CHAPTER VII
BUDGETING PROCESS
A budget is a detailed plan that shows how resources are expected to be acquired and used during a specified time period. In other words budget is a quantitative expression of management objectives and means of monitoring progress towards achievement of the same. An effective budget must be well coordinated with related management and accounting system.
Initially, budgeting identifies certain financial and operating targets that become management’s goals for the future. These targets which provide direction for the entity’s activities and transactions, is expected to lead to satisfactory profitable results. As the actual performance occurs, it is monitored and checked against the related targets for control purposes. If significant variances between the actual and planned performance are found, they are investigated and corrected whenever possible using the concept of management by exception.
Benefits of Budgeting
An entity’s financial performance must be planned and controlled through sound budgeting procedures in order to achieve and maintain acceptable profit results. To ensure that budgets are effectively used, both their benefits and limitations must be carefully considered. The benefits of budgeting are:
1. Planning : Budgeting forces management to plan ahead and systematically anticipate the future. Since managers are mostly preoccupied in their day-to-day business operations, they avoid formalized plans unless budgeting is part of their job. The budgeting forces managers to formalize their thinking about the future and participate in the firm’s goals setting activities.
2. Organization. Budgeting assist in (1) placing economic and human resources in the most financially rewarding areas and (2) making the various managers aware of the scarcity of resources.
3. Controlling: Budgeting provides managers with realistic performance targets against which actual results can be compared. Management by exception is performed by identifying significant variances that require corrective action if the firm is to achieve its goals.
4. Coordination: Budgeting coordinates the various segments of the organization and makes each manager aware of how the different activities fit together. Goal congruence of an organization can be achieved by the unifying efforts through budgeting.
5. Communication: Budgeting serves as a communication device that the various managers use to (1) exchange information concerning goals, ideas, and achievements and (2) interact and develop an awareness of how their activities contributes to the firm’s overall operation.
comparing actual performance with the goals serve as an important stimulus whenever budgeting is properly used.
Limitations of Budget
1. In many cases, a budget tends to oversimplify the facts of a real world situation and does not truly represent the complexities faced by management.
2. A budget may emphasize results (actual net income compared with amount budgeted) but not reasons (e.g. explanations for why marketing costs were higher than expected), when both are important.
3. The participative theme of budgeting demands complete management support and involvement. If managers are not convinced of budgeting’s benefits they are not likely to spend the time required to use it successfully.
4. The budget may undermine management’s initiative by discouraging new developments and actions not covered in the budget.
5. If excess pressure is applied to individual managers for the achievement of budget goals, the managers may react with decisions that adversely affect organizational goals.
6. The budgeting process is not an exact science and good judgment plays an essential role. Thus, budgeting is somewhat subjective and is based on best information available. Constant revision is needed as new facts become known.
Master Budget
The master budge is a set of separate but closely interrelated budget representing a comprehensive plan of action for a specified time period. This budget is typically prepared for the 12 month period representing a firm’s calendar or fiscal year. It is then subdivided into shorter periods (such as month or quarters) to facilitate time comparisons of actual and budgeted results.
The master budget consists of two components (1) the operating budget and (2) the financial budget. The operating budget is a detailed description of the revenues and costs required to achieve satisfactory profit results. The financial budget shows the cash flows and financial position expected with the planned operations. The master budget for a manufacturing firm would contain the following budgets:
Master Budget
Operating budget Financial budget
Sales budget Capital Expenditures budget
Production budget Budgeted Balance Sheet
Direct material budget Budgeted statement of cash flows
Manufacturing overhead budget Cost of goods sold budget Selling Expenses Budget
Types of Budgets
Functional Budget
A functional budget relates to any of the functions of an undertaking. Functional budgets are subsidiary to the master budget. The operating budgets listed above are examples of functional budgets.
Zero Based Budget
Zero Based budgeting can be defined as a planning and budgeting process which requires each manger to justify his entire budget request in detail from scratch (hence the zero based) and shifts the burden of proof to each manager to justify why he should spend any money at all i.e. taking zero as the base and the budget is based on the basis of likely activities for the future period.
Fixed Budget (Static Budget)
When a budget is drawn for one level of activity and one set of conditions on the assumption that there will no change in the budget level of activity, it is called a fixed budget.
Flexible Budget
A flexible budget gives different budget costs for different levels of activity. It is a budget designed to change in accordance with the level of activity actually attained. It is a tool that is extremely useful in cost control. The flexible budget is characterized as follows:
1. It is geared toward a range of activity rather than a single level of activity.
2. It is dynamic in nature rather than static. By using the cost volume formula, a series of budgets can be easily developed for various levels of activity.
The basic steps used to prepare a flexible budget are:
1. Select the measure of activity to be used to prepare the budget, e.g. units of production. 2. Define the relevant range of activity for the budgeted performance based on the measure
of activity selected in step 1.
3. Identify the cost items to be included in the budget.
4. Determine the cost behavior of each cost item over the relevant range.
5. Separate the cost items into variable and fixed cost categories (a mix cost is split between the two).
6. Select the specific levels of activity to be budgeted.
7. Use the cost behavior patterns identified in step 4 to estimate the budgeted amounts for each cost item.
Control Aspects of Budgeting
The control aspect of budgeting consists of three major steps:
1. Comparing the actual financial performance results with the budget estimates.
2. Identifying any significant variances (differences between the actual performance and budget estimates).
The Complete Periodic Budget
A complete set of budget generally consists of: 1. Sales estimates by:
a. Territory and product or
b. Territory, customer group, and product.
2. Estimates of inventory, production, labour, and factory overhead combined into a cost of goods sold schedule.
3. Estimates of materials, labour and factory overhead combined into a cost of goods sold schedule.
4. Detailed expense budget for marketing and administrative expenses.
5. A budget of major repairs, replacements, and improvements of plant and machinery, and research and development expenditures.
6. A cash budget showing cash receipts and disbursements. 7. A forecast income statement.
8. A forecast balance sheet showing the estimated financial position of the company at the end of the budget period.
Budgeting in Service Firms like Banks
The absence of inventory in a service firm does not eliminate the need for budgeting but it does alter the focus of its applications. Service firms such as banks, accounting firms, legal practitioners, medical clinic, architectural firm, etc. are typically labour intensive because their most important resources are the people who perform the revenue producing services. These people often engage in numerous non-repetitive activities because no two jobs are exactly alike. The lack of similarity of the services to be performed complicates the projection of the revenues and costs associated with the services.
The primary financial consideration is ensuring that the professional staff is kept busying, thereby generating enough revenue to support the operation. Consequently, the budgeting emphasis is on the labour budget to provide an adequate but not excessive amount of labour to satisfy the demand for services being performed.
Multiple Choice Questions
1. Budgetary control is a system designed:
a) To plan and control all quantifiable aspects of business activity b) To budget and control cash flows of a business
c) To monitor results of business d) None of above
2. Production budget comprises:
a) Plant capacity and utilization plan b) Production plan (quantities) c) Production cost budget d) All of the above
3. Unabosorbed or over absorbed cost means:
a) Under charging or over charging of overheads costs to cost of products manufactured. b) Less or excess overhead cost incurred as compared to last year.
c) Less or excess overhead cost incurred as compared to budget.
