance in the Overhead account is called
underapplied overhead.

1. Cutting Department:
$360,000
= = $7.50 per MH
48,000 MHs
Finishing Department:
$486,000
= = 180% of direct
2. Overhead Applied
Cutting Department: 80 MHs × $7.50 per MH..... $600
Finishing Department: $150 × 180%.................. 270
Total overhead cost applied............................... $870
3. Yes; if some jobs require a large amount of machine time and little labor
cost, they would be charged substantially less overhead cost if a
plantwide rate based on direct labor cost were used. It appears, for
example, that this would be true of Job 203 which required considerable
machine time to complete, but required only a small amount of labor
cost.

Problem 3-21 (60 minutes)
1. and 2.
Cash Accounts Receivable

Bal. 63,000 (m) 785,000 Bal. 102,000 (l) 850,000
(l) 850,000 (k) 925,000
Bal. 128,000 Bal. 177,000
Raw Materials Prepaid Insurance

Bal. 30,000 (b) 200,000 Bal. 9,000 (g) 7,000
(a) 185,000 Bal. 2,000
Bal. 15,000
Videos in Process Finished Goods

Bal. 45,000 (j) 550,000 Bal. 81,000 (k) 600,000
(b) 170,000 (j) 550,000
(f) 82,000 Bal. 31,000
(i) 290,000
Bal. 37,000
Studio and Equipment Accumulated Depreciation

Bal. 730,000 Bal. 210,000
(d) 84,000
Bal. 294,000
Studio Overhead Depreciation Expense

(b) 30,000 * (i) 290,000 (d) 21,000
(c) 72,000
(d) 63,000
(f) 110,000
(g) 5,600 Insurance Expense
(n) 9,400 Bal. 9,400 (g) 1,400
* $280,000 ÷ 7,000 hours = $40 per hour;
7,250 hours × $40 per hour = $290,000
Advertising Expense Miscellaneous Expense

(e) 130,000 (h) 8,600

Problem 3-21 (continued)
Administrative Salaries Expense Sales
(f) 95,000 (k) 925,000
Cost of Goods Sold Accounts Payable

(k) 600,000 (n) 9,400 (m) 500,000 Bal. 160,000
(a) 185,000
Bal. 590,600 (c) 72,000
(e) 130,000
(h) 8,600
Bal. 55,600
Salaries & Wages Payable

(m) 285,000 (f) 287,000
Bal. 2,000
Capital Stock Retained Earnings

Bal. 420,000 Bal. 270,000
3. Overhead is overapplied for the year by $9,400. Entry (n) above records
the closing of this overapplied overhead balance to Cost of Goods Sold.
4.
Supreme Videos, Inc.
Income Statement
For the Year Ended December 31
Sales of videos............................................ $925,000
Cost of goods sold ($600,000 – $9,400)....... 590,600
Gross margin.............................................. 334,400
Selling and administrative expenses:
Depreciation expense................................ $ 21,000
Advertising expense.................................. 130,000
Administrative salaries.............................. 95,000
Insurance expense.................................... 1,400
Miscellaneous expense.............................. 8,600 256,000
Net operating income.................................. $ 78,400

1. a. Raw Materials......................................... 275,000
Cash................................................. 275,000
b. Work in Process...................................... 220,000
Raw Materials.................................... 280,000
c. Work in Process...................................... 180,000
Sales Commissions Expense.................... 63,000
Salaries Expense..................................... 90,000
Cash................................................. 405,000
d. Manufacturing Overhead......................... 13,000
Rent Expense......................................... 5,000
Cash................................................. 18,000
e. Manufacturing Overhead......................... 57,000
Cash................................................. 57,000
f. Advertising Expense................................ 140,000
Cash................................................. 140,000
g. Manufacturing Overhead......................... 88,000
Depreciation Expense.............................. 12,000
Accumulated Depreciation.................. 100,000
h. Work in Process...................................... 297,000
Rmb330,000 165% of
= =
Rmb200,000 direct labor cost direct labor cost
Rmb180,000 actual direct labor cost × 165% = Rmb297,000

i. Finished Goods....................................... 675,000
Work in Process................................. 675,000
j. Cash...................................................... 1,250,000
Sales................................................. 1,250,000
Cost of Goods Sold.................................. 700,000
Finished Goods.................................. 700,000
2.
Raw Materials Work in Process
Bal. 25,000 (b) 280,000 Bal. 10,000 (i) 675,000
(a) 275,000 (b) 220,000
Bal. 20,000 (c) 180,000
(h) 297,000
Bal. 32,000
Finished Goods Manufacturing Overhead

Bal. 40,000 (j) 700,000 (b) 60,000 (h) 297,000
(i) 675,000 (c) 72,000
Bal. 15,000 (d) 13,000
(e) 57,000
(g) 88,000
Bal. 7,000
Cost of Goods Sold

(j) 700,000
3. Manufacturing overhead is overapplied by Rmb7,000 for the year. The

entry to close this balance to Cost of Goods Sold would be:
Manufacturing Overhead..................................... 7,000
Cost of Goods Sold......................................... 7,000

4.
Gold Nest Company
Income Statement
Sales...................................................... Rmb1,250,000
Cost of goods sold
(Rmb700,000 - Rmb7,000).................... 693,000
Gross margin.......................................... 557,000
Sales commissions................................ Rmb63,000
Administrative salaries.......................... 90,000
Rent expense....................................... 5,000
Advertising expense.............................. 140,000
Depreciation expense............................ 12,000 310,000
Net operating income.............................. Rmb 247,000

1. a. Raw Materials....................................... 170,000
Accounts Payable............................. 170,000
b. Work in Process.................................... 144,000
Raw Materials.................................. 180,000
c. Work in Process.................................... 200,000
Salaries Expense................................... 90,000
Salaries and Wages Payable............. 372,000
d. Manufacturing Overhead....................... 65,000
e. Advertising Expense.............................. 100,000
f. Manufacturing Overhead....................... 18,000
Insurance Expense................................ 2,000
Prepaid Insurance............................ 20,000
g. Manufacturing Overhead....................... 153,000
Depreciation Expense............................ 27,000
Accumulated Depreciation................ 180,000
h. Work in Process.................................... 350,000
Manufacturing Overhead.................. 350,000
$200,000 actual direct labor cost × 175% = $350,000 overhead applied
i. Finished Goods..................................... 700,000
Work in Process............................... 700,000
j. Accounts Receivable............................. 1,000,000
Sales............................................... 1,000,000
Cost of Goods Sold................................ 720,000
Finished Goods................................ 720,000

