Cost Accounting Standards with

respect to Capacity Management

and determination

Prof. (Dr.) Paresh Shah

FCMA.,Ph.D.,FDP
(IIM,Ahmedabad)
 Capacity Management

Capacity has a cost, whether it is used or not

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 Capacity
• Capacity is the maximum output or producing ability of a machine,
person, factory, etc.

• Capacity can be measured in physical terms

• Measure of the amount of work done
• Capacity is the measure of the maximum amount of work that can be done
in a given time

• Capacity = R * T
• R is the rate of output per unit of time
• T is the maximum amount of time available

• Capacity has a cost

• Cost to acquire or rent the facility, machine, operating costs, wages,
utilities, insurance, etc.
• The cost is incurred even if capacity is underused

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MEASURING THE COST OF CAPACITY

Traditional measures do not reflect the cost of capacity

usage or over capacity

Costs are part of overhead and allocated to production

- Focus is on inventory valuation, not managing
capacity
- Allocation base is chosen from five alternatives

-Theoretical
Maximum output when operating continuously at
maximum efficiency

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 MEASURING THE COST OF CAPACITY

• Level of output under current conditions, allowing for normal

downtime for setups, maintenance, vacations, etc.
Practical

• Average level of output achieved or anticipated over several years

Normal

• Level of output anticipated for the current year

Budget

• Level of output actually achieved in the current year

Actual

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 Measuring the Cost of Capacity
Amount of capacity-related overhead charged to
the output depends on the allocation base chosen

A stamping machine costs Rs400,000 per year to operate.

The machine can produce 200 stampings per hour.
The machine runs 24 hours per day.
The company does not work on weekends (104 days) or holidays (10 days)
Downtime for maintenance, setups, etc. averages 15 days per year.
The machine is idle because of lack of materials for an average of 5 days per year.
The equivalent of 8 days of production is lost each year because of defects
produced by the machine.
Management expects to produce an average of 1,000,000 stampings per year
over the next five years.
Planned output for the current year was 1,050,000 stampings.
Actual output for the current year was 1,032,000 stampings, requiring 215 days.
If successfully negotiated, a new contract with a customer would increase demand
for the stampings by 24,000 units per year. 6
 Measuring the Cost of Capacity
Traditional cost allocation measures
Operating Cost per
Output Cost (Rs) Unit(Rs)
Theoretical capacity
Units per hour 200
Hours per day * 24
Days per year * 365
Theoretical capacity = 1,752,000 400,000 0.228

Practical capacity
Units per hour 200
Hours per day * 24
Operating days per year* * 231
Practical capacity = 1,108,800 400,000 0.361
* 365-104-10-15-5=231 days

Normal capacity
Expected 5 year average output 1,000,000 400,000 0.400

Budget capacity
Planned output for the current year 1,050,000 400,000 0.381

Actual capacity
Actual output for the current year 1,032,000 400,000 0.388

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 MEASURING THE COST OF CAPACITY
• CAM-I capacity model focuses on the cost of used and unused capacity
– Capacity is divided into four categories

Rated capacity • Same as theoretical capacity

Productive • Capacity used to produce usable output

capacity
• Capacity that does not result in usable output
• Downtime for maintenance, setups, lack of
Nonproductive materials, etc.
• Productive time lost due to waste, scrap, rework,
capacity etc.
• Idle capacity 8
MEASURING THE COST OF CAPACITY

• Capacity that is not available due

Idle to policy decisions or market
reasons such as holidays, lack of
capacity orders, etc

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 Measuring the Cost of Capacity
• Cost is attached to the capacity categories based on the theoretical cost
per unit

Output Cost per

Capacity category Days (4,800 units per day) Unit(Rs) Capacity cost(Rs)
Rated 365 1,752,000 0.228 400,000
Productive 215 1,032,000 0.228 235,616
Nonproductive
Setups 15 72,000 0.228 16,438
Standby 5 24,000 0.228 5,479
Defects 8 38,400 0.228 8,767
Subtotal 28 134,400 0.228 30,685
Idle
Weekends, holidays114 547,200 0.228 124,932
Marketable 5 24,000 0.228 5,479
Not marketable 3 14,400 0.228 3,288
Subtotal 122 585,600 0.228 133,699
Total 365 1,752,000 0.228 400,000
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 Managing Capacity Costs
 Capacity costs may be fixed, but can still be managed

• Increasing sales to use unused capacity

Reduction of idle • Renting unused capacity to others
capacity • Reduction in “days off”

Reduction of
• Reduction of setup time, defects, etc.
nonproductive
capacity

• Replace the asset with one having less

Reduction of rated capacity
capacity • Lower capacity asset can be more fully
utilized
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IMPLICATIONS OF THE CAM-I MODEL

Illustrates the reasons for idle and

nonproductive capacity

Illustrates the cost of idle and

nonproductive capacity

Helps management prioritize

capacity utilization efforts

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 PRACTICAL CONSIDERATIONS IN
MEASURING CAPACITY

How is capacity Capacity may

defined? change over time

• Worker, • Assets slowing

machine, with age
factory, etc. • Technological
• Higher-level improvements
capacity to assets
(process,
factory, etc.) is
determined by
the lowest
capacity
component
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 Cost Accounting Standard On
Capacity Determination
• Cost Accounting Standard 2 (cas 2) issued by the Council of the
Institute of Cost and Works Accountants of India on “CAPACITY
DETERMINATION”.

