Airline Meal Services (AMS) makes prepared meals that it sells to regional airlines. The average materials cost per meal is $3.90, and the average labor cost is $2.40. AMS incurs approximately $720,000 of fixed manufacturing overhead costs annually. The marketing department estimated that AMS would sell approximately 300,000 meals during the coming year. Unfortunately, AMS has experienced a steady decline in sales even though the airline industry has had a steady increase in the number of meals sold. The chief accountant, Michelle Winters, was overheard saying that when she calculated the predetermined overhead rate, she deliberately lowered the estimated number of meals expected to be sold because she had lost faith in the marketing department’s ability to deliver on its estimated sales numbers. Ms. Winters explained, “This way, our actual cost is always below the estimated cost. It is about the only way we continue to make a profit.” Indeed, the company had a significant amount of overapplied overhead at the end of each year.
Required
a. Explain how the overapplied overhead affects the determination of year-end net income.
b. Assume that Ms. Winters used 280,000 meals as the estimated sales to calculate the predetermined overhead rate. Determine the difference in expected cost per meals she calculated and the cost per meals that would result if the marketing department’s estimate (300,000 units) had been used.
c. Assuming that AMS uses a cost-plus pricing policy, speculate how Ms. Winters’ behavior could be contributing to the decline in sales.