In addition to the accounting-related issues previously discussed in this chapter, managers must take a variety of other factors into account when planning capacity levels and in deciding how best to control and assign capacity costs. These factors include the level of uncertainty about both the expected costs and the expected demand for the installed capacity, the presence of capacity-related issues in the nonmanufacturing parts of the value chain, and the potential use of activity-based costing techniques in allocating capacity costs.
Practical capacity measures the available supply of capacity. Managers can usually use engineering studies and human resource considerations (such as worker safety) to obtain a reliable estimate of this denominator level for the budget period.
It is more difficult to obtain reliable estimates of demand-side denominator levels, especially longer-term normal capacity utilization figures. For example, many U.S. steel companies in the 1980s believed they were in the downturn of a demand cycle that would be followed by an upturn within 2 or 3 years. After all, steel had been a cyclical business in which upturns followed downturns, making the notion of normal capacity utilization appear reasonable. Unfortunately, the steel demand cycle did not turn up in the 1980s, resulting in numerous plants and some companies closing.
The recent global economic issues, including tensions in the trading relationship between the U.S. and China, demonstrate the extent to which demand projections can be inaccurate. Consider that Apple Inc. in January 2019 revised its forecast for first-quarter revenue for fiscal year 2019 down to $84 billion from $91.5 billion forecast just 2 months earlier. Similarly, citing growing international trade worries, Marriot International in November 2018 revised its growth forecast for revenue per available room for the fourth quarter of fiscal year 2018 down to 2% from the previous estimate of 2.5–3% made earlier in 2018.
In addition to dealing with economic cycles and inaccurate forecasts, companies also face the problem of marketing managers who may overestimate their ability to regain lost sales and market share. Their estimate of “normal” demand for their product may consequently be based on an overly optimistic outlook. Master-budget capacity utilization focuses only on the expected demand for the next year. Therefore, companies can more reliably estimate master-budget capacity utilization than normal capacity utilization. However, master-budget capacity utilization is still just a forecast, and the true demand realization could be either higher or lower than this estimate.
It is important to understand that costing systems, such as normal costing or standard costing, do not recognize uncertainty the way managers recognize it. A single amount, rather than a range of possible amounts, is used as the denominator level when calculating the budgeted fixed manufacturing cost per unit in absorption costing. Consider Stassen’s facility, which has an estimated practical capacity of 12,000 units. The estimated master-budget capacity utilization for 2020 is 8,000 units. However, there is still substantial doubt about the actual number of units Stassen will have to manufacture in 2020 and in future years. In contrast, managers do recognize uncertainty in their capacity-planning decisions. Stassen built its current plant with a 12,000-unit practical capacity in part to provide the capability to meet possible demand surges. Even if such surges do not occur in a given period, do not conclude that unused capacity in a given period is necessarily a wasted resource. The gains from meeting sudden demand surges may well outweigh the costs of having unused capacity in some periods.