This discussion question pertains to chapter 11 in the textbook. Brake Systems,

Question

This discussion question pertains to chapter 11 in the textbook. Brake Systems, Inc. (BSI), makes brake rotors that it sell to automobile manufacturers. The average materials cost per rotor is $15.60, and the average labor cost is $8.50. BSI incurs approximately $2,880,000 of fixed manufacturing overhead costs annually. The marketing department estimated that BSI would sell approximately 300,000 rotors during the coming year. Unfortunately, BSI has experienced a steady decline in sales even though the automobile industry has had an increase in the number of rotors sold. The chief accountant, Sara Jenkins, was overheard saying that when she calculated the predetermined overhead rate, she deliberately lowered the estimated number of rotors expected to be sold because she had lost faith in the marketing department’s ability to deliver on its estimated sales numbers. Ms. Jenkins explained, “This way, our actual cost is always below the estimated cost. It is about the only way we continue to make a profit.” Indeed, the company had a significant amount of over-applied overhead at the end of each year. Explain how the over-applied overhead affects the determination of year-end net income. Also, assuming that BSI uses a cost-plus pricing policy, speculate how Ms. Jenkins’ behavior could be contributing to the decline in sales.

Explanation / Answer

Since Ms Jenkins estimates the actual number of units sold to be lower than estimated, that is lower than 3lacs, she ends up allocating the fixed overhead expenses of $28.80lacs over a lesser number of units, thereby increasing the overall cost per unit. When, the actual number of units sold exceeds the number of units estimated by Ms. Jenkins , the company ends up having significant amount of applied overhead at the end of each year.

Also. Since BSI uses a cost plus pricing policy, the costs per unit are higher as explained above which leads to higher sales price. This high price which is actually a result of incorrect estimation and allocation of fixed overhead expenses, is leading to downfall in sales.

Looking forward to your valuable upvote.

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