Phalanges Systems, Inc. (PSI) makes keypads that it sells to manufacturers of products such as ATMs and PIN machines. The average materials cost per keypad is $4.70, and the average labor cost is $1.45. PSI incurs approximately $5,900,000 of fixed manufacturing overhead costs annually. The marketing department estimated that PSI would sell approximately 850,000 keypads during the coming year. Unfortunately, PSI has experienced a steady decline in sales even though the overall industry has had an increase in the number of keypads sold. The chief accountant, Hanna Fields, was overheard saying that when she calculated the predetermined overhead rate, she deliberately lowered the estimated number of keypads expected to be sold because she had lost faith in the marketing department's ability to deliver on its estimated sales numbers. Ms. Fields 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 overapplied overhead at the end of each year.
Required
a. Explain how the overapplied overhead affects the determination of year-end net income.
b. Assume that Ms. Fields used 750,000 keypads as the estimated sales to calculate the predetermined overhead rate. Determine the difference in expected cost per keypad she calculated and the cost per keypad that would result if the marketing department's estimate (850,000 units) had been used.
c. Assuming that PSI uses a cost-plus pricing policy, speculate how Ms. Fields' behavior could be contributing to the decline in sales.