4. Starting point for budgeting is: a) Production forecast
b) Capacity forecast c) Sales forecast
d) Manpower level forecast
5. A flexible budget is also called: a) A variable budget
b) A seasonal budget
c) A budget with loose controls d) A document yet to be finalized
6. A flexible budget is:
a) Not appropriate when costs and expenses are affected by fluctuation in volume limits. b) Appropriate for any relevant level of activity.
c) Appropriate for control of FOH but not for control of direct material and direct labour d) Appropriate for control of direct material and direct labour but not for control of FOH
7. A flexible budget is:
a) In which monthly variations are accommodated
b) Having a technique to adjust itself to current conditions
8. A standard cost system may be used in: a) Job order but not process costing.
b) Either job order costing or process costing. c) Process costing but not job order costing. d) Neither process costing nor job order costing
9. A budget in which a responsibility centre manager must justify each planned activity and its estimated total cost is called a:
a) Conventional budget b) Master budget
c) Program planning and budget system d) Zero based budget
10. Standard costs provide the building blocks for a: a) Variable cost
b) Unit cost c) Budgeted cost d) Overhead cost
11. In responsibility accounting system each cost must be assigned to: a) A division
b) An individual c) A profit centre
12. The important reason for measuring performance of a division can be associated with: a) Motivating personal managers
b) Public reporting
c) Determining divisional contribution to net earnings
13. The situation when the goals of a division or an individual are in harmony with the broad goals of the company is known as:
a) Management by exception b) Goal congruence
c) Division goal analysis
14. In divisional performance analysis, the sum of earnings of all the divisions of a company: a) Will be the same as the net earnings of the enterprise as a whole.
b) Probably will not be the same as the net earnings of the enterprise as a whole. c) Is called the return on investment.
15. Modern divisional performance reporting system give attention to: a) Costs
b) Costs and revenues
c) Costs, revenues and investment
a) Management by objective b) Management by domination c) Management by exception
Answer 1(a), 2 (b), 3 (c), 4 (c), 5 (a), 6(b), 7(b), 8(b), 9(d), 10(c), 11(b), 12(c), 13(b), 14(b), 15(c), 16(a)
Additional Multiple Choice Questions
1. A major weakness of static budgets is that:
a) They are geared only to a single level of activity.
b) They cannot be used to assess whether variable costs are under control.
c) They force the manager to compare actual costs at one level of activity to budgeted costs at a different level of activity.
d) All of the above.
Answer (d)
2. The budget or schedule that provides necessary input data for the direct materials budget is the :
a) Cash Budget c) Production budget
b) Raw materials purchase budget d) Schedule of cash collection
Answer (c). The compilation of direct material budget is based on production budget.
3. Turkey Company uses an accounting system that charges costs to the manager who has been delegated the authority to make decisions concerning the costs. For example, if the sales manager accepts a rush order that will result in higher than normal shipping costs, these additional costs are charged to the sales manager because the authority to accept or decline the rush order was given to the sales manager. This type of accounting system is known as:
a) Absorption accounting c) Operation budgeting
b) Contribution accounting d) Responsibility accounting
Answer (d)
4. Marker company’s sales are 50% cash and 50% on credit. Seventy percent of the credit sales are collected in the month of sale, 20% in the month following sale, and 5% in the second month following sale. The remainder is uncollectible. The following are budget sales data:
September October November December
Total Sales $ 50,000 $ 70,000 $ 60,000 $ 80,000
5. Leonardo Co. plans to sell 24,000 units during the month of August. If the company has 5,000 units on hand at the start of the month, and plans to have 4,000 units on hand at the end of the month, how many units must be produced during the month?
a) 23,000 b) 24,000 c) 25,000 d) 28,000
6. Champion Co. produces and sells volleyballs. To guard against out of stock situations, the company requires that 20% of the next month’s sales be on hand at the end of each month. Budgeted sales of volleyballs over the next four months are:
January February March April
Budgeted sales in units 60,000 80,000 120,000 100,000
Budgeted production for March would be:
a) 100,000 units b) 116,000 units c) 124,000 units 140,000 units
7. Corner Company plans the following beginning and ending inventory levels (in units) for July:
July 1 July 30
Raw material 80,000 100,000
Work in Process 20,000 20,000
Finished goods 160,000 100,000
Two units of raw materials are needed to produce each unit of finished product. If Corner Co. plans to sell 960,000 units during July, the number of units it would have to manufacture during July would be:
a) 880,000 units b) 900,000 units c) 960,000 d) 1,020,000 units
8. The Kentucky Co. has budgeted production for next year as follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter
Production in units 20,000 24,000 32,000 28,000
Five pounds of raw materials are required for each unit produced. Raw materials on hand at the start of the year totals 5,000 lbs. The raw materials inventory at the end of each quarter should equal 10% of the next quarter’s production needs. Budgeted purchases of raw materials in the second quarter would be:
a) 24,800 lbs. b) 116,000 lbs. c) 124,000 lbs. d) 160,000 lbs.
a) $ 14.00 b) $ 18.20 c) $ 20.80 d) $ 23.66
10. Robert Company has a cash balance of $ 18,000 on April 1. The company is required to maintain a minimum cash balance of $ 12,000. During April expected cash receipts are $ 90,000. Expected cash disbursement during the month total $ 104,000. During April the company need to borrow:
a) $ 4,000 b) $ 6,000 c) $ 8,000 d) $ 14,000
11. The Alpha Company makes and sells a single product. Budgeted sales for April are $ 600,000. Gross margin is budgeted at 30% of sales. If the net income for April is budgeted at $ 80,000, budgeted selling and administrative expenses must be:
a) $ 100,000 b) $156,000 c) 204,000 d) $ 266,666
12. Roma Restaurant compares monthly operating results with a static budget prepared at the beginning of the year. When actual sales are less than budget, would the restaurant usually report favour variances on fixed supervisory salaries and variable food costs?
Supervisory salaries Food costs
a) Yes Yes
b) Yes No
c) No Yes
d) No No
a) Answer A b) Answer B c) Answer C d) Answer D
Exercise 32
The following data on production, materials required for products X and Y, and inventory pertain to the budget of Pioneer Company.
Product X Product Y
Production Units 2,000 3,000
Materials (per Unit)
A 3.00 1.00
B 4.00 6.50
Beginning Desired Price/Unit
Ending (Rs.)
Material Inventory
A 2,000 3,000 2.00
Required :
a) Determine the number of units needed to produce products X and Y. b) Calculate the cost of materials used for production.
c) Determine the number of material units to be purchased. d) Calculate the cost of materials to be purchased.
