Capacity Utilization:
Using the CAM-I
Capacity Model in a
Multi-Hierarchical
Manufacturing
Environment
B Y PA RV E Z R . S O PA R I WA L A , P H . D .
BETTER
DECISION MAKING IS FACILITATED BY
MERGING TWO TRADITIONAL CAPACITY MEASUREMENT SYSTEMS INTO ONE THAT
PRODUCES MORE ACCURATE COSTS.
“Effectively managing the cost of capacity is a key to unlocking the value-creating potential of a company’s resources. The concept focuses on
identifying improvement opportunities. Consisting of a set of action-based tools for making products and providing better, faster, and
cheaper services to customers, the development of capacity management systems is synonymous with best management practice in management accounting. Reaching this goal is a journey, not a destination; there is no one, universally correct model, measure, or approach to
capacity management and measurement in complex, modern organizations.” 1
“Not since the severe recession of the early 1980s has capacity use in manufacturing stayed so low for so long, government data show. Production as a percentage of total capacity fell precipitously in the aftermath of the last recession, which ended in 2001, and 23 months into
the recovery, the upturn has still not come. On average, manufacturers are using less than 73% of their capacity.” 2
lization allows management to realign their product mix
to take advantage of their existing underutilized capacity. In the long term, recognition of the amount of structural idle capacity allows management to make a
strategic investment, prevent an unneeded acquisition
of additional resource capacity, or provide a justification
apacity underutilization is the norm in
practically every business environment.
That is why the role of capacity management has become more important in both
short-term and long-term periods. In the
short term, knowing the existing level of capacity uti-
C
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sation) and time-based resources (e.g., leased equipment). Third, the possibility that some fixed capacity
costs could be the cost of committed resources (e.g.,
machine operator’s salary) while others could be the
cost of flexible resources (e.g., machine operator’s
hourly wages) is recognized.
My proposed capacity measurement system provides
the following advantages. First, it allows for the determination of more accurate product costs for short- and
long-term decision making. Second, it permits the
determination of a composite capacity utilization rate
for time-based resources, such as plant and equipment,
for a plant or the entire organization, thereby providing
capacity utilization information necessary for operational, tactical, and strategic decision making at the
manufacturing function. Finally, it allows for the determination of the cost of idle, nonproductive, and productive capacities for people-based resources. This
development is significant because capacity measurement research, by and large, has dealt only with timebased resources like plant and equipment, and this
recognition of people-based resources enables the
application of these capacity management principles to
manufacturing and service companies alike.
for getting rid of idle capacity.
The cost/management accounting literature, led by
Robin Cooper and Robert Kaplan,3 has revived the
capacity management issue first raised in the 1920s,
when it was believed that the cost of idle capacity should
not be included in the cost of a product or service but
had to be written off to the income statement.4 As a
result, two streams of literature have arisen to assist in
the determination of the costs of used and idle capacities.
One stream, spearheaded by Michael Ostrenga, considers a multi-hierarchical manufacturing environment
and proposes that the cost of used and idle capacities
should be determined at the machine, shift, and plant
levels.5 As a result, it separates fixed capacity costs into
machine-, shift-, and plant-related costs and then divides
these costs by the practical capacities of machines, shifts,
and plant, respectively, in order to determine the unit
fixed cost at each hierarchical level.
The other stream, spearheaded by the Consortium for
Advanced Manufacturing-International (CAM-I), is the
CAM-I Capacity Model, which essentially examines how
acquired capacity is used or why it is allowed to remain
idle. Instead of merely separating acquired capacity into
used and idle capacity, it goes further and separates used
capacity into productive and nonproductive capacity and
separates idle capacity into idle off-limits, idle marketable, and idle nonmarketable capacities. As a result,
the CAM-I Capacity Model provides a deeper understanding as to how acquired capacity was used or why a
part of acquired capacity was kept idle.
I merge both streams of literature to create a capacity
measurement system for a manufacturing environment
where fixed capacity costs are separated into machine-,
shift-, and plant-related costs and each level is further
examined to determine how much of its costs represent
the cost of productive, idle, or nonproductive capacities.
My capacity measurement system determines the cost
of productive, idle, or nonproductive capacities at the
machine, shift, and plant levels.
In addition, to make my proposed capacity measurement system richer and more realistic, I add the following complexities. First, two dissimilar machines are
used, one of them for one shift and the other for two
shifts. Second, fixed capacity costs are divided into
people-based resources (e.g., machine operator compen-
M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY
W H AT I S
THE
S TAT E
OF THE
CURRENT
L I T E R AT U R E ?
The Ostrenga model was the first to provide guidance
on how to isolate excess capacity costs in order to
exclude them from product costs. He distinguished
between fixed costs that are capacity costs and those
that can be categorized as other fixed costs. He argued
that fixed capacity costs, like property taxes and insurance on building and equipment, are truly fixed and do
not vary regardless of the number of shifts the manufacturing facility runs. As a result, the fixed capacity cost
rate was computed by dividing these fixed capacity
costs by the practical capacity of the entire system
based on an established product mix.6 Finally, he
argued that other fixed costs are semi-variable and that
the other fixed cost rate should be computed by dividing these costs by the master budgeted capacity.7
Marinus DeBruine and Parvez Sopariwala (hereafter,
DS) extended Ostrenga in two ways. First, they
replaced fixed capacity costs with fixed plant costs that
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capacity, represents the maximum possible production
and is further split into idle, nonproductive, and productive capacity.12 Idle capacity represents unused
capacity and is further split into idle off-limits, idle marketable, and idle nonmarketable capacity, which are
defined as follows:
Idle off-limits capacity is unavailable for use. Examples of this capacity include government regulations,
management policy, and contractual arrangements.13
Idle marketable capacity is where a market exists but
our capacity is idle. Reasons may include competitors’
market share, the existence of product substitutes, distribution constraints, or price/cost constraints.14
Idle nonmarketable capacity is where a market does
not exist or management made a strategic decision to no
longer participate in the market. Capacity classified as
nonmarketable is a target for abandonment.15
Hence, idle off-limits capacity is capacity deemed
unavailable for use because management decides to
keep it idle (e.g., not working Sundays in deference to
religious conventions), governmental regulations
require that the plant be idle (e.g., not working on certain national holidays), or contractual agreements
require that the plant be idle (e.g., holidays determined
by union contracts). Understandably, such capacity
becomes available if management changes its policy or
government regulations or union contracts change.
Idle marketable capacity represents capacity that is idle
even though a market for the product exists; i.e., it represents management’s inability to exploit the existing market. For example, as Klammer points out, such capacity
could be caused by a faulty or inefficient distribution system and highlighting it would allow management to take
corrective action.16 Finally, idle nonmarketable capacity
represents capacity where a market does not exist (e.g.,
the manufacture of 78 r.p.m. records or 8-track tapes), or
management makes a decision not to participate in a
certain market (e.g., General Motors’ decision to discontinue the Oldsmobile product line).
Nonproductive capacity, as defined below, represents
capacity that is used, albeit unproductively. In other
words, it represents used capacity that does not add value
to the product or service.
Nonproductive capacity is capacity that is neither in a
productive state nor in one of the defined idle states….
“are incurred merely by having a manufacturing facility.”8 As a result, they argued that the fixed plant rate
should be determined by dividing the fixed plant costs
by the practical capacity of all existing cells and
processes and not merely the practical capacity of cells
and processes used to support the current product mix.
Second, they replaced other fixed costs with fixed shift
costs, which “are all fixed costs that are not categorized
as fixed plant costs.”9 Hence, the fixed shift rate was
determined by dividing the fixed shift costs by the
practical capacity for each shift instead of master budgeted capacity.
Sopariwala extended Ostrenga and DS in two ways.10
First, he pointed out that determining the fixed shift
cost rate based on the shifts activated could cause the
fixed shift cost rate to fluctuate because the cost to activate each shift could be different. Besides, because the
number of shifts activated depended on expected production, such predetermined fixed shift cost rates
would inevitably be influenced by production. To alleviate this concern, he suggested that the budgeted
fixed shift cost rate be determined by dividing the total
potential shift cost for all three shifts by the practical
capacity of the three shifts.
