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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 Winter '12
 Farrar
 mo rate, Fixed MO rate

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