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Systems Design: Job-Order Costing

Chapter Three

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Learning Objective 1

Distinguish between process costing and joborder costing and identify companies that would use each costing method.

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Types of Product Costing Systems


Process Costing

Job-order Costing

A company produces many units of a single product. One unit of product is indistinguishable from other units of product. The identical nature of each unit of product enables assigning the same average cost per unit.
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Types of Product Costing Systems


Process Costing

Job-order Costing

A company produces many units of a single product. Example companies: unit of product is indistinguishable 1.One Weyerhaeuser (paper manufacturing) from units Aluminum of product. 2.other Reynolds (refining aluminum ingots) identical nature and of each unit beverages) of product enables 3.The Coca-Cola (mixing bottling assigning the same average cost per unit.

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Types of Product Costing Systems


Process Costing

Job-order Costing

Many different products are produced each period. Products are manufactured to order. The unique nature of each order requires tracing or allocating costs to each job, and maintaining cost records for each job.

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Types of Product Costing Systems


Process Costing

Job-order Costing

Example companies: Products are manufactured to order. 1. Boeing (aircraft manufacturing) unique nature of each order requires tracing or 2.The Bechtel International (large scale construction) allocating costs to each job, and maintaining cost 3.records Walt Disney Studios for each job. (movie production)

Many different products are produced each period.

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Comparing Process and Job-Order Costing

Job-Order Number of jobs worked Cost accumulated by Average cost computed by Many Individual Job Job

Process Single Product Department Department

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Quick Check
Which of the following companies would be likely to use job-order costing rather than process costing? a. Scott Paper Company for Kleenex. b. Architects. c. Heinz for ketchup. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels.
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Quick Check
Which of the following companies would be likely to use job-order costing rather than process costing? a. Scott Paper Company for Kleenex. b. Architects. c. Heinz for ketchup. d. Caterer for a wedding reception. e. Builder of commercial fishing vessels.
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Learning Objective 2

Identify the documents used in a job-order costing system.

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Job-Order Costing An Overview

Direct Materials

Job No. 1
Direct Labor Job No. 2 Job No. 3

Manufacturing Overhead

Charge direct material and direct labor costs to each job as work is performed.
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Direct Manufacturing Costs


Manufacturing Overhead, including indirect materials and indirect labor, are allocated to all jobs rather than directly traced to each job.
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Direct Materials

Job No. 1
Direct Labor Job No. 2 Job No. 3

Manufacturing Overhead

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The Job Cost Sheet


PearCo Job Cost Sheet
Job Number A - 143 Department B3 Item Wooden cargo crate Direct Materials Req. No. Amount Date Initiated 3-4-05 Date Completed Units Completed

Direct Labor Manufacturing Overhead Ticket Hours Amount Hours Rate Amount

Cost Summary Direct Materials Direct Labor Manufacturing Overhead Total Cost Unit Product Cost

Units Shipped Date Number Balance

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Measuring Direct Materials Cost

Will E. Delite

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Measuring Direct Materials Cost

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Measuring Direct Labor Costs

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Job-Order Cost Accounting

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Learning Objective 3

Compute predetermined overhead rates and explain why estimated overhead costs (rather than actual overhead costs) are used in the costing process.

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Why Use an Allocation Base?


Manufacturing overhead is applied to jobs that are in process. An allocation base, such as direct labor hours, direct labor dollars, or machine hours, is used to assign manufacturing overhead to individual jobs.
We use an allocation base because: 1. It is impossible or difficult to trace overhead costs to particular jobs. 2. Manufacturing overhead consists of many different items ranging from the grease used in machines to production managers salary. 3. Many types of manufacturing overhead costs are fixed even though output fluctuates during the period.
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Manufacturing Overhead Application


The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period begins.
Estimated total manufacturing overhead cost for the coming period Estimated total units in the allocation base for the coming period

POHR =

Ideally, the allocation base is a cost driver that causes overhead.


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The Need for a POHR


Using a predetermined rate makes it possible to estimate total job costs sooner.

Actual overhead for the period is not known until the end of the period.
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Application of Manufacturing Overhead

Based on estimates, and determined before the period begins.

Overhead applied = POHR Actual activity


Actual amount of the allocation based upon the actual level of activity.

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Overhead Application Rate


Estimated total manufacturing overhead cost for the coming period

POHR =

Estimated total units in the allocation base for the coming period
$640,000 160,000 direct labor hours (DLH)

POHR =

POHR = $4.00 per DLH For each direct labor hour worked on a particular job, $4.00 of factory overhead will be applied to that job.
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Job-Order Cost Accounting

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Job-Order Cost Accounting

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Interpreting the Average Unit Cost

The average unit cost should not be interpreted as the costs that would actually be incurred if an additional unit were produced. Fixed overhead would not change if another unit were produced, so the incremental cost of another unit may be somewhat less than $118.