Second, Sopariwala recognized that fixed shift costs
included costs that were not necessarily influenced by
the number of shifts activated but were incurred when
a work cell or machine was activated (e.g., machine
operator’s wages). As a result, he added another
category, machine-related cost, to the already existing
shift-related and plant-related costs to enable the determination of more accurate costs.
In the other literature stream, the CAM-I Capacity
Model was developed as a tool for communicating to
management the state of capacity utilization of its facilities. In a break from Ostrenga, the CAM-I Capacity
Model used rated capacity instead of practical capacity
as its benchmark for representing maximum capacity
utilization.
According to Thomas Klammer, “Rated capacity uses
a time measure. It assumes 24 hours a day, every day,
with each tool producing at benchmark rates. The cost
of this capacity is 100% of the total cost assignable to
the process.”11
Hence, rated capacity, which is similar to theoretical
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substituting theoretical capacity for practical capacity,
one could argue that the yearly theoretical capacity of
leased equipment should be 8,760 hours [24 hours a day
x 365 days a year]. Similarly, a shift supervisor’s yearly
theoretical capacity, representing the number of hours
for which she is paid, should be 2,080 hours [8 hours a
day x 5 days a week x 52 weeks a year], assuming the
365th day was a Sunday.
Therefore, if these two costs are not separately divided by their appropriate theoretical capacities, spreading
the shift supervisor’s salary over the theoretical capacity
of the leased equipment would result in undercharging
each unit produced. In my manufacturing environment,
the salary of the shift supervisor will be allocated using
the theoretical or rated capacity of the supervisor, i.e.,
2,080 hours, while the cost of the leased equipment is
allocated using the theoretical or rated capacity of the
leased equipment, i.e., 8,760 hours.
Cost of flexible vs. committed resources. My manufacturing environment does not limit itself to considering
machine operator remuneration as either the cost of a
committed resource (i.e., a worker is paid a fixed weekly
or monthly salary irrespective of the number of hours she
works, thereby creating a potential for idle or unused
capacity) or the cost of a flexible resource (i.e., machine
operators are only paid for the hours they work).19 My
manufacturing environment allows for the possibility of
both types of machine operator compensation.
Table 1 provides the facts of a hypothetical company,
Jonah Corporation, which manufactures 500 units of
Product X using two machines, Machine A and
Machine B, each of which can potentially be operated
for three shifts during the year. Machine A operators are
salaried employees, i.e., the cost of a committed
resource, while Machine B operators are hourly employees, i.e., the cost of a flexible resource. The raw material is first processed by Machine A, and the standard
quantity of machine hours needed to process one unit
of Product X using Machine A is three hours. After the
processing in Machine A is complete, the semi-complete
product is further processed in Machine B, and the
standard quantity of machine hours needed to complete
one unit of Product X using Machine B is four hours. In
addition, it is assumed that each machine operator operates one and only one machine per shift. As a result,
Nonproductive capacity includes setups, maintenance,
standby, scheduled downtime, unscheduled downtime,
rework, and scrap. Variability is a primary cause of
nonproductive capacity.17
Nonproductive capacity includes time lost on activities such as setups, maintenance, yield losses (the difference between the actual hours used to manufacture a
product and the standard hours that should have been
used to manufacture that product), and standby capacity that represents buffer capacity necessary to deal with
the expected variability of a manufacturing environment caused by late receipt of material supplies, customers’ insistence on quick deliveries, slowdowns due
to machine age, and so forth.
Finally, productive capacity, as defined below, represents the time (the standard hours) needed to produce
and deliver the product or service to the customer:
Productive capacity provides value to the customer….
We use productive capacity to change a product or provide a service. Examples of productive use of capacity
include these: cutting, molding, welding, painting, furnace time, and assembly. Productive capacity results in
the delivery of good products or services.18
T H E P R O P O S E D C A PA C I T Y M E A S U R E M E N T
SYS T E M
In order to provide a richer and more realistic framework
for determining the cost of unused or idle capacity and
the capacity utilization ratio, I merged the Ostrenga and
CAM-I literature to create a manufacturing environment
with the following additional complexities:
Two different machines are used for a different number
of shifts. Instead of assuming that all machines in a fac-
tory are similar and used for the same number of shifts,
my manufacturing environment will consider two different machines, one of which will effectively be used
for one shift and the other one for two shifts.
Cost of time vs. people-based resources. DS and
Sopariwala include both people-based resources (e.g.,
shift supervisor’s salary) and time-based resources (e.g.,
equipment lease cost) in the fixed capacity costs and
divide them by one practical capacity level. As a result,
they ignore the different capacity levels that these
time- and people-based resources acquire. For example,
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Table 1: Jonah Corporation
The Facts
Panel A: Theoretical capacities and budgeted costs of resources acquired
Theoretical capacities:
Machine A
Machine B
Shifts
Plant
Machines A and B per shift
People-based resources (LHs)
2,080
Time-based resources (MHs)
2,920
2,920
Shifts
2,080
People-based resources (LHs)
Plant
People-based resources (LHs)
6,240
Time-based resources (MHs)
8,760
Budgeted costs of resources acquired:
Machines A and B
People-based resources:
$24,960
Machine operator–yearly salary per shift
Machine operator–wages per labor hour
$15.00
Time-based resources: yearly scheduled maintenance per machine/shift
$12,000
$15,000
Shifts
People-based resources: shift supervisor's yearly salary over three shifts
$195,000
Plant
People-based resources: plant manager's yearly salary
$180,000
Time-based resources: yearly property taxes
$300,000
Panel B: Operations for the year
Machine A
Production of Product X (units)
Standard LHs/MHs needed for 1 unit of Product X
Standard LHs/MHs for production of 500 units of Product X
Machine B
Shift 1
Shift 1
Shift 2
500
400
100
3
4
4
1,500
1,600
400
Yield losses (LHs/MHs)
200
90
50
Setups, etc. (LHs/MHs)
80
112
55
Repairs, etc. (LHs/MHs)
70
120
30
Defectives, waste, etc. (LHs/MHs)
42
70
85
1,892
1,992
620
Actual LHs/MHs used for production of 500 units of Product X
Panel C: Other details
1 The agreement between management and the labor union required the plant to remain closed on Sundays. The 365th day of the year is assumed to be a Sunday.
2 The plant did not operate on Saturdays due to inadequate demand.
3 The agreement between management and the labor union entitled salaried employees to 11 holidays.
4 Management decided not to operate the third shift.
5 All excess capacity, i.e., capacity not directly recognized as idle off-limits, idle-marketable, nonproductive, or productive, is assumed to be additional idle marketable.
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2 reveals that $6,164 is the cost of productive capacity
for the first shift. In addition, resulting from the 1:1
relationship between machine and machine operator,
the hours lost by Machine A due to yield losses, etc.,
are the same as the hours lost by its machine operators.
Hence, Panel C of Table 2 determines that $1,611 is
the cost of nonproductive capacity for the first shift.
Panel D of Table 2 determines the cost of idle capacities. First, the idle off-limits cost relating to the 11 holidays is determined in a manner similar to that for the
people-based costs, i.e., $362 [11 holidays x 8 hours per
shift x $4.11 per machine hour] for each of the three
shifts. As management and the labor union agreed to
the plant being shut on Sundays, $1,742 [53 Sundays x
8 hours per shift x $4.11 per machine hour] represents
idleness of 424 hours and is an additional cost of idle
off-limits capacity for all shifts. Management also decided that the plant would remain shut on Saturdays due
to inadequate demand for Product X. As a result, $1,710
[52 Saturdays x 8 hours per shift x $4.11 per machine
hour] represents idleness of 416 hours and is a cost of
idle marketable capacity for all shifts. In addition,
because management decided not to operate the third
shift, $8,186 [1,992 machine hours x $4.11 per machine
hour] represents the cost of idle off-limits capacity for
the third shift. For a similar reason, $8,186 represents
additional idle marketable capacity because Machine A
was not used in the second shift.
