1 INVENTORY COSTING & CAPACITY ANALYSIS 2 Overhead Allocation with Capacity Considerations B D E F G H Free work cells Answer cells 3 4 Jeanie Smith is the plant controller for Castle Lager Brewery, a privately-held brewery in New England. Castle is considering raising capital in the upcoming year so Jeanie is taking a serious look at how her accounting practices might affect the reported income for the company. Castle uses normal job costing, i.e. overhead is allocated into production using a budgeted allocation rate per barrel. All overhead variances are written off to COGS at year-end. Jeanie wants to examine how using different denominator-levels in the budgeted allocation rate FOR FIXED COSTS might affect the income for the company. 5 OPTION 1: VARIABLE COSTING OPTION 2: ABSORPTION COSTING, THEORETICAL CAPACITY 7 OPTION 3: ABSORPTION COSTING, PRACTICAL CAPACITY 8 OPTION 4: ABSORPTION COSTING, NORMAL CAPACITY 9 OPTION 5: ABSORPTION COSTING, BUDGETED VOLUME Under Variable Costing, only variable manufacturing costs are treated as product costs and are capitalized into inventory (i.e. initially recorded as inventory assets and later expensed as COGS). Any fixed manufacturing costs incurred are treated as period costs and are immediately expensed as COGS. Since no fixed cost is allocated into inventory, under Variable Costing there is no fixed overhead allocation rate. Under Absorption Costing, both variable and fixed manufacturing costs are treated as product costs and are capitalized into inventory (i.e. initially recorded as inventory assets and later expensed as COGS). "Theoretical Capacity" represents the volume that a factory could hypothetically produce at full efficiency, 100% utilization, and ideal conditions. Under Absorption Costing, both variable and fixed manufacturing costs are treated as product costs and are capitalized into inventory (i.e. initially recorded as inventory assets and later expensed as COGS). "Practical Capacity" represents a factory's theoretical capacity adjusted for (reduced for) unavoidable stoppages, scheduled maintenance, and holidays and weekends. Under Absorption Costing, both variable and fixed manufacturing costs are treated as product costs and are capitalized into inventory (i.e. initially recorded as inventory assets and later expensed as COGS). "Normal Capacity" represents the average demand level over several years, considering season, cydical and trend information. Under Absorption Costing, both variable and fixed manufacturing costs are treated as product costs and are capitalized into inventory (i.e. initially recorded as inventory assets and later expensed as COGS). "Budgeted Volume" represents the current year's expected demand level. 10 11 12 13 The Brewery is able to produce 0.5 barrels per hour at maximum efficiency. Due to unavoidable operating interruptions, production actually averages 0.475 barrels per working hour. There are three 8-hour shifts each day. Due to union and legal restrictions, the plant actually operates three 7-hour shifts per day and works 28 days per 30-day average month (12 months per year). Based on the current budget, Castle estimates that it will only be able to sell only 2,500 barrels this year but that demand in the future will normalize around 2,800 barrels. 14 Additional Information 15 Budgeted fixed overhead for the year: 16 Actual production for the year (barrels): 17 Actual sales for the year (barrels): 18 Actual fixed overhead for the year: 10 $ 27,900 2,671 2,460 $ 26,700