The management of Krach Corporation would like to investigate the possibility of basing its predetermined overhead rate on activity at capacity. The company's controller has provided an example to illustrate how this new system would work. In this example, the allocation base is machine-hours and the estimated amount of the allocation base for the upcoming year is 10,000 machine-hours. Capacity is 12,000 machine-hours and the actual level of activity for the year is assumed to be 9,500 machine-hours. All of the manufacturing overhead is fixed and both the estimated amount at the beginning of the year and the actual amount at the end of the year are assumed to be $12,000 per year. For simplicity, it is assumed that this is the estimated manufacturing overhead for the year as well as the manufacturing overhead at capacity. It is further assumed that this is also the actual amount of manufacturing overhead for the year. If the company bases its predetermined overhead rate on capacity, what would be the cost of unused capacity reported on the income statement prepared for internal management purposes?
A) $2,000
B) $2,500
C) $1,900
D) $600

Question

Quizplus · Accepted Answer

The cost of unused capacity is calculated by determining the difference between the capacity level and the actual activity level, then applying the predetermined overhead rate based on capacity. With a capacity of 12,000 machine-hours and actual activity of 9,500 machine-hours, there are 2,500 unused machine-hours. Since the total overhead is $12,000 and is based on a capacity of 12,000 machine-hours, the overhead rate per machine-hour is $1 ($12,000 / 12,000 machine-hours). Therefore, the cost of unused capacity is 2,500 machine-hours * $1/machine-hour = $2,500.

The Management of Krach Corporation Would Like to Investigate the Possibility