Cost Accounting Standard 2

Cost Accounting Standard 2

1
  
COST ACCOUNTING STANDARD ON  
CAPACITY DETERMINATION 
The following is the COST ACCOUNTING STANDARD 2 (CAS 2) issued by the 
Council of the Institute of Cost and Works Accountants of India on “CAPACITY 
DETERMINATION”. The standard deals with determination of capacity of a unit.   In 
this Standard, the standard portions have been set in bold italic type.  These are to be read 
in the context of the background material which has been set in normal type. 
1.  Introduction  
Better utilization of capacity means better utilization of  resources.  It is an important 
consideration for cost determination and cost  reduction.  Thus, it is  essential  to establish  
the capacity of the plant. Cost Accounting Records  Rules under section 209(1)(d) of 
Companies Act, 1956 and Cost Audit Report Rules, 2001 under section 233B of the said 
Act specify that comparative statement of  installed  capacity and actual capacity 
utilization is to be recorded and furnished in order to assess the operating level.  
2.   Objective 
2.1 The objective of the standard is to prescribe the method of determination of capacity 
to be applied uniformly and consistently. 
2.2 The standard is to help the management to identify the bottlenecks, imbalances and 
idle capacity for effective use of various resources. 
2.3 The standard is to help in proper allocation, apportionment and absorption of cost. 
3. Scope  
3.1 The standard should be followed for capacity determination required to be carried 
out for any purpose or under provisions of any Act, Rules or Regulations except 
where capacity determination has been prescribed otherwise. 
3.2 The standard shall also be followed for maintaining cost records under the Cost 
Accounting Records Rules or for furnishing information on Capacity Utilization 
under the Cost Audit Report Rules issued pursuant to  Section 209(1)(d) and 
section 233B  of Companies Act,1956 respectively. 
3.3 The standard is applicable for an undertaking, whether existing or new, where there 
is  expansion of more than 5% of the existing capacity due to introduction of  new 
machines or productive resources. Similarly, the standard is also applicable where 
there is more than 5% reduction of the existing capacity due to disposal or 
withdrawal  or  impairment  of old machines or productive resources. 2
4. Definitions 
4.1 ‘Licenced Capacity’  is the production capacity of the plant for  which licence 
has been issued by an appropriate  authority. 
  
4.2 ‘Installed Capacity’ is the maximum productive capacity according to the 
manufacturers’ specification of  machines / equipment.  Installed capacity of 
the unit/plant is determined  after taking into account imbalances in different 
machines/ equipment in the various  departments / production cost centres  in 
the unit / plant and number of   working shifts.   
4.3 ‘Practical or Achievable Capacity’ is  the maximum  productive capacity of a 
plant reduced by the predictable and unavoidable factors of interruption 
pertaining to internal causes.   
Thus, practical capacity is the installed capacity minus the inevitable interruptions 
due to  time lost for preventive maintenance, repairs, set ups, normal delays, 
weekly off-days and holidays etc.  Practical capacity does not consider the 
external factors causing reduction in production e.g. lack of orders. 
4.4 ‘Normal Capacity’ is the production achieved or achievable on an average over 
a period or season under normal circumstances taking into account the loss of 
capacity resulting from planned maintenance. 
Normal capacity  is  practical capacity minus the loss of  productive capacity due 
to external factors. 
4.5 ‘Actual Capacity Utilization’ is the volume of production achieved in relation to 
installed capacity.  
  
4.6 ‘Idle Capacity’ is the difference between installed capacity and the actual 
capacity utilization when actual capacity utilization is less than installed 
capacity.   
4.7 ‘Excess Capacity Utilization’ is the difference between installed capacity and the 
actual capacity utilization when actual capacity utilization is more than installed 
capacity.   
4.8 ‘Abnormal idle capacity’ is the difference between  practical capacity and   
normal capacity or actual capacity utilization whichever  is higher. 3
5.   Determination of Installed Capacity  
5.1 Installed capacity is  determined based on :  
i) Manufacturers’ Technical specifications  
ii) Capacities of individual or  interrelated production centres. 
iii) Operational constraints / capacity of critical machines
iv) Number of shifts
v) Any other factor 
5.2 In case of manufacturers’ technical specifications  are not available,  the estimates 
by technical experts on capacity under ideal conditions may be considered for 
determination of installed capacity. 
5.3 In case  a product passes  through different production processes and each process 
is having different capacity then the process which brings effective or ultimate 
production shall be considered for deciding installed capacity. 
6.       Determination of  Practical  / Achievable  Capacity  
6.1 Practical capacity or achievable  capacity should be determined after adjustment of 
the  following with the installed capacity. 
(i) Available  production hours taking into consideration  holidays, normal 
shut down days and normal idle time. 
(ii) Normal time loss in batch change over, break downs of machines, repairs  
etc 
(iii) Loss in efficiency  due to  ageing of the machines/ equipment 
(iv) Number of  shifts 
(v) Any other factor 
7. Determination of Normal Capacity 
7.1 Normal capacity is determined based on the productive capacity achieved over a 
period of time, say average  of three normal  years out of preceding five years  or 
expected to be achieved over a period of time, say next three to five years . 
  
