Samanca Cabinets makes custom wooden cabinets for high-end stereo systems from specialty woods. The company uses a job-order costing system. The capacity of the plant is determined by the capacity of its constraint, which is time on the automated band saw that makes finely beveled cuts in wood according to the preprogrammed specifications of each cabinet. The band saw can operate up to 150 hours per month. The estimated total manufacturing overhead at capacity is $11,000 per month. The company bases its predetermined overhead rate on capacity, so its predetermined overhead rate is $74 per hour of band saw use.

The results of a recent month's operations appear below:

Sales ......................................... $39,860

Beginning inventories ........................... $0

Ending inventories ............................... $0

Direct materials .............................. $4,820

Direct labor (all variable) .................. $9,640

Manufacturing overhead incurred........ $10,870

Selling and administrative expense ...... $9,350

Actual hours of bands aw use ................. 124

Required:

1. Prepare an income statement following the example in Appendix 4B in which any under applied overhead is directly recorded on the income statement as an expense.

2. Why is overhead ordinarily under applied when the predetermined overhead rate is based on capacity?