American Guitar Company

American Guitar Company manufactures two different high quality acoustic guitars for retailers: beginner model and professional model. The company has two service departments: the maintenance department and the power department, and two manufacturing departments: the construction department and the finishing department. American Guitar chooses the reciprocal method to allocate service department costs. It uses operation costing to assign direct materials and 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[1]. 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. The diagram below depicts the manufacturing process.

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The following historical information has been collected from American Guitar’s accounting information systems:





Annual sales

4146(B) & 1611(P)

4456(B) & 1256(P)

4668(B) & 1322(P)

4075(B) & 1300(P)

July sales

393(B) & 183(P)

398(B) & 163(P)

405(B) & 168(P)

372(B) & 155(P)


Total Overhead ($)

Total DLH of the two manufacturing departments[2]








































American Guitar’s direct[3]and indirect MOH costs for the two service and two manufacturing departments in 2012:

Power Department[4]

Maintenance Department[5]

Construction Department



Total Amount













Maintenance hours






Direct fixed costs






Direct variable costs






Indirect fixed costs


Indirect variable costs


American Guitar does not expect significant changes in its manufacturing costs in 2013.

At the end of June 2013, the balance in American Guitar’s Materials Inventory account, which included 150 pounds of grade A veneered wood, was $2,640; the balance in the finished-goods inventory, which was valuated using the last-in, first-out (LIFO) method, consisted of 2 models, was $16,600.

Quantity and Unit Cost

Beginner model

20 units @ $430 each

Professional model

10 units @ $800 each

The following pertains to the month of July.

There were no beginning inventories in both manufacturing departments.
American Guitar’s work-in-process inventory on July 31 consisted of two jobs: B0642 and P0642. The ending WIP inventories at the finishing department for B0642 and P0642 have 10 EU and 6 EU respectively.
Additions to and requisitions from the materials inventory during the month of July included the following.
Raw Materials

Purchased Parts


550 pounds of grade A veneered wood for $9,680

3300 pounds of grade B veneered wood for $41,580

100 set of premium bridges and strings for $1,840

400 set of regular bridges and strings for $6,560


Job B0639 (120 beginner units)

936 pounds of grade B wood

125 regular sets

Job B0640 (100 beginner units)

790 pounds of grade B wood

103 regular sets

Job B0641 (150 beginner units)

1170 pounds of grade B wood

153 regular sets

Job B0642 (15 beginner units)

118 pounds of grade B wood

10 regular sets

Job P0640 (30 professional units)

240 pounds of grade A wood

31 premium sets

Job P0641 (35 professional units)

273 pounds of grade A wood

32 premium sets

Job P0642 (10 professional units)

82 pounds of grade A wood

6 premium sets

The average hourly rate for the construction and finishing departments in July was $15 and $14 respectively. The total payroll taxes and fringe benefits rate for American Guitar was 40% of wages paid. The July labor hours consisted of the following:

Construction Department

Finishing Department

Job B0639 (120 beginner units)



Job B0640 (100 beginner units)



Job B0641 (150 beginner units)



Job B0642 (15 beginner units)



Job P0640 (30 professional units)



Job P0641 (35 professional units)



Job P0642 (10 professional units)



5. 372 beginner models & 70 professional models were sold on account for $600 (beginner model) & $960 (professional model) each. The finished-goods inventory is valuated using LIFO method.

6. The actual direct fixed costs for power department and maintenance department were $4,050 and $4,000 respectively. The actual direct variable costs for power department and maintenance department were $17,084 and $9,280 respectively.

7. The actual direct fixed costs for construction department and finishing department were $40,100 and $35,800 respectively. The actual direct variable for construction department and finishing department were $33,084.60 and $34,038.40 respectively.

8. Depreciation of the general facility and equipment shared by both manufacturing departments during July amounted to $12,000.

9. Rent paid in cash for warehouse space used by the manufacturing departments during July was $1,200. Utility costs incurred for the warehouse during July amounted to $600. The invoices for these costs were received, but the bills were not paid in July.

10. July property taxes on the general facility were paid in cash, $2,400.

11. The insurance cost covering factory operations for the month of July was $3,100. The insurance policy had been prepaid.

12. The costs of salaries and fringe benefits for sales and administrative personnel paid in cash during July amounted to $8,000.

13. Depreciation on administrative office equipment and space amounted to $4,000.

14. Other selling and administrative expenses paid in cash during July amounted to $35,000.

15. The July 1 balances in selected accounts are as follows:



Accounts Receivable


Prepaid Insurance


Accumulated Depreciation: Facility & Equipment


Accounts Payable



Part 1

Submit a hard copy of your work and email an Excel workbook to support your calculations on or before the due date for questions 1 – 7.

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 overapplied or underapplied overhead for July. Use 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 and performance evaluation? Why?

Part 2

Submit a hard copy of your work and email an Excel workbook to support your calculations on or before the due date for questions 1 – 11.

Recently, American Guitar has faced intense competition from oversea guitars manufacturers. Her competitors sell similar quality guitars averaged 25% less. American Guitar considers implementing the standard costing to improve cost control. After conducting task analysis in the manufacturing departments, American Guitar establishes the following standards:

1) Each finished guitar contains seven pounds of veneered wood. In addition, one pound of wood is typically wasted in the manufacturing process.

2) The veneered wood used in the beginner model has a standard price of $12 per pound and the professional model has a standard price of $18. The other parts needed to complete each beginner guitar (professional guitar), such as the bridge and strings, cost $15 ($18) per guitar.

3) The labor standards[6]for American Guitar’s two manufacturing departments are as follows:

Construction Department

Finishing Department

Beginner model (B)

3 hours of direct labor at $18 per hour

2 hours of direct labor at $20 per hour

Professional model (P)

4 hours of direct labor at $18 per hour

6 hours of direct labor at $20 per hour

8. Assuming American Guitar implements the standard costing, and calculate the followings:

– Direct material and direct labor variances

– variable manufacturing overhead variances for both manufacturing departments in July.

– fixed manufacturing overhead variances for both manufacturing departments in July.

– standard cost for the beginner model and the professional model.

9. Prepare the journal entries to record the transactions in July using the standard costing.

10. Prepare entries to close all the variances using the proration method.

11. Do you recommend American Guitar to price its products based on its standard costs? Why?

Prepare a presentation to answer the following questions:

12. Do you recommend American Guitar to keep its current cost-accounting system or to implement the standard costing system? Why?

13. Explain the interpretation and possible interactions between the variances calculated by the standard costing.

14. Write a memo to the company evaluating American Guitar’s July performance and indicate any appropriate action for management to fine-tune its strategy.

[1]Direct-material is added at the beginning of manufacturing process in construction department.The direct-material and conversion costs are incurred uniformly throughout the process in finishing department.

[2]American Guitar believes that overhead is affected by total monthly DLH of the two manufacturing departments.

[3]For amanufacturingdepartment, direct costs refer only to overhead costs that are directly traceable to the department.

[4]Power department is to provide electricity to maintenance, construction and finishing department. Its service is measured by the kilowatt-hours. The kilowatt-hours provided by the department for 2010 & 2011 were 84,200 & 88,000 respectively.

[5]Maintenance department is to maintain all the equipment in power, construction and finishing department. Its service is measured by the maintenance hours. The maintenance hours provided by the department for 2010 & 2011 were 2,150 and 2,240 respectively.

[6]Direct-labor rates include employee benefits.

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