[JSPERBER]

Can someone explain to me the concept of Idle Capacity used in managerial accounting using examples?

[Thrawn]

Capacity is the amount of goods or services a business or factory or employee can provide.

For example if I have a machine that can make 10 widgets per day my capacity with 1 machine is 10 widgets. If I am producing and selling 8 widgets I am operating at 80% capacity, if I am producing 11 widgets then I am operating at 110% capacity or building a backlog.

Idle capacity just means you are below maximum, or below maximum over a specific circumstance (for example capacity of one shift or workers). You might be able to expand capacity but it usually entails either more hours, more machines or more money.

BEC 87 Feb 14
REG 84 Apr 14
FAR 82 Nov 14
AUD 86 Feb 15

[JSPERBER]

Thank you My questions is how does “opportunity cost” come into play when a company is operating at “full capacity”

[JSPERBER]

Like why would their be an opportunity cost If I'm producing at full capacity?

[Thrawn]

You must mean with regards to a special project or intercompany sales.

So let's take an example where a plant is operating at 100% efficiency, and say that their sister company wants them to produce a widget for them at cost instead of at their normal selling price of cost +10%.

If they are operating at 100% efficiency and they produce that product it will require them to not make a sale to another customer, or to add costs. So they would be foregoing the cost + 10% sale to sell at simple cost so they lose the profit on that sale.

If they are only operating at 80% capacity and their sister company wants them to sell them a product at cost, then they are not harmed because they do not need to forego the sale to others.

The general rule is, if you have idle capacity and the incremental sale exceeds variable cost then you should take the sale because it provides positive contribution margin which helps defray per unit fixed costs.

BEC 87 Feb 14
REG 84 Apr 14
FAR 82 Nov 14
AUD 86 Feb 15

[Author]

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