Olive Branch Manufacturing Company produces a ball valve used in water systems. The company has selected normal capacity for estimating costs and for establishing the factory overhead application rate. For the December 31, 19X3, year just ended, the plant operated at only 90 percent of normal capacity. As a result, there is underapplied overhead for the year.

Olive Branch typically sells its valves for $160 each. However, at the beginning of 19X4, the firm received a one-time order for 1,000 units conditional on a unit sales price of $120.

The controller is advocating that management accept the order. He mentions two factors influencing his recommendation: First, the total unit manufacturing cost of $130 is composed of

$100 variable costs and $30 fixed costs. Second, the additional units can be manufactured within the company’s normal capacity.

Required:

a. Discuss the following capacity concepts:
(1) Theoretical capacity.
(2) Practical capacity.
(3) Normal capacity.
(4) Expected actual capacity.

b. Discuss the financial aspects that should be analyzed before deciding whether or not to accept the order.

c. Discuss the reason that the Factory Overhead Control account will probably reflect overapplied overhead for 19X4 if the order is accepted. Explain the disposition of any overapplied overhead.