"Firms Need to Use the Capacity of the Equipment or Division

question 161

Essay

"Firms need to use the capacity of the equipment or division that is the 'bottleneck' of the manufacturing process as the denominator volume in setting the fixed overhead allocation rate. In cases where there is more than one 'bottleneck,' the denominator should be the smallest capacity among the bottleneck production processes."

Required:
1. What type of variance is related to this "denominator?" Explain.
2. Define the terms theoretical capacity, practical capacity, and budgeted capacity utilization. Of the three, which is considered most relevant for setting the predetermined overhead application rate for internal reporting purposes, particularly for fixed overhead costs? Explain.

---

Definitions:

Accountant

A professional responsible for managing and examining financial records and ensuring accuracy and compliance with laws.

Buyer And Seller

Individuals or entities involved in the transaction of goods or services, where the buyer acquires these from the seller in exchange for money.

Terminal Value

An estimate of a company's value at the end of a specific period, often used in discounted cash flow analysis to calculate the present value of all future cash flows.

Future Cash Flows

Future cash flows refer to the projected streams of revenue or expenses expected to be generated or incurred by a business or investment over time.