Business Applications Case Predetermined overhead rate Silicon Storage Solutions (SSS) makes memory storage chips that it sells to independent computer manufacturers. The average materials cost per set of chips is $4.70, and the average labor cost is

$1.45. SSS incurs approximately $5,900,000 of fixed manufacturing overhead costs annually. The marketing department estimated that SSS would sell approximately 850,000 sets of chips during the coming year. Unfortunately, SSS has experienced a steady decline in sales even though the computer industry has had a steady increase in the number of computers sold. The chief accountant, Jessica Sellers, was overheard saying that when she calculated the predetermined overhead rate, she deliberately lowered the estimated number of chips expected to be sold because she had lost faith in the marketing department’s ability to deliver on its estimated sales numbers. Ms. Sellers 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. Sellers used 750,000 sets of chips as the estimated sales to calculate the predetermined overhead rate. Determine the difference in expected cost per set of chips she calculated and the cost per set of chips that would result if the marketing department’s estimate (850,000 units) had been used.

c. Assuming that SSS uses a cost-plus pricing policy, speculate how Ms. Sellers’s behavior could be contributing to the decline in sales.