Pat: Pat Miranda, the new controller of Vault Hard Drives, Inc. has just returned from a seminar on the choice of the activity level in the predetermined overhead rate. Even though the subject did not sound exciting at first, she found that there were some important ideas presented that should get a hearing at her company. After returning from the seminar, she arranged a meeting with the production manager, J. Stevens, and the assistant production manager, Marvin Washington I ran across an idea that I wanted to check out with both of you. It's about the way we compute predetermined overhead rates. We're all ears. Pat: We compute the predetermined overhead rate by dividing the estimated total factory overhead for the condng year, which is all a fixed cost, by the estimated total units produced for the Marvin lie've been doing that as long as I've been with the company. And it has been done that way at every other company I've worked at, except at most places they direct labor-hours. Pat: We use units because it is simple and we basically make one product with minor variations. But another way to do it. Instead of basing the overhead rate on the estimated total units produced for the coming year, we could base it on the total units produced at capacity. Marvin: on, the war ting Department wil love that. It will drop the costs on all of our products. They'll go wdid over there cutting prices. Pat: That is a worry, but I wanted to talk to both of you first before going over to Marketing. Aren't you always going to have a lot of unused capacity costs? That's correct, but let me show you how we would handle it. Here's an example based on our budget for next year. Pot: Budgeted (estimated) production Budgeted sales Capacity Selling price variable manufacturing cost Total manufacturing overhead cost (all fixed) Selling and administrative expenses (all fixed) Beginning inventories 34,600 units $4,000 units 100,000 units 374 per unit $18 per unit $ 1,932,600 $ 2,590,000 se Traditional Approach to computation of the Predetermined Overhead Rate Estimated total manufacturing overhead cost, $1,932,600 - $23.00 per unit Estimated total units produced, 84, 80e Budgeted Income Statement Revenue (84,000 units 594 per unit) $ 6,216,000 Cost of goods sold: variable manufacturing (84, ece units 518 per unit) $ 1,512,6 Manufacturing overhead applied (84,000 units 523 per unit) 1,932, 3,444,00 Gross margin 2,772,000 Selling and administrative expenses 2,590,000 Net Operating income $ 182,000 New Approach to Computation of the Predetermined Overhead Rate Using Capacity in the Denominator Estimated total manufacturing overhead cost at capacity 51,932.ee $19.32 per unit Total units at capacity, 109,00 units Budgeted Income Statement Revenue (84, cce units $74 per unit) $ 6,216,000 Cost of goods sold: variable manufacturing (64,000 units $15 per unit) $ 1,512,000 Manufacturing overhead applied (84,eee units $19.32 per unit) 1,622,50 3, 134,850 Gross margin 3,681,130 Cost of unused capacity [(188,800 units - 34,6ce units) . $19.22 per unit) 309,120 Selling and administrative expenses 2,590,000 Net operating income 182,000 put: Whoa!! I don't think I like the looks of that "cost of unused capacity." If that thing shows up on the income statement, someone from headquarters is likely to come down here looking for some people to lay off. Marvin: I'm worried about something else too. What happens when sales are not up to expectations? Can we pull the hat trick Pat: I'm sorry, I don't understand J! Marvin's talking about something that happens fairly regularly. when sales are down and profits look like they are going to be lower than the president told the owners they were going to be, the president comes down here and asks us to deliver sone more profits. Marvin: And we pull then out of our hat. Yeah, we just increase production until we get the profits we want. pot: I still don't understand you mean you increase sales? Nope, we increase production were the production managers, not the sales managers. I get it. Because you have produced more, the sales force has more units it can sell. Nope, the marketing people don't do a thing. We just build inventories and that does the trick. Required: In all of the questions below, assume that the predetermined overhead rate under the traditonal method is $23 per unit, and under the new capacity based method it is $19.32 per unit 1. Assume actual sales is 81000 units and the actual production in units actual selling price, actual variable manufacturing cost per unit, and actual fixed costs all equal their respective budgeted amounts. Given these assumptions a Compute net operating income using the traditional income statement format b. Compute net operating income using the new income statement format. 2. Assume that actual sales is 81,000 unts and the actual selling price, actual variable manufacturing cost per unit, and actual fred costs all equal their respective budgeted amounts. Under the traditional approach, how many units would have to be produced to realize net operating income of $182,000? 