Heidi Brooke is a consultant to Colorado Paper Products Company. She is helping one of the company’s divisions to install a standard cost system for 20X0. For product-costing purposes, the system must apply fixed factory costs to products manufactured. She has decided that the fixed-overhead rate should be based on machine hours, but she is uncertain about the appropriate volume to use in the denominator. 

Colorado Paper has grown rapidly; the division has added production capacity approximately every 4 years. The last addition was completed in early 20X0, and the total capacity is now 3,000,000 machine hours per year. Brooke predicts the following operating levels (in machine hours) through 20X4:

Year …………… Capacity Used

20X0 ………. 2,200,000 hours

20X1 ………. 2,500,000 hours

20X2 ………. 2,850,000 hours

20X3 ……..... 3,000,000 hours

20X4 ………. 3,100,000 hours

The current plan is to add another 500,000 machine hours of capacity in 20X4.

Brooke has identified three alternatives for the application base:

a. Predicted volume for the year in question

b. Average volume over the 4 years of the current production setup

c. Practical (or full) capacity

1. Suppose annual fixed factory overhead is expected to be $36,000,000 through 20X3. For simplicity, assume no inflation. Calculate the fixed-overhead rates (to the nearest cent) for 20X1, 20X2, and 20X3, using each of the three alternative application bases.

2. Provide a brief description of the effect of using each method of computing the application base.

3. Which method do you prefer? Why?