People-based Machine B-related costs. As 400 units of
Product X are manufactured in the first shift and 100
units of Product X are manufactured in the second
shift, Machine B is activated for two shifts. Therefore, a
machine operator is needed to operate Machine B in
each of the first two shifts and is paid $15 per labor
hour. Panel B of Table 3 reveals that $24,000 and $6,000
are charged to the cost of productive capacity for manufacturing 400 and 100 units in the first and second
shifts, respectively. Panel C of Table 3 reveals that
$5,880 and $3,300 of machine operator remuneration
are charged to the cost of nonproductive capacity in
shifts 1 and 2, respectively. There is no cost of idle
capacity because the machine operator is an hourly
employee, that is, the cost of a flexible resource.
Time-based Machine B-related costs. Panel A of Table 3
determines the time-based overhead rate of $5.14 per
there is a 1:1 relationship between each machine and its
operator, i.e., the use of one machine hour for a certain
task automatically involves the use of a labor hour.
Using the facts outlined in Table 1, Tables 2–6 reveal
how the costs of processing 500 units of Product X are
first divided into machine-, shift-, and plant-related
costs and subsequently allocated to the various capacity
types defined by CAM-I.
M A C H I N E - R E L AT E D C O S T S
Machine-related costs are either people-based costs or
time-based costs. The main difference is that the rated
capacity for people-based, committed costs for one shift
is 2,080 hours while the rated capacity for time-based
committed costs over one shift is 2,920 hours. In this
example, people-based costs are represented by
machine-operator remuneration while time-based costs
represent the yearly scheduled maintenance per machine
for each shift. Let’s look at how Machine A- and Brelated costs are allocated among idle off-limits, idle
marketable, nonproductive, and productive capacities.
People-based Machine A-related costs. As 1,892 labor
hours are used to manufacture 500 units of Product X in
the first shift, only one machine operator is needed to
run Machine A. Panel A of Table 2 shows that the
people-based hourly labor rate averages to $12.00
[$24,960 yearly salary/2,080 labor hours], and Panel B of
Table 2 reveals that $18,000 [1,500 standard hours x
$12.00 per labor hour] is the cost of productive capacity
for manufacturing 500 units. Panel C of Table 2 reveals
that $4,704, the cost of nonproductive capacity, is allocated among yield losses, setups, repairs, defectives,
waste, and so forth.20
Panel D of Table 2 determines the cost of idle capacity. Management and the union agreed to 11 holidays
during the year, so the cost of $1,056 [11 holidays x 8
hours per shift x $12.00 per labor hour] represents the
cost of idle off-limits capacity for the salaried machine
operator who works the first shift. The balance of 100
machine hours and its cost of $1,200 [100 labor hours x
$12.00 per labor hour] is attributable to additional idle
marketable capacity.
Time-based Machine A-related costs. Panel A of Table
2 determines the time-based overhead rate of $4.11 per
machine hour for each shift. Similarly, Panel B of Table
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Table 2: Determination of the cost of productive, nonproductive, and idle capacities
for Machine A costs using CAM-I*
TIME-BASED
PEOPLE-BASED
FIRST SHIFT
(LHs)
$
SECOND SHIFT
(LHs)
$
TOTAL
$
%
FIRST SHIFT
(MHs)
$
SECOND SHIFT
(MHs)
$
TOTAL COSTS
THIRD SHIFT
(MHs)
$
TOTAL
$
%
$
%
Panel A: The determination of applicable capacity-based labor and overhead rates
Budgeted committed resources (Note 1)
Theoretical capacity (LHs/MHs) (Note 1)
$24,960
$12,000
2,080
2,920
$12,000
2,920
$12,000
2,920
$12
Budgeted people-based rate per LH
Budgeted time-based overhead rate per MH
$4.11
$4.11
$4.11
Panel B: The cost of productive capacity
1,500 $18,000
Actual production (Note 2)
$18,000
72.12%
1,500
$6,164
$6,164
17.12% $24,164
39.64%
Panel C: The cost of nonproductive capacity
Yield loss (Note 2)
Setups (Note 2)
200
$2,400
$2,400
9.62%
200
$822
$822
2.28% $3,222
5.29%
80
$960
$960
3.85%
80
$329
$329
0.91% $1,289
2.11%
Repairs, etc. (Note 2)
70
$840
$840
3.37%
70
$288
$288
0.80% $1,128
1.85%
Defectives, waste, etc. (Note 2)
42
$504
$504
2.02%
42
$173
$173
0.48%
$677
1.11%
392
$4,704
$4,704
18.85%
392
$1,611
$1,611
4.47% $6,315
10.36%
424
$1,742
424
$1,742
$5,227
14.52% $5,227
8.58%
88
$362
88
$362
Total
Panel D: The cost of idle capacity
Idle off-limits capacity
Plant closed on Sundays (Note 3)
Plant closed for holidays (Note 4)
88
$1,056
$1,056
4.23%
Plant closed for third shift (Note 6)
Total
88
$1,056
$1,056
4.23%
100
$1,200
$1,200
4.81%
100
$1,200
$1,200
4.81%
2,080 $24,960
$24,960
100%
512
$2,104
512
$2,104
416
$1,710
416
$1,710
100
$411
516
$2,121
424
$1,742
88
$362
$1,085
3.01% $2,141
3.51%
1,992
$8,186
$8,186
22.74% $8,186
13.43%
2,504 $10,290 $14,499
40.27% $15,555
25.52%
$5,129
14.25% $5,129
8.41%
$411
1.14% $1,611
2.64%
Idle marketable capacity
Plant closed on Saturdays (Note 5)
Extra capacity–First shift (Note 7)
Extra capacity–Second shift (Note 8)
Total
1,992
$8,186
2,408
$9,896
416
$1,710
$8,186
22.74% $8,186
13.43%
$1,710 $13,726
38.13% $14,926
24.48%
2,920 $12,000 $36,000
100% $60,960
100%
416
Panel E: The cost of acquired capacity
Total costs
2,920 $12,000
2,920 $12,000
*Some totals have been rounded in the tables.
Notes
1 Extracted from Panel A of Table 1.
2 Hours extracted from Panel B of Table 1.
3 [53 Sundays x 8 hours/shift] This is idle off-limits capacity due to management’s agreement with labor not to work on Sundays.
4 [11 holidays x 8 hours/shift] This is idle off-limits capacity due to management’s agreement with labor not to work on certain holidays.
5 [52 Saturdays x 8 hours/shift] This is idle marketable capacity because the plant did not operate on Saturdays due to inadequate demand.
6 [Acquired capacity (2,920 hours) – idle off-limits capacity (424 + 88 hours) – idle marketable capacity (416 hours)] This is idle off-limits capacity because management decided not to operate the
third shift.
7 [Acquired capacity (2,080 hours) – productive capacity (1,500 hours) – nonproductive capacity (392 hours) – idle off-limits capacity (88 hours)] This excess capacity is considered to be
idle marketable.
8 [Acquired capacity (2,920 hours) – idle off-limits capacity (424 hours + 88 hours) – idle marketable capacity (416 hours)] This excess capacity is considered to be idle marketable.
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idle marketable, nonproductive, and productive capacities
is dependent on the allocations of Machine A and B costs
detailed earlier in Tables 2 and 3.
People-based first-shift-related costs. As the total cost for
three-shift shift supervisory salaries is $195,000 per year,
or an average of $65,000 yearly, Panel A of Table 4 shows
that the people-based overhead rate averages to $15.63
per labor hour. Production output equivalent to 3,100
standard labor hours (1,500 for Machine A and 1,600 for
Machine B) is processed during the first shift, so Panel B
of Table 4 reveals that $48,438 is charged to the cost of
productive capacity. In addition, Panel C of Table 4
determines $12,250 as the cost of nonproductive capacity.