2.
Raw Materials Finished Goods
Bal. 32,000 (b) 180,000 Bal. 48,000 (j) 720,000
(a) 170,000 (i) 700,000
Bal. 22,000 Bal. 28,000
Work in Process Manufacturing Overhead

Bal. 20,000 (i) 700,000 (b) 36,000 (h) 350,000
(b) 144,000 (c) 82,000
(c) 200,000 (d) 65,000
(h) 350,000 (f) 18,000
Bal. 14,000 (g) 153,000
Bal. 4,000
Cost of Goods Sold

(j) 720,000
3. Overhead is underapplied by $4,000 for the year. The entry to close this
balance to Cost of Goods Sold would be:
Cost of Goods Sold..................................... 4,000
Manufacturing Overhead........................ 4,000
4.
Almeda Products, Inc.
Income Statement
For the Year Ended March 31
Sales............................................................ $1,000,000
Cost of goods sold ($720,000 + $4,000)......... 724,000
Gross margin................................................. 276,000
Salary expense........................................... $ 90,000
Advertising expense.................................... 100,000
Insurance expense...................................... 2,000
Depreciation expense.................................. 27,000 219,000
Net operating income.................................... $ 57,000

1. and 2.
Cash Accounts Receivable

Bal. 7,000 (m) 234,000 Bal. 18,000 (l) 245,000
(l) 245,000 (k) 250,000
Bal. 18,000 Bal. 23,000
Raw Materials Prepaid Insurance

Bal. 9,000 (b) 38,000 Bal. 4,000 (g) 3,000
(a) 40,000 Bal. 1,000
Bal. 11,000
Work in Process Finished Goods

Bal. 20,000 (j) 140,000 Bal. 32,000 130,000
(b) 32,300 (j) 140,000 (k)
(f) 45,000 Bal. 42,000
(i) 60,000
Bal. 17,300
Plant and Equipment Accumulated Depreciation

Bal. 210,000 Bal. 53,000
(d) 36,000
Bal. 89,000
Manufacturing Overhead Depreciation Expense

(b) 5,700 * (i) 60,000 (d) 9,000
(c) 19,100
(d) 27,000
(f) 10,000
(g) 2,400 Insurance Expense
Bal. 4,200 (n) 4,200 (g) 600
*7,500 MH × $8 per MH = $60,000
Advertising Expense Miscellaneous Expense

(e) 48,000 (h) 9,500

Administrative Salaries Expense Sales
(f) 30,000 (k) 250,000
Cost of Goods Sold Accounts Payable

(k) 130,000 (m) 150,000 Bal. 38,000
(n) 4,200 (a) 40,000
Bal. 134,200 (c) 19,100
(e) 48,000
(h) 9,500
Bal. 4,600
Salaries & Wages Payable

(m) 84,000 (f) 85,000
Bal. 1,000
Capital Stock Retained Earnings

Bal. 160,000 Bal. 49,000
3. Overhead is underapplied by $4,200. Entry (n) above records the closing

of this underapplied overhead balance to Cost of Goods Sold.
4.
Hudson Company
Income Statement
For the Year Ended December 31
Sales............................................................ $250,000
Cost of goods sold ($130,000 + $4,200)......... 134,200
Gross margin................................................. 115,800
Depreciation expense.................................. $ 9,000
Advertising expense.................................... 48,000
Administrative salaries expense................... 30,000
Insurance expense...................................... 600
Miscellaneous expense................................ 9,500 97,100
Net operating income.................................... $ 18,700

1. Research & Documents predetermined overhead rate:
$840,000
= = $35 per hour
24,000 hours
Litigation predetermined overhead rate:
$360,000
= = 40% of direct
$900,000 direct attorney cost attorney cost
2. Research & Documents overhead applied:
26 hours × $35 per hour................................... $ 910
Litigation overhead applied: $5,700 × 40%........... 2,280
Total overhead cost............................................. $3,190
3. Total cost of Case 418-3:

Departments
Research &
Documents Litigation Total
Legal forms and supplies.... $ 80 $ 40 $ 120
Direct attorney cost........... 350 5,700 6,050
Overhead cost applied....... 910 2,280 3,190
Total cost.......................... $1,340 $8,020 $9,360
4. Research &
Documents Litigation
Departmental overhead cost incurred....... $870,000 $315,000
Departmental overhead cost applied:
26,000 hours × $35 per hour................ 910,000
$750,000 × 40%.................................. 300,000
Underapplied (or overapplied) overhead... $ (40,000) $ 15,000

1.
Raw Materials Work in Process
Bal. 30,000 (a) 16,800 Bal. 41,000* (e) 38,300
(a) 13,200
(b) 20,000
(d) 28,000
Bal. 63,900
Finished Goods Manufacturing Overhead

Bal. 50,000 (a) 3,600 (d) 28,000
(e) 38,300 (b) 7,000
(c) 19,400
Salaries & Wages Payable Accounts Payable

(b) 27,000 (c) 19,400
* Job 208 materials, labor, and overhead at May 31. . RUR28,700

Job 209 materials, labor, and overhead at May 31. . 12,300
Total Work in Process inventory at May 31............. RUR41,000
2. a. Work in Process.................................... 13,200 *

Raw Materials.................................. 16,800
*RUR6,000 + RUR7,200 = RUR13,200.
This entry is posted to the T-accounts as entry (a) above.
b. Work in Process.................................... 20,000 *
Salaries and Wages Payable............. 27,000
*RUR4,000 + RUR7,500 + RUR8,500 = RUR20,000.
This entry is posted to the T-accounts as entry (b) above.

c. Manufacturing Overhead....................... 19,400
This entry is posted to the T-accounts as entry (c) above.
3. The company uses a predetermined overhead rate of 140% of direct

labor cost. This figure can be determined by relating the May applied
overhead cost on the job cost sheets to the May direct labor cost shown
on these sheets. For example, in the case of Job 208:
May overhead cost RUR11,200
= = 140% of direct
May direct labor cost RUR8,000 labor cost
The overhead cost applied to each job during June was:
Job 208: RUR4,000 × 140%.......... RUR 5,600
Job 209: RUR7,500 × 140%.......... 10,500
Job 210: RUR8,500 × 140%.......... 11,900
Total applied overhead................. RUR28,000
The entry to record the application of overhead cost to jobs would be

[recorded as entry (d) in the T-accounts above]:
Work in Process................................ 28,000
Manufacturing Overhead.............. 28,000

4. The total cost of job 208 was:
Direct materials............................................................. RUR 9,500
Direct labor (RUR8,000 + RUR4,000)............................. 12,000
Manufacturing overhead applied (RUR12,000 × 140%)... 16,800
Total cost..................................................................... RUR38,300
The entry to record the transfer of the completed job is [recorded as
entry (e) in the T-accounts above]:
Finished Goods................................. 38,300
Work in Process........................... 38,300
5. As shown in the above T-accounts, the balance at June 30 was

RUR63,900. The breakdown of this amount between Jobs 209 and 210
is:
Job 209 Job 210 Total
Direct materials............... RUR11,100 RUR7,200 RUR18,300
Direct labor..................... 10,500 8,500 19,000
Manufacturing overhead
applied......................... 14,700 11,900 26,600
Total cost........................ RUR36,300 RUR27,600 RUR63,900

1. a.