Answer 32
Material A Material B
a) Number of units product X to be produced 2,000 2,000
Units needed to produce X 3 4
Total 6,000 8,000
Number of units product Y to be produced 3,000 3,000
Units needed to produce Y 1 6.5
Total 3,000 19,500
Total number of material units needed to 9,000 27,500 Produce product X and Y (6,000+3,000)
Material A Material B
b) Total number of material units 9,000 27,500
Unit price 2 1.20
Cost of materials used for production 18,000 33,000
Material A Material B
c) Total number of units needed for production 9,000 27,500
Add desired ending inventory 3,000 6,000
Total material needed 12,000 33,500
Less beginning inventory 2,000 6,000
Materials to be purchased 10,000 27,500
Material A Material B
d) Material to be purchased 10,000 27,500
Unit Price 2 1.20
Cost of material to be purchased 20,000 33,000
Exercise 33
M/s Saima Corporation manufactures and sells products that has peak sales in the third quarter of the year. The following information concerns operations for Year 2 and the first quarter of the 3rd
year.
a) The company’s single product sells for $ 8 per unit. Budgeted sales in units for the next six quarters are as follows:
1 2 3 4 1 2 Budgeted unit sales 40,000 60,000 100,000 50,000 70,000 80,000
b) Sales are collected in the following pattern: 75% in the quarter the sales are made and the remaining 25% in the following quarter. On January 1, Year 2, the company’s balance sheet showed $ 65,000 in accounts receivable, all of which will be collected in the first quarter of the year. Bad debts are negligible and can be ignored.
c) The company desires as ending finished goods inventory at the end of each quarter equal to 30% of the budgeted unit sales for the next quarter. On December 31, Year 1, the company has 12,000 units on hand.
d) Five pounds of raw materials are required to complete one unit of product. The company requires ending raw materials inventory at the end of each quarter equal to 10% of the following quarter’s production needs. On December 31, Year 1 the company had 23,000 pounds of raw material on hand.
e) The raw material costs $ 0.80 per pound. Raw material purchases are paid for in the following pattern. 60% paid in the quarter the purchases are made, and the remaining 40% paid in the following quarter. On January 1, Year 2, the company’s balance sheet showed $81,500 in accounts payable for raw material purchases, all of which will be paid for in the first quarter of the year.
Required:
Prepare the following budgets and schedule for the year, showing both quarterly and total figures.
1. A sales budget and a schedule of expected cash collections. 2. A production budget.
3. A direct material budget and schedule of expected cash payments for purchases of materials.
Answer 33
1. The sales budget is prepared as follows :
Year 2 Quarter
1 2 3 4 Year Budgeted unit sales 40,000 60,000 100,000 50,000 250,000 Selling Price per unit x $8 x $8 x $8 x $8 x $8 Total sales $320,000 480,000 $800,000 $400,000 $2,000,000
Based on the budgeted sales above, the schedule of expected cash collection is prepared as follows:
2 Quarter
1 2 3 4 Year
Accounts receivable, beginning balance $65,000 $ 65,000
Fourth quarter sales ($400,000 x75%) 300,000 300,000 Total cash collections 305,000 440,000 720,000 500,000 1,965,000
2. Based on the sales budget in units, the production budget is prepared as follows:
Year 2 Quarter Year 3 Quarter 1 2 3 4 Total 1 2 Budgeted units in sales 40,000 60,000 100,000 50,000 250,000 70,000 80,000 Add desired ending inventory 18,000 30,000 15,000 21,000 21,000 24,000
Total inventory needed 58,000 90,000 115,000 71,000 271,000 94,000 Less beginning inventory 12,000 18,000 30,000 15,000 12,000 21,000 Required Production 46,000 72,000 85,000 56,000 259,000 73,000
Note : Ending inventory 30% of the following quarter’s sales in units
4th quarter ending inventory is computed from the sales of 1st quarter of the third year’s sale
Beginning inventory of 1st quarter is based on the ending inventory of the previous year which is
given in the question.
Beginning inventory of subsequent quarter is based on the closing inventory of the previous quarter.
3. Based on the production budget, raw materials will needed to be purchased during the year as follows:
Year 2 Quarter Year 3 Quarter 1 2 3 4 Total 1 Required production (units) 46,000 72,000 85,000 56,000 259,000 70,000 Quantity per unit x 5 x 5 x 5 x 5 x 5 x 5 Product needs in Pounds 230,000 360,000 425,000 280,000 1,295,000 35,000 Add desired ending inventory 36,000 42,500 28,000 35,000 35,000
Total inventory needed 266,000 402,500 453,000 315,000 1,330,000 Less beginning inventory 23,000 36,000 42,500 28,000 23,000 Raw material to be purchased 243,000 366,500 410,500 287,000 1,307,000
Ending inventory is equivalent to 10% of the following quarter’s demand. 4th quarter ending inventory is computed on the data of 1 quarter of 3rd year.
Beginning inventory of the first quarter is based on the closing inventory of the previous quarter.
Based on the raw material purchases above, expected cash payments are as follows:
Year 2 Quarter
Cost per unit x $0.80 x $0.80 x $0.80 x $0.80 x $0.80 Cost of raw material $ 194,400 293,200 328,400 229,600 1,045,600
Accounts Payable (Beg.) 81,500 81,500
First quarter purchases
($194,400x60%, 40%) 116,640 77,760 194,400
2nd quarter purchases
($293,200x60%, 40%) 175,920 117,280 293,200 3rd quarter purchases
($328,400x60%, 40%) 197,040 131,360 328,400
4th quarter purchases
($229,600 x60%) 137,760 137,760 Total cash requirements $ 198,140 253,680 314,320 269,120 1,035,260
Exercise 34
A cash budget, by quarters, is given below for a retail company in thousands. The company requires a minimum cash balance of at least $ 5,000 to start each quarter.
Cash Balance, beginning $ 6 $ ? $ ? $ ? $ ? Add collections from customers ? ? 96 ? 323 Total cash available 71 ? ? ? ?
Less Disbursements
Purchase of inventory 35 45 ? 35 ? Operating expenses ? 30 30 ? 113 Equipment purchases 8 8 10 ? 36
Dividends 2 2 2 2 ?
Total disbursements ? 85 ? ? ?
Exces(deficiency) of cash
Available over disbursements (2) ? 11 ? ?
Financing
Borrowings ? 15 - - ?
Repayments (including interest) - - (?) (17) (?) Total financing ? ? ? ? ? Cash balance, ending ? ? ? ? ?
Answer 34
Total cash available 71 75 101 97 329
Less Disbursements
Purchase of inventory 35 45 48 35 163
Operating expenses 28 30 30 25 113
Equipment purchases 8 8 10 10 36
Dividends 2 2 2 2 8
Total disbursements 73 85 90 72 320
Exces(deficiency) of cash
Available over disbursements (2) (10) 11 25 9
Financing
Borrowings 7 15 - - 22
Repayments (including interest) - - (6) (17) (23) Total financing 7 15 (6) (17) (1) Cash balance, ending 5 5 5 8 8
Exercise 35
Pearl Product Ltd. manufactures and exports toys. Three cubic centimeters (cc) of solvent H300 are required to manufacture each unit of Supermix, one of the company’s products. The company is now planning raw materials need for the third quarter, the quarter in which peak sales of Supermix occur. To keep production and sales moving smoothly, the company has the following inventory requirements.
a) The finished goods inventory on hand at the end of each month must be equal to 3,000 units of supermix plus 20% of the next month’s sales. The finished goods inventory on June 30 is budgeted to be 10,000 units.
b) The raw materials inventory on hand at the end of each month must be equal to one half of the following month’s production needs for raw materials. The raw materials inventory on June 30 is budgeted to be 54,000 cc of solvent H300.
c) The company maintains no work in process inventories.
A sale budget for Supermix for the last six months of the year follows:
Budgeted sales in Units
July 35,000
August 40,000
September 50,000
October 30,000
November 20,000
Required:
1. Prepare a production budget for Supermix for the month July, August, September and October.
2. 2. Examine the production budget that you prepared. Why will the company produce more units than it sells in July and August, and less than it sells in September and October?
