CASE APPENDIX 5-3 Ethics Pat Miranda, the new controller of Vault Hard Drives, Inc., has just returned from a seminar rhead Rate and Capacity [LO5, LO6, LO7 on the choice of the activity level in the predetermined overhead rate. Even though the sub- did not sound exciting at first, she found that there were some important ideas presented ject that should get a hearing at her company. After returning from the seminar, she arrangeda meeting with the production manager, J. Stevens, and the assistant production manager, Marvin Washington. Pat: I ran across an idea that I wanted to check out with both of you. It's about the way we com- pute predetermined overhead rates. J.: We're all ears Pat: We compute the predetermined overhead rate by dividing the estimated total factory over- head for the coming year by the estimated total units produced for the coming year Marvin: We've been doing that as long as I've been with the company J.: And it has been done that way at every other company I've worked at, except at most places they divide by direct labor-hours. Pat: We use units because it is simpler and we basically make one product with minor varia- tions. But, there's another way to do it. Instead of basing the overhead rate on the estimated total units produced for the coming year, we capacity could base it on the total units produced at Marvin: Oh, the Marketing Department will love that. It will drop the costs on all of our prod- ucts. They'll go wild over there cutting prices. Pat: That is a worry, but I wanted to talk to both of you first before going over to Marketing. J.: Aren't you always going to have a lot of underapplied overhead? Pat: That's correct, but let me show you how we would handle it. Here's an example based on our budget for next year 160,000 units 160,000 units 200,000 units Budgeted sales Capacity Selling price Variable manufacturing cost Total manufacturing overhead cost (all fxed) Administrative and selling expenses (all foxed).... Beginning inventories. $60 per unit $15 per unit $4,000,000 $2,700,000 so Traditional Approach to Compubation of the Predetermined Overhead Rate Estimated total manofacturing overhead cost, $4,000,000 -$25 per unit total units 160,000 9,00,000 Revenue (160.000 units x $60 per unit Cost of goods sold Variable manufacturing (160,000 units x $15 per unt.$2.400.000 Manufacturing overhead applied (160,000 units x: $25S per unit 4000.000 400,000 3200000 2,700,000 S 500.000 Gross margin Selling and administrative expenses Net operating income CASE APPENDIX 5-3 Ethics Pat Miranda, the new controller of Vault Hard Drives, Inc., has just returned from a seminar rhead Rate and Capacity [LO5, LO6, LO7 on the choice of the activity level in the predetermined overhead rate. Even though the sub- did not sound exciting at first, she found that there were some important ideas presented ject that should get a hearing at her company. After returning from the seminar, she arrangeda meeting with the production manager, J. Stevens, and the assistant production manager, Marvin Washington. Pat: I ran across an idea that I wanted to check out with both of you. It's about the way we com- pute predetermined overhead rates. J.: We're all ears Pat: We compute the predetermined overhead rate by dividing the estimated total factory over- head for the coming year by the estimated total units produced for the coming year Marvin: We've been doing that as long as I've been with the company J.: And it has been done that way at every other company I've worked at, except at most places they divide by direct labor-hours. Pat: We use units because it is simpler and we basically make one product with minor varia- tions. But, there's another way to do it. Instead of basing the overhead rate on the estimated total units produced for the coming year, we capacity could base it on the total units produced at Marvin: Oh, the Marketing Department will love that. It will drop the costs on all of our prod- ucts. They'll go wild over there cutting prices. Pat: That is a worry, but I wanted to talk to both of you first before going over to Marketing. J.: Aren't you always going to have a lot of underapplied overhead? Pat: That's correct, but let me show you how we would handle it. Here's an example based on our budget for next year 160,000 units 160,000 units 200,000 units Budgeted sales Capacity Selling price Variable manufacturing cost Total manufacturing overhead cost (all fxed) Administrative and selling expenses (all foxed).... Beginning inventories. $60 per unit $15 per unit $4,000,000 $2,700,000 so Traditional Approach to Compubation of the Predetermined Overhead Rate Estimated total manofacturing overhead cost, $4,000,000 -$25 per unit total units 160,000 9,00,000 Revenue (160.000 units x $60 per unit Cost of goods sold Variable manufacturing (160,000 units x $15 per unt.$2.400.000 Manufacturing overhead applied (160,000 units x: $25S per unit 4000.000 400,000 3200000 2,700,000 S 500.000 Gross margin Selling and administrative expenses Net operating income