Solutions Manual, Appendix 4B 77
Problem 4B-3 (continued)
3. When the predetermined overhead rate is based on capacity,
the income statement as Cost of Unused Capacity.
4. Skid Road Recording’s fundamental problem is the competition that is
Under the conventional approach in which the predetermined overhead
rate is based on the estimated studio hours, the apparent cost of the
Under the alternative approach, the overhead cost of the Slug Fest job
is stable at $1,500 and lower than the costs reported under the
conventional method. Under the conventional method, managers may
While basing the predetermined rate on capacity rather than on
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document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
78 Managerial Accounting for Managers, 4th Edition
Case 4B-4 (120 minutes)
1. Traditional approach:
Actual total manufacturing overhead cost incurred
(assumed to equal the original estimate) ……………..
$2,000,000
Manufacturing overhead applied
(80,000 units × $25 per unit) …………………………...
2,000,000
Overhead underapplied or overapplied …………………..
$ 0
TurboDrives, Inc.
Income Statement: Traditional Approach
Sales (75,000 units × $70 per unit) ……………
$5,250,000
Cost of goods sold:
Variable manufacturing
(75,000 units × $18 per unit) ………………
$1,350,000
Manufacturing overhead applied
(75,000 units × $25 per unit) ………………
1,875,000
3,225,000
Gross margin ………………………………………..
2,025,000
Selling and administrative expenses …………..
1,950,000
Net operating income ……………………………..
$ 75,000
New approach:
TurboDrives, Inc.
Income Statement: New Approach
Sales (75,000 units × $70 per unit) ……………
$5,250,000
Cost of goods sold:
Variable manufacturing
(75,000 units × $18 per unit) ………………
$1,350,000
Manufacturing overhead applied
(75,000 units × $20 per unit) ………………
1,500,000
2,850,000
Gross margin ………………………………………..
2,400,000
Cost of unused capacity [(100,000 units
80,000 units) × $20 per unit] …………………
400,000
Selling and administrative expenses …………..
1,950,000
Net operating income ……………………………..
$ 50,000
Solutions Manual, Appendix 4B 79
Case 4B-4 (continued)
2. Traditional approach:
Under the traditional approach, the reported net operating income can
Additional net operating income required to attain target
net operating income ($210,000 − $75,000) (a) ……….
$135,000
Overhead applied per unit of output (b) …………………….
$25 per unit
Additional output required to attain target net
operating income (a) ÷ (b) …………………………..………
5,400 units
Actual total manufacturing overhead cost incurred ……….
$2,000,000
Manufacturing overhead applied
[(80,000 units + 5,400 units) × $25 per unit] …………..
2,135,000
Overhead overapplied …………………………..……………….
$ 135,000
TurboDrives, Inc.
Income Statement: Traditional Approach
Sales (75,000 units × $70 per unit) …………..
$5,250,000
Cost of goods sold:
Variable manufacturing
(75,000 units × $18 per unit) ……………..
$1,350,000
Manufacturing overhead applied
(75,000 units × $25 per unit) ……………..
1,875,000
Less: Manufacturing overhead overapplied .
135,000
3,090,000
Gross margin ……………………………………….
2,160,000
Selling and administrative expenses ………….
1,950,000
Net operating income …………………………….
$ 210,000
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80 Managerial Accounting for Managers, 4th Edition
Case 4B-4 (continued)
New approach:
Additional net operating income required to attain
target net operating income ($210,000 − $50,000)
(a) …………………………………………………………………
$160,000
Overhead applied per unit of output (b) ……………………
$20 per unit
Additional output required to attain target net
operating income (a) ÷ (b) ………………………………….
8,000 units
Estimated number of units produced ……………………….
80,000 units
Actual number of units to be produced …………………….
88,000 units
TurboDrives, Inc.
Income Statement: New Approach
Sales (75,000 units × $70 per unit) ………………….
$5,250,000
Cost of goods sold:
Variable manufacturing
(75,000 units × $18 per unit) ……………………..
$1,350,000
Manufacturing overhead applied
(75,000 units × $20 per unit) ……………………..
1,500,000
2,850,000
Gross margin …………………………..…………………..
2,400,000
Cost of unused capacity
[(100,000 units − 88,000 units) × $20 per unit] .
240,000
Selling and administrative expenses ………………….
1,950,000
Net operating income …………………………………….
$ 210,000
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
under the new method.
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Solutions Manual, Appendix 4B 81
Case 4B-4 (continued)
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
dramatic effect on net operating income under the new method as
noted above in part (3). In addition, since the predetermined overhead
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
owners want to tie up working capital in inventories just to artificially
attain a target net operating income for the period? And increasing the
assumed that there would not be an increase in overhead costs due to
the additional production, but that is likely not to be true.
is to meet targets so that bonuses will be paid to top managers.