3. Prepare a direct material budgets budget showing the quantity of solvent H300 to be purchased for July, August, September and for the quarter in total.
Answer 35
1. Production Budget
July August September October November December Sales 35,000 40,000 50,000 30,000 20,000 10,000 Ending Inventory 11,000 13,000 9,000 7,000 5,000
46,000 53,000 59,000 37,000 25,000 Less beginning
Inventory 10,000 11,000 13,000 9,000 7,000 Required Prod. 36,000 42,000 46,000 28,000 18,000
2. Ending Inventory 3,000 units plus 20% of next months sales
3. The entity is producing more in July and August to build inventory to match the higher level of sale in September and produces less in September because reduced demand in October.
Direct Material Budget
July August September October November December Required Prod 36,000 42,000 46,000 28,000 18,000 10,000 Quantity per unit x 3 x 3 x 3 x 3 x 3 Production
Requirements 108,000 126,000 138,000 84,000 54,000 Add End. Inventory 63,000 69,000 42,000 27,000 Total material needed 171,000 195,000 180,000 111,000
Less beginning
Inventory 54,000 63,000 69,000 42,000 Material Purchased 117,000 132,000 111,000 69,000
Exercise 36
Modern Company is a wholesale distributor of Swiss chocolates. The company’s balance sheet as of April 30 is given below:
Modern Company Balance Sheet
April 30 Assets
Cash $ 9,000
Accounts Receivable 54,000
Inventory 30,000
Building and equipment, net of depreciation 207,000
Total Assets 300,000
Liabilities and Stockholder’s Equity
Accounts Payable $ 63,000
Notes Payable 14,500
Capital stock, no par 180,000
Retained earning 42,500
Total liabilities and stockholder’s equity 300,000
The company is in the process of preparing budget data for May. A number of budget items have already been prepared as stated below:
1. Sales are budgeted at $200,000 for May. Of these sales, $60,000 will be for cash, the reminder will be credit sales. One half of a month’s credit sales are collected in the month the sales are made, and the reminder is collected in the following month. All of the April 30 accounts received will be collected in May.
2. Purchases of inventory are expected to total $120,000 during May. These purchases will all be on account. Fifty per cent of all purchases are paid for in the month of purchase, the reminder are paid in the following month. All of the April 30 accounts payable to suppliers will be paid during May.
3. The May 31 inventory balance is budgeted at $40,000.
4. Operating expenses for May are budgeted at $72,000, exclusive of depreciation. These expenses will be paid in cash. Depreciation is budgeted at $ 2,000 for the month.
5. The note payable on the April 30 balance sheet will be paid during May, with $100 in interest (All of the interest relates to May).
6. New refrigerating equipment costing $6,500 will be purchased for cash during May. 7. During May, the company will borrow $20,000 from its bank by giving a new note
payable to the bank for the amount. The new note will be due in one year. Required :
2. Prepare a budgeted income statement for May. Use the absorption costing income statement format.
3. Prepare a budgeted balance sheet of May 31.
Answer 36
Schedule of Cash Receipts
Collection of Accounts Receivable (April 30) 54,000
Cash Sales for May 60,000
Credit Sales (50% of 140,000) 70,000
Total Cash collection 184,000
Schedule of Cash Payments
Payment of Accounts Payable 63,000
Purchase of Inventory (50% down payment) 60,000
Total Cash Payments 123,000
Cash Budget for the month of May
Cash Balance opening 9,000
Add cash receipts from customers 184,000
Total cash available 193,000
Less disbursements during the month
Payment to suppliers 123,000
Payment of expenses 72,000
Payment of refrigerator 6,500 (201,500)
Excess/shortfall of cash - 8,500
Financing
Payment of note payable - 14,500 Interest on note payable - 100
Borrowing from Bank 20,000 5,400
Balance (Shortfall) 3,100
Budgeted Income Statement
Sales 200,000
Cost of goods sold
Opening Inventory 30,000
Purchases 120,000
Goods available for sale 150,000
Less closing inventory 40,000 110,000
Gross Margin 90,000
Operating Expenses
Depreciation 2,000
Interest 100 74,100
Net Income 15,900
Budgeted Balance Sheet Assets
Accounts Receivable 70,000
Inventory 40,000
Building & Equipment 205,000
Office Equipment 6,500 321,500
Liabilities
Bank Balance (Cr.) 3,100
Accounts Payable 60,000
Notes Payable (Bank Loan) 20,000
Capital Stock 180,000
Retained Earning 58,400
Total Liabilities & Owner’s Equity 321,500
Exercise 37
M/s Modern Garment is ready to begin its third quarter in which peak sales occur. The company has requested a $40,000, 90 days loan from its bank to help meet cash requirements during the quarter. Since the company has experienced difficulty in paying off its loan in the past, the loan officer at the bank has asked the company to prepare a cash budget for the quarter. In response to the bank’s requirement the following data have been assembled.
a. On July 1, the beginning of the third quarter the following will have a cash balance of $44,500.
b. Actual sales for the last two months and budgeted sales for the third quarter follow (all sales are on account).
May (actual) $ 250,000
June (actual) 300,000
July (budgeted) 400,000
August (budgeted) 600,000
September (budgeted) 320,000
Past experience shows that 25% of a month’s sales are collected in the month of sale, 70% in the month following sale, and 3% in the second month following sale. The reminder is uncollectable.
a. Budgeted merchandise purchases and budgeted expenses for the third quarter are given below:
Salaries and wages 45,000 50,000 40,000
Advertising 130,000 145,000 80,000
Rent payments 9,000 9,000 9,000
Depreciation 10,000 10,000 10,000
Merchandise purchases are paid in full during the month following purchase. Accounts payable for merchandise purchase on June 30, which will be paid during July, total $180,000.
b. Equipment costing $10,000 will be purchased for cash during July.
c. In preparing the cash budget, assume that the $40,000 loan will be made in July and repaid in September. Interest on the loan will total $1,200.
Required:
