Hansen and Company’s annual overhead budget equals $7,200,000 of fixed costs plus $80 per labor hour in variable costs. For the most recent year, budgeted direct labor hours were 100,000. Actual total overhead was $16,000,000 and actual direct labor hours were 110,000 during the year.

Jeremey Meyer, the CEO of Hansen and Company, believes that using the “longterm” normal volume of direct labor hours as the allocation base is more appropriate than using budgeted direct labor hours as the allocation base when computing overhead rates. Accordingly, Jeremy asks his accountant to re-compute the overhead rate using normal volume. After much deliberation and consultation with factory personnel, the accountant decides that the long-term normal volume of direct labor hours is 150,000.

Required:

a. Calculate Hansen’s total annual overhead rate using normal volume.

b. Calculate the amount of overapplied or underapplied overhead for the most recent year, if Hansen used the overhead rate you derived in part (a).

c. Hansen’s policy is to write off the amount of overapplied or underapplied overhead to cost of goods sold. Will Hansen’s income for the year rise or fall as a result of this policy?

d. Repeat parts (a) through (c) assuming that Hansen uses the budgeted volume of direct labor hours to compute the total overhead rate.

e. What are the relative merits of using normal volume, as opposed to budgeted volume, when computing predetermined overhead rates?