Carlisle company is a manufacturer of precision surgical tools. It initiated standard costing and a flexible budget on January 1, 2011. The company preseident, Monica Carlisle, has been pondering how fixed manufacturing overhead should be allocated to products. Machine hour have been chosen as the allocation base. Her remaining uncertainty is the denominator level for machine hours. She decided to wait for the first month's result before making a final choice of what denominator level should be used from that day forward.
During January 2011, the actual units of outout had a standard of 37680 machine-hours allowed. The fixed manufacturing overhead spending variance was $6000, favourable. If the company used practical capacity as the denominator level, the production - volume variance would be $12200, unfavourable. If the company used normal capacity utilization as the denominator level, the production - volume variance would be $2400, unfavourable. Budgeted fixed manufacturing overhead was $96600 for the month.
1. Compute the denominator level, assuming that the normal-capacity concept is chosen
2. Compute the denominator level, assuming that the practical capacity concept is chosen
3. Suppose you are the executive vice president. You want to maximize your 2011 bonus, which depends on 2011 operating income. Assume that the production volume variance is written off to cost of goods sold at year end, and assume that the compant expects inventories to increase during the year. Which denominator level would you favor? Why?