1. Prepare a schedule of expected cash collections for July, August and September and for quarter in total.
2. Prepare a cash a cash budget, by month and in total for the third quarter.
3. If the company needs a minimum cash balance of $ 20,000 to start each month can the loan be repaid as planned?
Answer 37
Schedule of Cash Collections
July August September Accounts Receivable
May 3% 250,000 7,500
June 70%, 3% 300,000 210,000 9,000
Sale for July (25%, 70%, 3%) 400,000 100,000 280,000 12,000
Sale for August 600,000 150,000 420,000
Sale for September 320,000 80,000
Total Cash collections 317,500 439,000 512,000
Cash Budget Month
July August September
Cash Balance – Opening 44,500 28,000 23,000
Add collections during the month 317,500 439,000 512,000
Total cash available 362,000 467,000 535,000
Less Cash disbursement
Payment for Accounts Payable for June 180,000
Payment for purchases 240,000 350,000
Salaries and Wages 45,000 50,000 40,000
Advertising 130,000 145,000 80,000
Rent Payments 9,000 9,000 9,000
Purchase of Equipments 10,000 -
-Total Cash disbursements 374,000 444,000 479,000
Financing
Bank Loan 40,000
Repayment
Total Financing 40,000 - -41,200
Cash Balance Closing 28,000 23,000 14,800
Exercise 38
Hero Cycle Co. has prepared the following incomplete flexible budget:
Standard Direct Labour Hours Manufacturing overhead Rate per hour 20,000 24,000 28,000 32,000 Variable Costs
Indirect labour $ 45,000
Maintenance 64,200
Utilities 30,800
Total 140,000
Fixed Costs
Supervisory salaries 52,000
Rent 32,000
Insurance 14,500
Depreciation 48,500
Total 147,000
Total manufacturing overhead 287.000 Required:
Complete the flexible budget
Answer 38
Standard Direct Labour Hours Manufacturing overhead Rate per hour 20,000 24,000 28,000 32,000 Variable Costs
Indirect labour $ 2.25 $ 45,000 54,000 63,000 72,000
Maintenance 3.21 64,200 77,040 89,880 102,720
Utilities 1.54 30,800 36,960 43,120 49,280
Total 140,000 168,000 196,000 224,000
Fixed Costs
Supervisory salaries 52,000 52,000 52,000 52,000
Rent 32,000 32,000 32,000 32,000
Insurance 14,500 14,500 14,500 14,500
Depreciation 48,500 48,500 48,500 48,500
Total manufacturing overhead 287.000 315,000 343,000 371,000
Note
Rate computation variable cost = $ 45,000/20,000, 64,200/20,000, 30,800/20,000
Fixed cost will remain unchanged for all the three levels of production unless additional fixed cost is needed for additional level.
Exercise 39
M/s Burns Food Co. produces special Beryani pack for lunch. The firm uses flexible budget for planning and controlling costs. Below are budget and actual production data for the previous year.
Budgeted Budgeted Actual
Number of packs 70,000 90,000 82,500
Supervision $30,000 $38,000 $73,500
Materials 28,000 36,000 33,500
Maintenance 9,000 11,000 11,000
Depreciation 18,000 18,000 18,000
Utilities 7,000 9,000 8,500
Required :
c. Determine the cost behavior pattern for each mixed cost. d. Prepare a flexible budget performance report for the last year.
Answer 39
By using high and low method variable and fixed cost is segregated as under.
Supervision = 38,000 – 30,000/(90,000 – 70,000) = $0.40 variable cost rate Fixed cost = 38,000 – 90,000 (0.40) = $ 2,000
Materials = 36,000 - 28,000/(90,000 – 70,000) = $0.40 variable cost rate Fixed cost = 36,000 – 90,000(0.40) = 0
Maintenance = 11,000 – 9,000 /(90,000 – 70,000) = 0.10 variable cost rate Fixed cost = 11,000 – 90,000(0.10) = $ 2,000
Utilities = 9,000 - 7,000/(90,000 – 70,000) = 0.10 variable cost rate Fixed cost = 9,000 – 90,000(0.10) = 0
Burns Food Company Flexible Overhead Budget
Cost Variable cost Fixed
Supervision $ 0.40 $ 2,000
Materials 0.40
Depreciation -0- 18,000
Utilities 0.10
Burns Food Company
Flexible Budget Report
Budgeted Actual Variance
Number of Packs 82,500 82,500
Costs
Supervision $35,000 73,500 $ 38,500 U
Material $ 33,000 33,500 500 U
Maintenance 10,250 11,000 750 U
Depreciation 18,000 18,000
-0-Utilities 8,250 8,500 250 U
Computation :
Supervision (82,500 x 0.40) + 2,000 = $35,000 Material (82,500 x 0.40) + 0 = $33,000
Maintenance (82,500 x 0.10) + 2,000 = $10,250 Utilities (82,500 x 0.10) + 0 = $8,250
Exercise 40
M/s Gold Company provides the following budget that were prepared at the beginning of the year. Budgeted capacity was set at 20,000 units.
20,000 units 27,500 units
Direct materials $30,000 $41,250
Direct labour 22,000 30,250
Factory utilities 60,000 82,500
Sales Promotion 10,000 13,750
Production supervision salaries 12,000 12,000
Marketing Manager’s salary 8,000 8,000
Administration salaries 32,000 32,000
Total 174,000 219,750
At the end of the month, analysis of the cost record reveals that Gold incurred the following costs and expenses for producing and selling 21,600 units.
Direct materials $ 33,000
Direct labour 25,100
Factory utilities 64,900
Production supervisor salaries 12,500
Sales Promotion 11,300
Marketing manager salary 7,800
Total 187,300 Required :
a. Determine the flexible budget formula for all expenses, expressing variable cost on per unit basis.
b. Compute the factory overhead application rate.
c. Determine variances for each line item using a flexible budget, indicating whether the variances are favourable or unfavourable.
Answer 40
Fixed cost
Production Supervisor’s salary $ 12,000
Marketing Manager’s salary 8,000
Administrative salaries 32,000
Total fixed cost 52,000
Variable cost
Direct material ($30,000/20,000 = $ 1.50) Direct labour ($22,000/20,000 = $ 1.10) Factory utilities ($60,000/20,000 = $ 3.00) Sales Promotion ($10,000/20,000 = $ 0.50)
Total variable cost $ 6.10
b. Flexible budget formula = $ 6.10 per unit Fixed cost $ 52,000
c.
Actual cost Budget for 21,600 units Variance
Direct material $ 33,000 32,400 ($1.50 x 21,600) $ 600 U
Direct labour 25,100 23,760 ($1.10 x 21,600) $ 1,340 U
Factory Utilities 64,900 64,800 ($3.00 x 21,600) $ 100 U
Production Supervisor 12,500 12,000 $ 500 U
Sales Promotion 11,300 10,800 ($0.50 x 21,600) $ 500 U
Market Manager’s S. 7,800 8,000 $ 200 F
Administrative Sal. 32,700 32,000 $ 700 U
Total 187,300 183,760 3,540 U
Exercise 40
In the first quarter of 2006, Griffin Manufacturing Company projects its sales in units to be as follow:
January 3,270
February 2,965
March 3,315
In addition, it desires to have the following units of finished goods inventory in hand:
January 1 2,975
January 31 2,705
March 3,000
Required : Prepare a production budget for the first quarter 2006.
Answer 40
Production Budget Griffin Manufacturing Co.
January February March
Sales $ 3,270 2,965 3,315
Add Ending Inventory 2,705 2,650 3,000
Total production 5,975 5,615 6,315
Less Beginning Inventory 2,975 2,705 2,650
Required Production 3,000 2,910 3,665
Exercise 41
The Pelican Company provided the following information from their annual budget for 2003.
