HO #1 Proration of overhead. The McDonnell Company has commercial and defense contracting business. A contracting officer for the United States Air Force has insisted that under-applied overhead should no longer be written off directly as an adjustment of Cost of Defense Goods Sold for a given year. His insistence arose because $50 million of under-applied overhead was added to the $400 million of unadjusted Cost of Goods Sold in 20_X. There were no beginning inventories. Factory overhead is applied as a percentage of direct labor costs as contracts are produced. The air force had a large cost-plus-fixed-fee contract representing $300 million of the $400 million of defense production started and sold during 20_X. It had no other contracts pending with McDonnell. An analysis of costs showed (in millions): Defense Business Contracts in Progress Cost of Goods Sold Direct material used Direct labor cost Factory overhead applied Total before adjustment Add: Underapplied overhead Total after adjustment $425 45 90 $560 Finished Goods Inventory $25 5 10 $40 $250 50 100 $400* 50 $450 $560 $40 *Includes $300 million attributable to air force contracts. Required 1. What overhead rate based on direct labor costs would have resulted in factory overhead applied equaling factory overhead incurred? 2. As a judge trying to settle a dispute on the disposition of the under-applied overhead, what position would you favor? Why? Show computation and assuming your answer would be formally recorded in the general ledger, show a journal entry for the proration. 3. As the contracting officer, what basis of proration of the under-applied overhead would you favor? Why? Show computations. HO #1 Proration of overhead. The McDonnell Company has commercial and defense contracting business. A contracting officer for the United States Air Force has insisted that under-applied overhead should no longer be written off directly as an adjustment of Cost of Defense Goods Sold for a given year. His insistence arose because $50 million of under-applied overhead was added to the $400 million of unadjusted Cost of Goods Sold in 20_X. There were no beginning inventories. Factory overhead is applied as a percentage of direct labor costs as contracts are produced. The air force had a large cost-plus-fixed-fee contract representing $300 million of the $400 million of defense production started and sold during 20_X. It had no other contracts pending with McDonnell. An analysis of costs showed (in millions): Defense Business Contracts in Progress Cost of Goods Sold Direct material used Direct labor cost Factory overhead applied Total before adjustment Add: Underapplied overhead Total after adjustment $425 45 90 $560 Finished Goods Inventory $25 5 10 $40 $250 50 100 $400* 50 $450 $560 $40 *Includes $300 million attributable to air force contracts. Required 1. What overhead rate based on direct labor costs would have resulted in factory overhead applied equaling factory overhead incurred? 2. As a judge trying to settle a dispute on the disposition of the under-applied overhead, what position would you favor? Why? Show computation and assuming your answer would be formally recorded in the general ledger, show a journal entry for the proration. 3. As the contracting officer, what basis of proration of the under-applied overhead would you favor? Why? Show computations