Chapter 9 Notes

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Financial Accounting
G.Quan Fun

Chapter 9 Income Effects of Denominator Level on Inventory Valuation NotesDenominator Levels A Complex Decision with Complex Effectseach of the four choices for denominator level constrains output produced through either supply or demand capacitythe first two denominatorlevel choices constrain output because of the supply that can be provided by existing capacityotheoretical capacity is amount of output theoretically possible if there were never any delays or interruptions in productionopractical capacity is the amount of output practically possible after taking into account required idle time for maintenance safety inspections holidays and other relevant factorstheoretical capacity is always greater than practical capacity because practical capacity excludes volume lost through idle timethe following two denominatorlevel choices constrain output produced because of the existing demand level for the outputonormal capacity is level of output that will satisfy average customer demand over a time period and complies with GAAPomasterbudget capacity is the level of output that will satisfy customer demand for a single budget cycle and complies with Canada Revenue Agency CRA for tax purposesSupply Theoretical Capacity or Practical Capacitytheoretical capacity is based on the production of output at full efficiency all the timeno idle time results in highest possible supplyside denominator level lowest fixed overhead cost rate and inventory valuationif however actual production is less than theoretical capacity because there is no demand or production is interrupted the productionvolume variance will be high and indicates the cost of idle productive capacitypractical capacity is the capacity concept that reduces theoretical capacity for unavoidable operating interruptionsthis type of scheduled idle capacity is often called offlimits idle capacitystrategically companies might schedule offlimits idle capacity to comply with regulations and safety legislationan important job for the production manager is to schedule setups to minimize nonproductive idle capacitythis type of capacity is not offlimits because it can be minimized with either excellent scheduling or deployed in other waysDemand Normal Capacity or MasterBudget Capacitynormal capacity utilization is the capacity concept based on the level of capacity utilization that satisfies average customer demand over a period say of two or three years that includes seasonal cyclical or other trend factorsmasterbudget capacity utilization is the capacity concept based on the anticipated level of capacity utilization for the next operating budget period of a month a quarter or a yearthey key difference is the time period under con
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