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 –
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