Osborn Manufacturing uses a predetermined overhead rate of $18.20 per direct labor-hour. This predetermined rate was based on a cost formula that estimates $218,400 of total manufacturing overhead for an estimated activity level of 12,000 direct labor-hours. The company incurred actual total manufacturing overhead costs of $215,000 and 11,500 total direct labor-hours during the period.
Required:
1. Determine the amount of underapplied or overapplied manufacturing overhead for the period.
2. Assuming that the entire amount of the underapplied or overapplied overhead is closed out to cost of goods sold, what would be the effect of the underapplied or overapplied overhead on the company's gross margin for the period?

1. overheads have been under-applied by $5,700

2. Gross Profit Margin will decrease by $5,700

Explanation:

Applied Overheads = predetermined rate × actual activity

Where, predetermined rate = Budgeted Overheads / Budgeted Activity

                                              = $218,400 / 12,000

                                              = $18.20 per direct labor-hour

Therefore, Applied Overheads = $18.20 ×  11,500

                                                   =  $209,300

Under - Applied = Actual Overheads > Applied Overheads

Over - Applied = Actual Overheads < Applied Overheads

In our case,

Actual Overheads $215,000 > Applied Overheads $209,300

Therefore, overheads have been under-applied by $5,700

Effect on Gross Profit Margin

Under-applied amount is added to Cost of Sales

This means that the Gross profit will decrease by the amount of under-applied overheads.

Thus Gross Profit Margin will decrease by $5,700

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