Why in the following question, we use Actual Manufacturing overhead cost incurred to compute the cost of unused capacity instead of using the formula : Cost of Unused Capacity = (Amount of the allocation base at capacity - Actual amount o the allocation base ) x Predetermined overhead rate.

[QUESTION] 5. The management of Garn Corporation would like to investigate the possibility of basing its predetermined overhead rate on activity at capacity rather than on the estimated activity for the coming year. The Corporations controller has provided an example to illustrate how this new system would work. In this example, the allocation base is machine-hours and the estimated activity for the upcoming year is 69,000 machine-hours. Capacity is 85,000 machine-hours. All of the manufacturing overhead is fixed and is $4,105,500 per year within the range of 69,000 to 85,000 machine-hours. If the Corporation bases its predetermined overhead rate on capacity but the actual level of activity for the year turns out to be 69,700 machine-hours, the cost of unused capacity shown on the income statement prepared for internal management purposes would be closest to:

A) $772,800

B) $780,640

C) $738,990

D) $41,650

Answer: C

Feedback: Predetermined overhead rate = Estimated total manufacturing overhead at capacity Estimated total amount of the allocation base at capacity = $4,105,500 85,000 machine-hours = $48.30 per machine-hour

Actual manufacturing overhead cost incurred $4,105,500

Manufacturing overhead applied to jobs:

Predetermined overhead rate $48.30 per machine-hour

Actual hours 69,700 machine-hours

Manufacturing overhead applied to jobs $3,366,510

Cost of unused capacity $738,990