Question

In: Accounting

The Brown Bag company makes a two varieties of bags for its customers. The first is...

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.

Solutions

Expert Solution

Solution

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 Labor

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

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

Budget as per Activity Based Costing

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 Favorable

Material Cost

52,000*$1.50=$78,000

52,000*$2.00=$104,000

(26,000) Unfavorable

55,000*$0.50=$27,500

55,000*$0.45=$24,750

2,750 Favorable

Material Processing

($240,000/60,000 hours)*52,000 hours=$208,000

($275,000/63000 hours)*52,000 hours=$227,240

(19,240) Unfavorable

($240,000/60,000 hours)*11,000 hours=$44,000

($275,000/63000 hours)*11,000 hours=$47,760

(3,760) Unfavorable


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