American Guitar Company manufactures two dissimilar high quality acoustic guitars for retailers that are beginner model and professional model. The firm has two service departments that are the maintenance department and the power department and two manufacturing departments that are the construction department and the finishing department. American Guitar selects the reciprocal method to allocate service department costs. It uses operation costing to allocate direct materials as well as conversion costs to its products and absorption costing with normal costs for external reporting purposes.
In the Construction Department the wooden guitars are built by highly skilled craftsmen and coated with several layers of lacquer. Then the units are transferred to the Finishing Department where the bridge of the guitar is attached and the strings are installed. The guitars also are tuned and inspected in the Finishing Department. American Guitar estimates to have an annual practical capacity of 6000 guitars (1500 units of professional model and 4500 units of beginner model). The budgeted sales for 2013 are 1300 units professional model and 4300 units of beginner model.
Question
1. What is the predetermined manufacturing overhead rate for external reporting purpose? Is it the most appropriate rate for managerial accounting? Why?
2. Prepare the journal entries to record the transactions in July using normal costing.
3. Calculate the over applied or under applied overhead for July. Utilize the proration method to prepare a journal entry to close this balance.
4. Prepare a schedule of cost of goods manufactured for July.
5. Prepare a schedule of cost of goods sold for July.
6. Prepare an income statement for July.
7. From the perspective of long-run product pricing do you recommend American Guitar to keep its absorption costing with normal costs for pricing decision as well as performance evaluation? Why?
8. Do you recommend American Guitar to keep its current cost-accounting system or to implement the standard costing system? Why?
9. Explain the interpretation and possible interactions between the variances calculated by the standard costing.
10. Write a memo to the company evaluating American Guitar's July performance and indicate any appropriate action for management to fine-tune its strategy.