Question 9.4: A bicycle manufacturer estimates that the company will use 3...
A bicycle manufacturer estimates that the company will use 3,000 direct labor hours (DLH). Direct labor hours are used to allocate overhead. The company estimates that fixed overhead costs will be $30,000, and variable costs will be $20/direct labor hour. At the end of the year, the company finds that it estimated fixed overhead and variable overhead per direct labor hour correctly, but used 4,000 direct labor hours. What is the relation between actual overhead costs and allocated overhead costs?
The manufacture estimates the following overhead costs:
| Fixed costs | $30,000 |
| Variable costs ($20/DLH × 3,000 DLH) | 60,000 |
| Total estimated overhead costs | $90,000 |
The application rate is $90,000/3,000 DLH, or $30/DLH. The company actually uses 4,000 DLH, so (4,000 DLH × $30/DLH), or $120,000 of overhead is allocated to the products. The actual overhead, however, is as follows:
| Fixed costs | $30,000 |
| Variable costs ($20/DLH × 4,000 DLH) | 80,000 |
| Total actual overhead costs | 80,000 |
Therefore, the allocated overhead costs are $120,000 – $110,000, or $10,000 greater than the actual overhead costs. The overhead costs are over-absorbed.