Northcoast Manufacturing Company, a small manufacturer of parts used in appliances, just completed its first year of operations. The company's controller, Vic Trainor, has been reviewing the actual results for the year and is concerned about the allocation of production overhead. Trainor uses the following information to assess operations:
€¢ Northcoast's equipment consists of several machines with a combined cost of $2,200,000 and no residual value. Each machine has an output of five units of product per hour and a useful life of 20,000 hours.
€¢ Selected actual data of Northcoast's operations for the year just ended is presented here:
Product manufactured................................ 500,000 units
Machine utilization................................... 130,000 hours
Direct labour usage .....................................35,000 hours
Labour rate ..............................................$15 per hour
Total production overhead .............................$1,130,000
Cost of goods sold .....................................$1,720,960
Finished goods inventory (at year end)................$ 430,240
Work-in-process inventory (at year end) ......................$ 0
€¢ Total production overhead is allocated to each unit using an estimated, plant-wide rate.
€¢ The budgeted activity for the year included 20 employees, each working 1,800 productive hours per year to produce 540,000 units of product. The machines are highly automated, and each employee can operate two to four machines simultaneously. Normal activity is for each employee to operate three machines. Machine operators are paid $15 per hour.
€¢ Budgeted production overhead costs for the past year for various levels of activity are shown here:

You might want to use a spreadsheet to perform calculations.
REQUIRED
A. Choose the budgeted level of activity (in units) closest to actual activity for the period, and determine the dollar amount of total overapplied/underapplied production overhead. Explain why this amount is material.
B. Vic Trainor believes that Northcoast Manufacturing Company should be using machine hours to allocate production overhead. Using the data given, determine the amount of total overapplied/underapplied production overhead if machine hours had been used as the allocation base.
C. Explain why machine hours might be a more appropriate allocation base than number of units.
D. Explain why using units as denominator volume might cause managers to build up inventories under absorption costing in periods when sales were slumping.

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Units of product Labour hours Machine hours Production overhead costs Plant supervision Plant rent Equipment amortization Maintenance Utilities Indirect material Other costs Total 30,000 72,000 540,000 36,000 108,000 720,000 42,000 144,000 $ 70,000 40,000 288,000 42,000 144,600 90,000 11,200 $685,800 $ 70,000 70,000 40,000 576,000 60,000 288,600 180,000 22,000 $961,200 $1,236,600 40,000 432,000 51,000 216,600 135,000 16,600 1