Detailed Answer
Answer (B) is correct. Practical capacity is the maximum level at which output is produced efficiently. It includes consideration of idle time caused by human and equipment inefficiencies but not by inadequate sales demand. Practical capacity exceeds the other commonly used denominator levels included in the calculation of the fixed factory overhead rate. Because practical capacity will almost always exceed the actual use of capacity, it will result in an unfavorable production volume variance. Moreover, this variance (the difference between budgeted fixed overhead and the fixed overhead applied based on standard input allowed for the actual output) will be greatest given a practical capacity measure. The unfavorable production volume variance is charged to income summary, so the effect of using a larger denominator volume is the more rapid write-off of fixed overhead (practical capacity may be used for federal income tax purposes).
