Shen Company is a manufacturer of MP3 players. It implemented standard costs and a flexible budget on January 1, 2013. The president has been pondering how fixed manufacturing overhead should be allocated to products. Machine-hours have been chosen as the allocation base. Her remaining uncertainty is the denominator level for machine-hours. She decides to wait for the first month’s results before making a final choice of what denominator level should be used from that day forward.

In January 2013, the actual units of output had a standard of 28,000 machine-hours allowed. If the company used practical capacity as the denominator level, the fixed manufacturing overhead rate variance would be $4,000, unfavourable, and the production-volume variance would be $14,400, unfavourable. If the company used normal capacity utilization as the denominator level, the production-volume variance would be $8,000, favourable. Budgeted fixed manufacturing overhead was $48,000 for the month.

REQUIRED

1. Compute the denominator level, assuming that the normal-capacity-utilization concept is chosen.

2. Compute the denominator level, assuming that the practical-capacity concept is chosen.

3. Suppose you are the executive vice-president. You want to maximize your 2013 bonus, which depends on 2013 operating income. Assume that the production-volume variance is written off to cost of goods sold at year end. Which denominator level would you favour? Why?