$800,000
= =160%
$500,000 direct materials cost
b. Before the underapplied or overapplied overhead can be computed,

we must determine the amount of direct materials used in production
for the year.
Raw materials inventory, beginning...................... $ 20,000
Add, Purchases of raw materials.......................... 510,000
Raw materials available....................................... 530,000
Deduct: Raw materials inventory, ending.............. 80,000
Raw materials used in production......................... $450,000
Actual manufacturing overhead costs:

Indirect labor................................................... $170,000
Property taxes.................................................. 48,000
Depreciation of equipment................................ 260,000
Maintenance..................................................... 95,000
Insurance......................................................... 7,000
Rent, building................................................... 180,000
Total actual costs................................................ 760,000
Applied manufacturing overhead costs:
$450,000 × 160%............................................ 720,000
Underapplied overhead........................................ $ 40,000

2. Gitano Products
Direct materials:
Raw materials inventory, beginning............... $ 20,000
Add purchases of raw materials..................... 510,000
Total raw materials available......................... 530,000
Deduct raw materials inventory, ending......... 80,000
Raw materials used in production..................... $ 450,000
Direct labor..................................................... 90,000
process........................................................ 720,000
Total manufacturing costs................................ 1,260,000
Add: Work in process, beginning...................... 150,000
1,410,000
Deduct: Work in process, ending...................... 70,000
Cost of goods manufactured............................ $1,340,000
3. Cost of goods sold:

Finished goods inventory, beginning................... $ 260,000
Add: Cost of goods manufactured...................... 1,340,000
Goods available for sale..................................... 1,600,000
Deduct: Finished goods inventory, ending.......... 400,000
Cost of goods sold............................................. $1,200,000
The underapplied overhead can either be closed out to Cost of Goods
Sold or allocated between Work in Process, Finished Goods, and Cost of
Goods Sold based on the overhead applied during the year in the ending
balance in each of these accounts.
4. Direct materials................................................... $ 8,500

Direct labor......................................................... 2,700
Overhead applied ($8,500 × 160%)...................... 13,600
Total manufacturing cost...................................... $24,800
$24,800 × 125% = $31,000 price to the customer

5. The amount of overhead cost in Work in Process was:
$24,000 direct materials cost × 160% = $38,400
The amount of direct labor cost in Work in Process is:
Total ending work in process............... $70,000
Deduct: Direct materials..................... $24,000
Manufacturing overhead........ 38,400 62,400
Direct labor cost.................................. $ 7,600
The completed schedule of costs in Work in Process was:
Direct materials................................... $24,000
Direct labor......................................... 7,600
Manufacturing overhead...................... 38,400
Work in process inventory................... $70,000

1. Molding Department predetermined overhead rate:
$602,000
= = $8.60 per machine-hour
70,000 MHs
Painting Department predetermined overhead rate:
$735,000
= = 175% of direct
2. Molding Department overhead applied:

110 machine-hours × $8.60 per machine-hour. $ 946
Painting Department overhead applied:
$680 direct labor cost × 175%........................ 1,190
Total overhead cost............................................. $2,136
3. Total cost of Job 205:

Molding Painting
Dept. Dept. Total
Direct materials.......................... $ 470 $ 332 $ 802
Direct labor................................ 290 680 970
Manufacturing overhead applied. . 946 1,190 2,136
Total cost................................... $1,706 $2,202 $3,908
Unit product cost for Job 205:

Total cost, $3,908
= $78.16 per unit
50 units

4. Molding Painting
Dept. Dept.
Manufacturing overhead incurred............. $570,000 $750,000
Manufacturing overhead applied:
65,000 MHs × $8.60 per MH................. 559,000
$436,000 direct labor cost × 175%....... 763,000
Underapplied (or overapplied) overhead... $ 11,000 ($ 13,000)

1. a.
$840,000
= = 140% of direct
b. $9,500 × 140% = $13,300
Fabricating Machining Assembly

2. a. Department Department Department
Estimated manufacturing
overhead cost (a)......... $350,000 $400,000 $ 90,000
Estimated direct labor
cost (b)........................ $200,000 $100,000 $300,000
Predetermined overhead
rate (a) ÷ (b)............... 175% 400% 30%
b. Fabricating Department:
$2,800 × 175%............................. $4,900
Machining Department:
$500 × 400%................................ 2,000
Assembly Department:
$6,200 × 30%............................... 1,860
Total applied overhead..................... $8,760
3. The bulk of the labor cost on the Koopers job is in the Assembly
Department, which incurs very little overhead cost. The department has
an overhead rate of only 30% of direct labor cost as compared to much
higher rates in the other two departments. Therefore, as shown above,
use of departmental overhead rates results in a relatively small amount
of overhead cost being charged to the job.
Use of a plantwide overhead rate in effect redistributes overhead costs
proportionately between the three departments (at 140% of direct labor
cost) and results in a large amount of overhead cost being charged to
the Koopers job, as shown in Part 1. This may explain why the company

bid too high and lost the job. Too much overhead cost was assigned to
the job for the kind of work being done on the job in the plant.
On jobs that require a large amount of labor in the Fabricating or
Machining Departments the opposite will be true, and the company will
tend to charge too little overhead cost to the jobs if a plantwide
overhead rate is being used. The reason is that the plantwide overhead
rate (140%) is much lower than the rates would be if these
departments were considered separately.
4. The company’s bid was:

Direct materials........................................... $ 4,600
Direct labor................................................. 9,500
Manufacturing overhead applied (above)...... 13,300
Total manufacturing cost............................. $27,400
Bidding rate................................................ × 1.5
Total bid price............................................. $41,100
If departmental overhead rates had been used, the bid would have
been:
Direct materials........................................... $ 4,600
Direct labor................................................. 9,500
Manufacturing overhead applied (above)...... 8,760
Total manufacturing cost............................. $22,860
Bidding rate................................................ × 1.5
Total bid price............................................. $34,290
Note that if departmental overhead rates had been used, Teledex
Company would have been the low bidder on the Koopers job because
the competitor underbid Teledex by only $2,000.
5. a. Actual overhead cost....................................... $864,000

