Capacity Management

 
 

            * Theoretical -  Maximum possible (not practical)
 
            *  Practical -  Downward adjustment of theoretical to                      
                            make allowance for unavoidable capacity losses
 
            *  Normal - Average output over past 3-5 years

            *  Budgeted - Expected in upcoming year

            *  Actual - Work actually done during current year
 

 

A Capacity Manaagement Example

 

Company A and Company B each manufacture one product that is very similar in nature.  Company A recently invested in modern machinery (new technology) that reduces its manufacturing labor cost.  Company B continues to be labor intensive using its older machinery.  Accordingly, Company A has much more fixed factory overhead annually than Company B ($ 1,500,000 compared to $ 600,000).  The respective selling price and variable costs per unit are as follows:
                                                                         Company A              Company B

                             Selling Price                         $ 20.00                         $  20.00

                             Direct Materials                  $  2.00                           $    2.00
                             Direct Labor                         $  1.00                           $   6.00
                             Variable Overhead               $  1.00                          $    1.00

Required:    Compute the gross margins on the product of each company assuming an annual volume of production and sales of 100,000 units;  then 200,000 units.
 

Solution:             (100,000 units)
                                       Cost:
                                            Variable Costs/Unit     $  4.00                       $  9.00
                                             Fixed Cost/Unit             15.00                           6.00
                                             Total Cost/Unit            $19.00                       $ 15.00

                                       Selling Price                       $20.00                       $ 20.00

                                    Total Gross Margin            $100,000                 $ 500,000

                           (200,000 units)
                                      Only change is Fixed
                                               costs per unit             $ 7.50                          $ 3.00

                                  Total Gross Margin             $ 1,700,000             $ 1,600,000