Osborne Corporation is a manufacturer of computer accessories. It uses absorption costing based on standard costs and reports the following data for the year.

There are no rate or efficiency variances. Actual operating costs equal budgeted operating costs. The production-volume variance is written off to COGS. For each choice of denominator level, the budgeted production cost per unit is also the cost per unit of beginning inventory.

1.	What is the production-volume variance for the year when the denominator level is (a) theoretical capacity, (b) practical capacity, and (c) normal capacity utilization?
2.	Prepare absorption costing-based statements of comprehensive income for Osborne Corporation using theoretical capacity, practical capacity, and normal capacity utilization as the denominator levels.
3.	Why is the operating income under normal capacity utilization lower than the other two scenarios?
4.	Reconcile the difference in operating income based on theoretical capacity and practical capacity with the difference in fixed manufacturing overhead included in inventory.

Requirement 1. What is the production-volume variance for the year when the denominator level is (a) theoretical capacity, (b) practical capacity, and (c) normal capacity utilization?

Begin by determining the formula that is used to calculate the production-volume variance. (Abbreviation used:

mfg=manufacturing.)

						Production-
	(		x		) =	volume variance

Part 2

Next, calculate the production-volume variance for each denominator level (a) theoretical capacity, (b) practical capacity, and (c) normal capacity utilization. Label each variance as favourable (F) or unfavourable (U).

	Production-
Capacity type	volume variance
(a) Theoretical
(b) Practical
(c) Normal

Part 3

Requirement 2. Prepare absorption costing-based statements of comprehensive income for

Osborne

Corporation using theoretical capacity, practical capacity, and normal capacity utilization as the denominator levels.

Prepare the statements of comprehensive income one at a time, starting with theoretical capacity. Label each variance as favourable (F) or unfavourable (U). (Use parentheses or a minus sign for an operating loss.)

	Theoretical
Revenue
Cost of goods sold
Beginning inventory
Variable manufacturing costs
Allocated fixed mfg overhead
Cost of goods available for sale
Ending inventory
Production-volume variance
Total cost of goods sold
Gross margin
Operating costs
Operating income (loss)

Practical

Normal

Part 4

Requirement 3. Why is the operating income under normal capacity utilization lower than the other two scenarios?

During the year,

Osborne

had

a decrease

an increase

in inventory levels. The

smaller the denominator level, the smaller is the budgeted fixed cost

smaller the denominator level, the larger is the budgeted fixed cost

allocated to each unit of production, and, when those units are sold, the

larger is the cost of each unit sold and the smaller is the operating income.

smaller is the cost of each unit sold and the larger is the operating income.

Normal utilization capacity is the

largest

smallest

capacity of the three; hence in this year, when production was

less

more

than sales, the absorption-costing based operating income is the smallest when normal capacity utilization is used as the denominator level.

Part 5

Requirement 4. Reconcile the difference in operating income based on theoretical capacity and practical capacity with the difference in fixed manufacturing overhead included in inventory. (Abbreviation used:

mfg=manufacturing.)

Less:				Less:
				Multiply by:
Difference in operating income			=	Difference in fixed mfg overhead included in inventory

Data table