Using Panel D of Tables 2 and 3, Panel D of Table 4
shows that $2,750 and $1,563 are the costs of idle
off-limits and idle marketable capacities, respectively.
People-based second-shift-related costs. The second
shift processes 400 standard hours of production on
Machine B, so Panel B of Table 4 reveals that $6,250 is
charged to the cost of productive capacity. Panel C of
Table 4 determines that $3,438 of the shift supervisor’s
salary is charged to the cost of nonproductive capacity.
Panel D of Table 4 determines the cost of $2,750 representing the 11 holidays in the same manner as above.
Next, because Machine B was idle for 1,372 hours in the
second shift, $21,438 is charged to idle marketable capacity. Finally, because Machine A was not used during the
second shift, 1,992 labor hours represent idle capacity,
and $31,125 is charged to idle marketable capacity.
A brief evaluation. Table 4 reveals that about 93% of
the people-based resources in the first shift were used
productively or nonproductively, while only about 15%
of the people-based resources were so used in the second shift. This outcome is understandable because the
first shift was used completely while only a small portion of the second shift was used.
machine hour for each shift. Panel B of Table 3 reveals
that $8,219 and $2,055 are the cost of productive capacity for manufacturing 400 and 100 units during the first
and second shifts, respectively. In addition, resulting
from the 1:1 relationship between the machines and
machine operators, the hours lost by Machine B due to
yield losses, etc., are the same as the hours lost by its
machine operators. Therefore, Panel C of Table 3
determines that $2,014 and $1,130 are the costs of nonproductive capacity for the first and second shifts,
respectively.
Panel D of Table 3 determines the cost allocated to
idle off-limits capacity (i.e., plant closed on Sundays
and holidays) and idle marketable capacity (i.e., plant
closed on Saturdays) in a manner similar to that for
Machine A in Panel D of Table 2. In addition, because
Machine B was not used to its full capacity in the
second shift, $7,048 [1,372 machine hours x $5.14 per
machine hour] represents the cost of additional idle
marketable capacity. Finally, because management
decided not to operate the third shift, $10,233 [1,992
machine hours x $5.14 a machine hour] represents the
cost of idle off-limits capacity for the third shift.21
A brief evaluation. Tables 2 and 3 reveal that most of
the people-based resources were used either productively or nonproductively. This is understandable
because Machine A’s operator accounted for all her time
during the first shift and both Machine B operators
were hourly workers. More than 70% of the time-based
resources, however, were idle. This can be attributed to
the fact that a large portion of the second shift and the
entire third shift were idle.
S H I F T- R E L AT E D C O S T S
People-based shift-related costs, represented here by a
shift supervisor’s yearly salary, are incurred because a shift
is activated.22 Her rated capacity per shift is 2,080 hours.
A shift is activated even if only one of the two machines
is activated because a shift supervisor is hired to supervise
both machines and, if one machine is idle, her salary
attributable to that machine is idle capacity. As two
machines can be activated each shift, the shift capacity for
each activated shift is 4,160 labor hours [2,080 labor hours
per shift x 2 machines]. The following discussion reveals
that the allocation of these costs among idle off-limits,
M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY
P L A N T- R E L AT E D C O S T S
Plant-related costs are usually a cost of committed
resources and can be either people-based costs, represented here by the plant manager’s salary of $180,000
per year, or time-based costs, represented here by yearly property taxes of $300,000. A plant would be considered activated even if one out of three shifts is activated
because the plant manager, even though she is not
24
WINTER 2006, VOL. 7, NO. 2
Table 3: Determination of the cost of productive, nonproductive, and idle capacities
for Machine B costs using CAM-I
TIME-BASED
PEOPLE-BASED
FIRST SHIFT
(LHs)
$
SECOND SHIFT
TOTAL
(LHs)
$
$
FIRST SHIFT
%
(MHs)
$
SECOND SHIFT
(MHs)
$
TOTAL COSTS
THIRD SHIFT
(MHs)
$
TOTAL
$
%
$
%
Panel A: The determination of applicable capacity-based labor and overhead rates
Budgeted committed resources (Note 1)
$15,000
Theoretical capacity (LHs/MHs) (Note 1)
2,920
$15,000
2,920
$5.14
Budgeted time-based overhead rate per MH
Budgeted people-based rate per LH (Note 1)
$15
$15,000
2,920
$5.14
$5.14
$15
Panel B: The cost of productive capacity
1,600 $24,000
Actual production (Note 2)
400
$6,000
$30,000
76.57%
1,600
$8,219
400
$2,055
$10,274
22.83% $40,274
47.84%
Panel C: The cost of nonproductive capacity
Yield loss (Note 2)
90
$1,350
50
$750
$2,100
5.36%
90
$462
50
$257
$719
1.60% $2,819
3.35%
Setups (Note 2)
112
$1,680
55
$825
$2,505
6.39%
112
$575
55
$283
$858
1.91% $3,363
3.99%
Repairs, etc. (Note 2)
120
$1,800
30
$450
$2,250
5.74%
120
$616
30
$154
$771
1.71% $3,021
3.59%
70
$1,050
85
$1,275
$2,235
5.93%
70
$360
85
$437
$796
1.77% $3,121
3.71%
392
$5,880
220
$3,300
$9,180
23.43%
392
$2,014
220
$1,130
$3,144
6.99% $12,324
14.64%
Plant closed on Sundays (Note 3)
424
$2,178
424
$2,178
14.52% $6,534
7.76%
Plant closed for holidays (Note 4)
88
$452
88
$452
Defectives, waste, etc. (Note 2)
Total
Panel D: The cost of idle capacity
Idle off-limits capacity
Plant closed for third shift (Note 6)
Total
512
$2,630
416
$2,137
512
$2,630
424
$2,178
$6,534
88
$452
$1,356
3.01% $1,356
1.61%
1,992 $10,233 $10,233
22.74% $10,233
12.16%
2,504 $12,863 $18,123
40.27% $18,123
21.53%
Idle marketable capacity
Plant closed on Saturdays (Note 5)
Extra capacity–Second shift (Note 7)
Total
416
$2,137
416
$2,137
1,372
$7,048
1,788
$9,185
416
$6,411
14.25% $6,411
7.62%
$7,048
15.66% $7,048
8.37%
$2,137 $13,459
29.91% $13,459
15.99%
2,920 $15,000 $45,000
100% $84,180
100%
416
$2,137
Panel E: The cost of acquired capacity
1,992 $29,880
Total costs
620
$9,300
$39,180
100%
2,920 $15,000
2,920 $15,000
Notes
1 Extracted from Panel A of Table 1.
2 Hours extracted from Panel B of Table 1.
3 [53 Sundays X 8 hours/shift] This is idle off-limits capacity due to management’s agreement with labor not to work on Sundays.
4 [11 holidays X 8 hours/shift] This is idle off-limits capacity due to management’s agreement with labor not to work on certain holidays. There is no corresponding holiday time for the people-based
resources because the machine operators are hourly employees.
5 [52 Saturdays X 8 hours/shift] This is idle marketable capacity since the plant did not operate on Saturdays due to inadequate demand.
6 [Acquired capacity (2,920 hours) – idle off-limits capacity (424 hours + 88 hours) – idle marketable capacity (416 hours)] This is idle off-limits capacity because management decided not to operate
the third shift.
7 [Acquired capacity (2,920 hours) – productive capacity (400 hours) – nonproductive capacity (220 hours) – idle off-limits capacity (424 hours + 88 hours) – idle marketable capacity (416 hours)] This
excess capacity is considered to be idle marketable.
M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY
25
WINTER 2006, VOL. 7, NO. 2
costs of productive, nonproductive, and idle capacities
for all shifts.
