CHAPTER 7

QUESTIONS

1. A budget is a planning device that helps the factory overhead budget, cost of goods sold
company set goals and a gauge against budget, selling and administrative expenses
which the results can be measured. budget, and the budgeted income state-
2. The successful use of budgets in a business ment. Financial budgets include the cash
setting helps to assure the maximum effi- budget, capital expenditures budget, and
cient use of resources and the most favor- pro-forma financial statements including the
able results possible. balance sheet, retained earnings statement,
3. The general principles of budgeting have and statement of cash flows.
several requirements: 7. The sales budget, or sales forecast, must be
• Management must clearly define its prepared before the other operating budg-
objectives. ets. The number of units to be sold will have
• These goals must be realistic and pos- a direct effect on the planning of the produc-
sible to attain. tion budget. Also affected will be budgets for
administrative and selling expenses, cash,
• Development of the budget must care- receivables, and capital expenditures.
fully consider global economic develop-
8. Demand software takes numerous vari-
ments, the general business and indus-
ables, such as projected economic condi-
try-specific climate, and consumer and
tions in the industry and in the economy as
supplier behavior that may influence
a whole, estimates of currency exchange
sales and costs.
rates, and predicted weather patterns, into
• There must be a plan to analyze actual consideration when forecasting sales for the
operating results and compare them to sales budget.
the budget.
9. It is important to have front-line managers
• The budget must be flexible enough so participate in the budgeting process be-
that it can be modified in the light of cause they are the ones closest to the indi-
changing conditions. vidual sales territories or production depart-
• Responsibility for forecasting costs and ments and, therefore, should be most famil-
accountability for actual results must be iar with the operations. Also, if they partici-
assigned to specific members of the or- pate in formulating the budget, they have
ganization. more of a vested interest in meeting or beat-
4. A continuous budget “rolls forward” so that ing the budget numbers.
as one month or quarter is completed a new 10. Not necessarily. The production plan must
month or quarter is added to the end of the take into consideration not only the number
budget, resulting in a budget that is always of units to be sold but also the inventory pol-
one year in advance. Advocates of continu- icy, the number of units in the year’s begin-
ous budgeting argue that it causes manag- ning inventory, and the number of units re-
ers to have a more long-term perspective, quired for the ending inventory.
rather than just concentrating on the next 11. a. If a company’s sales fluctuate greatly
month or quarter. during the year, the advantage it gains
5. Zero-based budgeting assumes a “zero dol- from a stable production policy is that it
lar” starting point for budget allocations, re- can maintain a stable work force
quiring managers to justify all budget dollars throughout the year. Thus, the problems
requested for the coming period. This differs of labor turnover—such as hiring and
from the traditional approach to budgeting training new employees, the use of un-
where the starting point is the current year’s skilled workers, and costly unem-
allocated amounts. ployment insurance premiums—are
6. Answers will vary. Operating budgets in- greatly reduced.
clude the sales budget, production budget,
direct materials budget, direct labor budget,

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Chapter 07

A disadvantage of a stable production 17. A flexible budget is better than a master

