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Effect of Using A Denominator Level on the Absorption Costing Income
Statement
The calculation of the fixed mfg overhead rate is usually based on
estimates
made at the beginning of the year.
Budgeted Mfg Ohd
rate
=
Estimated Fixed Ohd in $
Estimated units of activity
In standard cost systems, the estimated units of activity is the
denominator
level
and is
some measure of production volume such as plant capacity, ‘normal
volume’, master budget volume, etc.
Whenever the
actual production volume
is different from the
denominator
volume
, then there will be a volume variance, calculated in diagram form as
follows:
Budgeted
Denom. Level
X
Fixed Ohd rate
=
Fixed Ohd
Actual
production
X
Fixed Ohd rate
=
Applied Fixed Ohd
Volume Variance
If the actual production level is > the denominator level, the volume variance will
be favourable.
If actual production is
<
the denominator level, the volume
variance will be unfavourable (because of assumed lost sales, loss CM, and lost
income.).
The volume variance is treated as an adjustment to COGS.
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 Winter '12
 Farrar
 Income Statement

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