A brief evaluation. Table 5 shows that about 36% of
the people-based resources and about 26% of the timebased resources were used either productively or nonproductively. The low percentage usage for both
resources is directly attributable to the fact that a large
percentage of these resources were idled during the
second shift and that the third shift was completely
idled.
physically present for all three shifts, is responsible for
the operations in these three shifts, and, if a shift is idle,
her salary relating to that shift is idle capacity. The following discussion reveals that the allocation of plantrelated people- and time-based costs among idle
off-limits capacity, idle marketable capacity, nonproductive capacity, and productive capacity is dependent
largely on the allocations of Machine A, Machine B, and
shift-related costs detailed earlier in Tables 2–4.
People-based plant-related costs. As there are two
machines, Machines A and B, and at least one of them
operates during the year, the plant capacity is 12,480
labor hours [2,080 hours per machine per shift x 3 shifts
x 2 machines]. In consideration that the plant’s three
shifts are not used evenly, however, the yearly cost of
$180,000 and the plant capacity of 12,480 labor hours
are divided by three so that each shift can be treated
separately.
As a result, Panel A of Table 5 reveals the average
hourly overhead rate of $14.42 per shift. The productive, nonproductive, and idle labor hours for the first
two shifts are derived directly from Panels B through D
of Tables 2 through 4. Based on the hourly overhead
rate of $14.42, Panels B through D of Table 5 show
costs of productive, nonproductive, and idle capacities
for the first two shifts. The third shift is idle as a result
of management’s directive, so $60,000 of the plant manager’s salary is charged to idle off-limits capacity as
follows: $2,538 representing holidays and $57,462 representing the remaining 3,984 [(2,080 hours – 88 holiday
hours) x 2 machines] labor hours idled due to the plant
being closed for the third shift.
Time-based plant-related costs. As the plant operated
at least one shift, the plant capacity is 17,520 machine
hours [2,920 hours per machine per shift x 3 shifts x
2 machines]. Again, the yearly cost of $300,000 and the
plant capacity of 17,520 machine hours are divided by
three so that each shift can be treated separately, considering that the three shifts are not used evenly.
Panel A of Table 5 reveals the average hourly overhead rate is $17.12 per shift. The productive, nonproductive, and idle labor hours for the first two shifts are
derived directly from the time-based Panels B through
D of Tables 2–4. As a result, using the hourly overhead
rate of $17.12, Panels B through D of Table 5 show the
M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY
S U M M A RY
Table 6 summarizes the results from Tables 2–5 and
breaks up the total cost of $755,140 into people-based
costs of $374,140 and time-based costs of $381,000. In
addition, Table 6 also provides capacity utilization ratios
for the people- and time-based costs, which reveal the
following:
People-based costs. Panels A through C of Table 6
reveal that about 53% of the acquired people-based
capacity was put to productive or nonproductive use.
Most of the idle capacity, however, is in the form of the
shift supervisor or plant manager salary, which can only
be reduced if the plant is utilized more.
Time-based costs. Panels A through C of Table 6 also
show that about 26% of the acquired time-based capacity was put to productive and nonproductive use; i.e., its
capacity utilization ratio is 26%. The idle capacity here
is caused primarily by the fact that the plant was essentially operating one shift and should be a reminder to
management that the plant has quite a bit of idle capacity left and could use an infusion of new business to
enhance its capacity utilization.
T H E C A PA C I T Y M E A S U R E M E N T S Y S T E M
A
AS
DECISION-MAKING AID
The proposed capacity measurement system also can
be used as a decision-making aid, for example, to determine if a recently received new order should be accepted. Assume that the plant receives a one-time special
order for 100 units of a Product X wannabe (hereafter
Product XX) for which the prospective customer is willing to pay $40,000. Product XX, whose details are provided in Table 7, requires material costing $6,000 and
extensive setups as evidenced by the 40 setup hours
26
WINTER 2006, VOL. 7, NO. 2
Table 4: Determination of the cost of productive, nonproductive, and
idle capacities for shift-related costs using CAM-I
PEOPLE-BASED
FIRST SHIFT
(LHs)
$
SECOND SHIFT
%
(LHs)
$
%
TOTAL
$
%
Panel A: The determination of applicable capacity-based labor and overhead rates
Budgeted committed resources (Note 1)
Theoretical capacity (LHs/MHs) (Note 2)
$65,000
$65,000
4,160
Budgeted people-based overhead rate per LH
4,160
$15.63
$15.63
Panel B: The cost of productive capacity
Actual production (Note 3)
3,100 $48,438
74.52%
400
$6,250
9.62% $54,688 42.07%
Panel C: The cost of nonproductive capacity
Yield loss (Note 3)
290
$4,531
6.97%
50
$781
1.20%
$5,313
4.09%
Setups (Note 3)
192
$3,000
4.62%
55
$859
1.32%
$3,859
2.97%
Repairs, etc. (Note 3)
190
$2,969
4.57%
30
$469
0.72%
$3,438
2.64%
Defectives, waste, etc. (Note 3)
112
$1,750
2.69%
85
$1,328
2.04%
$3,078
2.37%
784 $12,250
18.85%
220
$3,438
5.29% $15,688 12.07%
Total
Panel D: The cost of idle capacity
Idle off-limits capacity
Plant closed on Sundays (Note 4)
Plant closed for holidays (Note 5)
176
$2,750
4.23%
176
$2,750
4.23%
$5,500
4.23%
176
$2,750
4.23%
176
$2,750
4.23%
$5,500
4.23%
100
$1,563
2.40%
$1,563
1.20%
Plant closed for third shift (Note 6)
Total
Idle marketable capacity
Plant closed on Saturdays (Note 4)
Extra capacity–Machine A–first shift
(Note 7)
Extra capacity–Machine A–second shift
(Note 8)
1,992
$31,125
47.88% $31,125 23.94%
Extra capacity–Machine B–second shift
(Note 9)
1,372
$21,438
32.98% $21,438 16.49%
80.87% $54,125 41.63%
Total
100
$1,563
2.40%
3,364
$52,563
4,160 $65,000
100%
4,160
$65,000
Panel E: The cost of acquired capacity
Total costs
100% $130,000
100%
Notes
1 Extracted from Panel A of Table 1.
2 Theoretical capacity for one machine operator per shift is 2,080 hours (Panel A of Table 1). Because the shift supervisor supervises two machine operators, the
theoretical capacity per shift is 4,160 hours.
3 The sum of the people-based amounts relating to Machine A (Note 2 from Table 2) and Machine B (Note 2 from Table 3).
4 As supervisors are not paid to work on weekends, there is no idle capacity for Saturdays and Sundays.
5 As supervisors are entitled to 11 paid holidays, 88 hours for each shift (176 hours) represent idle off-limits capacity.
6 As management decided not to operate the third shift, there is no people-based idle off-limits capacity for this shift.
7 Please refer to Note 7 from Table 2.
8 [Acquired capacity (2,080 hours) – idle off-limits capacity (88 hours)] This excess capacity is considered to be idle marketable.
9 [Acquired capacity (2,080 hours) – productive capacity (400 hours) – nonproductive capacity (220 hours) – idle off-limits capacity (88 hours)] This excess
capacity is considered to be idle marketable.