policy with fluctuating sales is that the budget for comparing actual results to
company must have storage facilities budgeted expectations because the variable
that would be unused during some part items such as revenue and certain costs will
of the year, with the related costs of up- differ in total when the actual level of pro-
keep, insurance, and taxes. Another duction or sales volume achieved is different
disadvantage is that the company would than the planned master budget level.
have a considerable amount of capital 18. It is important to distinguish between vari-
tied up in finished goods, with the prob- able costs and fixed costs when preparing a
lem of spoilage or possible obsolescence. flexible budget because fixed costs will re-
b. The advantage of a stable inventory pol- main the same in total within a relevant
icy is that it reduces the need for stor- range of activity, whereas variable costs will
age to a minimum and releases capital change in total depending upon the volume
for other purposes. level achieved.
A disadvantage is that fluctuating pro- 19. The concept of relevant range is important
duction requires manufacturing facilities when preparing a flexible budget because
to handle peak loads, but these would the assumptions made regarding unit selling
prices, variable costs per unit, and total fixed
be idle part of the time. The company
costs are only applicable within the relevant
would also be faced with the problems
range.
of employee turnover and feelings of ill
20. Yes, as illustrated in the flexible budget in
will when it attempts to adjust the labor
Fig. 7-13, you may have a favorable vari-
force to different levels of production.
ance for sales because the actual selling
12. The direct materials budget, direct labor
price charged was greater than the selling
budget, and factory overhead budget can be
price budgeted for, given the actual sales
prepared subsequent to the preparation of
volume achieved.
the production budget.
However, the actual sales revenue earned
13. “Kaizen” means continuous improvement
may be less than the master budget sales
and kaizen budgeting is the practice of
figure because the number of units sold was
building continuous improvement into the
less than the sales volume used in prepar-
budget numbers, such as tightening labor
ing the master budget.
time or materials quantity allowable per unit
of production. 21. a. Theoretical capacity represents the
14. Information from the sales budget, cost of maximum number of units that could be
goods sold budget, and selling and adminis- manufactured with the completely effi-
cient use of all facilities and personnel.
trative expenses budget is needed to pre-
pare the budgeted income statement. b. Practical capacity is the level of pro-
15. Using “Web-based budgeting” employees duction that provides complete utili-
can input the data for which they are re- zation of all facilities and personnel, but
sponsible directly into the master budget at allows for some idle time due to operat-
the budget website. This precludes employ- ing interruptions or inefficiencies.
ees from having to prepare individual c. Normal capacity is the level of pro-
spreadsheets for their areas of responsibil- duction that will meet normal require-
ity, which then have to be uploaded and co- ments of an ordinary sales demand over
ordinated by the budget staff. a period of years.
16. A flexible budget is a plan that shows what
would happen to costs under varying sets of
conditions. Whereas the master budget is
prepared for a single level of activity, the
flexible budget is prepared for a range of ac-
tivities within which the firm may operate.

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 Chapter 07

22. Yes. Normal capacity, or 100% of capacity, historical costs that have been adjusted for
usually represents the most efficient use of any distorting items and future trends and
the present facilities under normal operating possible changes. These combined esti-
conditions with some allowance for operat- mated overhead expenses are then divided
ing interruptions. It is possible, however, for by the standard number of units to be pro-
a factory to manufacture more units than duced to determine the standard cost per
normal by working overtime, increasing ma- unit.
chinery or workers, and adding facilities. 25. It is important that the standard cost which a
service department was expected to incur,
23. No. The unit cost for factory overhead would
rather than the actual expenses which were in-
be determined at the 100% level of normal curred, be used to charge service department
capacity, and this unit cost would be costs to producing departments, so that extra
charged to Work in Process, regardless of costs resulting from the inefficient operation of
the number of units manufactured in a given service departments are not passed on to the
month. producing departments.
24. Factory overhead for the standard, or nor-
mal, level of production is an estimation.
The calculation must take into consideration

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Chapter 07

EXERCISES

E7-1 Macro Manufacturing Co.

Sales Budget
For the Month Ended June 30, 20--
Unit Sales Unit Selling Total
Region Volume Price Sales
East 15,000 $25 $375,000
West 5,000 $25 125,000
Total 20,000 $500,000

Macro Manufacturing Co.

Production Budget
For the Month Ended June 30, 20--
Units
Sales (from sales budget) ................................................ 20,000
Plus desired ending inventory, June 30 ........................... 2,000
Total................................................................................. 22,000
Less estimated beginning inventory, June 1 .................... 3,000
Total production ............................................................... 19,000

E7-2 F. Pollard Manufacturing Co.

a. Production Budget
For the Month Ended March 31, 20--
Units to be sold ................................................................ 20,000
Plus desired ending inventory, March 31 ......................... 1,000
Total................................................................................. 21,000
Less estimated beginning inventory, March 1 .................. 3,000
Total production ............................................................... 18,000

b. F. Pollard Manufacturing Co.

