The Predetermined Overhead

Rate and Capacity

Appendix 3A

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Copyright2012byTheMcGrawHillCompanies,Inc.Allrightsreserved.
 3A-2

Learning Objective 8

Understand the
implications of basing
the predetermined
overhead rate on activity
at capacity rather than
on estimated activity for
the period.
 3A-3

Predetermined Overhead Rate and

Capacity
Calculating predetermined overhead rates using an
estimated, or budgeted amount of the allocation base
has been criticized because:
1.Basing the predetermined overhead rate upon
budgeted activity results in product costs that fluctuate
depending upon the activity levels.
2.Calculating predetermined rates based upon
budgeted activity charges products for costs that they
do not use.
 3A-4

Capacity-Based Overhead Rates

Criticisms
Criticisms can
can be
be overcome
overcome by by using
using
estimated
estimated total
total units
units in
in the
the allocation
allocation base
base
at
at capacity
capacity in
in the
the denominator
denominator of of the
the
predetermined
predetermined overhead
overhead rate
rate calculation.
calculation.

Lets look at the difference!

 3A-5

Capacity-Based Overhead Rates:

An Example
Equipment is leased for $100,000 per
year. Running at full capacity, 50,000
units may be produced. The company
estimates that 40,000 units will be
produced and sold next year. What is
the predetermined overhead rate?
 3A-6

An Example
Equipment is leased for $100,000 per year.
Running at full capacity, 50,000 units may be
produced. The company estimates that 40,000 units
will be produced and sold next year.

Traditional $100,000
= = $2.50 per unit
Method 40,000

Capacity $100,000
= = $2.00 per unit
Method 50,000
 3A-7

Quick Check
Crest
Crest Winery
Winery in in Woodinville
Woodinville leases
leases anan
automatic
automatic corking
corking machine
machine for
for $100,000
$100,000 perper
year.
year.At
At full
full capacity,
capacity,itit can
can cork
cork 50,000
50,000 cases
cases ofof
wine
wine per
per year.
year.The The company
company estimates
estimates 40,000
40,000
cases
cases of
of wine
wine willwill be
be produced
produced andand sold
sold next
next
year.
year. What
What is is the
the predetermined
predetermined overhead
overhead rate
rate
based
based on
on the
the estimated
estimated number
number of of cases
cases ofof
wine?
wine?
a.
a. $2.00
$2.00 per
per case.
case.
b.
b. $2.50
$2.50 per
per case.
case.
c.
c. $4.00
$4.00 per
per case.
case.
 3A-8

Quick Check
Crest
Crest Winery
Winery in in Woodinville
Woodinville leases
leases anan
automatic
automatic corking
corking machine
machine for
for $100,000
$100,000 perper
year.
year.At
At full
full capacity,
capacity,itit can
can cork
cork 50,000
50,000 cases
cases ofof
wine
wine per
per year.
year.The The company
company estimates
estimates 40,000
40,000
cases
cases of
of wine
wine willwill be
be produced
produced andand sold
sold next
next
year.
year. What
What is is the
the predetermined
predetermined overhead
overhead rate
rate
based
based on
on the
the estimated
estimated number
number of of cases
cases ofof
wine?
wine?
a.
a. $2.00
$2.00 per
per case.
case.
b.
b. $2.50
$2.50 per
per case.
case.
c.
c. $4.00
$4.00 per
per case.
case.
 3A-9

Quick Check
Crest Winery in Woodinville leases an
automatic corking machine for $100,000 per
year. At full capacity, it can cork 50,000 cases of
wine per year. The company estimates 40,000
cases of wine will be produced and sold next
year. What is the predetermined overhead rate
based on the number of cases of wine at
capacity?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.
 3A-10

Quick Check
Crest Winery in Woodinville leases an
automatic corking machine for $100,000 per
year. At full capacity, it can cork 50,000 cases of
wine per year. The company estimates 40,000
cases of wine will be produced and sold next
year. What is the predetermined overhead rate
based on the number of cases of wine at
capacity?
a. $2.00 per case.
b. $2.50 per case.
c. $4.00 per case.
 3A-11

Quick Check
When
When capacity
capacity is
is used
used in
in the
the denominator
denominator of of the
the
predetermined
predetermined rate,
rate, what
what happens
happens to to the
the
predetermined
predetermined overhead
overhead raterate as
as estimated
estimated activity
activity
decreases?
decreases?
a.
a. The
The predetermined
predetermined overhead
overhead rate
rate goes
goes upup when
when
activity
activity goes
goes down.
down.
b.
b. The
The predetermined
predetermined overhead
overhead rate
rate stays
stays the
the same
same
because
because itit isis not
not affected
affected by
by changes
changes in in activity.
activity.
c.
c. The
The predetermined
predetermined overhead
overhead rate
rate goes
goes down
down when
when
activity
activity goes
goes down.
down.
 3A-12

Quick Check
When
When capacity
capacity is
is used
used in
in the
the denominator
denominator of of the
the
predetermined
predetermined rate,
rate, what
what happens
happens to to the
the
predetermined
predetermined overhead
overhead raterate as
as estimated
estimated activity
activity
decreases?
decreases?
a.
a. The
The predetermined
predetermined overhead
overhead rate
rate goes
goes upup when
when
activity
activity goes
goes down.
down.
b.
b. The
The predetermined
predetermined overhead
overhead rate
rate stays
stays the
the same
same
because
because itit isis not
not affected
affected by
by changes
changes in in activity.
activity.
c.
c. The
The predetermined
predetermined overhead
overhead rate
rate goes
goes down
down when
when
activity
activity goes
goes down.
down.
 3A-13

Quick Check
When estimated activity is used in the
denominator of the predetermined rate, what
happens to the predetermined overhead rate as
estimated activity decreases?
a. The predetermined overhead rate goes up
when activity goes down.
b. The predetermined overhead rate stays the
same because it is not affected by changes in
activity.
c. The predetermined overhead rate goes down
when activity goes down.
 3A-14

Quick Check
When estimated activity is used in the
denominator of the predetermined rate, what
happens to the predetermined overhead rate as
estimated activity decreases?
a. The predetermined overhead rate goes up
when activity goes down.
b. The predetermined overhead rate stays the
same because it is not affected by changes in
activity.
c. The predetermined overhead rate goes down
when activity goes down.
 3A-15

Income Statement Preparation

Capacity
 3A-16

Income Statement Preparation

Traditional