Products Expected Sales Estimated Sale Required material
Price Per unit Per unit A B
Tribolite 80,000 $ 1.80 1 kg 2 kg
Polycal 40,000 2.00 2 kg
-Power X 100,000 0.80 - 1 kg
Estimated inventories at the beginning and desired quantities at the end of the year :
Material Beginning Ending Purchase Price
Per Kg
A 10,000 kg 12,000 kg $ 0.20
B 12,000 kg 15,000 kg $ 0.10
Product Beginning Ending Direct labour hours
Per 1,000 units
Tribolite 5,000 6,000 50
Polycal 4,000 2,000 125
Power X 10,000 8,000 12.5
Required :
1. Prepare a production Budget.
2. Prepare a purchase budget for each material.
3. Prepare a budget of manufacturing costs by products and in total.
Answer 41
Production Budget
Tribolite Polycal Power X
Budgeted Sales 80,000 40,000 100,000
Add ending inventory 6,000 2,000 8,000
Total units required 86,000 42,000 108,000
Less beginning inventory 5,000 4,000 10,000
Required Production 81,000 38,000 98,000
Purchase Budget – Material A
Tribolite Polycal Power X
Required Production 81,000 38,000 98,000
Required material per unit x 1 kg x 2 kg
-Required material 81,000 kg 76,000 kg
-Total material required 81,000 + 76,000 = 157,000 kg
Add ending inventory 12,000
169,000
Less beginning inventory 10,000
Material to be purchased 159,000
Rate per kg $ 0.20
Budgeted purchased Price $ 31,800
Purchase Budget – Material B
Tribolite Polycal Power X
Required Production 81,000 38,000 98,000
Required material per unit x 2 kg - x 1 kg
Required material 162,000 kg - 98,000
Total material required 162,000 + 98,000 = 260,000 kg
Add ending inventory 15,000
275,000
Less beginning inventory 12,000
Material to be purchased 263,000
Rate per kg $ 0.10
Manufacturing Budget Material A (81,000 x 1 x 0.20) $ 16,200
(38,000 x 2 x 0.20) 15,200 $ 31,400 Material B (81,000 x 2 x $0.10) 16,200
(98,000 x 1 x $0.10) 9,800 26,000 $ 57,400 Direct labour
Tribolite 81 x 50 hr x $8 = 32,400
Polycal 38 x 125 hr x $8 = 38,000
Power X 98 x 12.5 hr x $8 = 9,800 80,200
Manufacturing overhead
Variable 81 x 50 hr x $6 = 24,300
38 x 125 hr x $6 = 28,500 98 x 12.5 hr x $6 = 7,350 60,150
Fixed Manufacturing overhead 40,000 100,150
Total manufacturing cost 237,750
Note : For Manufacturing budget actual material required for production is taken into account to compute the total manufacturing cost.
Exercise 42
Karen Vance is a highly successful attorney specializing in automobile insurance claims settlements. She has a staff consisting of four attorneys and three clerical workers. The staff attorneys are paid $ 4,000 per month and the clerical workers are paid $1,400. Other operating expenses are fixed at $ 9,800 per month. Ms. Vance charges her clients based on the number of hours worked. The fee structure is as follows:
Charges per hour
K. Vance $ 90.00
Staff attorneys 60.00
Clerical Staff 16.00
Ms. Vance’s practice has been seasonal in the past. Due to snow and ice during the winter, a dramatic increase in automobile accidents occurs from November to February. Below is an analysis of the average hours charged to clients per month.
November – February March – October
K. Vance 160 hrs 100 hrs each
Staff attorneys 170 hrs each 110 hrs each
Clerical staff 150 hrs each 80 hrs each
Required :
Answer 42
Karen Vance, Attorney at Law Schedule for Annual Budget
Revenue
1st Quarter 2th Quarter
Jan Feb Mar Total April May June
K. Vance 160 160 100 420 100 100 100 300
Charges per hr. $ 90 $ 90
$37,800 $27,000
3rd Quarter 4th Quarter
July Aug Spt. Total Oct. Nov. Dec. Total 100 100 100 300 100 160 160 420
$ 90 $ 90
$27,000 $ 37,800
Total = $37,800 + 27,000 + 27,000 + 37,800 = $ 129,600
Staff Attorney (4) 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Hours 1,800 1,320 1,320 1.800
Rate $ 60 $ 60 $ 60 $ 60 $ 108,000 $79,200 $79,200 $108,000 Total $ 108,000 + 79,200 + 79,200 + 108,000 = $ 374,400
Attorney hours = 1st quarter 170 + 170 + 100 = 450 x 4 = 1,800 hrs
Rest may be calculated in the same way
Clerical Staff (4) 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Hours 1,140 720 720 1.140
Rate $ 16 $ 16 $ 16 $ 16 $ 18,240 $11,520 $11,520 $18,240 Total $ 18,240 + 11,520 + 11,520 + 18,240 = $ 59,520
Staff hours = 1st quarter 150 + 150 + 80 = 380 x 3 = 1,140 hrs
Rest may be calculated in the same way
Expenses
Salaries
Operating Expenses $ 9,800 x 4 = $ 39,200
Karen Vance Attorney At Law
Annual Budget of Revenue and Expenses
1
st 2nd 3 rd 4th Total
Revenue
Karen Vance $37,800 27,000 27,000 37,800 129,600 Staff Attorney 108,000 79,200 79,200 108,000 374,400 Clerical Staff 18,240 11,520 11,520 18,240 59,520 Total Revenue 164,040 117,720 117,720 164,040 563,520
Expenses Salaries
Attorneys 16,000 16,000 16,000 16,000 64,000 Clerical Staff 4,200 4,200 4,200 4,200 16,800 Operating Expenses 9,800 9,800 9,800 9,800 39,200 Total expenses 30,000 30,000 30,000 30,000 120,000
Net Income 134,040 87,720 87,720 134,040 443.520
CHAPTER VIII
A standard is a benchmark for measuring performances. Standards are observed everywhere. In manufacturing and service institutions standards are set for each major input such as raw materials and labour time. The performance thereafter is evaluated by comparing the actual results with the predetermined standards. If either the quantity or price or other inputs departs significantly from the standards, managers investigate the discrepancy to find out the cause of the problem and eliminate it. This process is called management by exception.
Ideal versus Practical Standards
Ideal Standards can be defined as a standard which can be attained only under the best circumstances. They allow for no machine break down or any other work interruptions, and they call for a level of effort that can be attained only by the most skilled and efficient employees working at peak effort 100% of the time.
Practical Standards are standards that are “tight but attainable”. They allow for normal machine downtime and employee rest periods and they can be attained through reasonable though highly efficient, efforts by the average workers. In real life ideal standards cannot be used for practical applications, because they do not allow for normal inefficiencies and result in unrealistic forecasts.
Standard cost system have a number of advantages.
1. Standard costs are a key element in a management by exception approach. If costs conform to the standards, managers can focus on other issues. When costs are significantly outside the standards, managers investigate the causes for that problem. This approach helps them to focus on important issues.
2. Standards that are viewed as reasonable by employees can promote economy and efficiency in the working.
3. Standard costs can greatly simplify bookkeeping. Instead of recording actual costs for each job, the standard costs for direct materials, direct labour and factory overhead can be charged to jobs.
4. Standard costs fit naturally in an integrated system of “responsibility accounting”.
Material Variance
Material variance comprises of two components. i) Material Price Variance. It evaluates the actual unit price paid for an item and the standard price, multiplied by the quantity purchased. ii) Material quantity variance. The difference between the actual quantity of material used in production and the standard quantity allowed for the actual output, multiplied by the standard price per unit of materials.
(1) (2) (3)
Actual Quantity Actual Quantity Standard Quantity
at actual price at standard price at standard price
(AQ x AP) (AQ x SP) (SQ x SP)
│ │ │
│ Price Variance │ Quantity Variance │
│ (1) - (2) │ (2) - (3) │
│ │ │
│
│
│
The above working can be presented with the help of the following equation.
