Maui Manufacturing, a small manufacturer of electronic parts, has just completed its third year of operations. The company€™s controller, Leilani Sorter, has been reviewing the actual results for the year and is concerned about the allocation of production over-head. Sorter uses the following information to assess operations:

€¢ Maui€™s equipment consists of several machines with a combined cost of $1,650,000 and no residual value. Each machine has an output of five units of product per hour and a useful life of 15,000 hours.

€¢ Selected actual data of Maui€™s operations for the year just ended is presented here:

Product manufactured..........................................375,000 units

Machine utilization..................................................97,500 hours

Direct labour usage.................................................26,250 hours

Labour rate.............................................................$ 11.25 per hour

Total production overhead..................................$ 847,500

Cost of goods sold...........................................$ 1,290,720

Finished goods inventory (at year end)..............$ 322,680

Work-in-process inventory (at year end).......................$ 0

€¢ Total production overhead is allocated to each unit using an estimated, plant-wide rate.

€¢ The budgeted activity for the year included 20 employees, each working 1,800 productive hours per year to produce 405,000 units of product. The machines are highly automated, and each employee can operate two to four machines simultaneously. Normal activity is for each employee to operate three machines. Machine operators are paid $11.25 per hour.

€¢ Budgeted production overhead costs for the past year for various levels of activity are shown here:

Required:

A. Choose the budgeted level of activity (in units) closest to actual activity for the period, and determine the dollar amount of total overapplied/underapplied production overhead. Explain why this amount is material.

B. Leilani Sorter believes that Maui Manufacturing should be using machine hours to allocate production overhead. Using the data given, determine the amount of total overapplied/underapplied production overhead if machine hours had been used as the allocation base.

C. Explain why machine hours might be a more appropriate allocation base than number of units.

D. Explain why using units as denominator volume might cause managers to build up inventories under absorption costing in periods when sales were slumping.

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Units of product 540,000 270,000 405,000 30,000 Labour hours 36,000 42,000 54,000 108,000 Machine hours 81,000 Production Overhead Costs: $ 52,500 $ 52,500 $ 52,500 Plant supervision 30,000 Plant rent 30,000 30,000 324,000 Equipment amortization 216,000 432,000 38,250 31,500 45,000 Maintenance Utilities 108,450 162,450 216,450 67,500 135,000 Indirect material 101,250 Other costs 8,400 12,450 16,500 $ 514,350 $720,900 $927,450 Total