Wixis Cabinets makes custom wooden cabinets for high-end stereo systems from specialty woods. The company uses a job-order costing system. The capacity of the plant is determined by the capacity of its constraint, which is time on the automated bandsaw that makes finely beveled cuts in wood according to the preprogrammed specifications of each cabinet. The handsaw can operate up to 180 hours per month. The estimated total manufacturing overhead at capacity is $14,760 per month. The company bases its predetermined overhead rate on capacity, so its predetermined overhead rate is 582 per hour of handsaw use.
The results of a recent month’s operations appear below:
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $43,740
Beginning inventories . . . . . . . . . . . . . . . . . . . . $0
Ending inventories . . . . . . . . . . . . . . . . . . . . . . . $0
Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . $5,350
Direct labor (all variable) . . . . . . . . . . . . . . . . . . $8,860
Manufacturing overhead incurred . . . . . . . . . . . $14,220
Selling and administrative expense . . . . . . . . . $8,180
Actual hours of bandsaw use . . . . . . . . . . . . . . 150

Required:
1. Prepare an income statement following the example in Appendix 3A in which any underapplied overhead is directly recorded on the income statement as an expense.
2. Why is overhead ordinarily underapplied when the predetermined overhead rate is based on capacity?