Applied overhead cost ($580,000 × 140%)....... 812,000
Underapplied overhead cost............................. $ 52,000

b. Department
Fabricating Machining Assembly Total Plant
Actual overhead
cost....................... $360,000 $420,000 $84,000 $864,000
Applied overhead
cost:......................
$210,000 × 175%. . 367,500
$108,000 × 400%. . 432,000
$262,000 × 30%.... 78,600 878,100
Underapplied
(overapplied)
overhead cost........ ($ 7,500) ($ 12,000) $ 5,400 ($ 14,100)

1. The cost of raw materials put into production was:
Raw materials inventory, 1/1................. $ 15,000
Debits (purchases of materials)............. 120,000
Materials available for use..................... 135,000
Raw materials inventory, 12/31............. 25,000
Materials requisitioned for production..... $110,000
2. Of the $110,000 in materials requisitioned for production, $90,000 was

debited to Work in Process as direct materials. Therefore, the difference
of $20,000 was debited to Manufacturing Overhead as indirect
materials.
3. Total factory wages accrued during the year (credits to

the Factory Wages Payable account)............................. $180,000
Less direct labor cost (from Work in Process)................... 150,000
Indirect labor cost........................................................... $ 30,000
4. The cost of goods manufactured was $470,000—the credits to the Work

in Process account.
5. The Cost of Goods Sold for the year was:

Finished goods inventory, 1/1............................................ $ 40,000
Add: Cost of goods manufactured (from Work in Process)... 470,000
Goods available for sale.................................................... 510,000
Finished goods inventory, 12/31........................................ 60,000
Cost of goods sold............................................................ $450,000
6. The predetermined overhead rate was:

$240,000
= = 160% of direct

7. Manufacturing overhead was overapplied by $10,000, computed as
follows:
Actual manufacturing overhead cost for the year (debits). $230,000
Applied manufacturing overhead cost (from Work in
Process—this would have been the credits to the
Manufacturing Overhead account)................................. 240,000
Overapplied overhead..................................................... $(10,000)
8. The ending balance in Work in Process is $30,000. Direct materials

make up $9,200 of this balance, and manufacturing overhead makes up
$12,800. The computations are:
Balance, Work in Process, 12/31..................................... $30,000
Less: Direct labor cost (given)........................................ (8,000)
Manufacturing overhead cost ($8,000 × 160%)...... (12,800)
Direct materials cost (remainder).................................... $ 9,200

1. a. Raw Materials.................................... 200,000
Accounts Payable.......................... 200,000
b. Work in Process................................. 185,000
Raw Materials............................... 185,000
c. Manufacturing Overhead.................... 63,000
Utilities Expense................................. 7,000
d. Work in Process................................. 230,000
Salaries Expense................................ 110,000
Salaries and Wages Payable.......... 430,000
e. Manufacturing Overhead.................... 54,000
f. Advertising Expense........................... 136,000
g. Manufacturing Overhead.................... 76,000
Depreciation Expense......................... 19,000
Accumulated Depreciation............. 95,000
h. Manufacturing Overhead.................... 102,000
Rent Expense..................................... 18,000
i. Work in Process................................. 390,000
Manufacturing Overhead............... 390,000
Nkr360,000
= = Nkr400 per DLH
900 DLHs
975 actual DLH × Nkr400 per DLH = Nkr390,000

j. Finished Goods................................... 770,000
Work in Process............................. 770,000
k. Accounts Receivable........................... 1,200,000
Sales............................................ 1,200,000
Cost of Goods Sold............................. 800,000
Finished Goods.............................. 800,000

2.
Accounts Receivable Sales
(k) 1,200,000 (k) 1,200,000
Raw Materials Cost of Goods Sold

Bal. 30,000 185,000 (k) 800,000
(a) 200,000 (b)
Bal. 45,000
Work in Process Manufacturing Overhead

Bal. 21,000 (j) 770,000 (c) 63,000 (i) 390,000
(b) 185,000 (d) 90,000
(d) 230,000 (e) 54,000
(i) 390,000 (g) 76,000
Bal. 56,000 (h) 102,000
Bal. 5,000
Finished Goods Advertising Expense

Bal. 60,000 (k) 800,000 (f) 136,000
(j) 770,000
Bal. 30,000
Accumulated Depreciation Utilities Expense

(g) 95,000 (c) 7,000
Accounts Payable Salaries Expense

(a) 200,000 (d) 110,000
(c) 70,000
(e) 54,000 Depreciation Expense
(f) 136,000 (g) 19,000
(h) 120,000
Salaries & Wages Payable Rent Expense

(d) 430,000 (h) 18,000

3. Froya Fabrikker A/S
Direct materials:
Raw materials inventory, beginning......... Nkr 30,000
Purchases of raw materials..................... 200,000
Materials available for use....................... 230,000
Raw materials inventory, ending.............. 45,000
Materials used in production.................... Nkr185,000
Direct labor............................................... 230,000
process.................................................. 390,000
Total manufacturing costs......................... 805,000
Add: Work in process, beginning................ 21,000
826,000
Deduct: Work in process, ending................ 56,000
Cost of goods manufactured...................... Nkr770,000
4. Manufacturing Overhead........................... 5,000

Cost of Goods Sold............................... 5,000
Schedule of cost of goods sold:

Finished goods inventory, beginning........ Nkr 60,000
Add: Cost of goods manufactured............ 770,000
Goods available for sale.......................... 830,000
Deduct finished goods inventory, ending.. 30,000
Unadjusted cost of goods sold................. 800,000
Deduct: Overapplied overhead................ 5,000
Adjusted cost of goods sold..................... Nkr795,000

5. Froya Fabrikker A/S
Income Statement
Sales...................................................... Nkr1,200,000
Cost of goods sold.................................. 795,000
Gross margin.......................................... 405,000
Advertising expense............................. Nkr136,000
Utilities expense................................... 7,000
Salaries expense.................................. 110,000
Depreciation expense........................... 19,000
Rent expense....................................... 18,000 290,000
Net operating income.............................. Nkr 115,000
6. Direct materials.......................................................... Nkr 8,000

Direct labor................................................................ 9,200
Manufacturing overhead applied
(39 hours × Nkr400 per hour).................................. 15,600
Total manufacturing cost............................................ 32,800
Add markup (60% × Nkr32,800)................................. 19,680
Total billed price of Job 412........................................ Nkr52,480
Nkr52,480 ÷ 4 units = Nkr13,120 per unit