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Quick Check
Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? a. $200. b. $350. c. $380. d. $730.
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Quick Check
Job WR53 at NW Fab, Inc. required $200 of direct materials and 10 direct labor hours at $15 per hour. Estimated total overhead for the year was $760,000 and estimated direct labor hours were 20,000. What would be recorded as the cost of job WR53? Pred. ovhd. rate $760,000/20,000hours $38 a. $200. materials $200 b. $350. Direct Direct labor $15 x 10 hours $150 c. $380. Manufacturing overhead $38 x 10 hours $380 Total cost $730 d. $730.
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Learning Objective 4

Understand the flow of costs in a job-order costing system and prepare appropriate journal entries to record costs.

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Job-Order Costing Document Flow Summary

A sales order is the basis of issuing a production order.

A production order initiates work on a job.

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Job-Order Costing Document Flow Summary

Materials used may be either direct or indirect.

Direct materials

Job Cost Sheets

Materials Requisition Indirect materials Manufacturing Overhead Account

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Job-Order Costing Document Flow Summary


An employees time may be either direct or indirect.

Direct Labor

Job Cost Sheets

Employee Time Ticket Indirect Labor Manufacturing Overhead Account

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Job-Order Costing Document Flow Summary

Employee Time Ticket

Indirect Labor

Other Actual OH Charges

Manufacturing Applied Overhead Overhead Account

Job Cost Sheets

Materials Requisition
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Indirect Material
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Learning Objectives 4 & 7

Understand the flow of costs in a job-order costing system and prepare appropriate journal entries to record costs. Use T-accounts to show the flow of costs in a job-order costing system.

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Job-Order Costing: The Flow of Costs

The transactions (in Taccount and journal entry form) that capture the flow of costs in a joborder costing system are illustrated on the following slides.

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The Purchase and Issue of Raw Materials


Raw Materials
Material Direct Purchases Materials Indirect Materials

Work in Process (Job Cost Sheet)


Direct Materials

Mfg. Overhead
Actual Applied Indirect Materials

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Cost Flows Material Purchases


Raw material purchases are recorded in an inventory account.

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Cost Flows Material Usage


Direct materials issued to a job increase Work in Process and decrease Raw Materials. Indirect materials used are charged to Manufacturing Overhead and also decrease Raw Materials.

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The Recording of Labor Costs


Salaries and Wages Payable
Direct Labor Indirect Labor

Work in Process (Job Cost Sheet)


Direct Materials Direct Labor

Mfg. Overhead
Actual Indirect Materials Indirect Labor
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The Recording of Labor Costs


The cost of direct labor incurred increases Work in Process and the cost of indirect labor increases Manufacturing Overhead.

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Recording Actual Manufacturing Overhead


Salaries and Wages Payable
Direct Labor Indirect Labor

Work in Process (Job Cost Sheet)


Direct Materials Direct Labor

Mfg. Overhead
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Recording Actual Manufacturing Overhead


In addition to indirect materials and indirect labor, other manufacturing overhead costs are charged to the Manufacturing Overhead account as they are incurred.

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Learning Objective 5

Apply overhead cost to Work in Process using a predetermined overhead rate.

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Applying Manufacturing Overhead


Salaries and Wages Payable
Direct Labor Indirect Labor

Work in Process (Job Cost Sheet)


Direct Materials Direct Labor Overhead Applied

Mfg. Overhead
Actual Applied Indirect Materials Overhead Indirect Applied to Labor Work in Other Process Overhead McGraw-Hill/Irwin

If actual and applied manufacturing overhead are not equal, a year-end adjustment is required.
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Applying Manufacturing Overhead


Work in Process is increased when Manufacturing Overhead is applied to jobs.

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Accounting for Nonmanufacturing Cost


Nonmanufacturing costs are not assigned to individual jobs; rather they are expensed in the period incurred.

Examples: 1. Salary expense of employees who work in a marketing, selling, or administrative capacity. 2. Advertising expenses are expensed in the period incurred.
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Accounting for Nonmanufacturing Cost


Nonmanufacturing costs (period expenses) are charged to expense as they are incurred.

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Learning Objective 6

Prepare schedules of cost of goods manufactured and cost of goods sold.

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Transferring Completed Units


Work in Process (Job Cost Sheet)
Direct Materials Direct Labor Overhead Applied

Finished Goods
Cost of Goods Mfd.

Cost of Goods Mfd.

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Transferring Completed Units


As jobs are completed, the Cost of Goods Manufactured is transferred to Finished Goods from Work in Process.

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Transferring Units Sold


Work in Process (Job Cost Sheet)
Direct Materials Direct Labor Overhead Applied

Finished Goods
Cost of Goods Mfd.

Cost of Goods Mfd.