Direct Materials Budget
For the Month Ended March 31, 20--
Material A Material B
Materials required for production of 18,000 units .. 18,000 gal. 18,000 lbs.
Plus desired ending inventory, March 31 .............. 1,000 1,000
Total...................................................................... 19,000 gal. 19,000 lbs.
Less estimated beginning inventory, March 1 ....... 500 1,000
Total quantity to be purchased.............................. 18,500 gal. 18,000 lbs.
Unit price............................................................... $2 $1
Total direct materials purchases .......................... $ 37,000 $ 18,000

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 Chapter 07

E7-3

a. Barnes Manufacturing Co.

Production Budget
For the Month Ended October 31, 20--

Units
Sales ................................................................................ 45,000
Plus desired ending inventory, October 31....................... 4,000
Total ................................................................................. 49,000
Less estimated beginning inventory, October 1 ............... 5,000
Total production ............................................................... 44,000

b. Barnes Manufacturing Co.

Direct Labor Budget
For the Month Ended October 31, 20--

Cutting Assembly Total

Hours required for production:
44,000 units x 0.25................................. 11,000
44,000 units x 0.50................................. 22,000
Hourly rate.............................................. $14 $12
Total direct labor cost ............................. $154,000 $264,000 $418,000

E7-4 Crest Hills Manufacturing Co.

Cost of Goods Sold Budget
For the Year Ended December 31, 2016

Finished goods inventory, Jan. 1 ...................... $ 19,300

Direct materials inventory, Jan. 1...................... $ 31,000
Direct materials purchases ............................... 854,000
Direct materials available.................................. $ 885,000
Less direct materials inventory, Dec. 31 ........... 26,000
Cost of direct materials used ............................ $ 859,000
Direct labor ....................................................... 539,500
Factory overhead .............................................. 818,000
Cost of goods manufactured............................. 2,216,500
Cost of goods available for sale ........................ $ 2,235,800
Less finished goods inventory, Dec. 31 ............ 22,400
Cost of goods sold ............................................ $ 2,213,400

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Chapter 07

E7-5 MacLaren Manufacturing Co.

Cost of Goods Sold Budget
For the Year Ended December 31, 2016

Finished goods inventory, Jan. 1 ....................... $ 13,900

Direct materials inventory, Jan. 1 ...................... $ 36,000
Direct materials purchases ................................ 548,000
Direct materials available................................... $ 584,000
Less direct materials inventory, Dec. 31 ............ 23,000
Cost of direct materials used ............................. $ 561,000
Direct labor ........................................................ 395,500
Factory overhead............................................... 481,000
Cost of goods manufactured.............................. 1,437,500
Cost of goods available for sale......................... $ 1,451,400
Less finished goods inventory, Dec. 31 ............. 24,200
Cost of goods sold............................................. $ 1,427,200

E7-6 Roman Company

Budgeted Income Statement
For the Year Ended December 31, 2016

Sales................................................................... $ 1,222,700
Cost of goods sold .............................................. 727,300
Gross profit ......................................................... $ 495,400
Selling and administrative expenses................... 244,500
Income from operations ...................................... $ 250,900
Income tax (30%)................................................ 75,270
Net income.......................................................... $ 175,630

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 Chapter 07

E7-7

a. Per unit items are as follows:

Sales = $100,000/10,000 units = $10

Direct materials = $20,000/10,000 units = $2
Direct labor = $15,000/10,000 units = $1.50
Variable factory overhead = $10,000/10,000 units = $1

Budgeted totals at the 8,000-unit level:

Sales (8,000 × $10) .................................................. $80,000

Direct materials (8,000 × $2) .................................... $16,000
Direct labor (8,000 × $1.50) ..................................... $12,000
Variable factory overhead (8,000 × $1) .................... $ 8,000
Fixed factory overhead (same at all levels within relevant range) $25,000

b. Budgeted totals at the 12,000-unit level:

Sales (12,000 × $10) ................................................ $120,000

Direct materials (12,000 × $2) .................................. $ 24,000
Direct labor (12,000 × $1.50) ................................... $ 18,000
Variable factory overhead (12,000 × $1) .................. $ 12,000
Fixed factory overhead (same at all levels within relevant range) $ 25,000

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Chapter 07

E7-8

$ per unit 14,000 units 15,000 units 16,000 units

Sales ..................... $75.00 $1,050,000 $1,125,000 $1,200,000

Less variable
costs:

