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    Finance changed the method of allocating fixed factory overhead

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    Company X uses a standard cost system and budgeted 50K machine hours to manufacture 100K units in 2007. Budgeted total fixed factory overhead was 9 million after charging the production volume variance to cost of good sold of the period.

    Finance believes the denominator activity level of 50K machine hours is too low. The max capacity of the firm is between 5 and 6 million machine hours. Finance considers a denominator level of half the low end capacity to be reasonable. Additionally, they believe the unfavourable production volume variance should be capitalized, rather than written off against current period's earnings, because the demand for the firm's products has been increasing rapidly.

    A conservative projection of the firm's sales places the total sales at a level that will require at least 5 million machine hours in less than 5 years. Finance was able to show a substantial improvement in operating income after revising the cost data. This revised operating result was to brief financial analysts.

    What is the net effect on operating income of the two changes made regarding fixed factory overhead?

    Is it ethical for Finance to make the changes?

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    Solution Preview


    Given a denominator level of half the low end capacity to be reasonable, the standard fixed overhead rate is $3.60 per machine hours ($9,000,000/2,500,000 machine hours). Thus, the budgeted fixed overhead to manufacture 100,000 units at ...

    Solution Summary

    The solution examines how finance changed the method of allocating fixed factory overhead. The demand for the firm's products increased rapidly is determined.