Proration of overhead

The Ride-On-Wave Company (ROW) produces a line of non-motorized boats. ROW uses a normal-costing system and allocates manufacturing overhead using direct manufacturing labor cost.

The following data are for 2014:

Budgeted manufacturing overhead cost $125,000
Budgeted direct manufacturing labor cost $250,000
Actual manufacturing overhead cost $117,000
Actual direct manufacturing labor cost $228,000

Inventory balances on December 31, 2014, were as follows:
2014 direct manufacturing
Account Ending balance labor cost in ending balance
Work in process $ 50,700 $ 20,520
Finished goods 245,050 59,280
Cost of goods sold 549,250 148,200

Required:
1. Calculate the manufacturing overhead allocation rate.
2. Compute the amount of under- or overallocated manufacturing overhead.
3. Calculate the ending balances in work in process, finished goods, and cost of goods sold if under- or overallocated manufacturing overhead is as follows:
a. Written off to cost of goods sold
b. Prorated based on ending balances (before proration) in each of the three accounts
c. Prorated based on the overhead allocated in 2014 in the ending balances (before proration) in each of the three accounts
4. Which method would you choose? Justify your answer.

=

2. Overhead allocated = 50% Actual direct manufacturing labor cost
= 50% $228,000 = $114,000

Underallocated
manufacturing
overhead = Actual
manufacturing
overhead costs – Allocated plant
overhead costs
= $117,000 – $114,000 = $3,000

Underallocated manufacturing overhead = $3,000

3a. All underallocated manufacturing overhead is written off to cost of goods sold.

Both work-in-process (WIP) and finished goods inventory remain unchanged.

Account Dec. 31, 2014
Balance
(Before Proration)
(1) Proration of $3,000
Underallocated
Manuf. Overhead
(2) Dec. 31, 2014
Balance
(After Proration)
(3) = (1) + (2)
WIP $ 50,700 $ 0 $ 50,700
Finished Goods 245,050 0 245,050
Cost of Goods Sold 549,250 3,000 552,250
Total $845,000 $3,000 $848,000

3b. Underallocated manufacturing overhead prorated based on ending balances:

Account Dec. 31, 2014 Account Balance
(Before Proration)
(1) Account
Balance as a
Percent of Total
(2) = (1) ÷ $845,000 Proration of $3,000
Underallocated
Manuf. Overhead
(3) = (2) $3,000
Dec. 31, 2014 Account Balance
(After Proration)
(4) = (1) + (3)
WIP $ 50,700 0.06 0.06 $3,000 = $ 180
$ 50,880
Finished Goods 245,050 0.29 0.29 $3,000 = 870
245,920
Cost of Goods Sold 549,250 0.65 0.65 $3,000 = 1,950
551,200
Total $845,000 1.00 $3,000 $848,000

3c. Underallocated manufacturing overhead prorated based on 2014 overhead in ending balances:

Account Dec. 31, 2014 Account
Balance
(Before Proration)
(1) Allocated Manuf.
Overhead in
Dec. 31, 2014 Balance
(Before Proration)
(2) Allocated Manuf. Overhead in
Dec. 31, 2014
Balance as a
Percent of Total
(3) = (2) ÷ $114,000 Proration of $3,000
Underallocated
Manuf. Overhead
(4) = (3) $3,000
Dec. 31, 2014 Account
Balance
(After Proration)
(5) = (1) + (4)
WIP $ 50,700 $ 10,260a 0.09 0.09 $3,000 = $ 270
$ 50,970
Finished Goods 245,050 29,640b 0.26 0.26 $3,000 = 780
245,830
Cost of Goods Sold 549,250 74,100c 0.65 0.65 $3,000 = 1,950
551,200
Total $845,000 $114,000 1.00 $3,000 $848,000

a,b,c Overhead allocated = Direct manuf. labor cost 50% = $20,520; $59,280; $148,200 50%

4. Writing off all of the underallocated manufacturing overhead to Cost of Goods Sold (CGS) is usually warranted when CGS is large relative to Work-in-Process and Finished Goods Inventory and the underallocated manufacturing overhead is immaterial. Both these conditions apply in this case. ROW should write off the $3,000 underallocated manufacturing overhead to Cost of Goods Sold Account.