The management of Garn Corporation would like to investigate the possibility of basing its predetermined overhead rate on activity at capacity rather than on the estimated activity for the coming year. The Corporation's controller has provided an example to illustrate how this new system would work. In this example, the allocation base is machine-hours and the estimated activity for the upcoming year is 60,400 machine-hours. Capacity is 76,400 machine-hours. All of the manufacturing overhead is fixed and is $3,361,600 per year within the range of 60,400 to 76,400 machine-hours. If the Corporation bases its predetermined overhead rate on capacity but the actual level of activity for the year turns out to be 61,200 machine-hours, the cost of unused capacity shown on the income statement prepared for internal management purposes would be closest to:

A) $43,942
B) $712,742
C) $668,800
D) $44,525

Question

Hannah Bobias · Accepted Answer

Final Answer : C, Explanation :  Under the proposed new system, the predetermined overhead rate would be calculated as follows:Predetermined overhead rate = Total manufacturing overhead cost at capacity / Capacity= $3,361,600 / 76,400 machine-hours= $44 per machine-hourIf the actual level of activity for the year turns out to be 61,200 machine-hours, then the amount of overhead applied to production would be:Overhead applied = Actual machine-hours x Predetermined overhead rate= 61,200 machine-hours x $44 per machine-hour= $2,696,800The actual manufacturing overhead cost incurred during the year is given as $3,361,600. Therefore, the cost of unused capacity shown on the income statement prepared for internal management purposes would be:Cost of unused capacity = Actual manufacturing overhead cost incurred during the year - Overhead applied= $3,361,600 - $2,696,800= $664,800Therefore, the closest option to the cost of unused capacity would be C) $668,800.

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