Question

Alternative denominator-level capacity concepts effect on operating income. Lucky Lager has just purchased the Austin Brewery. The brewery is two years old and uses absorption costing. It will “sell” its product to Lucky Lager at $45 per barrel. Paul Brandon, Lucky Lager’s controller, obtains the following information about Austin Brewery’s capacity and budgeted fixed manufacturing costs for 2009:

1.         Compute the budgeted fixed manufacturing overhead rate per barrel for each of the denominator-level capacity concepts. Explain why they are different.

2.         In 2009, the Austin Brewery reported these production results:

There are no variable cost variances. Fixed manufacturing overhead cost variances are written off to cost of goods sold in the period in which they occur. Compute the Austin Brewery’s operating income when the denominator-level capacity is (a) theoretical capacity, (b) practical capacity, and (c) normal capacity utilization.

Answer 1

Alternative denominator-level capacity concepts effect on operating income.

1.

						Budgeted Fixed
	Budgeted Fixed	Days of	Hours of		Budgeted	Manufacturing
Denominator-Level Capacity Concept	Manuf. Overhead per Period	Production per Period	Production per Day	Barrels  per Hour	Denominator Level (Barrels)	Overhead Rate  per Barrel
	(1)	(2)	(3)	(4)	(5) = (2) (3) (4)	(6) = (1) (5)
Theoretical capacity	$28,000,000	360	24	540	4,665,600	$ 6.00
Practical capacity	28,000,000	350	20	500	3,500,000	8.00
Normal capacity utilization	28,000,000	350	20	400	2,800,000	10.00
Master-budget utilization
(a) January-June 2009	14,000,000	175	20	320	1,120,000	12.50
(b) July-December 2009	14,000,000	175	20	480	1,680,000	8.33

The differences arise for several reasons:

a.   The theoretical and practical capacity concepts emphasize supply factors, while normal capacity utilization and master-budget utilization emphasize demand factors.

b.   The two separate six-month rates for the master-budget utilization concept differ because of seasonal differences in budgeted production.

2.         

Using column (6) from above,

Absorption-Costing Income Statement