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.
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 costs |
100,000 |
100,000 |
| Net income |
$530,000 |
$435,000 |
Required
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?