Question

3. XYZ Ltd incurred $500 000 of manufacturing overhead costs during the financial year 2021. However, only $400 000 of overhead was applied to production. At the end of the financial year, the following amounts of the applied overhead remained in the various manufacturing accounts: Work in process inventory Finished goods inventory Cost of goods sold $80,000 100,000 220,000 Required: a. Explain whether the overhead cost was over applied or under applied to production. Determine the amount. b. Show your calculation to prorate the amount calculated in (a) above, to the three manufacturing accounts. What would be the effect on profit if the alternative method of closing off overhead

were used?
. ​

Answer 1

a. The overhead cost was under applied to production. The amount of under applied overhead can be calculated as follows:

Total manufacturing overhead costs incurred: $500,000

Less: Overhead applied to production: $400,000

Under applied overhead: $100,000

b. To prorate the under applied overhead to the three manufacturing accounts, we need to calculate the percentage of overhead in each account. The calculation is as follows:

Work in process inventory: ($80,000 / $400,000) x $100,000 = $20,000

Finished goods inventory: ($100,000 / $400,000) x $100,000 = $25,000

Cost of goods sold: ($220,000 / $400,000) x $100,000 = $55,000

If the alternative method of closing off overhead were used, the effect on profit would be a decrease of $100,000, as the under applied overhead would be added to the cost of goods sold account, reducing the profit.