Terri Ronsin has just transferred to a new position as divisional controller.  One of her first tasks as divisional controller is to develop the division’s predetermined overhead rate for the upcoming year.  The predetermined overhead rate is computed by dividing the estimated total manufacturing overhead cost by the estimated total direct-labor hours.  The production manager estimates that she will need about 440,000 direct-labor hours to meet the sales projections for the year.  Teri develops the predetermined overhead rate and goes to her manager for approval.  Harry Irving, the general manager, asks Terri to reduce the estimated total direct labor-hours to 420,000.  He explains to Terri that if you shave about 5%  off of the estimated total direct labor-hours that there will be an increase in net operating income at the end of the year.

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If Terri were to lower the estimated total direct labor-hours, the predetermined overhead rate will be higher, resulting in overapplied overhead.  In this situation the overapplied overhead would be closed out to Cost of Goods Sold.  This would be done by debiting Cost of Goods Sold and crediting Manufacturing Overhead resulting in a decrease in Cost of Goods Sold.  At the end of the year, Cost of Goods Sold and operating expenses are subtracted from sales.  The result of this is the net operating income.  Therefore, if the Cost of Goods Sold is lower, then the net operating income will ...

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