Platinum Tracks, Inc., is a small audio recording studio located in Los Angeles. The company handles work for advertising agencies—primarily for radio ads—and has a few singers and bands as clients. Platinum Tracks handles all aspects of recording from editing to making a digital master from which CDs can be copied. The competition in the audio recording industry in Los Angeles has always been tough, but it has been getting even tougher over the last several years. The studio has been losing customers to newer studios that are equipped with more up-to-date equipment and that are able to offer very attractive prices and excellent service. Summary data concerning the last two years of operations follow:

The company applies studio overhead to recording jobs on the basis of the hours of studio service provided. For example, 40 hours of studio time were required to record, edit, and master the Verde Baja music CD for a local Latino band. All of the studio overhead is fixed, and the actual overhead cost incurred was exactly as estimated at the beginning of the year in both 2008 and 2009.

Required:

1. Platinum Tracks computes its predetermined overhead rate at the beginning of each year based on the estimated studio overhead and the estimated hours of studio service for the year. How much overhead would have been applied to the Verde Baja job if it had been done in 2008? In 2009? By how much would overhead have been underapplied or overapplied in 2008? In 2009?

2. The president of Platinum Tracks has heard that some companies in the industry have changed to a system of computing the predetermined overhead rate at the beginning of each year based on the hours of studio service that could be provided at capacity. He would like to know what effect this method would have on job costs. How much overhead would have been applied using this method to the Verde Baja job if it had been done in 2008? In 2009? By how much would overhead have been underapplied or overapplied in 2008 using this method? In 2009?

3. How would you interpret the underapplied or overapplied overhead that results from using studio hours at capacity to compute the predetermined overhead rate?

4. What fundamental business problem is Platinum Tracks facing? Which method of computing the predetermined overhead rate is likely to be more helpful in facing this problem? Explain.

2009 2008 Estimated hours of studio service 1,000 800 Estimated studio overhead cost $160,000 $160,000 Actual hours of studio service provided Actual studio overhead cost incurred 750 500 $160,000 $160,000 Hours of studio service at capacity 1,600 1,600