Expected Actual Capacity As The Level Of Capacity Utilization

Expected Actual capacity utilization : The short-range or short-term planning and control approach, or expected actual capacity utilization concept, advocates a rate in which overhead and production are based on the expected actual output for the next production period. The method usually results in the use of a different predetermined rate for each period depending on increases or decreases in estimated factory overhead and production figures.

The use of a predetermined rate based on expected actual production is often due to the difficulty of judging current performance on a long-range or normal capacity level. The fact that at times the factory overhead charged to production approaches the expenses actually incurred often makes the use of the expected actual factory overhead rate seem logical and acceptable even though the expenses are not representative of normal operations. Capacity utilization depicts how well we managed our resources.

Following example of product costing uses overhead rates based on both activity levels. Assume the normal capacity utilization for a company is 150,000 direct labor hours. For the past year the actual capacity utilization attained was 1 16,000 hours. The management believes that 120,000 hours will be worked during the coming year. Fixed expenses for either capacity level are $120,000, and variable expenses are $.50 per direct labor hour.

 The predetermined factory overhead rate based on normal capacity utilization is 30 per direct labor hour, and the overhead rate based on expected actual capacity utilization is $1.50 per direct labor hour.  Since fixed expenses are the same for both levels, it must be assumed that management anticipated a volume of business requiring such an amount of fixed costs. It is executive management’s task to reach that level of operation which will assure a profitable and competitive position.