# Quiz 17: Job Order Cost Systems and Overhead Allocations

Manufacturing overheads include all costs which go into production other than direct labor and material charges. Overheads are predetermined on a rate basis and may differ from the actual costs at the end of the period. TC ltd. uses machine hours to estimate total overhead costs. For the given period, it's estimated overhead costs as given below: (a) \$24,000 represents that part of the overall manufacturing that is not yet completed but has been committed. This can be termed as work in progress asset. To allocate this amount to jobs TC Ltd. will post the following journal in its books of account is as given below: (b) Actual overhead costs explicitly given in the question amounts to \$23,800. As stated earlier, the allocated costs are estimates and vary from the actuals. Manufacturing overhead account is closed for the period by debiting the actual costs applicable to jobs. These actual costs relate to indirect charges and has been referred to as 'various' as per information. The variance between the actual and estimated overhead cost is given as \$200. This is over applied overhead cost which will be carried forward to the next period. The journal to record actual overhead costs is as given below: (c) If the over-applied overhead cost is not carried forward to the next period, it shall be closed directly with cost of goods sold account. The rationale behind this is that the overall cost estimated was more than actual overhead and shall be reduced by debiting cost of goods sold account.

a. If the machine is purchased, yearly depreciation will increase by \$50,000 (\$500,000/10 years). Thus, total overhead will increase to \$396,000. Production of 10,000 wood cabinets will require 20,000 hours of direct labor and production of 7,500 metal cabinets will require 18,750 hours of direct labor. The resulting overhead application rate will be: \$396,000 / 38,750 DLH = \$10.22 per direct labor hour The resulting cost per unit for each type of cabinet is: b. From Mary's point of view, her per unit costs will decrease if the machine is purchased. Since she is evaluated on per unit costs, the decision to purchase seems justified. However, if she purchases the machine, the per unit cost to produce wood cabinets will increase even though there has been no change in the use of resources by the Wood Division. As equipment purchases affect the per unit costs of both divisions (through overhead allocation), both managers should be involved in such decisions. c. The information needed to evaluate the purchase is whether the direct labor costs saved per unit is more than the additional per unit cost of using the machine. Since the machine will be used for 10 years and will produce 7,500 cabinets per year, the cost per cabinet of using the machine is calculated as: \$500,000/75,000 total units produced = \$6.67 per cabinet The direct labor reduction per cabinet by using the machine is.5 hours. Thus, the labor cost reduction per cabinet is: .5 hours x \$10/hr = \$5.00 per cabinet Thus, although \$5.00 in labor cost is saved per unit, the added cost of the machine is \$6.67 per unit, resulting in an overall increase of \$1.67 per unit. d. If each manager's performance evaluation is based on the unit costs calculated in part a, Walter will appear to have performed poorly relative to the initial estimated unit costs, while Mary will appear to have performed extremely well. However, as shown in part c, Mary's true cost of producing a metal cabinet would have been \$1.67 higher than the initial estimates if the machine were purchased. Since there would be no real change in the resources used by Walter to produce wood cabinets, his cost per unit should equal the estimated amount. Thus, the total unit costs as calculated in part a would not be a fair or accurate representation of either manager's performance.

Cost accounting systems are the methods and techniques used by enterprises to track resources consumed in creating and delivering products and services to customers. Employees use the information provided by cost accounting systems to help them manage the activities that consume resources. Management uses the information produced by cost accounting systems to evaluate and reward employee performance. In addition, the cost information is reported on external financial statements as, for example, inventories, cost of goods sold, and period expenses.

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