Question

9-31 DENOMINATOR-LEVEL PROBLEM. AJG Inc. is a manufacturer of the very popular G36 motorcycles. The management at AJG has recently adopted absorption costing and is debating which denominator level concept to use. The G36 motorcycles sell for an average price of $8,500. Budgeted fixed manufacturing overhead costs for 2018 are estimated at $4,000,000. AJG Inc. uses subassembly operators that provide component parts. The following are the denominator-level options that management has been considering: a. Theoretical capacity-based on two shifts, completion of four motorcycles per shift, and a 360-day year-2 x 4 x 360 = 2,880. b. Practical capacity-theoretical capacity adjusted for unavoidable interruptions, breakdowns, and so forth-2 x 3 x 320 = 1,920. C. Normal capacity utilization-estimated at 1,200 units. d. Master-budget capacity utilization-the growing popularity of motorcycles has prompted the marketing department to issue an estimate for 2018 of 1,500 units. Required 1. Calculate the budgeted fixed manufacturing overhead cost rates under the four denominator-level concepts. 2. What are the benefits to AJG Inc. of using either theoretical capacity or practical capacity? 3. Under a cost-based pricing system, what are the negative aspects of a master-budget denominator level? What are the positive aspects?

Answer 1

1) Determine the budgeted fixed manufacturing overhead cost under the four denominator level: Budgeted fixed overhead cost Estimated Denominator Estimated manufacturing overhead cost (a) capacity (b) level concepts rates (a)/(b) (c) Theoretical Practical Normal Master budget $400,000 $400,000 $400,000 $400,000 $138.89 2,880 1,920 $208.33 1,200 1,500 $333.33 $266.67 Therefore, the budgeted overhead cost rate at theoretical level is $138.9 practical $208.33 nomal $333.33 and masterbudget is $266.67

2) Explain the benefit of using theoretical or practical capacity to "A" Inc. The variance from the usage of capacity levels will result in divergence between the supply of capacity and demand of capacity. Hence, it is beneficiary for the company to follow theoretical capacity or practical capacity

3) Negative aspect: If the master budget level denominator is used it will result in greater number of fixed cost that is allocated to the individual product level. Thus, it will result in higher price and lower demand for the product. Positive aspect: The positive aspect of master-budget denominator level is based on the demand for the product and price ofthe product that is determined bythe company to recover all cost per unit and earn higher profit. It is used to evaluate the performance of the company