Which amounts would you use to calculate the overhead rate, and why? What are th

Question

Which amounts would you use to calculate the overhead rate, and why?

What are the advantages of using the high or low estimates?

Are there any ethical issues in selecting the estimates?

What are the ramifications or under- or overestimating the overhead?

SkinFX Corporation Management Decisions SkinFX Corporation manufactures the special materials used to create face masks and realistic body parts for the movie industry. The company is preparing its projected financial statements for the upcoming year, and hopes to use them to secure a bank loan. The proceeds of the loan will be used to increase capacity at the plant. At current capacity, total overhead is about $1.2M, with about 170,000 total direct labors hours. If the company expands, the increased capacity will generate total overhead of $1.7M, with 195,000 direct labor hours.

Explanation / Answer

Low over head is used

.1. Excess of overhead applied to work-in-process inventory over the amount of overhead actually incurred. This amount (called favorable variance) is added to the budgeted profit in the end-of-accounting-period financial statements. Also called overabsorbed overhead. See also underapplied overhead.
2. A situation in which the overhead applied to a work in progress (WIP) product is more than the overhead that the WIP actually incurs. This results in the manufacturing overhead having a credit balance. Overapplied overhead is reported on the balance sheet and is reported as unearned revenue.

The over or under-applied manufacturing overhead is defined as the difference between manufacturing overhead cost applied to work in process and manufacturing overhead cost actually incurred during a period.

If the manufacturing overhead cost applied to work in process is more than the manufacturing overhead cost actually incurred during a period, the difference is known as over-applied manufacturing overhead. On the other hand; if the manufacturing overhead cost applied to work in process is less than the manufacturing overhead cost actually incurred during a period, the difference is known as under-applied manufacturing overhead.

The occurrence of over or under-applied overhead is normal in manufacturing businesses because overhead is applied to work in process using a predetermined overhead rate. Predetermined overhead rate is computed at the beginning of the period using estimated information and is used to apply manufacturing overhead cost throughout the period.

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