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.

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

Answer 1