Material Price Variance = (AQ x AP) – (AQ x SP) = AQ (AP – SP) Material Quantity Variance = (AQ x SP) - (SQ x SP) = SP (AQ – SQ)
Labour Variance
Another important variance is termed as labour variance. The labour rate variance measures any deviation from standard in the average hourly rate paid to direct labour workers. The labour efficiency variance attempts to measure the productivity of direct labour. The management, therefore, keenly watches these variances because they believe that increasing direct labour productivity is vital to reducing cost.
(1) (2) (3)
Actual Hours Actual Hours Standard Hours
of input in put allowed for actual output at actual Rate at standard rate at standard rate
(AH x AR) (AH x SR) (SH x SR)
│ │ │
│ Rate Variance │ Efficiency Variance │
│ (1) - (2) │ (2) - (3) │
│ │ │
│
│
│
The equation for the labour rate variance and labour efficiency variance is expressed as follows:
Labour Rate Variance = (AH x AR) – (AH x SR) = AH (AR - SR) Labour Efficiency Variance = (AH x SR) - (SH x SR) = SR (AH - SH)
The variable portion of manufacturing overhead can also be analyzed using the same basic formula as direct material variance and direct labour variance. The variances are, however, termed as variable overhead spending variance and variable overhead efficiency variance.
(1) (2) (3)
Actual Hours Actual Hours Standard Hours
of input in put allowed for actual output at actual Rate at standard rate at standard rate
(AH x AR) (AH x SR) (SH x SR)
│ │ │
│ Spending Variance │ Efficiency Variance │
│ (1) - (2) │ (2) - (3) │
│ │ │
│
│
│
Variable Overhead Spending Variance = (AH x AR) – (AH x SR) = AH (AR - SR) Variable Overhead Efficiency Variance = (AH x SR) - (SH x SR) = SR (AH - SH)
Other Variances (Formula):
The undernoted variances are helpful in computing variances relating to sales volume, selling price variance and variable volume variance in order assess the operating performance of an entity.
Sale Volume Variance (Actual Sales in units - Budgeted Sales in units) x Budgeted variable margin
Selling Price Variance (Actual Selling Price - Budgeted Selling Price) x Actual Units Sold
Variable Volume Variance Actual Cost per Unit - Budgeted Cost per Unit) x Actual units sold
Multiple Choice Questions
1. A basic objective of standard costing is to: a) Determine the breakeven production level. b) Control costs.
c) Eliminate the need for subjective decision by management. d) Allocate cost more accurately.
2. In standard costing standard hours allowed is a mean of measuring: a) Standard output at standard hours
d) Actual output at actual hours.
3. Material price variance is:
a) (Actual quantity – Standard quantity) x Actual price b) (Actual quantity – Standard quantity) x Standard Price c) (Actual price – Standard price) x Standard quantity d) (Actual price – Standard price) x Actual quantity
4. Labour rate variance:
a) (Actual hours – Standard hours) x Actual rate b) (Actual hours – Standard hours) x Standard rate c) (Actual rate – Standard rate) x Standard hours d) (Actual rate – Standard rate) x Actual hours
5. In standard costing when FOH are applied to the production: a) FOH applied is debited and WIP is credited
b) FOH applied is credited and WIP is debited
c) FOH control is debited and cost of goods sold is credited d) None of the above
6. Standard is an important tool for: a) Cost control
b) Pricing
c) Price regulation d) None of the above
7. Managerial cost includes the discussion on: a) Cost volume profit analysis
b) Breakeven analysis c) Both of the above two d) None of the above.
8. Internal financial control methods include: a) Internal check
b) Internal audit
c) Internal check as well as internal audit d) None of the above
9. The type of cost presented to management for elimination of a product line should be limited to:
a) Relevant costs b) Standard costs c) Controllable costs d) Conversion costs
a) Understate cost of goods manufactured in that period. b) Overstate current assets.
c) Overstate goods profit from sales in that period. d) Understate income for that period.
Understatement of work in process inventory will increase the cost of goods manufactured which in turn will increase the cost of finished goods ending inventory. An increase in cost of goods ending inventory will reduce cost of goods sold and increase the profit of the entity.
Answers :
1 (b), 2(b), 3(d), 4(d), 5(b), 6(a), 7(c), 8(c), 9(a), 10(b)(c)
Additional Multiple Choice Questions
1. Which of the following variances would be used in calling attention to possible problems in the control of spending on overhead items?
Variable Fixed Fixed
Overhead Overhead Overhead
Spending Budget Volume
Variance Variance Variance
a) No No No
b) No Yes Yes
c) Yes No No
d) Yes Yes Yes
a) Answer A b) Answer B c) Answer C d) Answer D
2. The higher the denominator level of activity:
a) The more profitable operations likely will be.
b) The less likely is the occurrence of a volume variance. c) The lower the unit product cost.
d) The higher the unit product cost.
3. An increase in denominator level of activity will:
a) Decrease the fixed portion of the predetermined overhead rate. b) Increase the fixed portion of the predetermined overhead rate. c) Decrease the variable portion of the predetermined overhead rate. d) Increase the variable portion of the predetermined overhead rate.
a) Fixed overhead budget variance. b) Fixed overhead volume variance. c) Variable overhead efficiency variance. d) Variable overhead spending variance.
5. The fresh company applies manufacturing overhead costs to products on the basis of direct labour hours. The standard cost card shows that 6 direct labour hours are required per unit of product. For August, the company budgeted to work 180,000 direct labour hours and to incur the following total manufacturing overhead costs:
Total variable overhead costs $ 198,000 Total fixed overhead costs $ 237,600
During August, the company completed 28,000 units of product, worked 172,000 direct labour hours and incurred the following total manufacturing overhead costs:
Total variable overhead costs $ 197,800 Total fixed overhead costs $ 230,600
The denominator activity in the predetermined overhead rate is 180,000 direct labour hours. The variable overhead spending variance for August is :
a) $ 8,600 F b) $ 8,600 U c) $ 13,000 F d) $ 13,000 U
6. The fresh company applies manufacturing overhead costs to products on the basis of direct labour hours. The standard cost card shows that 6 direct labour hours are required per unit of product. For August, the company budgeted to work 180,000 direct labour hours and to incur the following total manufacturing overhead costs:
Total variable overhead costs $ 198,000 Total fixed overhead costs $ 237,600
During August, the company completed 28,000 units of product, worked 172,000 direct labour hours and incurred the following total manufacturing overhead costs:
Total variable overhead costs $ 197,800 Total fixed overhead costs $ 230,600
The denominator activity in the predetermined overhead rate is 180,000 direct labour hours. The variable overhead efficiency variance for August is :
a) $ 0 b) $ 3,600F c) $ 4,400F d) $ 4,400 U
7. The fresh company applies manufacturing overhead costs to products on the basis of direct labour hours. The standard cost card shows that 6 direct labour hours are required per unit of product. For August, the company budgeted to work 180,000 direct labour hours and to incur the following total manufacturing overhead costs:
Total variable overhead costs $ 198,000 Total fixed overhead costs $ 237,600
During August, the company completed 28,000 units of product, worked 172,000 direct labour hours and incurred the following total manufacturing overhead costs:
Total variable overhead costs $ 197,800 Total fixed overhead costs $ 230,600
a) $ 7,000F b) $ 7,000 U c) $ 6,400 F d) $ 6,400 U
8. The fresh company applies manufacturing overhead costs to products on the basis of direct labour hours. The standard cost card shows that 6 direct labour hours are required per unit of product. For August, the company budgeted to work 180,000 direct labour hours and to incur the following total manufacturing overhead costs:
Total variable overhead costs $ 198,000 Total fixed overhead costs $ 237,600
During August, the company completed 28,000 units of product, worked 172,000 direct labour hours and incurred the following total manufacturing overhead costs:
Total variable overhead costs $ 197,800 Total fixed overhead costs $ 230,600
The denominator activity in the predetermined overhead rate is 180,000 direct labour hours. The fixed overhead volume variance for August is :
a) $ 8,600 U b) $ 9,960 F c) $ 9,960 U d) $ 15,840 U
Exercise 43
M/s X Company produces a single product. Variable manufacturing overhead is applied to products on the basis of direct labour hours. The standard costs for one unit of product are as follows:
Direct material 6 ounces at $0.50 per ounce $ 3
Direct labour 1.8 hours at $ 10 18
Variable manufacturing ovherad 1.8 hours at $ 5 per hr. 9
Total standard variable cost per unit $30
During June, 2000 units were produced. The costs associated with June’s operations were as follow:
Material purchased 18,000 ounces at $ 0.60 per ounce $ 10,800 Material used in production 14,000 oz
Direct labour 4,000 hours at $9.75 per hours $ 39,000
Variable manufacturing overhead costs incurred $ 20,800
Required : Compute the direct materials, direct labour and variable manufacturing overhead variances.
