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Motivational considerations in denominator-level

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Unformatted text preview: Motivational considerations in denominator-level capacity selection (continuation of 9-32). 1. If the plant manager gets a bonus based on operating income, he/she will prefer the denominator-level capacity to be based on normal capacity utilization (or master-budget utilization). In times of rising inventories, as in 2009, this denominator level will maximize the fixed overhead trapped in ending inventories and will minimize COGS and maximize operating income. Of course, the plant manager cannot always hope to increase inventories every period, but on the whole, he/she would still prefer to use normal capacity utilization because the smaller the denominator, the higher the amount of overhead costs capitalized for inventory units. Thus, if the plant manager wishes to be able to “adjust” plant operating income by building inventory, normal capacity utilization (or master-budget capacity utilization) would be preferred. 2. Given the data in this question, the theoretical capacity concept reports the lowest operating income and thus (other things being equal) the lowest tax bill for 2009. Lucky Lager benefits by having deductions as early as possible. The theoretical capacity denominator-level concept maximizes the deductions for manufacturing costs. 3. The IRS may restrict the flexibility of a company in several ways: a. Restrict the denominator-level concept choice (to say, practical capacity). b. Restrict the cost line items that can be expensed rather than inventoried. c. Restrict the ability of a company to use shorter write-off periods or more accelerated write-off periods for inventoriable costs. d. Require proration or allocation of variances to represent actual costs and actual capacity used. 9-34 9-34 (25 min.) Denominator-level choices, changes in inventory levels, effect on operating income. 1. Normal Theoretical Practical Utilization Capacity Capacity Capacity Denominator level in units 144,000 120,000 96,000 Budgeted fixed manuf. costs $1,440,000 $1,440,000 $1,440,000 Budgeted fixed manuf. cost allocated per unit $ 10.00 $ 12.00 $ 15.00 Production in units 104,000 104,000 104,000 Allocated fixed manuf. costs (production in units × budgeted fixed manuf. cost allocated per unit) $1,040,000 $1,248,000 $1,560,000 Production volume variance (Budgeted fixed manuf. costs – allocated fixed manuf. costs) a $ 400,000U $ 192,000U $ 120,000F a PVV is unfavorable if budgeted fixed manuf. costs are greater than allocated fixed costs 2. Normal Theoretical Practical Utilization Capacity Capacity Capacity Units sold 112,000 112,000 112,000 Budgeted fixed mfg. cost allocated per unit $10 $12 $15 Budgeted var. mfg. cost per unit $ 3 $ 3 $ 3 Budgeted cost per unit of inventory or production $13 $15 $18 ABSORPTION-COSTING BASED INCOME STATEMENTS Revenues ($3 selling price per unit × units sold) $ 3,36 0,000 $ 3,36 0,000 $ 3,36 0,000 Cost of goods sold Beginning inventory (10,000 units × budgeted cost per unit of inventory) 130,000 150,000 180,000 Variable manufacturing costs (104,000 units × $3 per unit) 312,000 312,000 312,000 Allocated fixed manufacturing overhead (104,000...
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Motivational considerations in denominator-level capacity...

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