Cost of Goods Sold

Cost of Goods Sold

Cost of Goods Sold


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Transferring Units Sold


When finished goods are sold, two entries are required: (1) to record the sale, and (2) to record COGS and reduce Finished Goods.

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Learning Objective 8

Compute underapplied or overapplied overhead cost and prepare the journal entry to close the balance in Manufacturing Overhead to the appropriate accounts.

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Problems of Overhead Application


The difference between the overhead cost applied to Work in Process and the actual overhead costs of a period is referred to as either underapplied or overapplied overhead.
Underapplied overhead exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is less than the total amount of overhead actually incurred during the period.
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Overapplied overhead exists when the amount of overhead applied to jobs during the period using the predetermined overhead rate is greater than the total amount of overhead actually incurred during the period.
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Overhead Application Example


PearCos actual overhead for the year was $650,000 with a total of 170,000 direct labor hours worked on jobs. How much total overhead was applied to PearCos jobs during the year? Use PearCos predetermined overhead rate of $4.00 per direct labor hour.

Overhead Applied During the Period


Applied Overhead = POHR Actual Direct Labor Hours Applied Overhead = $4.00 per DLH 170,000 DLH = $680,000
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Overhead Application Example


PearCos actual overhead for the year was $650,000 with a total of 170,000 direct labor hours worked on jobs. PearCo has overapplied How much total overhead was applied to overhead for the year PearCos jobs during the year? Use by $30,000. What will PearCos predetermined overhead rate of PearCo do? $4.00 per direct labor hour.

Overhead Applied During the Period


Applied Overhead = POHR Actual Direct Labor Hours Applied Overhead = $4.00 per DLH 170,000 DLH = $680,000
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Quick Check
Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined overhead rate of $4.00 per machine hour. Tiger, Inc. worked 290,000 machine hours during the period. Tigers manufacturing overhead is a. $50,000 overapplied. b. $50,000 underapplied. c. $60,000 overapplied. d. $60,000 underapplied.

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Quick Check
Tiger, Inc. had actual manufacturing overhead costs of $1,210,000 and a predetermined Overhead Applied overhead rate of $4.00 per machine Tiger, $4.00 per hour hour. 290,000 hours = $1,160,000 Inc. worked 290,000 machine hours during the Underapplied Overhead is period. Tigers manufacturing overhead a. $50,000 overapplied. c. $60,000 overapplied. d. $60,000 underapplied.
$1,210,000 - $1,160,000 = $50,000

b. $50,000 underapplied.

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Disposition of Under- or Overapplied Overhead


PearCos Method

$30,000 may be allocated to these accounts.

$30,000 may be closed directly to cost of goods sold.

OR
Work in Process Finished Goods Cost of Goods Sold
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Cost of Goods Sold


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Disposition of Under- or Overapplied Overhead

PearCos Cost of Goods Sold


Unadjusted Balance $30,000 Adjusted Balance

PearCos Mfg. Overhead


Actual Overhead overhead applied costs to jobs $650,000 $30,000 $680,000 $30,000 overapplied

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Allocating Under- or Overapplied Overhead Between Accounts


Assume the overhead applied in ending Work in Process Inventory, ending Finished Goods Inventory, and Cost of Goods Sold is shown below:
Work in process Finished Goods Cost of Goods Sold Total Amount $ 68,000 204,000 408,000 $ 680,000 Percent of Total 10% 30% 60% 100% Allocation of $30,000 $ 3,000 9,000 18,000 $ 30,000

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Allocating Under- or Overapplied Overhead Between Accounts


We would complete the following allocation of $30,000 overapplied overhead:
Percent of Total 10% 30% 60% 100% Allocation of $30,000 $ 3,000 9,000 18,000 $ 30,000

Work in process Finished Goods Cost of Goods Sold Total

Amount $ 68,000 204,000 408,000 $ 680,000

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Allocating Under- or Overapplied Overhead Between Accounts


Amount $ 68,000 204,000 408,000 $ 680,000 Percent of Total 10% 30% 60% 100% Allocation of $30,000 $ 3,000 9,000 18,000 $ 30,000

Work in process Finished Goods Cost of Goods Sold Total

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Overapplied and Underapplied Manufacturing Overhead - Summary


PearCos Method
If Manufacturing Overhead is . . . UNDERAPPLIED (Applied OH is less than actual OH) OVERAPPLIED (Applied OH is greater than actual OH) DECREASE Cost of Goods Sold Alternative 1 Close to Cost of Goods Sold INCREASE Cost of Goods Sold Alternative 2 Allocation INCREASE Work in Process Finished Goods Cost of Goods Sold DECREASE Work in Process Finished Goods Cost of Goods Sold

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Quick Check
What effect will the overapplied overhead have on PearCos net operating income? a. Net operating income will increase. b. Net operating income will be unaffected. c. Net operating income will decrease.