Direct material Variance
(1) (2) (3)
Actual Quantity Actual Quantity Standard Quantity
of input in put allowed for actual output at actual price at standard price at standard price
(AQ x AP) (AQ x SP) (SQ x SP)
18,000 x $0.60 18,000 x $0.50 12,000 x $ 0.50
= $10,800 = $ 9,000 = $ 6,000
│ │ │
│ Price Variance │ Quantity Variance │
│ (1) - (2) │ (2) - (3) │
│$10,800 – 9,000 = 1,800U │ │
│
│
│
14,000 x $ 0.50 = 7,000 │
│ │
│ │
│$ 7,000 – 6,000 = 1,000 U │
│Quantity variance │
Standard quantity = 6 ounce x 2,000 units = 12,000 ounce
Using the formula the material variance can be computed as follows:
Material price variance = AQ (AP – SP)
18,000 ($0.60 – $0.50) = $ 1,800 U
Material quantity variance = SP(AQ - SQ)
$0.50 (14,000 – 12,000) = $ 1,000 U
Note : While computing quantity variance, actual quantity consumed is used and not actual quantity purchased.
Direct Labour Variance
(1) (2) (3)
Actual Hours Actual Hours Standard Hours
at actual Rate at standard rate at standard rate
(AH x AR) (AH x SR) (SH x SR)
4,000 hrs x $ 9.75 4,000 hrs x $10.00 3,600 hrs x $ 10.00
= $39,000 = $40,000 $ 36,000
│ │ │
│ Rate Variance │ Efficiency Variance │
│ (1) - (2) │ (2) - (3) │
│ $1,000 F │ $4,000 U │ │
│
│
The formula for the labour rate variance and efficiency variance is expressed as follows:
Labour Rate Variance = AH (AR - SR)
4,000 ($9.75 - $10.00) $ 1,000 F
Labour Efficiency Variance = SR(AH - SH)
$10.00 (4,000 – 3,600) $4,000 U
Total units produced = 2,000 units Actual hours used 4,000 hrs.
Actual hours per unit 4,000/2,000 = 2 hr per unit Standard hours per unit 1.8 hrs (given)
Permissible standard hours 2,000 x 1.8 = 3,600 hrs
Variable Manufacturing Overhead Variance
(1) (2) (3)
Actual Hours Actual Hours Standard Hours
of input in put allowed for actual output at actual Rate at standard rate at standard rate
(AH x AR) (AH x SR) (SH x SR)
4,000 x $5.2 4,000 x $ 5 3,600 x $ 5
=$ 20,800 $20,000 $18,000
│ │ │
│ Spending Variance │ Efficiency Variance │
│ (1) - (2) │ (2) - (3) │
│ $ 800 U │ $ 2,000 U │
│
│
│
Using the formulas the variable manufacturing overhead variance would be computed as follows:
Variable overhead spending variance = AH (AR – SR)
Variable overhead efficiency variance = SR (AH – SH)
$ 5.00 (4,000 hrs – 3,600 hrs) = 2,000 U
Actual hours used 4,000
Variable manufacturing cost incurred $20,800
Actual variable manufacturing rate $20,800/4,000 = $5.2
Exercise 44
Wales Ice Cream Ltd. makes premium handcrafted chocolates. The owner of the company is setting up a standard cost system and has collected the following data for one of the company’s products, Chocolate Brand. This product is made with the fine white chocolate and various fillings. The data below pertain only to the white chocolate used in the product.
Material requirements, kilograms of white chocolate per dozen 0.70 kilograms Allowance for waste, kilograms of white chocolate per dozen 0.03 kilograms Allowance for rejections, kilograms of white chocolate per dozen 0.02 kilograms
Purchase price, finest grade white chocolate $ 7.50 per kilograms
Purchase discount 8% of purchase price
Shipping cost from the supplier $0.30 per kilogram
Receiving and handling cost $0.04 per kilogram
Required :
1. Determine the standard price of a kilogram of white chocolate. 2. Determine the standard quantity of white chocolate for a dozen pack. 3. Determine the standard cost of the white chocolate in a dozen pack.
Answer 44
Standard Price of a kilogram white chocolate
Material $ 7.50
Less discount @ 8% 0.60
Net material cost 6.90
Shipping cost 0.30
Receiving and handling cost 0.04
Standard Price per kg. $ 7.24
Standard Quantity for a dozen pack
Material 0.70 kg
Allowance for wastage 0.03
Allowance for rejection 0.02
Standard Quantity for a dozen pack 0.75 kg
Standard Price x Standard Quantity
$ 7.24 x $ 0.75 = $ 5.43
Exercise 45
Fuji toys Ltd. produces toys. The company has recently established a standard cost system to help control costs and has established the following standards for the manufacture of a new series of toys:
Direct materials 6 microns per toy @ $0.50 per micron Direct labour 1.3 hours per toy at $ 8 per hour
During July, the company produced 3,000 toys. Production data for the month on the toy follows:
Direct material : 25,000 microns were purchased at a cost of $ 0.48 per micron. 5,000 of these microns were still in inventory at the end of the month.
Direct labour: 4,000 direct labour hours were worked at a cost of $36,000.
Required
1. Compue the following variances for July:
a. Direct materials price and quantity variances. b. Direct labour rate and efficiency variances.
2. Prepare a brief explanation of the possible cause of each variance.
Answer 45
a. Material Price variance AQ (AP - SP)
25,000 ($0.48 – $0.50) = $ 500 F Material Quantity variance
SP (AQ – SQ)
$0.50 (20,000 – 18,000) = $ 1,000 U
Total material variance
$ 500 F - $1,000 U = $ 500 U
Note : While calculating material price variance, the entire quantity purchased is taken for computation of variance. While computing quantity variance, the quantity actually consumed is considered for computing the variance.
Standard quantity = 3,000 toys x 6 microns per toy = 18,000 microns
b. Direct labour variance AH (AR – SR)