• The standard deals with determination of Capacity of a unit.

• Better utilization of capacity means better utilization of resources. It is

an important consideration for cost determination and cost reduction. It
is an important consideration for cost determination and cost reduction.

• Thus, it is essential to establish the capacity of the plant. Cost

Accounting Records Rules under section 209(1)(d) of Companies Act,
1956 and Cost Audit Report Rules, 2001 under section 233B of the said
Act specify that comparative statement of installed capacity and actual
capacity utilization is to be recorded and furnished in order to assess the
operating level.
 Objective

• The objective of the standard is to prescribe the method of

determination of capacity to be applied uniformly and consistently.

• The standard is to help the management to identify the bottlenecks,

imbalances and idle capacity for effective use of various resources.

• The standard is to help in proper allocation, apportionment and

absorption of cost.
 Scope
• The standard should be followed for capacity determination required to be
carried out for any purpose or under provisions of any Act, Rules or
Regulations except where capacity determination has been prescribed
otherwise.

• The standard shall also be followed for maintaining cost records under the
Cost Accounting Records Rules or for furnishing information on Capacity
Utilization under the Cost Audit Report Rules issued pursuant to Section
209(1)(d) and section 233B of Companies Act,1956 respectively

• The standard is applicable for an undertaking, whether existing or new,

where there is expansion of more than 5% of the existing capacity due to
introduction of new machines or productive resources. Similarly, the
standard is also applicable where there is more than 5% reduction of the
existing capacity due to disposal or withdrawal or impairment of old
machines or productive resources.
 Definitions
• is the production capacity of the plant for which license has been
Licensed issued by an appropriate authority.
Capacity

• is the maximum productive capacity according to the

manufacturers’ specification of machines / equipment. Installed
capacity of the unit/plant is determined after taking into account
Installed imbalances in different machines/ equipment in the various
Capacity departments / production cost centers in the unit / plant and number
of working shifts.

• is the maximum productive capacity of a plant reduced by the

Practical or predictable and unavoidable factors of interruption pertaining to
Achievable internal causes.
Capacity
 Definitions (contd.)
• is the production achieved or achievable on an average over a
period or season under normal circumstances taking into account
Normal the loss of capacity resulting from planned maintenance.
Capacity

• is the volume of production achieved in relation to installed

Actual capacity.
Capacity
Utilization

• is the difference between installed capacity and the actual capacity

utilization when actual capacity utilization is less than installed
Idle capacity.
Capacity
 Definitions (contd.)

• is the difference between installed capacity and the actual

capacity utilization when actual capacity utilization is more
Excess Capacity than installed capacity.
Utilization

• is the difference between practical capacity and normal

capacity or actual capacity utilization whichever is higher.
Abnormal idle
capacity
 Determination of Installed Capacity

Installed capacity is determined based on :

Capacities of Operational
Manufacturers’ individual or constraints /
Number of Any other
Technical interrelated capacity of
shifts factor
specifications production critical
centres. machines
Determination of Installed Capacity (contd.)

• In case of manufacturers’ technical specifications are not

available, the estimates by technical experts on capacity under
ideal conditions may be considered for determination of installed
capacity.

• In case a product passes through different production processes

and each process is having different capacity then the process
which brings effective or ultimate production shall be considered
for deciding installed capacity
 Determination of Practical/Achievable
Capacity
Practical capacity or achievable capacity should
be determined after adjustment of the following
with the installed capacity.
Available
production
hours taking Normal time
Loss in
into loss in batch
efficiency due
consideration change over, Number of Any other
to ageing of
holidays, break downs of shifts factor
the machines/
normal shut machines,
equipment
down days and repairs etc
normal idle
time.
Determination of Normal Capacity
• Normal capacity is determined based on the productive capacity
achieved over a period of time, say average of three normal years out
of preceding five years or expected to be achieved over a period of
time, say next three to five years .

• This capacity is determined after adjustment of external factors with

practical capacity.

• Normal capacity of production process involved in the production of

a product or the productive capacity of the plant as a whole should be
taken into account to arrive at normal capacity for a product or plant,
as the case may be

• The periods influenced by abnormalities should be excluded for this

purpose.
 Explanation
• In case the same products with different specifications and of
different ranges in terms of size, type, variety etc are
manufactured, then there is a need to determine equivalence
among them in order to determine the capacity.

• In case some intermediate products / components etc are also

produced, they should be taken into consideration for determining
equivalent capacity.

• In case some machines are leased out/let out or some machines are
taken on lease, resulting decrease / increase in capacity should
also be considered.
Example
Calculation