1. The predetermined overhead rate is:
Sfr900,000
= = 12Sfr per MH
75,000 MHs
2. Actual manufacturing overhead cost....................... Sfr850,000

Manufacturing overhead cost applied to Work in
Process during the year: 60,000 actual MHs ×
Sfr12 per MH...................................................... 720,000
Underapplied overhead cost................................... Sfr130,000
3. Cost of Goods Sold.................................... 130,000

Manufacturing Overhead...................... 130,000
4. The underapplied balance would be allocated using the following

percentages:
Overhead applied during the year in:
Work in process.................................. Sfr 36,000 5%
Finished goods................................... 180,000 25 %
Cost of goods sold.............................. 504,000 70 %
Total.................................................... Sfr720,000 100 %
The entry to record the allocation of the underapplied overhead would
be:
Work in Process (5% × Sfr130,000)......... 6,500
Finished Goods (25% × Sfr130,000)......... 32,500
Cost of Goods Sold (70% × Sfr130,000)... 91,000
Manufacturing Overhead................. 130,000

5. Cost of goods sold if the underapplied overhead is
closed directly to cost of goods sold
(Sfr1,400,000 + Sfr130,000)................................ Sfr1,530,000
Cost of goods sold if the underapplied overhead is
allocated among the accounts
(Sfr1,400,000 + Sfr91,000).................................. 1,491,000
Difference in cost of goods sold.............................. Sfr 39,000
Thus, net operating income will be Sfr39,000 greater if the underapplied
overhead is allocated rather than closed directly to cost of goods sold.

Case 3-33 (45 minutes)
1. Shaving 5% off the estimated direct labor-hours in the predetermined
overhead rate will result in an artificially high overhead rate. The
artificially high predetermined overhead rate is likely to result in
overapplied overhead for the year. The cumulative effect of
overapplying the overhead throughout the year is all recognized in
December when the balance in the Manufacturing Overhead account is
closed out to Cost of Goods Sold. If the balance were closed out every
month or every quarter, this effect would be dissipated over the course
of the year.
2. This question may generate lively debate. Where should Terri Ronsin’s
loyalties lie? Is she working for the general manager of the division or
for the corporate controller? Is there anything wrong with the
“Christmas bonus”? How far should Terri go in bucking her boss on a
new job?
While individuals can certainly disagree about what Terri should do,
some of the facts are indisputable. First, understating direct labor-hours
artificially inflates the overhead rate. This has the effect of inflating the
Cost of Goods Sold in all months prior to December and overstating the
costs of inventories. In December, the huge adjustment for overapplied
overhead provides a big boost to net operating income. Therefore, the
practice results in distortions in the pattern of net operating income over
the year. In addition, because all of the adjustment is taken to Cost of
Goods Sold, inventories are still overstated at year-end. This means, of
course, that the net operating income for the entire year is also
overstated.
While Terri is in an extremely difficult position, her responsibilities under
the IMA’s Statement of Ethical Professional Practice seem to be clear.
The Credibility Standard states that management accountants have a
responsibility to “disclose all relevant information that could reasonably
be expected to influence an intended user’s understanding of the
reports, analyses or recommendations.” In our opinion, Terri should
discuss this situation with her immediate supervisor in the controller’s
office at corporate headquarters. This step may bring her into direct
conflict with the general manager of the division, so it would be a very
difficult decision for her to make.

Case 3-33 (continued)
In the actual situation that this case is based on, the corporate
controller’s staff were aware of the general manager’s accounting tricks,
but top management of the company supported the general manager
because “he comes through with the results” and could be relied on to
hit the annual profit targets for his division. Personally, we would be
very uncomfortable supporting a manager who will resort to deliberate
distortions to achieve “results.” If the manager will pull tricks in this
area, what else might he be doing that is questionable or even perhaps
illegal?

Case 3-34 (75 minutes)
1. The revised predetermined overhead rate is determined as follows:
Original estimated total manufacturing overhead. . $3,402,000
Plus: Lease cost of the new machine................... 348,000
Plus: Cost of new technician/programmer............ 50,000
Estimated total manufacturing overhead.............. $3,800,000
Original estimated total direct labor-hours............ 63,000
Less: Estimated reduction in direct labor-hours..... 6,000
Estimated total direct labor-hours........................ 57,000
Predetetermined = Estimated total manufacturing overhead
$3,800,000
=
57,000 DLHs
= $66.67 per DLH
The revised predetermined overhead rate is higher than the original rate
because the automated milling machine will increase the overhead for
the year (the numerator in the rate) and will decrease the direct labor-
hours (the denominator in the rate). This double-whammy effect
increases the predetermined overhead rate.
2. Acquisition of the automated milling machine will increase the apparent

costs of all jobs—not just those that use the new facility. This is because
the company uses a plantwide overhead rate. If there were a different
overhead rate for each department, this would not happen.
3. The predetermined overhead rate is now considerably higher than it

was. This will penalize products that continue to use the same amount
of direct labor-hours. Such products will now appear to be less profitable
and the managers of these products will appear to be doing a poorer
job. There may be pressure to increase the prices of these products
even though there has in fact been no increase in their real costs.

Case 3-34 (continued)
4. While it may have been a good idea to acquire the new equipment
because of its greater capabilities, the calculations of the cost savings
were in error. The original calculations implicitly assumed that overhead
would decrease because of the reduction in direct labor-hours. In
reality, the overhead increased because of the additional costs of the
new equipment. A differential cost analysis would reveal that the
automated equipment would increase total cost by about $316,000 a
year if the labor reduction is only 2,000 hours.
Cost consequences of leasing the automated equipment:
Increase in manufacturing overhead cost:
Lease cost of the new machine................................. $348,000
Cost of new technician/programmer.......................... 50,000
398,000
Less: labor cost savings (2,000 hours × $41 per hour).. 82,000
Net increase in annual costs........................................ $316,000
Even if the entire 6,000-hour reduction in direct labor-hours had
happened, that would have added only $164,000 (4,000 hours × $41
per hour) in cost savings. The net increase in annual costs would have
been $152,000 and the machine would still be an unattractive proposal.
The entire 6,000-hour reduction may ultimately be realized as workers
retire or quit. However, this is by no means automatic.
There are two morals to this tale. First, predetermined overhead rates
should not be misinterpreted as variable costs. They are not. Second, a
reduction in direct labor requirements does not necessarily lead to a
reduction in direct labor hours paid. It is often very difficult to actually
reduce the direct labor force and may be virtually impossible except
through natural attrition in some countries.

