Capacity Costs

In computing a predetermined overhead rate regard must be had to determination of level of activity. Such a predetermined rate will vary according to different capacities, e.g., maximum, practical, normal. Thus if the estimated expenditure be Rs. 1,000 and maximum and practical capacities be 500 and 400 labour hours respectively, the predetermined rates are: .

• Rate based on maximum capacity = Rs.1000/500 = Rs. 2.00 per labour-hour.
• Rate based on practical capacity = Rs.1000/400 = Rs. 2.50 per labour-hour.

(1) Maximum capacity:

Maximum capacity is the maximum productive capacity of a plant or department. Some losses are bound to occur in actual practice, but as such losses are not considered in determining maximum capacity, it is also called ideal or theoretical capacity. It is equal to the rated capacity specified by the manufacturers that may be achieved provided no operating time is lost. This maximum capacity is thus rarely achieved and is seldom used.

(2) Practical capacity:

Practical or operating capacity is the maximum capacity less inevitable interruption, such as, time lost for breakdown, repairs, set up, normal delays, sundays and holidays, inventory taking etc. Practical capacity does not consider the external factors, such as, lack of orders from customers, unbalanced capacity, etc. Although the nature and extent of inevitable interruptions would depend on the type of plant, nature of product and other circumstances, practical capacity may be taken as 80 to 90% of the maximum capacity. Predetermined overhead rate is sometimes based on practical capacity.

(3) Capacity based on sales expectancy:

This is the capacity based on expected sales and is determined after a careful study of the market conditions. In most cases this capacity is less than the operating capacity because of lack of orders from customers. Predetermined overhead rate is sometimes computed based on sales expectancy.

(4) Actual capacity:

This is the volume of production achieved in a particular period. Actual capacity depends on various factors prevailing is the organisation and may be below or above the practical capacity and capacity based on sales expectancy.

(5) Normal capacity:

Normal capacity is generally the long term average capacity based on sales expectancy. But opinions differ as to what should be regarded as the normal capacity and accordingly normal capacity may be the practical or operating capacity and in rare cases the maximum capacity.  In determining the normal capacity, the rated capacity of a plant and the sales potential are not so important as its physical capacity and long-term average sales expectancy. While determining normal capacity, machinery and equipment purchased should be excluded.