Question

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

Part A :

Flexible Budget Perfomance Report
Particulars	Fixed budget($)	Actuals ($)	Difference
Selling price per unit	50	48.281	1.719
Less - Variable Costs
Direct material	18	17.625
Direct Labor	10	10.031
Indirect material	0.5	0.619
Indirect Labor	0.7	0.703
Utilities	0.36	0.3
Maintenance	0.44	0.4
wages	0.5	0.625
Total Variable costs	30.5	30.303	0.197
Contribution	19.5	17.978
Sales units	36000	38400	-2400
Total contribution	702000	690360	11640
Less - Fixed Costs
Depreciation	216000	216000
Salaries	108000	110400
utilities	51840	65280
Maintenance	23760	23040
Commissions	54000	66000
Advertising	72000	79200
Rent	36000	42000
Total Fixed Costs	561600	601920	-40320
Income from Operations	140400	88440	51960

Part B :

Top reasons for likely reduction in Income from operation are :

• Increase in Fixed costs, fixed costs not incurred as per budgets. There is a difference of 40,320 fixed costs over & above the budgted costs
• Even though there is a decrease in Total variable cost per unit, the decrease in sale price unit resulted in Decrease in income
• Due to Decrease in Sale price, Contribution per unit decreased thus resulting in reduction in Income