Company: Plastic Composites Inc.
From: Jane Doe
Date: March 1, 2012
RE: Allocation Options for Fixed Manufacturing Overhead Costs
Dear Mr. Oray,
After researching the different methods allowed for you to use in allocating the fixed manufacturing costs to the work in process and finished goods I have come to the conclusion that normal capacity is the best method for your business. First I will define theoretical, practical and normal capacity and then I will explain to you which allocation method must be used for financial statement purposes under GAAP. Theoretical Capacity
The word capacity relates to the upper limits or constraints of a production facility. Theoretical Capacity is defined as the level the production facility would be running if it was in full capacity. This means that the facility would be running 24 hours a day seven days a week. This type of capacity level does not allow for any production downtime. An example of down time would be for plant maintenance, interruptions in the production process, assembly-line problems, or other production factors. (Horngren, Datar, Foster, Rajan, Ittner, 313). Theoretical capacity represents the best capacity of an operation. In general, theoretical capacities are unobtainable because no production facility can operate without some kind of unavoidable interruptions. Practical Capacity
Practical capacity is the theoretical capacity that also takes takes into consideration unavoidable operational downtimes. Such downtimes again could include schedule maintenance times, shut down for holidays, and so on (Horngren, Datar, Foster, Rajan, Ittner, 313). Practical capacity measures capacity levels in terms of what a production facility can supply. For example, practical annual capacity could be: forty units per shift, times two shifts per day, times three hundred days. Normal Capacity
Normal capacity measures capacity levels by the demand of the product from the customer. The demand...