MY question is on Managerial Accounting

Question

A public accounting firm employs 10 full-time professionals who provide services to clients. All professional labour compensation is traced directly to clients on a per professional labour-hour basis. Any other costs are included in a single indirect-cost pool (same as overhead) and allocated to individual clients according to billable professional labourhours.

Operating costs and data for the year included the following:

Estimated Actual

Overhead (indirect) costs $1,000,000 $1,200,000

Number of billable professional

labour-hours 40,000 50,000 Total professional compensation 750,000 750,000

Required:

a. By how much, if any, was the overhead cost underapplied or overapplied?

b. Prepare a summary journal entry to close any underapplied or overapplied overhead cost to a Cost of Services Provided account.

c. Explain qualitatively and quantitatively (in as much detail as possible) the source(s) of any underapplied or overapplied overhead cost

Answer 1

At the beginning of the period, a Predetermined Overhead Rate (POHR) is determined and used during the period to allocate cost to clients. This POHR is based on a projection of the period's level of activity and is a best guess.

Based on this company's projection, their POHR will be calculated as follows:

$1,000,000/ 40,000 DLH = $25/direct labor hour.

Amount of cost allocated/applied to clients during the period = POHR x actual direct labor hours

$25 x 50,000 direct labor hours =$1,250,000

Amount over(under)applied = $1,250,000 - $1,200,000 = $50,000 overapplied

The journal entry to dispose of overapplied overhead:

Dr. Overhead Costs $50,000

Cr. Cost of Services Provided $50,000

The allocation overhead rate of $25 is calculated at the beginning of the period based on estimate. It is highly unlikely that the actual level of activity will match initial projections, so some variance is expected.

So, if actual volume is higher than expected, total charge out to clients, based on POHR will be higher and vice versa.