Question

Question 5 (14 marks)

The Mystic River Flyfishing Company designs, manufactures and retails fly-rods to fishing enthusiasts around the world via its website. Mystic River is known for its advanced materials, innovative designs and lifetime warranties against breakage. Mystic River produces three fly-rod designs that are targeted to fly fishers of different abilities: beginning (Smooth 100), intermediate (Crisp 200) and advanced (Rapid 300). The company prepared a fixed/master budget for the year 2018 shown below, assuming production and sales of 36,000 units. This level of production represents 80% of the company’s total production capacity.

Sales		$1,800,000
Cost of goods sold:
Direct materials	$648,000
Direct Labor	360,000
Indirect materials (variable)	18,000
Indirect labor (variable)	25,200
Depreciation	216,000
Salaries	108,000
Utilities (80% fixed)	64,800
Maintenance (40% variable)	39,600	1,479,600
Gross profit		$320,400
Operating expenses:
Commissions	$54,000
Advertising (fixed)	72,000
Wages (variable)	18,000
Rent	36,000
Total operating expenses		180,000
Income from operations		$140,400

However, the senior manager of the company found the company’s profitability was not as good as expected. At the end of the year 2018, the actual sales volume was 38,400 units, higher than budgeted of 36,000 units, but the income from operations was much lower than budgeted at the beginning of the year. The company’s actual activity for the year follows.

Sales (38,400 units)		$1,854,000
Cost of goods sold
Direct materials	$676,800
Direct labor	385,200
Indirect materials (variable)	23,760
Indirect labor (variable)	27,000
Depreciation	216,000
Salaries	110,400
Utilities (85% fixed)	76,800
Maintenance (40% variable)	38,400	1,554,360
Gross profit		$299,640
Operating expenses:
Commissions	$66,000
Advertising (fixed)	79,200
Wages (variable)	24,000
Rent	42,000
Total operating expenses		211,200
Income from operations		$88,440

Required:

(1) With higher than expected number of units sold, income from operations dropped dramatically, the senior manager of The Mystic River Flyfishing Company wants to find out what went wrong. He asks you, an experienced senior management accountant to prepare a flexible budget performance report that shows variable costs per unit, total fixed costs using the contribution margin format. (11 marks)

(2) Based on your answer in (1) above, please explain which top three reasons are most likely to reduce the income form operation. (3 marks)

Answer 1

1)

Flexible Budget performance report

Particulars	Amount	Amount
Sold units		38,400 units
Sales	38400 units * $50	$1920000
Less: Variable costs
Direct materials	38400* $18	$691200
Direct labor	38400*$10	$384000
Indirect materials	38400* $0.5	$19200
Indirect labor	38400* $0.7	$26880
Utilities	38400* $0.36	$13824
Maintenance	38400* $0.44	$16896
Commissions	38400* $1.83	$70272
Wages	38400* $0.67	$25728
Total variable costs	38400*$32.5	($1248000)
Contribution (Sales – Variable costs)	38400* $17.5	$672000
Less: Fixed costs
Depreciation		$216000
Salaries		$110400
Utilities		$51840
Maintenance		$23760
Advertising		$79200
Rent		$42000
Total fixed costs		($523,200)
Income from operations		$148800

*) Budgeted selling price per unit= Master budget sales/ Budgeted sales units

= $1800000/ 36000 units= $50 per units

*) Budgeted Direct materials cost per unit= Master budget cost/ Budgeted sales units= $648000/ 36000 units= $18 per unit

*) Budgeted Direct labor cost per unit= Master budget cost/ Budgeted sales units

= $360000/ 36000 units= $10 per unit

*) Budgeted Indirect materials cost per unit= Master budget cost/ Budgeted sales units = $18000/ 36000= $0.5 per unit

*) Budgeted Indirect labor cost per unit= Master budget cost/ Budgeted sales units

= 25200/ 36000 units= $0.7 per unit

*) Budgeted variable utilities cost per unit= Master budget cost/ Budgeted sales units

= (64800*20%) /36000 units= $0.36 per unit

Budgeted fixed utility cost= Total cost – Variable cost= 64800 – 20%= $51840

*)

Budgeted variable maintenance cost per unit= Master budget cost/ Budgeted sales units

= (39600*40%)/ 36000 units= $0.44 per unit

Budgeted fixed maintenance cost= Total cost – Variable cost= $39600 – 40%= $23760

*)

Budgeted commission per unit= Master budget cost/ Budgeted sales units

= $66000/ 36000 units= $1.83 per unit

*)

Budgeted wages cost per unit= Master budget cost/ Budgeted sales units

= $24000/ 36000 units= $0.67

*) Production within the relevant range. So fixed costs will same as of master budget.

*) Total variable cost per unit=

$18 +$10+$0.5+$0.7+$0.36+$0.44+$1.83+0.67= $32.5

Flexible budget variance

Particulars	Actual- Flexible	Variance
Sales	$1854000-$1920000	$66000 Unfavorable
Less: Variable costs
Direct materials	$676800-$691200	$14400 Favorable
Direct labor	$385200-$384000	$1200 Unfavorable
Indirect materials	$23760-$19200	$4560 Unfavorable
Indirect labor	$27000-$26880	$120 Unfavorable
Utilities	$11520-$13824	$2304 Favorable
Maintenance	$15360-$16896	$1536 Favorable
Commissions	$66000-$70272	$4272 Favorable
Wages	$24000-$25728	$1728 Favorable
Total variable costs	($1229640-$1248000)	($18360 Favorable)
Contribution (Sales – Variable costs)	($624360-$672000)	$47640 Unfavorable
Less: Fixed costs
Depreciation	$216000-$216000	-
Salaries	$110400-$110400	-
Utilities	$65280-$51840	$13440 Unfavorable
Maintenance	$23040-$23760	$720 Favorable
Advertising	$79200-$72000	$7200 Unfavorable
Rent	42000-36000	$6000 Unfavorable
Total fixed costs	$535920-$523200	$12720 Unfavorable
Income from operations	$88440-$148800	$60360 Unfavorable

2)

First reason is that actual selling price is lower than the budgeted. That why the actual sales revenue is lower than the budgeted and generating an unfavorable variance.

Direct materials cost generating an unfavorable variance amounting $14400. This is the next strong reason that making actual income from operation lower. Actual direct material cost is higher than the budgeted that why there is an unfavorable variance is arising.

Total fixed expenses are causing an unfavorable variance. Among fixed expenses utilities causing the highest effect. Actual fixed Utilities expense is higher than the budgeted and creating an unfavorable variance.