Question

Osborn Manufacturing uses a predetermined overhead rate of $19.60 per direct labor-hour. This predetermined rate was based on a cost formula that estimates $262,640 of total manufacturing overhead for an estimated activity level of 13,400 direct labor-hours. The company actually incurred $255,000 of manufacturing overhead and 12,900 direct labor-hours during the period. Required: 1. Determine the amount of underapplied or overapplied manufacturing overhead for the period. 2. Assume that the company's underapplied or overapplied overhead is closed to Cost of Goods Sold. Would the journal entry to dispose of the underapplied or overapplied overhead increase or decrease the company’s gross margin? By how much?

Answer 1

Predetermined overhead rate = $19.60 per direct labor-hour
Estimated overhead = $262,640
Actual hours = 12,900
Actual overhead incurred = $255,000

Overhead applied = Actual hours * Predetermined overhead rate
= $19.60 * 12,900 hours
= $252,840

a). Overhead underapplied = Actual overhead - Overhead applied
Overhead underapplied = $255,000 - $252,840
Overhead underapplied = $2,160

b). When underapplied overhead is closed to cost of goods sold, the gross margin would decrease by $2,160 because the closing journal entry would incease the cost of goods sold by $2160 and hence gross margin would decrease.