Motivational considerations in denominator-level capacity selection (continuation of 9-37)

Required

1. If the plant manager of the Jacksonville Brewery gets a bonus based on operating income, which denominator-level capacity concept would he prefer to use? Explain.

2. What denominator-level capacity concept would Castle Lager prefer to use for U.S. income-tax reporting? Explain.

3. How might the IRS limit the flexibility of an absorption-costing company like Castle Lager attempting to minimize its taxable income?

Continuation of 9-37

Alternative denominator-level capacity concepts, effect on operating income. Castle Lager has just purchased the Jacksonville Brewery. The brewery is two years old and uses absorption costing. It will “sell” its product to Castle Lager at $47 per barrel. Peter Bryant, Castle Lager’s controller, obtains the following information about Jacksonville Brewery’s capacity and budgeted fixed manufacturing costs for 2017:

Required

1. Compute the budgeted fixed manufacturing overhead rate per barrel for each of the denominator-level capacity concepts. Explain why they are different.

2. In 2017, the Jacksonville Brewery reported these production results:

There are no variable cost variances. Fixed manufacturing overhead cost variances are written off to cost of goods sold in the period in which they occur. Compute the Jacksonville Brewery’s operating income when the denominator-level capacity is (a) theoretical capacity, (b) practical capacity, and (c) normal capacity utilization.