Research and Application 3-35
1. Toll Brothers succeeds first and foremost because of its product
leadership customer value proposition. The annual report mentions in
numerous places that Toll Brothers focuses on Luxury Homes and
Communities and high quality construction. Page 8 of the 10-K says ‘We
believe our marketing strategy, which emphasizes our more expensive
“Estate” and “Executive” lines of homes, has enhanced our reputation as
a builder-developer of high-quality upscale housing.” Page 2 of the 10-K
says “We are the only publicly traded national home builder to have won
all three of the industry’s highest honors: America’s Best Builder (1996),
the National Housing Quality Award (1995), and Builder of the Year
(1988).” Toll Brothers seeks to realize manufacturing efficiencies for the
benefit of its shareholders, but its customers choose Toll Brothers for its
leadership position in the luxury home market.
2. Toll Brothers faces numerous business risks as described in pages 10-11

of the 10-K. Students may mention other risks beyond those specifically
mentioned in the 10-K. Here are four risks faced by Toll Brothers with
suggested control activities:
 Risk: Downturns in the real estate market could adversely impact Toll
Brothers’ sales. Control activities: Diversify geographic markets
served so that a downturn in one region of the country will not
cripple the company.
 Risk: Large sums of money may be spent buying land that,
geologically speaking, cannot support home construction. For
example, soil conditions may be too unstable to support the weight
of a home. Control activities: Pay engineers to certify that targeted
properties can support home construction.
 Risk: Raw material costs may increase thereby depressing profit
margins. Control activities: Vertically integrate by operating
manufacturing facilities (see page 12 of the 10-K for a discussion of
Toll Brothers’ manufacturing facilities). Buying raw materials at
wholesale prices cuts out a middleman in the value chain. In
addition, Toll Brothers can purchase raw materials in large volumes
to realize purchase price discounts.

Research and Application 3-35 (continued)
 Risk: Subcontractors may perform substandard work resulting in

warranty claims and dissatisfied customers. Control activities: Employ
a project manager within each community who serves in a quality
assurance capacity.
3. Toll Brothers would use job-order costing because its homes are unique
rather than homogeneous. Each home being built would be a considered
a job. Toll Brothers’ standard floor plans differ from one another
particularly across its main product lines such as Move-Up, Empty
Nester, Active Adult, Urban In-Fill, High-Density Suburban, and Second
Homes (see pages 5 and 9 of the annual report). In 2004, Toll Brothers
introduced 87 new home models (see page 4 of the 10-K).
Beyond the fact that Toll Brothers offers a wide variety of floor plans,
homes are further distinguished from one another by customer
upgrades that add an average of $103,000 to the price of a home (see
page 1 of the annual report). Upgrades include items such as additional
garages, guest suites, extra fireplaces, and finished lofts (see page 4 of
10-K).
4. Examples of direct materials used in Toll Brothers’ manufacturing

facilities include lumber and plywood for wall panels, roofs, and floor
trusses, as well as other items such as windows and doors (see page 12
of the 10-K). Examples of direct materials used at the home sites
include shingles, exterior finishes such as stone, stucco, siding, or brick,
kitchen cabinets, cement for the foundation, bathroom fixtures, etc.
The standard bill of materials (e.g., prior to considering a specific
customer’s upgrade requests) for each home would differ. For example,
differences in the square footage of homes would drive numerous
differences in their bills of materials. Bigger homes would require more
lumber, sheet rock, electrical wiring, etc. Bills of materials are also likely
to differ across geographic regions of the country. For example, homes
in Florida typically do not have basements whereas homes in New
England are likely to have basements. Front porches may be more
prevalent in South Carolina than in Ohio. Different grades of windows
and insulation may be used in homes in the North than in the South.

5. Toll Brothers incurs two types of direct labor costs. The company
employs its own direct laborers in its manufacturing facilities in
Morrisville, Pa. and Emporia, Va. The costs of these workers can be
traced to specific items such as roof trusses that can in turn be traced to
particular houses. Work at the home sites is performed by
subcontractors. The labor cost embedded in a subcontractor’s fixed
price contract is directly traceable to the home being built. However, the
direct laborers are not employed by Toll Brothers. Toll Brothers would
not use employee time tickets at its home sites because the
subcontractors are not employees of Toll Brothers, Inc. and they are
paid a fixed price that is unaffected by the amount of hours worked.
6. There are numerous examples of overhead costs mentioned in the

annual report and 10-K. Some examples are: land acquisition costs, land
development costs (e.g., grading and clearing), road construction costs,
underground utility installation costs, swimming pools, golf courses,
tennis courts, marinas, community entrances, model home costs
(including construction, furnishing and staffing), and project manager
salaries. These costs are incurred to create housing communities but
they cannot be easily and conveniently traced to specific homes.
7. It appears that Toll Brothers does not use cost-plus pricing to establish
selling prices for its base models. Page 8 of the 10-K says “In
determining the prices for our homes, we utilize, in addition to
management’s extensive experience, an internally developed value
analysis program that compares our homes with homes offered by other
builders in each local marketing area.” In other words, the value to the
customer and competitive conditions determine prices—not the cost of
building a particular home.
Page 5 of the annual report says “When there is strong demand, we
benefit from exceptional pricing power because we have greater ability
to raise prices than those builders who target buyers on tight budgets:
it’s easier to hit doubles, triples and home runs selling to luxury buyers.”
This quote implies that pricing is driven by the customers’ willingness
and ability to pay and not by the cost of building a particular house.

8. Based on information contained in the 10-K, it appears that Toll
Brothers assigns overhead to cost objects in two ways. First, page 16 of
the 10-K says “Land, land development and related costs (both incurred
and estimated to be incurred in the future) are amortized to the cost of
homes closed based upon the total number of homes to be constructed
in each community.” In other words, each home is assigned an equal
share of overhead costs. Page 16 also says, “The estimated land,
common area development and related costs of master planned
communities (including the cost of golf courses, net of their estimated
residual value) are allocated to individual communities within a master
planned community on a relative sales value basis.” In other words,
higher priced communities within a master planned community are
assigned a greater portion of master planned community overhead
costs.
In master planned communities, the allocation of overhead appears to
take place in two stages. First, the overhead costs common to all
communities contained with the master planned community are
assigned to communities based on relative sales value. Then, all
overhead costs related to a particular community within the master
planned community are assigned equally to each home site.
The company needs to assign overhead costs to homes so that it can
derive a cost of sales number for the income statement and an
inventory number for the balance sheet. Page 29 of the annual report
shows the components of the company’s ending inventory balance of
$3.878 billion. Inventoriable costs include land and land development
costs ($1.242 billion), construction in progress ($2.178 billion), sample
homes and sales offices ($208 million), land deposits and costs of future
development ($237 million), and other ($12 million). Construction in
progress is similar to work in process for a manufacturing company.
Overhead costs (as well as direct costs) flow through the construction in
progress account and hit cost of home sales when a customer has a
closing and takes possession of the home.

