Question

You have recently been appointed management accountant for Rugby Coffee Mugs Pty Ltd. The company commenced its operations on 1 July 2019 manufacturing one size coffee mugs with individual club names and club logos of rugby union clubs playing in the New South Wales, Queensland, Victoria and Western Australia local rugby union competition. The company currently does not have any management accounting controls and part of your appointment involves improving the company’s manufacturing internal control systems to facilitate the projection, monitoring and if need be the taking immediate action to ensure that the company’s internal manufacturing performance is efficient thereby ensuring that the company’s profitability is maximised. Given the urgency of the situation, you have decided to propose to the company’s chief financial officer that you establish a budget and standard costing system against which actual performance will be measured in quantitative and qualitative terms. Additionally, you will prepare a static budget for the month of March 2020, subsequent to which you will prepare a flexible budget for the month of March 2020 against which the actual performance in March 2020 will be measured, and an explanation of specific variations in performance against the static and flexible budget. A report to the chief financial officer will include the following:

1. Initial memorandum explaining the key issues relating to the establishment of budgets and a standard costing system.

2. A static budget for the month of March 2020.

3. Flexible budget responding to the actual performance in the month of March 2020.

4. A table showing the variance between the actual performance and the static and flexible budgets for the month of March 2020.

5. An explanation of specific variations in actual performance against the static and flexible budgets.

PART A Required Prepare a report to the company’s chief financial officer explaining the following:

1. Four reasons for implementing a standard costing system.

2. The steps you will follow in developing a flexible budget. 3.

The key difference between a static budget and a flexible budget.

4. The arguments for and against using ideal standards.

5. The reason why the managers will find a flexible-budget analysis more informative than a static-budget analysis.

6. How might the production manager gain insight into the causes of a flexible-budget variance for direct materials?

4 PART B

You have developed the following standard costs and budget for the month of March 2020:

Average selling price per coffee mug $8.20

Direct materials - Direct materials cost per gram $0.036 -

Number of grams per coffee mug 100

Direct manufacturing labour - Direct manufacturing labour cost per hour $15.00 -

Average labour productivity rate (coffee mugs per hour) 100

Sales commission cost per coffee mug $0.72

Fixed overhead $990,000

Budgeted sales for March in units 700,000

Budgeted hours - 700,000 units / 100 units per hour 7,000

The following are the actual results for March 2020:

▪ Unit sales and production were 90% of budget.

▪ Actual average selling price per coffee mug was $8.30.

▪ Actual direct materials cost per gram was $0.039.

▪ Direct materials used amounted to 100 grams per coffee mug.

▪ Actual direct manufacturing labour cost was $15.20 per hour.

▪ Productivity dropped to 90 coffee mugs per hour.

▪ Actual sales commissions were $0.70 per coffee mug.

▪ Fixed overhead costs were $20 000 above budget.

Required Prepare a report to the company’s chief executive officer showing the following for March 2020:

1. Static-budget and actual operating profit.

2. Static-budget variance for operating profit. (1 mark)

3. Detailed flexible-budget operating profit and variance with actual results.

4. Net total flexible-budget variance for operating profit.

5. Net total sales-volume variance for operating profit.

6. Price and efficiency variances for direct materials.

7. Price and efficiency variances for direct manufacturing labour.

8. Net flexible-budget variance for direct manufacturing labour. (1 mark)

4 PART C Required: Prepare a report to the company’s chief financial officer addressing the following:

1. Identification of three possible causes of the total direct materials variance.

2. Explanation of three possible reasons for the total direct labour variance.

3. Explanation of how your variance analysis will help in continuous improvement.

4. Explanation of why might an analyst examining variances in the production area look beyond that business function for explanations of those variances?

5. Commentary on the following statement made by a plant manager: ‘Meetings with my management accountant are frustrating. All he wants to do is pin the blame on someone for the various variances he reports.’

6. Explanation of why is it important that the managers do not evaluate variances in isolation? (3marks)

Answer 1

The answer to PART A is as follows:

Answer 1:

The four reasons for implementing a standard costing system are as follows:

1. The major benefit by implementing a standard costing system for Rugby Coffee Mugs Pty Ltd. would be that it will help the company in providing a standard for each type of cost that is been occurred. Therefore the increase or decrease from such standard will help the company in realising the areas of improvement and also the best pratices followed by the company.

2. It helps the Higher Level Management in formulating a cash flow budget for the entire company. Thereby, also allowing them to take a note of expenses done by the company in different areas. This also helps the management in making further decisions, whether a certain process or machinery is beneficial to the organisation or not.

3. The benefit that Rugby Coffee will get by implementing a standard costing budget will be that the cost that will incur in the budget of the organisation as there will be a control on the different spends occurred by the lower management. Thereby, keeping the costs in control

4. The standard costing system, since takes into consideration the price of each and every component, it helps the various cost centres to receive a certain budget and also to work around the same budget.

Answer 2:

The steps while developing a flexible budget are as follows:

1. To consider the activities, cost centres and various departments for which the Flexible Budget is to be prepared.

2. To consider which are the fixed costs and which are the variable costs of the company. This would be based on the fixed costs like rent, depreciation, etc. and recurring costs like electricity, wages, overhead.

3. To base the Variable costs based on the units been produced by the company

4. To allocate these units and costs as per the cost centre, department or for the company.

Answer 3:

The key difference between a static budget and a flexible budget.

1. The major difference between a static budget and a flexible budget is the actual number of units produced or manufactured. The static budget does not take into account the number of units produced, whereas the flexbile budget takes the number of units produced as a basis of the budget.

2. The static budget does not classify the costs as per fixed and variable costs, therefore there is no classification available for the costs. Wheras, the step for formulating the flexible budget include the classification of costs, based on which the number of units are further multiplied and the end budget is formulated.

3. The static budget focuses mainly on the entire company and it is usually very difficult for to create budgets department or cost centes wise. Whereas the flexible budget as the name suggests, is very helpful for creating budget for the company or the cost centres, with very less hassle.

4. The assumption while preparing the static budget is that all the operational conditions while preparing the budget will remain unaltered.Whereas, the main feature of the flexible budget is that, it is been prepared at different operational conditions.

Answer 4:

The arguments for and against the use of ideal standards are as follows:

1. The ideal standards helps as a basis to form the company, it can act as a start point of the organisation. Also, since the standards are already defined they are not specific to the company and the industry and therefore are not recommended as they do not serve the actual purpose of the company.

2. The ideal standards since are already defined, save the company time and resources to create a specific set of standards. There is a possibility of missing out on the areas that might need attention, which might only be discovered when the specific standards are set as per the requirements of the company.

3. The ideal standards, as are available, might work as a useful tool for the company to analyse the variances taking places and help them to decrease the cost. But, since, they are already specified the do not take into account the current market scenarios which might be industry specific.