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Quick Check
What effect will the overapplied overhead have on PearCos net operating income? a. Net operating income will increase. b. Net operating income will be unaffected. c. Net operating income will decrease.

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Multiple Predetermined Overhead Rates


To this point, we have assumed that there is a single predetermined overhead rate called a plantwide overhead rate.

Large companies often use multiple predetermined overhead rates.

May be more complex but . . .


May be more accurate because it reflects differences across departments.
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Job-Order Costing in Service Companies


Job-order costing is used in many different types of service companies.

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The Use of Information Technology


Technology plays an important part in many job-order cost systems. When combined with Electronic Data Interchange (EDI) or a webbased programming language called Extensible Markup Language (XML), bar coding eliminates the inefficiencies and inaccuracies associated with manual clerical processes.

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The Predetermined Overhead Rate & Capacity


Appendix 3A

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Learning Objective 9

(Appendix 3A)
Understand the implications of basing the predetermined overhead rate on activity at capacity rather than on estimated activity for the period.

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Predetermined Overhead Rate and Capacity


Calculating predetermined overhead rates using an estimated, or budgeted amount of the allocation base has been criticized because:
1. Basing the predetermined overhead rate upon budgeted activity results in product costs that fluctuate depending upon the activity level. 2. Calculating predetermined rates based upon budgeted activity charges products for costs that they do not use.

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Capacity-Based Overhead Rates


Criticisms can be overcome by using estimated total units in the allocation base at capacity in the denominator of the predetermined overhead rate calculation.

Lets look at the difference!

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An Example
Equipment is leased for $100,000 per year. Running at full capacity, 50,000 units may be produced. The company estimates that 40,000 units will be produced and sold next year. What is the predetermined overhead rate?

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An Example
Equipment is leased for $100,000 per year. Running at full capacity, 50,000 units may be produced. The company estimates that 40,000 units will be produced and sold next year. What is the predetermined overhead rate?
Traditional = Method $100,000 40,000 = $2.50 per unit

Capacity Method
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$100,000 50,000

= $2.00 per unit

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Quick Check
Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run at full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the estimated number of cases of wine? a. $2.00 per case. b. $2.50 per case. c. $4.00 per case.

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Quick Check
Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run at full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the estimated number of cases of wine? a. $2.00 per case. b. $2.50 per case. c. $4.00 per case.

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Quick Check
Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run at full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the number of cases of wine at capacity? a. $2.00 per case. b. $2.50 per case. c. $4.00 per case.

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Quick Check
Crest Winery in Woodinville leases an automatic corking machine for $100,000 per year. If run at full capacity, it can cork 50,000 cases of wine per year. The company estimates 40,000 cases of wine will be produced and sold next year. What is the predetermined overhead rate based on the number of cases of wine at capacity? a. $2.00 per case. b. $2.50 per case. c. $4.00 per case.

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Quick Check
When capacity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases? a. The predetermined overhead rate goes up when activity goes down. b. The predetermined overhead rate stays the same; it is not affected by changes in activity. c. The predetermined overhead rate goes down when activity goes down.

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Quick Check
When capacity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases? a. The predetermined overhead rate goes up when activity goes down. b. The predetermined overhead rate stays the same; it is not affected by changes in activity. c. The predetermined overhead rate goes down when activity goes down.

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Quick Check
When estimated activity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases? a.The predetermined overhead rate goes up when activity goes down. b.The predetermined overhead rate stays the same; it is not affected by changes in activity. c.The predetermined overhead rate goes down when activity goes down.

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Quick Check
When estimated activity is used in the denominator of the predetermined rate, what happens to the predetermined overhead rate as estimated activity decreases? a.The predetermined overhead rate goes up when activity goes down. b.The predetermined overhead rate stays the same; it is not affected by changes in activity. c.The predetermined overhead rate goes down when activity goes down.

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Income Statement Preparation


Actual volume Selling price Variable production cost Fixed manufacturing overhead Capacity Predetermined overhead rate Fixed selling and admin. expense Revenue Cost of goods sold Gross margin Cost of idle capacity Selling and admin. expense Net operating income
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40,000 $40.00 $24.00 $100,000 50,000 $2.00 $500,000 $ 1,600,000 1,040,000 560,000 20,000 500,000 $ 40,000

cases per case per case per year cases per case per year

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Income Statement Preparation


Actual volume Selling price Variable production cost Fixed manufacturing overhead Capacity Predetermined overhead rate Fixed selling and admin. expense Revenue Cost of goods sold Gross margin Cost of idle capacity Selling and admin. expense Net operating income
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40,000 $40.00 $24.00 $100,000 40,000 $2.50 $500,000 $ 1,600,000 1,060,000 540,000 500,000 $ 40,000

cases per case per case per year cases per case per year

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End of Chapter 3

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