Appendix 3A
The Predetermined Overhead Rate and Capacity
Exercise 3A-1 (30 minutes)

1. The overhead applied to Mrs. Brinksi’s account would be computed as
follows:
2008 2009
Estimated overhead cost (a).............................. $310,500 $310,500
Estimated professional staff hours (b)................ 4,500 4,600
Predetermined overhead rate (a) ÷ (b).............. $69.00 $67.50
Professional staff hours charged to Ms. Brinksi’s
account......................................................... × 2.5 × 2.5
Overhead applied to Ms. Brinksi’s account.......... $172.50 $168.75
2. If the actual overhead cost and the actual professional hours charged
turn out to be exactly as estimated there would be no underapplied or
overapplied overhead.
2008 2009
Predetermined overhead rate (see above).......... $69.00 $67.50
Actual professional staff hours charged to
clients’ accounts (by assumption).................... × 4,500 × 4,600
Overhead applied............................................. $310,500 $310,500
Actual overhead cost incurred (by assumption). . 310,500 310,500
Underapplied or overapplied overhead............... $ 0 $ 0
3. If the predetermined overhead rate is based on the professional staff

hours available, the computations would be:
Estimated overhead cost (a)............................... $310,500 $310,500
Professional staff hours available (b)................... 6,000 6,000
Predetermined overhead rate (a) ÷ (b)............... $51.75 $51.75
Professional staff hours charged to Ms. Brinksi’s
account........................................................... × 2.5 × 2.5
Overhead applied to Ms. Brinksi’s account........... $129.38 $129.38

Exercise 3A-1 (continued)
4. If the actual overhead cost and the actual professional staff hours
charged to clients’ accounts turn out to be exactly as estimated,
overhead would be underapplied as shown below.
2008 2009
Predetermined overhead rate (see above) (a)...... $51.75 $51.75
Actual professional staff hours charged to
clients’ accounts (by assumption) (b)................ × 4,500 × 4,600
Overhead applied (a) × (b)................................. $232,875 $238,050
Actual overhead cost incurred (by assumption).... 310,500 310,500
Underapplied overhead...................................... $ 77,625 $ 72,450
The underapplied overhead is best interpreted in this situation as the
cost of idle capacity. Proponents of this method of computing
predetermined overhead rates suggest that the underapplied overhead
be treated as a period expense that would be disclosed separately on
the income statement as Cost of Unused Capacity.

Solutions Manual, Appendix 3A 141
Problem 3A-2 (60 minutes)
1. The overhead applied to the Verde Baja job is computed as follows:
2008 2009
Estimated studio overhead cost (a).................. $160,000 $160,000
Estimated hours of studio service (b)............... 1,000 800
Predetermined overhead rate (a) ÷ (b)............ $160 $200
Verde Baja job’s studio hours ......................... × 40 × 40
Overhead applied to the Verde Baja job .......... $6,400 $8,000
Overhead is underapplied for both years as computed below:

2008 2009
Predetermined overhead rate (see above) (a). . $160 $200
Actual hours of studio service provided (b)...... 750 500
Overhead applied (a) × (b)............................. $120,000 $100,000
Actual studio cost incurred.............................. 160,000 160,000
Underapplied overhead................................... $ 40,000 $ 60,000
2. If the predetermined overhead rate is based on the hours of studio

service at capacity, the computations would be:
2008 2009
Estimated studio overhead cost at capacity (a). $160,000 $160,000
Hours of studio service at capacity (b)............. 1,600 1,600
Predetermined overhead rate (a) ÷ (b)............ $100 $100
Verde Baja job’s studio hours ......................... × 40 × 40
Overhead applied to the Verde Baja job .......... $4,000 $4,000
Overhead is underapplied for both years under this method as well:

2008 2009
Predetermined overhead rate (see above) (a). . $100 $100
Actual hours of studio service provided (b)...... 750 500
Overhead applied (a) × (b)............................. $ 75,000 $ 50,000
Actual studio cost incurred.............................. 160,000 160,000
Underapplied overhead................................... $ 85,000 $110,000

Problem 3A-2 (continued)
3. When the predetermined overhead rate is based on capacity, the
underapplied overhead is interpreted as the cost of idle capacity.
Indeed, proponents of this method suggest that the underapplied
overhead should be treated as a period expense that would be disclosed
separately on the income statement as Cost of Unused Capacity.
4. Platinum Track’s fundamental problem is the competition that is drawing

customers away. The competition is able to offer the latest equipment,
excellent service, and attractive prices. The company must do
something to counter this threat or it will ultimately face failure.
Under the conventional approach in which the predetermined overhead
rate is based on the estimated studio hours, the apparent cost of the
Verde Baja job has increased between 2008 and 2009. That happens
because the company is losing business to competitors and therefore
the company’s fixed overhead costs are being spread over a smaller
base. This results in costs that seem to increase as the volume declines.
Under this method, Platinum Track’s managers may be misled into
thinking that the problem is rising costs and they may be tempted to
raise prices to recover their apparently increasing costs. This would
almost surely accelerate the company’s decline.
Under the alternative approach, the overhead cost of the Verde Baja job
is stable at $4,000 and lower than the costs reported under the
conventional method. Under the conventional method, managers may
be misled into thinking that they are actually losing money on the Verde
Baja job and they might refuse such jobs in the future—another sure
road to disaster. This is much less likely to happen if the lower cost of
$4,000 is reported. It is true that the underapplied overhead under the
alternative approach is much larger than under the conventional
approach and is growing. However, if it is properly labeled as the cost of
idle capacity, management is much more likely to draw the appropriate
conclusion that the real problem is the loss of business (and therefore
more idle capacity) rather than an increase in costs.
While basing the predetermined rate on capacity rather than on

estimated activity will not solve the company’s basic problems, at least
this method is less likely to send managers misleading signals.

Case 3A-3 (120 minutes)
1. Traditional approach:
Actual total manufacturing overhead cost incurred
(assumed to equal the original estimate).................. $4,000,000
(160,000 units × $25 per unit)................................ 4,000,000
Overhead underapplied or overapplied........................ $ 0
Vault Hard Drives, Inc.

