Capacity measures affect the setting of predetermined overhead rates because the use of

• expected capacity (the budgeted capacity for the upcoming year) will result in a predetermined overhead rate that would probably be most closely related to an actual overhead rate.

• practical capacity (the capacity that allows for normal operating interruptions) will generally re¬ sult in a predetermined overhead rate that is sub¬ stantially lower than an actual overhead rate would be.

• normal capacity (the capacity that reflects a long- mn average) can result in an overhead rate that is higher or lower than an actual overhead rate, depending on whether capacity has been over- or underutilized during the years under consid¬ eration.

• theoretical capacity (the estimated maximum po¬ tential capacity) will result in a predetermined overhead rate that is exceptionally lower than an actual overhead rate; however, this rate reflects a company’s true ability to use its capacity.

LO.1