M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY
27
WINTER 2006, VOL. 7, NO. 2
Table 5: Determination of the cost of productive, nonproductive, and idle capacities
for plant-related costs using CAM-I*
TIME-BASED
PEOPLE-BASED
FIRST SHIFT SECOND SHIFT THIRD SHIFT
(LHs)
$
(LHs)
$
(LHs)
TOTAL
$
$
TOTAL COSTS
FIRST SHIFT SECOND SHIFT THIRD SHIFT
%
(MHs)
$
(MHs)
$
(MHs)
$
TOTAL
$
%
$
%
Panel A: The determination of applicable capacity-based overhead rates
Budgeted committed resources (Note 1)
Theoretical capacity (LHs/MHs) (Note 2)
$60,000
4,160
Budgeted people-based overhead rate per LH
$60,000
4,160
$60,000
4,160
$14.42
$14.42
$100,000
5,840
$100,000
5,840
$100,000
5,840
$14.42
Budgeted time-based rate per MH
$17.12
$17.12
$17.12
Panel B: The cost of productive capacity
3,100 $44,712
Actual production (Note 2)
400
$5,769
$50,481
28.04% 3,100 $53,082
400
$6,849
$59,932 19.98% $110,412
23.00%
Panel C: The cost of nonproductive capacity
Yield loss (Note 3)
290
$4,183
50
$721
$4,904
2.72%
290
$4,966
50
$856
$5,822
1.94% $10,726
2.23%
Setups (Note 3)
192
$2,769
55
$793
$3,563
1.98%
192
$3,288
55
$942
$4,229
1.41%
1.62%
$7,792
Repairs, etc. (Note 3)
190
$2,740
30
$433
$3,173
1.76%
190
$3,253
30
$514
$3,767
1.26%
$6,940
1.45%
Defectives, waste, etc. (Note 3)
112
$1,615
85
$1,226
$2,841
1.58%
112
$1,918
85
$1,455
$3,373
1.12%
$6,215
1.29%
784 $11,308
220
$3,173
$14,481
8.04%
784 $13,425
220
$3,767
$17,192
5.73% $31,673
6.60%
848 $14,521
848 $14,521
848 $14,521 $43,562 14.52% $43,562
9.08%
176
176
Total
Panel D: The cost of idle capacity
Idle off-limits capacity
Plant closed on Sundays (Note 4)
Plant closed for holidays (Note 5)
176
$2,538
176
$2,538
$2,538
$7,615
4.23%
3.01% $16,656
3.47%
3,984 $57,462
$57,462
31.92%
3,984 $68,219 $68,219 22.74% $125,681
26.18%
$2,538 4,160 $60,000
$65,077
36.15% 1,024 $17,534 1,024 $17,534 5,008 $85,753 $120,822 40.27% $185,899
38.73%
Plant closed for third shift (Note 6)
Total
176
$2,538
176
176
$3,014
$3,014
176
$3,014
$9,041
Idle marketable capacity
Plant closed on Saturdays (Note 4)
832 $14,247
Extra capacity–Machine A–
first shift (Note 7)
100
$1,442
$1,442
0.80%
100
832 $14,247
$1,712
832 $14,247 $42,740 14.25% $42,740
$1,712
0.57%
8.90%
$3,155
0.66%
Extra capacity–Machine A–
second shift (Note 8)
1,992 $28,731
$28,731
15.96%
1,992 $34,110
$34,110
$62,840
13.09%
Extra capacity–Machine B–
second shift (Note 9)
1,372 $19,788
$19,788
10.99%
1,372 $23,493
$23,493
7.83% $43,282
9.02%
$1,442 3,364 $48,519
$49,962
27.76%
932 $15,959 4,196 $71,849
832 $14,247 $102,055 34.02% $152,016
31.67%
Total
100
Panel E: The cost of acquired capacity
Total costs
4,160 $60,000 4,160 $60,000 4,160 $60,000 $180,000
100% 5,840 $100,000 5,840 $100,000 5,840 $100,000 $300,000
100% $480,000
100%
* Some totals have been rounded in the tables.
Notes
1 Extracted from Panel A of Table 1.
2 For people-based resources, please refer to Note 1 from Table 4. Theoretical capacity for one machine per shift is 2,920 hours (Panel A of Table 1). For two machines, the theoretical capacity per
shift is 5,840 hours.
3 The sum of the people-based and time-based hours relating to Machine A (Note 2 from Table 2) and Machine B (Note 2 from Table 3).
4 The sum of the people-based and time-based hours relating to Machines A and B (Notes 3 and 5 from Tables 2 and 3).
5 The sum of the people-based and time-based hours relating to Machines A and B (Note 4 from Tables 2 and 3).
6 The sum of the people-based and time-based hours relating to Machines A and B (Note 6 from Tables 2 and 3).
7 The sum of the people-based and time-based hours relating to Machine A (Note 7 from Table 2).
8 The sum of the people-based and time-based hours relating to Machine A (Note 8 from Table 2 and Note 8 from Table 4).
9 The sum of the people-based and time-based hours relating to Machine B (Note 7 from Table 3 and Note 9 from Table 4).
M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY
28
WINTER 2006, VOL. 7, NO. 2
Table 6: Determination of the cost of productive, nonproductive, and idle capacities using CAM-I
A summary for the production of 500 units of Product X
Machine A-related
Table 2
Machine B-related Shift-related
Table 3
Table 4
Plant-related
Total costs
Capacity utilization ratios
Table 5
Timebased
(% of acquired capacity)
Peoplebased
Timebased
Peoplebased
Timebased
Peoplebased
Peoplebased
Peoplebased
Timebased
Peoplebased
Timebased
Total
$18,000
$6,164
$30,000
$10,274
$54,688
$50,481
40.94%
20.04%
30.40%
$2,400
$822
$2,100
$719
$5,313
$4,904
$5,822
$14,716
$7,363
$22,079
3.93%
1.93%
2.92%
Setups
$960
$329
$2,505
$858
$3,859
$3,563
$4,229
$10,887
Repairs, etc.
$840
$288
$2,250
$771
$3,438
$3,173
$3,767
$9,701
$5,416
$16,303
2.91%
1.42%
2.16%
$4,825
$14,526
2.59%
1.27%
Defectives, waste, etc.
$504
$173
$2,325
$796
$3,078
$2,841
$3,373
1.92%
$8,748
$4,342
$13,091
2.34%
1.14%
1.73%
$4,704
$1,611
$9,180
$3,144
$15,688
$14,481
$17,192
$44,052
$21,947
$65,999
11.77%
5.76%
8.74%
$13,418
$70,375
$64,962
$77,123 $197,221
$98,316 $295,537
52.71%
25.80%
39.14%
$5,500
$7,615
$43,562
$9,041
$14,171
$55,323
$55,323
0.00%
14.52%
7.33%
$11,482
$25,654
3.79%
3.01%
3.40%
$57,462
$68,219
$57,462
Total
Panel A: The cost of productive capacity
Actual production
$59,932 $153,168
$76,370 $229,538
Panel B: The cost of nonproductive capacity
Yield loss
Total
Panel C: The cost of used capacity (productive + nonproductive capacity)
Total costs
$22,704
$7,775
$39,180
Panel D: The cost of idle capacity
Idle off-limits capacity
Plant closed on Sundays
Plant closed for holidays
$5,227
$6,534
$1,056
$1,085
$1,356
$8,186
$10,233
$1,056
$14,499
$18,123
$5,129
$6,411
Plant closed for third shift
Total
$5,500
$65,077 $120,822
$86,638 $144,100
15.36%
22.74%
19.08%
$71,633 $153,444 $225,077
19.15%
40.27%
29.81%
$54,279
$54,279
0.00%
14.25%
7.19%
$2,123
Idle marketable capacity
Plant closed on Saturdays
Extra capacity–Machine A–first shift
$1,200
Extra capacity–Machine A–second shift
$411
$1,563
$1,442
$1,712
$4,205
$6,328
1.12%
0.56%
0.84%
$8,186
$31,125
$28,731
$34,110
$59,856
$42,296 $102,152
16.00%
11.10%
13.53%
$23,493
$41,226
$30,541
Extra capacity–Machine B–second shift
Total
Total idle capacity
$42,740
$7,048
$21,438
$19,788
$71,767
11.02%
8.02%
9.50%
$1,200
$13,726
$13,459
$54,125
$49,962 $102,055 $105,287 $129,240 $234,526
28.14%
33.92%
31.06%
$2,256
$28,225
$31,582
$59,625 $115,038 $222,877 $176,919 $282,684 $459,603
47.29%
74.20%
60.86%
$24,960
$36,000
$45,000 $130,000 $180,000 $300,000 $374,140 $381,000 $755,140
100%
100%
100%
Panel E: The cost of acquired capacity
Total costs
$39,180
M A N A G E M E N T A C C O U N T I N G Q U A R T E R LY
29
WINTER 2006, VOL. 7, NO. 2
needed for Machines A and B.
Table 7: Facts relating to the new order of 100 units of
Product XX
Incorporating the details from Table 7
into Tables 2–5 provides Table 8 (i.e., an
Machine A
Machine B
updated Table 6), which reveals that the
Production of Product XX (units)
100
100
total costs for 500 units of Product X and
3
4
Standard LHs/MHs needed for 1 unit of Product XX
100 units of Product XX would amount to
Standard LHs/MHs for production of 100 units of Product XX
300
400
$786,895 (amount in bold) whereas the
total costs for only 500 units of Product X
12
8
Yield losses (LHs/MHs)
amounted to $755,140 (Table 6). In other
Setups, etc. (LHs/MHs)
40
40
words, the additional 100 units of Product
Repairs, etc. (LHs/MHs)
5
5
XX require an additional nondirect,
57
53
Total expected nonproductive time (LHS/MHs)
material-related cost of $31,755.
Panel A of Table 9 explains this differExpected LHs/MHs needed to produce 100 units of Product XX
357
453
ence of $31,755 in the context of changes
in the cost of used (i.e., productive and
nonproductive), idle, and acquired capaciOn the other hand, assume that the customer wants
ties. Panels B through E provide more detailed explanations depending on whether the order for 100 units of
to arrange for a five-year commitment to supply 100
Product XX is a short-term or special order or a longerunits of Product XX each year. As this is a long-term
order, its feasibility is determined using the “accrual” or
term, three- to five-year contract.
the “resources used” approach: The order will be
We first assume that this order for 100 units of Prodacceptable if the yearly revenue of $40,000 over five
uct XX is a short-term, special order. As a result, its feayears exceeds the expected cost of resources needed to
sibility is determined using the “cash flow” or the
manufacture and ship 100 units of Product XX over the
“resources available or acquired” approach: The order
same five years. As a result, Panels B and C provide
will be acceptable if the net cash inflow of $40,000
details regarding the long-term cost of manufacturing
exceeds the net resources needed to be acquired to
100 units of Product XX.
manufacture and ship 100 units of Product XX. Panel E
For example, using the labor and overhead rates
of Table 9 provides the cash outflow implications of
determined in Panels A of Tables 2–5, Panel B reveals
accepting this order. These cash outflows include the
the cost of productive capacity (i.e., at standard cost)
cost of hiring a second-shift machine operator for
that would be used in the manufacture of 100 units of
Machine A at a yearly salary of $24,960, the additional
Product XX, and Panel C reveals the cost of nonprowages of $6,000 for Machine B’s operator (representing
ductive capacity that is expected to be incidental to
the 400-hour productive capacity needed to manufacthe manufacture of 100 units of Product XX. As a
ture 100 units of Product XX on Machine B in the secresult, all things being equal, the long-term order for
ond shift), and the additional wages of $795 for
100 units of Product XX would not be approved
Machine B’s operator (representing the 53-hour nonprobecause the expected yearly revenues of $40,000 fall
ductive capacity incidental to the manufacture of 100
23
short of the yearly cost of resources expected to be
are
no
XX
on
Machine
B).
There
units of Product
used of $59,082 [$6,000 direct material + $53,082 othcash flow implications for any other nondirect, materialer costs].
related resources needed to manufacture and ship 100
The divergence in results is caused by the difference
units of Product XX. As a result, all things being equal,
in the assumptions used for determining the feasibility
the short-term order for 100 units of Product XX would
of short- vs. long-term contracts. For a short-term conbe approved because the expected cash inflow of
tract, only those resources that need to be acquired to
$40,000 exceeds the expected total cash outflow of
complete the order are acquired. As a result, no addi$37,755 [$6,000 direct material + $31,755 other costs].
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Table 8: Determination of the costs of productive, nonproductive, and idle capacities using CAM-I
A summary for the production of 500 units of Product X and 100 units of Product XX
Machine A-related
Table 2
Machine B-related Shift-related
Table 3
Table 4
Plant-related
Total costs
Capacity utilization ratios
Table 5
Timebased
(% of acquired capacity)
Peoplebased
Timebased
Peoplebased
Timebased
Peoplebased
Peoplebased
Peoplebased
Timebased
$21,600
$7,397
$36,000
$12,329
$65,625
$60,577
Yield loss
$2,544
$871
$2,220
$760
$5,625
$5,192
$6,164
$15,581
$7,796
Setups
Peoplebased
Timebased
Total
45.28%
24.05%
35.00%
$23,377
3.84%
2.05%
2.97%
2.74%
Total
Panel A: The cost of productive capacity
Actual production
$71,918 $183,802
$91,644 $275,446
Panel B: The cost of nonproductive capacity
$1,440
$493
$3,105
$1,063
$5,109
$4,716
$5,599
$14,371
$7,156
$21,527
3.54%
1.88%
Repairs, etc.
$900
$308
$2,325
$796
$3,594
$3,317
$3,938
$10,136
$5,043
$15,179
2.50%
1.32%
1.93%
Defectives, waste, etc.
$504
$173
$2,325
$796
$3,078
$2,841
$3,373
$8,748
$4,342
$13,901
2.16%
1.14%
1.66%
$5,388
$1,845
$9,975
$3,416
$17,406
$16,067
$19,075
$48,837
$24,337
$73,173
12.03%
6.39%
9.30%
$15,745
$83,031
$76,644
$90,993 $232,638 $115,980 $348,619
57.31%
30.44%
44.30%
$55,323
$55,323
0.00%
14.52%
7.03%
$5,500
$7,615
$9,041
$15,227
$11,482
$26,710
3.75%
3.01%
3.39%
$57,462
$68,219
$57,462
Total
Panel C: The cost of used capacity (productive + nonproductive capacity)
Total costs
$26,988
$9,242
$45,975
Panel D: The cost of idle capacity
Idle off-limits capacity
Plant closed on Sundays
Plant closed for holidays
$5,227
$6,534
$2,112
$1,085
$1,356
$8,186
$10,233
$2,112
$14,499
$18,123
$5,129
$6,411
Plant closed for third shift
Total
$43,562
$5,500
$65,077 $120,822
$86,638 $144,100
14.16%
22.74%
18.31%
$72,689 $153,444 $226,133
17.91%
40.27%
28.74%
$54,279
$54,279
0.00%
14.25%
6.90%
$2,123
Idle marketable capacity
Plant closed on Saturdays
Extra capacity–Machine A–first shift
Extra capacity–Machine A–second shift
$1,200
$411
$1,563
$1,442
$1,712
$4,205
$6,328
1.04%
0.56%
0.80%
$19,620
$6,719
$25,547
$23,582
$27,997
$68,749
$34,716 $103,464
16.94%
9.11%
13.15%
$4,721
$14,359
$13,255
$15,736
$27,614
$20,457
$48,071
6.80%
5.37%
6.11%
$20,820
$12,259
$11,132
$41,469
$38,279
$88,185 $100,568 $111,576 $212,143
24.78%
29.28%
26.96%
$22,932
$26,758
$29,255
$46,969 $103,356 $209,007 $173,257 $265,020 $438,276
42.69%
69.56%
55.70%
$49,920
$36,000
$45,000 $130,000 $180,000 $300,000 $405,895 $381,000 $786,895
100%
100%
100%
Extra capacity–Machine B–second shift
Total
Total idle capacity
$42,740
Panel E: The cost of acquired capacity
Total costs
$45,975
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Table 9: Changes in the costs of used (i.e., productive and nonproductive),
idle, and acquired capacities resulting from the new order for 100 units of Product XX
Panel A: A reconciliation of the cost of capacities between Table 6 and Table 8
Cost of productive capacity (Panel A, Tables 6 & 8)
Cost of nonproductive capacity (Panel B, Tables 6 & 8)
Cost of used capacity (Panel C, Tables 6 & 8)
Cost of idle capacity (Panel D, Tables 6 & 8)
Cost of acquired capacity (Panel E, Tables 6 & 8)
500 units
[Table 6]
600 units
[Table 8]
Increase/
(Decrease)
$229,538
$275,446
$45,908
$65,999
$73,173
$7,174
$295,537
$348,619
$53,082
$459,603
$438,276
$(21,327)
$755,140
$786,895
$31,755
Panel B: An explanation for the increase in the cost of productive capacity
Machine A-related labor costs [300 hours x $12.00]
$3,600
Machine B-related labor costs [400 hours x $15.00]
$6,000
Machine A-related overhead costs [300 hours x $4.11]
$1,233
Machine B-related overhead costs [400 hours x $5.14]
