Final answer:
The appropriate denominator activity level can have a profound effect on the allocation of overhead costs, the calculation of variable costs, and the pricing strategy of the company.
Step-by-step explanation:
The appropriate denominator activity level can have a profound effect on the allocation of overhead costs. By choosing the right denominator activity level, a company can accurately distribute overhead costs across its products or departments. For example, if a company chooses the number of machine hours as the denominator activity level, products that require more machine hours will be assigned a higher share of the overhead costs.
This decision also impacts the calculation of variable costs. Variable costs are costs that change in direct proportion to the level of activity. The choice of denominator activity level affects the calculation of variable costs because it determines the basis for allocating overhead costs. If the wrong denominator activity level is chosen, the variable costs may be inaccurate, leading to faulty pricing decisions.
In conclusion, the appropriate denominator activity level plays a crucial role in determining the allocation of overhead costs and affects the calculation of variable costs, making it an essential factor in the pricing strategy of a company.