3-1 By definition, manufacturing overhead consists of costs that cannot be practically traced to jobs. Therefore, if these costs are to be assigned to jobs, they must be allocated rather than traced. 3-2 The first step is to estimate the total amount of the allocation base (the denominator) that will be required for next period’s estimated level of production. The second step is to estimate the total fixed manufacturing overhead cost for the coming period and the variable manufacturing overhead cost per unit of the allocation base. The third step is to use the cost formula Y = a + bX to estimate the total manufacturing overhead cost (the numerator) for the coming period. The fourth step is to compute the predetermined overhead rate. 3-3 The job cost sheet is used to record all costs that are assigned to a particular job. These costs include direct materials costs traced to the job, direct labor costs traced to the job, and manufacturing overhead costs applied to the job. When a job is completed, the job cost sheet is used to compute the unit product cost. 3-4 A sales order is issued after an agreement has been reached with a customer on quantities, prices, and shipment dates for goods. The sales order forms the basis for the production order. The production order specifies what is to be produced and forms the basis for the job cost sheet. The job cost sheet, in turn, is used to summarize the various production costs incurred to complete the job. These costs are entered on the job cost sheet from materials requisition forms, direct labor time tickets, and by applying overhead. 3-5 Some production costs such as a factory manager’s salary cannot be traced to a particular product or job, but rather are incurred as a result of overall production activities. In addition, some production costs such as indirect materials cannot be easily traced to jobs. If these costs are to be assigned to products, they must be allocated to the products. 3-6 If actual manufacturing overhead cost is applied to jobs, the company must wait until the end of the accounting period to apply overhead and to cost jobs. If the company computes actual overhead rates more frequently to get around this problem, the rates may fluctuate widely due to seasonal factors or variations in output. For this reason, most companies use predetermined overhead rates to apply manufacturing overhead costs to jobs. 3-7 The measure of activity used as the allocation base should drive the overhead cost; that is, the allocation base should cause the overhead cost. If the allocation base does not really cause the overhead, then costs will be incorrectly attributed to products and jobs and product costs will be distorted. 3-8 Assigning manufacturing overhead costs to jobs does not ensure a profit. The units produced may not be sold and if they are sold, they may not be sold at prices sufficient to cover all costs. It is a myth that assigning costs to products or jobs ensures that those costs will be recovered. Costs are recovered only by selling to customers—not by allocating costs. 3-9 The Manufacturing Overhead account is credited when overhead cost is applied to Work in Process. Generally, the amount of overhead applied will not be the same as the amount of actual cost incurred because the predetermined overhead rate is based on estimates. 3-10 Underapplied overhead occurs when the actual overhead cost exceeds the amount of overhead cost applied to Work in Process inventory during the period. Overapplied overhead occurs when the actual overhead cost is less than the amount of overhead cost applied to Work in Process inventory during the period. Underapplied or overapplied overhead is disposed of by either closing out the amount to Cost of Goods Sold or by allocating the amount among Cost of Goods Sold and ending inventories in proportion to the applied overhead in each account. The adjustment for underapplied overhead increases Cost of Goods Sold (and inventories) whereas the adjustment for overapplied overhead decreases Cost of Goods Sold (and inventories). 3-11 Manufacturing overhead may be underapplied for several reasons. Control over overhead spending may be poor. Or, some of the overhead may be fixed and the actual amount of the allocation base may be less than estimated at the beginning of the period. In this situation, the amount of overhead applied to inventory will be less than the actual overhead cost incurred. 3-12 Underapplied overhead implies that not enough overhead was assigned to jobs during the period and therefore cost of goods sold was understated. Therefore, underapplied overhead is added to cost of goods sold. On the other hand, overapplied overhead is deducted from cost of goods sold. 3-13 A plantwide overhead rate is a single overhead rate used throughout a plant. In a multiple overhead rate system, each production department may have its own predetermine overhead rate and its own allocation base. Some companies use multiple overhead rates rather than plantwide rates to more appropriately allocate overhead costs among products. Multiple overhead rates should be used, for example, in situations where one department is machine intensive and another department is labor intensive. 3-14 When automated equipment replaces direct labor, overhead increases and direct labor decreases. This results in an increase in the predetermined overhead rate—particularly if it is based on direct labor.