Problems with Overhead Application: Decision Focus

44. Problems with Overhead Application: Decision Focus – Bergan Brewery uses the latest in modern brewing technology to produce a prizewinning beer. In both 2011 and 2012, Bergan produced and sold 100,000 cases of beer and had no raw materials, work in process, or finished goods inventory at the beginning or end of either year. At the end of 2011, the company installed machines to perform some of the repetitive tasks previously performed with direct labor. At the beginning of 2012, Bergan’s bookkeeper estimated that net income would increase from $ 530,000 in 2011 to $ 706,000 in 2012: 2011 Actual 2012 Estimated Beer sales (100,000 cases) $1,000,000 $1,000,000 Less: Cost of goods sold Direct material 150,000 150,000 Direct labor 125,000 25,000 Applied overhead* 95,000 19,000 Gross profit $630,000 $806,000 Less: Selling and administrative costs 100,000 100,000 Net income $530,000 $706,000
For 2012, overhead was applied at the 2011 rate of $ 9.50 per direct labor hour for an estimated 2,000 hours of direct labor. A total of 10,000 direct labor hours were worked in 2011. Bergan’s bookkeeper estimates that 5,000 machine hours will be worked in 2012.

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However, when actual overhead was used to calculate net income at the end of the year, net income decreased from $ 530,000 in 2011 to $ 435,000 in 2012: 2011 Actual 2012 Actual Beer sales (100,000 cases) $1,000,000 $1,000,000 Less: Cost of goods sold Direct material 150,000 150,000 Direct labor 125,000 25,000 Actual overhead: Lease expense 25,000 25,000 Utilities expense 15,000 30,000 Depreciation (equipment) 50,000 200,000 Equipment maintenance 5,000 35,000 Gross profit $630,000 $535,000 Less: Selling and administrative expense 100,000 100,000 Net income $530,000 $435,000

a) What potential problems do you see in the bookkeeper’s income estimate for 2012? b) On the basis of the information given, would you change the cost driver or predetermined overhead rate for 2012? What cost driver would you suggest? What would be the new predetermined overhead rate? c) Using the cost driver and predetermined overhead rate you suggested in B, and assuming that 5,000 machine hours will be incurred, recalculate Bergan’s estimated net income for 2012. d) Bergan has set a goal of increasing net income to $ 550,000 in 2013. However, sales are expected to be flat. How might the company reach its goal of increasing income to $550,000? What qualitative factors should be considered in its decision?

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