7.2 This capacity is determined after adjustment of external factors with practical 
capacity. 
7.3 Normal capacity  of   production process  involved in the production of a product 
or the productive capacity of the plant as a whole  should be taken into account to 
arrive at normal capacity for a product  or plant, as the case may be . 
7.4 The periods influenced by abnormalities should be excluded for this purpose. 4
Explanation :  
1. In  case the same  products with different specifications and of different ranges in 
terms of size, type, variety  etc are manufactured, then there is a need to determine   
equivalence among them in order to determine the capacity. 
2. In case some intermediate products / components etc are also produced,  they should 
be taken into consideration for  determining equivalent capacity. 
3. In case some machines are leased out/let out  or some machines are taken on lease, 
resulting  decrease / increase  in capacity should also be considered. 
8. Disclosure  
8.1 The details of basis for arriving at the capacity, variables  used and  assumptions 
made  should be disclosed. 
8.2 Any change in the installed capacity due to modifications in the machines/ 
equipment or addition of  balancing equipment  or disposal or impairment  of some 
machines/ equipment  should be disclosed.   
8.3 The licenced capacity and  installed capacity should be disclosed in absolute term 
of production whereas practical capacity, normal capacity and actual capacity 
utilization should be disclosed in absolute term as well as  in percentage of installed 
capacity. 
8.4 In  case the same  products with different specifications and of different ranges in 
terms of size, type, variety  etc are manufactured, then there is a need to determine   
equivalence among them and capacity should be established in terms of equivalent  
units. 
8.5 In case some machines are taken on lease or some machines are leased out, their  
impact in terms of increase/ decrease  in capacity should be  disclosed separately. 
8.6 In case of low capacity utilization as compared to the installed capacity, reasons for 
the same should be disclosed. Comments  on the shortfall in production should also 
specify the factors which are controllable  and uncontrollable in short term or in 
long term. 
8.7 In case of  excess capacity utilization, the same should  be disclosed separately in 
absolute terms  and  in  terms of percentage with reasons. 5
Exhibit 1 
 Illustration   
Manufacturers’  Specifications - capacity  per hour       =   500 units 
No of shifts  ( each shift 8 hours )                          =   3 shifts 
Holidays in a year  : 
Sundays                                                                   =   52  days 
Other holidays                   =  13  days 
Annual maintenance is done within these 13 hoildays
Preventive Weekly  Maintenance for the machine    on Sunday. 
Normal idle capacity for batch change over, 
Lunch, personal need etc                                                                  =    1 hr per shift 
Production  based on sales expectancy  in past 5 years  
                                                            = 30.1, 26.9, 29.7, 24.4 and 30.2 lakh units 
Actual Production for the year                                                        = 30.1 
Calculation  
Installed Capacity   for the machine   =    365 * 8 *3 * 500  = 43.8 lakh units 
Practical Capacity  = ( 365 – 52 - 13 ) * ( 8 - 1)  * 3 * 500  = 31.5 lakh units  
Out of the past five years, normal capacity is average of  3 normal years. 
Normal Capacity  = ( 30.1 + 29.7 + 30.2 ) / 3 = 30.0 lakh units 
Actual Capacity Utilization   = 30.1 lakh units =  68.7 % 
Idle Capacity   =  ( 43.8 – 30.1) = 13.7 lakh unit = 31.3 % 
Abnormal  idle capacity = 31.5 – 30.1  = 1.4 lakh units 6