$2,055
Shift-related overhead costs [(300 hours + 400 hours) x $15.63]
$10,938
Plant-related overhead costs [(300 hours + 400 hours) x $31.54]
$22,082
$9,600
$36,308
$45,908
Panel C: An explanation for the increase in the cost of nonproductive capacity
Machine A-related labor costs [57 hours x $12]
$684
Machine B-related labor costs [53 hours x $15]
$795
Machine A-related overhead costs [57 hours x $4.11]
$234
Machine B–related overhead costs [53 hours x $5.14]
$1,479
$272
Shift-related overhead costs [(57 hours + 53 hours) x $15.63]
$1,719
Plant-related overhead costs [(57 hours + 53 hours) x $31.54]
$3,470
$5,695
$7,174
Panel D: An explanation for the net [decrease) in the cost of idle capacity
$20,676
Machine A-related labor costs [(2,080 hours – 300 hours – 57 hours) x $12 per hour]
Machine A-related overhead costs [357 hours x $4.11]
$(1,467)
Machine B-related overhead costs [453 hours x $5.14]
$(2,327)
Shift-related overhead costs [(357 hours + 453 hours) x $15.63]
$(12,656)
Plant-related overhead costs [(357 hours + 453 hours) x $31.54]
$(25,553)
$(42,003)
$(21,327)
Panel E: An explanation for the increase in the cost of acquired capacity
Machine A operator's salary in 2nd shift
$24,960
$6,000
Machine B operator's productive wages [400 hours x $15 per hour]
Machine B operator's nonproductive wages [53 hours x $15 per hour]
$795
$31,755
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costs derived from the proposed capacity measurement
system to show how short- and long-term decision making could be facilitated. ■
tional resources for shifts and plant are acquired
because there is adequate idle capacity. On the other
hand, a long-term contract cannot automatically assume
that additional resources for shifts and plant will not be
needed in the future merely because they are not needed in the present. In other words, idle capacity cannot
be assumed in the future merely because idle capacity
exists at present. Therefore, the cost of a long-term
contract represents the cost of resources that are expected to be used to complete such a contract.
Finally, Panel D of Table 9 reveals the net changes in
the cost of idle capacity. For example, Panel E reveals
that a machine operator had to be hired to work
Machine A during the second shift. Because Machine A
was used for only 357 productive and nonproductive
hours during the second shift, the remaining 1,753
hours were idle, causing an increase in the cost of idle
capacity of $20,676. On the other hand, because the
production of 100 units of Product XX used the existing
idle capacity, it correspondingly reduced the cost of idle
capacity by $42,003, of which $36,308 was transferred to
the cost of productive capacity (Panel B), and $5,695
was transferred to the cost of nonproductive capacity
(Panel C). Hence, a plant with idle capacity will understandably find it easier to accept short-term orders as
compared to longer-term orders because the idle capacity has already been acquired.
Parvez R. Sopariwala, Ph.D., is a professor in the Accounting and Taxation Department, Grand Valley State University,
Grand Rapids, Mich. You can contact him at (616) 3317406 or [email protected].
E N D N OT E S
1 Institute of Management Accountants, Measuring the Cost of
Capacity, SMA No. 4Y, Montvale, N.J., 1996.
2 Louis Uchitelle, “Overcapacity Stalls New Jobs,” The New York
Times on the Web, October 19, 2003.
3 Robin Cooper and Robert Kaplan, “Activity-Based Systems:
Measuring the Costs of Resource Usage,” Accounting Horizons,
September 1992, pp. 1-13.
4 C. J. McNair and Richard Vangermeersch, Total Capacity Management, The IMA Foundation for Applied Research, Inc., St.
Lucie Press, Boca Raton, Fla., 1998, pp. 147-172.
5 Michael R. Ostrenga, “A Methodology for Identifying Your
Excess Capacity Costs,” Journal of Cost Management, Summer
1988, pp. 39-44.
6 “Practical capacity is the level of capacity that reduces theoretical capacity by unavoidable operating interruptions, such as
scheduled maintenance time, shutdowns for holidays, and so
on,” Charles T. Horngren, Srikant M. Datar, and George M.
Foster, Cost Accounting, 11th ed., Prentice-Hall, Upper Saddle
River, N. J., 2003, p. 300.
7 “Master-budget capacity utilization is expected level of capacity utilization for the current budget period, typically one year,”
Ibid., p. 301.
8 Marinus DeBruine and Parvez R. Sopariwala, “The Use of
Practical Capacity for Better Management Decisions,” Journal
of Cost Management, Spring 1994, p. 26.
9 Ibid., p. 26.
10 Parvez R. Sopariwala, “Using Practical Capacity for Determining Fixed Overhead Rates,” Journal of Cost Management,
September/October 1998, pp. 34-40.
11 Thomas Klammer, Capacity Measurement & Improvement, Irwin
Professional Publishing, Chicago, 1996, p. 16.
12 “Theoretical capacity is the optimum amount of work that a
process or plant can complete using a 24-hour, seven-day operation with zero waste. It allows for no adjustment for preventive maintenance, unplanned downtime, shutdowns, or any
other form of nonproductive capacity,” McNair and Vangermeersch, 1998, pp. 27-28.
13 Klammer, p. 31.
14 Ibid., p. 29.
15 Ibid., p. 30.
16 Ibid., p. 30.
17 Ibid., p. 32.
18 Ibid., p. 41.
19 “Committed resources are purchased before they are used,”
Don R. Hansen and M. Mowen, Management Accounting, 7th ed.,
Thomson/South-Western, Mason, Ohio, 2005, p. 708; “Flexible resources can be easily purchased in the amount needed
and at the time of use,” Hansen and Mowen, p. 708.
20 While workers other than machine operators often perform
N E W C A PA C I T Y M E A S U R E M E N T S Y S T E M
Recognizing manufacturing companies’ need for capacity utilization information, I merge two streams of
cost/managerial accounting literature, one that separates
fixed capacity costs in a multi-hierarchical manufacturing environment into machine-, shift-, and plant-related
costs and one that provides a greater understanding of
fixed capacity costs by separating them into the costs of
idle, nonproductive, and productive capacities.
I use both streams of literature to propose a capacity
measurement system for a manufacturing environment
that determines the cost of idle, nonproductive, and
productive capacities and capacity utilization ratios for
time-based resources, such as lease on manufacturing
equipment, property taxes, etc., and for people-based
resources, such as machine operator salaries, plant manager salaries, etc. In addition, I use the more accurate
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setups and repairs at many manufacturing companies, I have
chosen a simpler model wherein the machine operator performs these functions as well. Including separate personnel to
perform setups, etc., would complicate the model but not
affect its fundamentals.
21 One could determine idle off-limits capacity by first considering that the number of total hours lost due to the nonoperation
of the third shift is 2,920 hours. Such a starting point would
then require one to determine, for example, that the number
of total hours lost due to 11 holidays was 176 hours, i.e., one
would not lose 24 hours for each holiday but only 16 hours
since the remaining eight hours are already assigned to the
nonoperating third shift. In order to avoid this awkward result,
I start by first excluding Saturdays, Sundays, and holidays, all
for 24 hours each per day, and then determine the time lost for
other causes.
22 In the absence of an appropriate time-based, shift-related cost,
only people-based shift-related costs are used in this example.
23 The second machine operator for Machine A is needed
because the original production of 500 units of Product X completely exhausted the first-shift capacity for Machine A.
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