The ability of a factory to produce with the present resources and facilities which it commands is called the capacity of a factory. A factory may have a number of machines and in order to run the machines it may require proper equipment’s, buildings, material, labour force, working capital and all other facilities.
If the factory is capable of producing 300 units of the product per day with all these resources, the capacity of the factory is said to be 300 units of the product per day. Capacity may be expressed in terms of units of products, production hours or value in rupees.
If the products manufactured in a factory are uniform, same physical unit of the product as tonnes of casting in foundry, 1000 bricks in brick making, kilowatt hour for electric generation and distribution etc. may be taken as a measure of the capacity.
But where the products are of diverse nature and are expressed in different physical units, the capacity may be expressed in terms of production hours. For example for 50 machines in a factory which can be operated for 8 hours per day, the total capacity would be 50 x 8 = 400 hours per day.
Where the machine is not predominant factor productive hours can be calculated with reference to time content of each product or job Capacity can also be expressed in terms of the total direct labour wages content of the cost of production of the factory in terms of money value.
Determining the actual overhead rate on any of the bases presents no difficulty as the actual level of capacity achieved is taken for this purpose. Where predetermined rates are required to be computed, decision regarding the suitable levels of activity to be adopted is to be taken.
The overhead rate will vary if different types of capacities i.e. normal, expected or maximum are adopted as the basis. For example, if maximum capacity is 5,000 labour hours and the expected capacity is 80%, the overhead rate for an estimated expenditure of Rs.10,000 based on this level will be: