Note on plant capacity and MO rates

# Note on plant capacity and MO rates - How the...

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How the Pre-determined Overhead Rate is Affected by the Choice of the Allocation Base Units If a company uses the expected level of activity for its estimate of the allocation base units in determining the MO rate at the beginning of the year, then the MO rate will fluctuate from year to year. In a high volume year, the rate will be lower and in a low volume year, the rate will be higher. Example: MO rate, year 1 = \$180,000 = \$3.00 per DLH 60,000 DLH’s MO rate, year 2 = \$180,000 = \$6.00 per DLH 30,000 DLH’s When output falls in year 2, the units become more expensive to make and the business will be tempted to raise prices to cover the added cost. This would be very detrimental during a business downturn when demand and output have fallen. As an alternative, some businesses use plant capacity rather than expected level of activity. Plant capacity is usually a much higher level of output than expected level. This makes the MO rate generally lower.

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Note on plant capacity and MO rates - How the...

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