3. Assume that actual sales is 81.000 units and the actual selling price, actual variable manufacturing cost per unit. and actual fixed costs all equal their respective budgeted amounts. Under the new capacity-based approach, how many units would have to be produced to realize net operating income of $182,000? Pat: Pat Miranda, the new controller of Vault Hard Drives, Inc. has just returned from a seminar on the choice of the activity level in the predetermined overhead rate. Even though the subject did not sound exciting at first, she found that there were some important ideas presented that should get a hearing at her company. After returning from the seminar, she arranged a meeting with the production manager, J. Stevens, and the assistant production manager, Marvin Washington I ran across an idea that I wanted to check out with both of you. It's about the way we compute predetermined overhead rates. We're all ears. Pat: We compute the predetermined overhead rate by dividing the estimated total factory overhead for the condng year, which is all a fixed cost, by the estimated total units produced for the Marvin lie've been doing that as long as I've been with the company. And it has been done that way at every other company I've worked at, except at most places they direct labor-hours. Pat: We use units because it is simple and we basically make one product with minor variations. But another way to do it. Instead of basing the overhead rate on the estimated total units produced for the coming year, we could base it on the total units produced at capacity. Marvin: on, the war ting Department wil love that. It will drop the costs on all of our products. They'll go wdid over there cutting prices. Pat: That is a worry, but I wanted to talk to both of you first before going over to Marketing. Aren't you always going to have a lot of unused capacity costs? That's correct, but let me show you how we would handle it. Here's an example based on our budget for next year. Pot: Budgeted (estimated) production Budgeted sales Capacity Selling price variable manufacturing cost Total manufacturing overhead cost (all fixed) Selling and administrative expenses (all fixed) Beginning inventories 34,600 units $4,000 units 100,000 units 374 per unit $18 per unit $ 1,932,600 $ 2,590,000 se Traditional Approach to computation of the Predetermined Overhead Rate Estimated total manufacturing overhead cost, $1,932,600 - $23.00 per unit Estimated total units produced, 84, 80e Budgeted Income Statement Revenue (84,000 units 594 per unit) $ 6,216,000 Cost of goods sold: variable manufacturing (84, ece units 518 per unit) $ 1,512,6 Manufacturing overhead applied (84,000 units 523 per unit) 1,932, 3,444,00 Gross margin 2,772,000 Selling and administrative expenses 2,590,000 Net Operating income $ 182,000 New Approach to Computation of the Predetermined Overhead Rate Using Capacity in the Denominator Estimated total manufacturing overhead cost at capacity 51,932.ee $19.32 per unit Total units at capacity, 109,00 units Budgeted Income Statement Revenue (84, cce units $74 per unit) $ 6,216,000 Cost of goods sold: variable manufacturing (64,000 units $15 per unit) $ 1,512,000 Manufacturing overhead applied (84,eee units $19.32 per unit) 1,622,50 3, 134,850 Gross margin 3,681,130 Cost of unused capacity [(188,800 units - 34,6ce units) . $19.22 per unit) 309,120 Selling and administrative expenses 2,590,000 Net operating income 182,000 put: Whoa!! I don't think I like the looks of that "cost of unused capacity." If that thing shows up on the income statement, someone from headquarters is likely to come down here looking for some people to lay off. Marvin: I'm worried about something else too. What happens when sales are not up to expectations? Can we pull the hat trick Pat: I'm sorry, I don't understand J! Marvin's talking about something that happens fairly regularly. when sales are down and profits look like they are going to be lower than the president told the owners they were going to be, the president comes down here and asks us to deliver sone more profits. Marvin: And we pull then out of our hat. Yeah, we just increase production until we get the profits we want. pot: I still don't understand you mean you increase sales? Nope, we increase production were the production managers, not the sales managers. I get it. Because you have produced more, the sales force has more units it can sell. Nope, the marketing people don't do a thing. We just build inventories and that does the trick. Required: In all of the questions below, assume that the predetermined overhead rate under the traditonal method is $23 per unit, and under the new capacity based method it is $19.32 per unit 1. Assume actual sales is 81000 units and the actual production in units actual selling price, actual variable manufacturing cost per unit, and actual fixed costs all equal their respective budgeted amounts. Given these assumptions a Compute net operating income using the traditional income statement format b. Compute net operating income using the new income statement format. 2. Assume that actual sales is 81,000 unts and the actual selling price, actual variable manufacturing cost per unit, and actual fred costs all equal their respective budgeted amounts. Under the traditional approach, how many units would have to be produced to realize net operating income of $182,000? 3. Assume that actual sales is 81.000 units and the actual selling price, actual variable manufacturing cost per unit. and actual fixed costs all equal their respective budgeted amounts. Under the new capacity-based approach, how many units would have to be produced to realize net operating income of $182,000