EXERCISE 3-17 (30 MINUTES)

2. Traditional approach:

Under the traditional approach, the reported net operating income can

be increased by increasing the production level which then results in

overapplied overhead which is deducted from Cost of Goods Sold.

Additional net operating income required to attain tar-

get net operating income ($500,000 – $300,000) (a).... $200,000

Overhead applied per unit of output (b) ... $25 per unit

Additional output required to attain target net operat-

ing income (a) ÷ (b) ... 8,000 units

Actual total manufacturing overhead cost incurred ... $4,000,000

Manufacturing overhead applied

[(160,000 units + 8,000 units) × $25 per unit] ... 4,200,000

Overhead overapplied... $ 200,000

Vault Hard Drives, Inc.

Income Statement: Traditional Approach

Revenue (150,000 units × $60 per unit)... $9,000,000

Cost of Goods Sold:

Variable manufacturing

(150,000 units × $15 per unit) ... $2,250,000

(150,000 units × $25 per unit) ... 3,750,000

Less: Manufacturing overhead overapplied... 200,000 5,800,000

Gross margin ... 3,200,000

Administrative and selling expenses ... 2,700,000

Net operating income ... $ 500,000

Note: If the overapplied manufacturing overhead were prorated be-

tween ending inventories and Cost of Goods Sold, more units would

Case 3-34 (continued)

New approach:

Under the new approach, the reported net operating income can be in-

creased by increasing the production level. This results in less of a deduc-

tion on the income statement for the Cost of Unused Capacity.

Additional net operating income required to attain target

net operating income ($500,000 – $250,000) (a) ... $250,000

Overhead applied per unit of output (b)... $20 per unit

Additional output required to attain target net operating

income (a) ÷ (b) ... 12,500 units

Estimated number of units produced ... 160,000 units

Actual number of units to be produced ... 172,500 units

Income Statement: New Approach

(150,000 units × $20 per unit) ... 3,000,000 5,250,000

Gross margin ... 3,750,000

Cost of Unused Capacity [(200,000 units –