Final answer:
The student's question deals with overhead allocation based on direct labor cost. The predetermined overhead rate is calculated using estimated figures and applied to actual direct labor costs. At year-end, the under- or overapplied overhead is closed to the cost of goods sold, and 'spreading the overhead' means allocating fixed costs over units produced, which is represented by a decreasing average fixed cost curve.
Step-by-step explanation:
The question centers around the concept of overhead application in a manufacturing or production setting. When a company applies overhead based on direct labor cost, it is using an indirect cost allocation method. Estimated overhead and direct labor costs at the beginning of the year are used to calculate a predetermined overhead rate. This rate is then applied to the actual direct labor costs throughout the year to assign overhead costs to products.
If the estimated overhead is $120,500 and the estimated direct labor cost is $124,100, the predetermined overhead rate is calculated by dividing the estimated overhead by the estimated direct labor costs, yielding a rate of (120,500 / 124,100 = 0.971 or 97%). This rate is then applied to the actual direct labor costs, in this case, $110,800, giving us an applied overhead of 97% of 110,800, which is approximately $107,476.
At year-end, the actual overhead incurred was $106,500, which is less than the applied overhead of $107,476 by $976. Since this difference is considered immaterial, it would typically be closed out to the cost of goods sold or another appropriate account through a simple journal entry which debits Overhead and credits Cost of Goods Sold or the appropriate account.
When discussing fixed costs such as overhead, the concept of "spreading the overhead" refers to the allocation of those fixed costs over the units of output produced. The average fixed cost curve visually represents how the per-unit fixed cost decreases as the quantity of output increases. Therefore, if the fixed cost is $1,000, the more units produced, the lower the average fixed cost per unit becomes. This concept is essential for understanding economies of scale and cost management in production.