Brake Systems, Inc. (BSI), makes brake rotors that it sells to automobile manufacturers. The average materials cost per rotor is $15.60, and the average labor cost is $8.50. BSI incurs approximately $2,880,000 of fixed manufacturing overhead costs annually. The marketing department estimated that BSI would sell approximately 300,000 rotors during the coming year. Unfortunately, BSI has experienced a steady decline in sales even though the automobile industry has had an increase in the number of rotors sold. The chief accountant, Sara Jenkins, was overheard saying that when she calculated the predetermined overhead rate, she deliberately lowered the estimated number of rotors expected to be sold because she had lost faith in the marketing department’s ability to deliver on its estimated sales numbers. Ms. Jenkins explained, “This way, our actual cost is always below the estimated cost. It is about the only way we continue to make a profit.” Indeed, the company had a significant amount of over-applied over-head at the end of each year.
a. Explain how the overapplied overhead affects the determination of year-end net income.
b. Assume that Ms. Jenkins used 280,000 rotors as the estimated sales to calculate the predetermined overhead rate. Determine the difference in expected cost per rotor she calculated and the cost per rotor that would result if the marketing department’s estimate (300,000 units) had been used.
c. Assuming that BSI uses a cost-plus pricing policy, speculate how Ms. Jenkins’ behavior could be contributing to the decline in sales.