Indirect cost rates and the death spiral Famous Flange Company manufactures a variety of special flanges for numerous customers. Annual capacity-related (manufacturing overhead) costs are $4,000,000 and the practical capacity level of machine hours is 120,000. The company uses planned machine hours as the cost driver in determining the plantwide cost driver rate. Until last year, the company used approximately 100,000 machine hours per year. Last year, competition increased and demand for the company’s flanges fell. In the face of continuing competition, the company estimates that it will use 80,000 machine hours in the coming year. The company sets its prices at 150% of production cost per unit.
(a) What is likely to happen if demand decreases further and Famous Flange continues to recompute its cost driver rate using the same approach?
(b) Advise the company on choosing a cost driver quantity for computing cost driver rates and explain why you advocate your choice of quantity.
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