competitor has not done this, and because of its higher selling price, Gostkowski’s sales decline.
Consequently, 2014 budgeted quantities are even lower, which increases the unit cost and selling
price. This phenomenon is known as the downward demand spiral, and it causes Gostkowski to
continually inflate its selling price, which in turn leads to progressively lower sales.
Fixed manufacturing overhead rate = $576,000/48,000 units = $12 per unit
Manufacturing cost per unit:
$20 direct materials + $35 direct mfg. labor + $9 var. mfg. OH + $12 fixed mfg. OH = $76
$76 × 130% = $98.80
If Gostkowski had used practical capacity as its denominator level of activity, its initial selling
price of $98.60 would have been virtually in line with the $98.40 selling price of Gostkowski’s
competitor, and it would likely have resulted in higher sales. Using practical capacity will result
in a higher unfavorable production-volume variance, which will most likely be written off to cost
of goods sold and reduce operating income. However, as sales and production increase in future
years and the company “grows into” its capacity, the amount of unused capacity will be lower,
resulting in future cost savings.