The Effects of the Choice of Denominator Level-1

The Effects of the Choice of Denominator Level-1 - The...

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The Effects of the Choice of Denominator Level on the MO Rate and the Size of the Volume Variance The measure a business uses for its denominator level affects three things: 1. The amount of the Fixed MO rate Recall that the Fixed MO rate is calculated as follows: Fixed MO rate = Fixed MO Budgeted $ Denominator Level The larger the denominator level, the smaller the Fixed MO rate. For example, plant capacity is the largest denominator level. Therefore it yields the smallest Fixed MO per unit. 2. The size and direction of the Volume Variance . A volume variance arises whenever the Actual level of output is different from the Denominator output. There is usually a large unfavourable volume variance when a business uses plant capacity as the denominator since most businesses operate at an actual production level much lower than plant capacity. Therefore, actual production will always be less than denominator production and an unfavaourable variance will result. On the other hand, when Master Budget volume is used, actual production should be very
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