"Firms need to use the capacity of the equipment or division that is the 'bottleneck' of the manufacturing process as the denominator volume in setting the fixed overhead allocation rate.In cases where there is more than one 'bottleneck,' the denominator should be the smallest capacity among the bottleneck production processes."
Required: (a)What type of variance is related to this "denominator?" Explain.
(b)Why should a firm choose the smallest capacity "bottleneck" as the denominator in a manufacturing process?

Question

Quizplus · Accepted Answer

Feedback: (a)The "denominator" relates to production-volume variance.This denominator is the base activity measure to determine the rate for applying fixed manufacturing overhead cost to production.A variance between the total amount of applied fixed overhead (using the standard fixed overhead application rate,which is a function of the denominator volume selected)and budgeted fixed overhead is a (rough)measure of under- or over- capacity utilization.
(b)For short-term planning purposes.The smallest capacity,"bottleneck," represents the maximum flow of production (throughput)possible in a firm under existing physical conditions.This "bottleneck" measure represents the maximum capacity,and a rate determined at this level of activity is achievable.Any rate set above the "bottleneck" activity level will result in underapplied fixed overhead.The smallest capacity "bottleneck" activity level is the maximum currently attainable standard.

"Firms Need to Use the Capacity of the Equipment or Division