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 42,000 units. This level of production represents 80% of the company’s total production capacity.

Sales		$2,100,000
Cost of goods sold:
Direct materials	$756,000
Direct Labor	420,000
Indirect materials (variable)	21,000
Indirect labor (variable)	29,400
Depreciation	252,000
Salaries	126,000
Utilities (80% fixed)	75,600
Maintenance (40% variable)	46,200	1,726,200
Gross profit		$373,800
Operating expenses:
Commissions	$63,000
Advertising (fixed)	84,000
Wages (variable)	21,000
Rent	42,000
Total operating expenses		210,000
Income from operations		$163,800

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 44,800 units, higher than budgeted of 42,000 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 (44,800 units)		$2,163,000
Cost of goods sold
Direct materials	$789,600
Direct labor	449,400
Indirect materials (variable)	27,720
Indirect labor (variable)	31,500
Depreciation	252,000
Salaries	128,800
Utilities (85% fixed)	89,600
Maintenance (40% variable)	44,800	1,813,420
Gross profit		$349,580
Operating expenses:
Commissions	$77,000
Advertising (fixed)	92,400
Wages (variable)	28,000
Rent	49,000
Total operating expenses		246,400
Income from operations		$ 103,180

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