Lucky Lager recently purchased a brewing plant from a bankrupt company. It was constructed only two years ago. The plant has budgeted fixed manufacturing overhead of $50 million per year ($4,167 million each month) in 2012. Paul Vautin, the controller of the brewery, must decide on the denominator-level concept to use in its absorption costing system for 2012. The options available to him are:

a. Theoretical capacity: 600 barrels an hour for 24 hours a day for 365 days = 5,256,000 barrels

b. Practical capacity: 500 barrels an hour for 20 hours a day for 350 days = 3,500,000 barrels

c. Normal capacity utilization for 2012: 400 barrels an hour for 20 hours a day for 350 days = 2,800,000 barrels

d. Master-budget capacity utilization for 2012 (separate rates computed for each half-year):

♦ January to June 2012 budget—320 barrels an hour for 20 hours a day for 175 days =

1.120,000 barrels

♦ July to December 2012 budget—480 barrels an hour for 20 hours a day for 175 days =

1.680,000 barrels

Variable standard manufacturing costs per barrel are $51.40 (variable direct materials, $38.40; variable manufacturing labour, $6.00; and variable manufacturing overhead, $7.00). The brewery “sells” its output to the sales division of Lucky Lager at a budgeted price of $82.00 per barrel.

In 2012, the brewery of Lucky Lager showed these results:

Unit data in barrels:

Beginning inventory, January 1, 2012 ......... 0

Production .................... 2,60,000

Ending inventory, December 31, 2012 ........ 200,000

The brewery had actual costs of Cost data:

Variable manufacturing............$144,456,000

Fixed manufacturing overhead........ $ 48,758,400

The sales division of Lucky Lager purchased 2,400,000 barrels in 2012 at the $82 per barrel rate. All manufacturing variances are written off to cost of goods sold in the period in which they are incurred.

REQUIRED

1. Compute the budgeted fixed manufacturing overhead rate using each of the four denominator-level concepts for (a) beer produced in March 2012 and (b) beer produced in September 2012. Explain why any differences arise.

2. Explain why the theoretical capacity and practical capacity concepts are different.

3. Which denominator-level concept would the plant manager of the brewery prefer when senior management of Lucky Lager is judging plant manager performance during 2012? Explain.

4. Compute the operating income of the brewery using the following: (a) theoretical capacity, (b) practical capacity, and (c) normal capacity utilization denominator-level capacity concepts. Explain any differences between (a), (b), and (c).

5. What denominator-level concept would Lucky Lager prefer for income tax reporting? Explain.

6. Explain the ways in which the Canada Revenue Agency might restrict the flexibility of a company like Lucky Lager, which uses absorption costing to reduce its reported taxable income.