Question

The Brown Bag company makes a two varieties of bags for its customers. The first is an organically created, Non-GMO, totally biodegradable bag used at a large number of Whole Foods stores and various other high end groceries. The company sells these bags for $10.00 per hundred (1 unit). The second bag is a reusable bag that sells for $5.00 each. The company currently uses a plant-wide allocation for factory overhead based upon machine hours, however, the company feels like there is something amiss since they believe the biodegradable bag should be its greatest profit center but the results of the plant-wide allocation seem to be allocating in a manner not consistent with the true allocation. The company has hired your firm to give a budget, by product type, under both the plant-wide and activity based costing method and are seeking you to explain the results and give any recommendations. They are seeking a budgeted income statement under both methods for both products.

The direct materials for the Biodegradable bags is $1.50 per hundred/per unit (please note for the purposes of presentation and internal books, the company considers 100 of these bags to be 1 unit). The cost for materials for the reusable bag is $0.50 per unit. In addition, the direct labor for the biodegradable is $1.50 per unit, whereas for the reusable it is a $1.00 per unit.

The company expects to sell 50,000 units of the biodegradable units (5,000,000 individual bags) and 50,000 of the reusable bags.

The following information has been given regarding production, factory overhead.

Activity	Budgeted Overhead	Estimated Volume
Material Handing/Processing	$240,000	60,000 Machine Hours
Production Set-ups	$64,000	20 Set-ups
Packing and Shipping	$44,000	100,000 shipments

Activity	Bio-Degradable Bags (1 unit = 100 bags)	Reusable Bags	Overall Totals for the Company
Material Handing/Processing	50,000 Machine Hours	10,000 machine Hours	60,000 Machine Hours
Production Set-ups	5 Set-ups	15 Set-ups	20 Set-ups
Packing and Shipping	50,000 Shipments	50,000 Shipments	100,000 Shipments

In addition, the company pays $0.25 sales commission per unit for the biodegradable bags and $0.50 for the reusable bags.   Last, the company has other general and administrative expenses, i.e. fixed expenses, in the amount of $40,000.

Please prepare the required income statements, analysis and explanation. For the biodegradable bags, please give in units not per bag, for the reusable use per unit which equals one bag.

After you finished your budget, the company came and reported the following, they want you to do a comparison and determine the variances and give any other items you view as important. An actual contribution margin might be helpful.

The company sold 52,000 units of the bio-bags, and 55,000 units of the reusable bags at the expected sales price.

The overall labor costs for the bio-bag per unit was $1.55 and for the reusable it was $0.90. For the direct materials, there was a bio-material shortage, so the cost per unit of the bio-bag was $2.00, whereas plastic fibers went down and the cost was $0.45 per unit.

For the variable overhead above, the material handing was actually $275,000, production and packing and shipping were the same as budgeted.

Please prepare a variance report based upon the actual versus budgeted on a flexible budget methodology.

Answer 1

Budget as per Plant Wide Costing

Particulars	Biodegradable Bags	Total- Bio	Reusable Bags	Total- Reusable
Sales	50,000 units*$10	$500,000	50,000bags*$5	$250,000
(-) Direct Material	50,000*$1.50	$75,000	50,000*0.50	$25,000
(-) Direct Labour	50,000*$1.50	$75,000	50,000*$1.00	$50,000
(-) Factory Overhead	50,000 Machine Hours*$6.47 (see calculation below)	$323,500	10,000 Machine Hours*$6.47	$64,700
(-) Sales Commission	50,000 units*$0.25	$12,500	50,000 bags*$0.50	25,000
	Income as per Plant wide costing	$14,000		$85,700

Calculation of Factory Overhead Rate :-

Total Overheads - $240,000+$64,000+$44,000+$40,000

$388,000

Total Machine Hours- 60,000 hours

Overhead Rate- $388,000/60,000 hours

$6.47/ hour

Budget as per Activity Based Costing

Particulars	Biodegradable Bags	Total- Bio	Reusable Bags	Total- Reusable
Sales	50,000 units*$10	$500,000	50,000bags*$5	$250,000
(-) Direct Material	50,000*$1.50	$75,000	50,000*0.50	$25,000
(-) Direct Labour	50,000*$1.50	$75,000	50,000*$1.00	$50,000
(-) Material Handling	50,000 Machine Hours*$4	$200,000	10,000 Machine Hours*$4	$40,000
(-) Production Setup	5 Setups*$3,200	$16,000	15 Setups*$3,200	$48,000
(-) Shipping	50,000 shipments*$0.44	$22,000	50,000 shipments*$0.44	$22,000
(-) Sales Commission	50,000 units*$0.25	$12,500	50,000 bags*$0.50	$25,000
(-) fixed expenses	50,000 units*$0.40	$20,000	50,000 bags*$0.40	$20,000
	Income as per Plant wide costing	$79,500		$20,000

Recommendation :- It is recommended to use Activity Based Costing method as it is the more logical approach for multi product companies and also it gives more logical results as compared to plant wide costing.

Flexible Budget

Particulars	Budget- Bio	Actual- Bio	Variance- Bio	Budget- Reusable	Actual- Reusable	Variance- Reusable
Sales	$520,000	$520,000	Nil	$275,000	$275,000	Nil
Labour Cost	52000*$1.50=$78,000	52000*$1.55=$80,600	(2,600) Unfavourable	55,000*$1= $55,000	55,000*$0.90=$49,500	$5,500 Favourable
Material Cost	52,000*$1.50=$78,000	52,000*$2.00=$104,000	(26,000) Unfavourable	55,000*$0.50=$27,500	55,000*$0.45=$24,750	2,750 Favourable
Material Processing	($240,000/60,000 hours)*52,000 hours=$208,000	($275,000/63000 hours)*52,000 hours=$227,240	(19,240) Unfavourable	($240,000/60,000 hours)*11,000 hours=$44,000	($275,000/63000 hours)*11,000 hours=$47,760	(3,760) Unfavourable