Income Statement: Traditional Approach
Sales (150,000 units × $60 per unit)............ $9,000,000
Cost of goods sold:
Variable manufacturing
(150,000 units × $15 per unit)................ $2,250,000
(150,000 units × $25 per unit)................ 3,750,000 6,000,000
Gross margin.............................................. 3,000,000
Selling and administrative expenses.............. 2,700,000
Net operating income.................................. $ 300,000
New approach:
Income Statement: New Approach
Sales (150,000 units × $60 per unit).................... $9,000,000
Cost of goods sold:
(150,000 units × $15 per unit)....................... $2,250,000
(150,000 units × $20 per unit)....................... 3,000,000 5,250,000
Gross margin...................................................... 3,750,000
Cost of unused capacity [(200,000 units –
160,000 units) × $20 per unit].......................... 800,000
Selling and administrative expenses..................... 2,700,000
Net operating income.......................................... $ 250,000

Case 3A-3 (continued)
2. Traditional approach:
Under the traditional approach, the reported net operating income can
be increased by increasing the production level which then results in
overapplied overhead which is deducted from Cost of Goods Sold.
Additional net operating income required to attain

target net operating income ($500,000 – $300,000)
(a)............................................................................ $200,000
Overhead applied per unit of output (b)......................... $25 per unit
Additional output required to attain target net operating
income (a) ÷ (b)........................................................ 8,000 units
Actual total manufacturing overhead cost incurred.......... $4,000,000
[(160,000 units + 8,000 units) × $25 per unit]............ 4,200,000
Overhead overapplied................................................... $ 200,000

Income Statement: Traditional Approach
Sales (150,000 units × $60 per unit)............... $9,000,000
Cost of goods sold:
(150,000 units × $15 per unit)................... $2,250,000
(150,000 units × $25 per unit)................... 3,750,000
Less: Manufacturing overhead overapplied.... 200,000 5,800,000
Gross margin.................................................. 3,200,000
Selling and administrative expenses................. 2,700,000
Net operating income..................................... $ 500,000
Note: If the overapplied manufacturing overhead were prorated

between ending inventories and Cost of Goods Sold, more units would
have to be produced to attain the target net profit of $500,000. In fact,
it can be shown that the total production level would have to be
169,014 units rather than 168,000 units.

New approach:
Under the new approach, the reported net operating income can be
increased by increasing the production level. This results in less of a
deduction on the income statement for the Cost of Unused Capacity.
Additional net operating income required to attain target

net operating income ($500,000 – $250,000) (a)........... $250,000
Overhead applied per unit of output (b)........................... $20 per unit
Additional output required to attain target net operating
income (a) ÷ (b).......................................................... 12,500 units
Estimated number of units produced............................... 160,000 units
Actual number of units to be produced............................ 172,500 units

Income Statement: New Approach
Sales (150,000 units × $60 per unit)................... $9,000,000
Cost of goods sold:
(150,000 units × $15 per unit)...................... $2,250,000
(150,000 units × $20 per unit)...................... 3,000,000 5,250,000
Gross margin..................................................... 3,750,000
Cost of unused capacity [(200,000 units –
172,500 units) × $20 per unit]......................... 550,000
Selling and administrative expenses.................... 2,700,000
Net operating income......................................... $ 500,000

3. Net operating income is more volatile under the new method than under
the old method. The reason for this is that the reported profit per unit
sold is higher under the new method by $5, the difference in the
predetermined overhead rates. As a consequence, swings in sales in
either direction will have a more dramatic impact on reported profits
under the new method.
4. As the computations in part (2) above show, the “hat trick” is a bit
harder to perform under the new method. Under the old method, the
target net operating income can be attained by producing an additional
8,000 units. Under the new method, the production would have to be
increased by 12,500 units. Again, this is a consequence of the difference
in predetermined overhead rates. The drop in sales has had a more
dramatic effect on net operating income under the new method as
noted above in part (3). In addition, because the predetermined
overhead rate is lower under the new method, producing excess
inventories has less of an effect per unit on net operating income than
under the traditional method and hence more excess production is
required.
5. One can argue that whether the “hat trick” is unethical depends on the
level of sophistication of the owners of the company and others who
read the financial statements. If they understand the effects of excess
production on net operating income and are not misled, it can be
argued that the hat trick is not unethical. However, if that were the
case, there does not seem to be any reason to use the hat trick. Why
would the owners want to tie up working capital in inventories just to
artificially attain a target net operating income for the period? And
increasing the rate of production toward the end of the year is likely to
increase overhead costs due to overtime and other costs. Building up
inventories all at once is very likely to be much more expensive than
increasing the rate of production uniformly throughout the year. In this
case, we assumed that there would not be an increase in overhead
costs due to the additional production, but that is likely not to be true.
In our opinion, the hat trick is unethical unless there is a good reason
for increasing production other than to artificially boost the current
period’s net operating income. It is certainly unethical if the purpose is
to fool users of financial reports such as owners and creditors or if the
purpose is to meet targets so that bonuses will be paid to top managers.


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Chapter 3

Systems Design: Job-Order Costing

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

© The McGraw-Hill Companies, Inc., 2010

* Some of the listed companies might use either a process costing or a

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

b. Work in Process.................. 62,000

c. Work in Process.................. 101,000

d. Manufacturing Overhead..... 175,000

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2. Cost of Goods Sold

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Cash Raw Materials

Work in Process Finished Goods

Manufacturing Overhead Cost of Goods Sold

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2. Because manufacturing overhead is underapplied, the cost of goods sold

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© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

2. Actual overhead costs incurred............................... $530,000

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2. Cost of Goods Sold.......................................... 70,000

3. The underapplied overhead will be allocated to the other accounts on

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3. Overhead is underapplied by $4,000 for the year, as shown in the

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© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

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© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

2. Manufacturing Overhead Work in Process

3. The cost of the completed job is $592,000 as shown in the Work in

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Predetermined = Estimated total manufacturing overhead cost

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1. Harris Chan James

4. The balance in the Overhead account can be determined as follows:

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Cash Accounts Receivable

Raw Materials Prepaid Insurance

Videos in Process Finished Goods

Studio and Equipment Accumulated Depreciation

Studio Overhead Depreciation Expense

Advertising Expense Miscellaneous Expense

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Cost of Goods Sold Accounts Payable

Salaries & Wages Payable

Capital Stock Retained Earnings

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© The McGraw-Hill Companies, Inc., 2010. All rights reserved.

Finished Goods Manufacturing Overhead

Cost of Goods Sold

3. Manufacturing overhead is overapplied by Rmb7,000 for the year. The