Question

Question 3 [Flexible Budget]

Makosah Limited deals in authentic African bitters. For the financial year 2019, the cost accountant provided the following budgeted information. At full capacity (100% level of activity), the company produces an output of 20,000 units.

purposes

[2 marks]

Direct Material (GHc)
Direct labour (GHc)
Production Overheads (GHc) Administrative Overheads (GHc) Depreciation (GHc)

Level of Activity 70% 80%

88900 101600 224000 256000 152500 160000 85000 85000 20000 20000

90%

114300
288000
167500
85000
20000

During June, the company’s activity level was anticipated to be around 85% activity level

Required:

1. Prepare a flexible budget for the anticipated activity level. [13 marks]

2. Explain the relevance of an activity variance for expenses for management decision making

[Question 3 = 15 marks]

Answer 1

Flexible budget

	Per unit	70% [ 14,000 units]	80%[ 16,000 units ]	90%[ 18,000 units ]	85% [17,000 units]
	GHc	GHc	GHc	GHc	GHc
Direct materials	6.35	88,900	101,600	114,300	107,950
Direct labor	16.00	224,000	256,000	288,000	272,000
Variable overhead
Production overhead	3.75	52,500	60,000	67,500	63,750
Marginal cost	26.10	365,400	417,600	469,800	443,700
Fixed overhead
Production overhead		100,000	100,000	100,000	100,000
Administration overhead		85,000	85,000	85,000	85,000
Depreciation		20,000	20,000	20,000	20,000
Total fixed cost		205,000	205,000	205,000	205,000
Total cost		570,400	622,600	674,800	648,700
Cost per unit		40.74	38.91	37.49	38.16

Calculation for fixed production overhead and perpetual unit cost of variable production overhead :

Let consider fixed production overhead = x

Variable production overhead per unit = y

In, 70% level of activity ,

152,500 = x + [ 14,000 X y ]

x = 152,500 - 14,000 y [ equation one ]

In 80% level of activity

160,000 = x + [ 16,000 X y]

x = 160,000 - 16,000 y [ equation two ]

Now ,we put the value of x from equation one to equation two.

We get,

152,500 - 14,000y = 160,000 - 16,000 y

2,000y = 160,000 - 152,500 = 7,500

y = 7,500/ 2,000 = 3.75 [ variable production overhead rate ]

x = 152,500 - [ 14,000 X 3.75] = 100,000 [ Fixed production overhead ]

An activity variance is really important for management decisions. It is the difference between a cost item in a static budget and a flexible budget. It depicts the differences of cost in respect to flexible budget and planning budget.