Direct materials ..... $24.00 336,000 360,000 384,000

Direct labor ............ 7.50 105,000 112,500 120,000

Variable factory
overhead ............... 15.00 210,000 225,000 240,000

Variable selling
and administrative
expenses ............... 12.00 168,000 180,000 192,000

Total variable
costs………………. $58.50 $ 819,000 $ 877,500 $ 936,000

Contribution
margin ................... $16.50 $ 231,000 $ 247,500 $ 264,000

Less fixed costs:

Fixed factory
overhead ............... 75,000 75,000 75,000

Fixed selling and

administrative
expenses ............... 80,000 80,000 80,000

Total fixed
costs ..................... $ 155,000 $ 155,000 $ 155,000

Operating
income .................. $ 76,000 $ 92,500 $ 109,000

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 Chapter 07

E7-9

Cortez Manufacturing Inc.

Performance Report
For the Month Ended May 31, 20—

Budget Actual
(5,000 units) (5,000 units) Variance

Sales ................................. $125,000 $120,000 $ 5,000 U

Less variable costs:

Direct materials ................. $ 25,000 $ 26,000 $ 1,000 U

Direct labor ........................ 15,000 14,000 1,000 F

Variable factory
overhead ........................... 20,000 25,500 5,500 U

Variable selling and

administrative expenses.... 5,000 5,500 500 U

Total variable costs ........... $ 65,000 $ 71,000 $ 6,000 U

Contribution margin ........... $ 60,000 $ 49,000 $11,000 U

Fixed costs:

Fixed factory overhead...... $ 25,000 $ 26,750 $ 1,750 U

Fixed selling and

administrative expenses.... 20,000 19,800 200 F

Total fixed costs ................ $ 45,000 $ 46,550 $ 1,550 U

Operating income ............. $ 15,000 $ 2,450 $12,550 U

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Chapter 07

E7-10
Rivers Manufacturing Inc.
Performance Report
For the Month Ended May 31, 20--

Budget Actual
(6,000 units) (6,000 units) Variance

Sales $120,000 $125,000 $5,000 F

Less variable costs:

Direct materials ................ 30,000 32,000 2,000 U

Direct labor ....................... 18,000 19,000 1,000 U

Variable factory
overhead .......................... 24,000 26,500 2,500 U

Variable selling and

administrative expenses... 6,000 6,500 500 U

Total variable costs .......... $ 78,000 $ 84,000 $6,000 U

Contribution margin .......... $ 42,000 $ 41,000 $1,000 U

Less fixed costs:

Fixed factory overhead..... 20,000 18,750 1,250 F

Fixed selling and

administrative
expenses .......................... 15,000 14,500 500 F

Total fixed costs ............... $ 35,000 $ 33,250 $1,750 F

Operating income ............. $ 7,000 $ 7,750 $ 750 F

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 Chapter 07

E7-11
a. Calculation of factory overhead allowed: 5,000 5,200 4,500
Units Units Units
(100%) (104%) (90%)
Fixed costs ................................................. $ 2,500 $ 2,500 $ 2,500
Variable costs............................................. 7,500 7,800* 6,750**

Total factory overhead ............................... $ 10,000 $ 10,300 $ 9,250

b. Factory overhead per unit .......................... $2.00 $1.98 $2.06

*$7,500 × 5,200/5,000 or $7,500/5,000 × 5,200

**$7,500 × 4,500/5,000 or $7,500/5,000 × 4,500

E7-12
a. Calculation of factory overhead allowed: 7,500 7,875 6,750
Units Units Units
(100%) (105%) (90%)
Fixed costs ................................................. $ 10,000 $10,000 $10,000
Variable costs............................................. 15,000 15,750* 13,500**

Total factory overhead ............................... $ 25,000 $ 25,750 $23,500

b. Factory overhead per unit .......................... $3.33 $3.27 $3.48

*$15,000 × 7,875/7,500 or $15,000/7,500 × 7,875

**$15,000 × 6,750/7,500 or $15,000/7,500 × 6,750

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Chapter 07

E7-13
Calculation of factory overhead allowed:
Standard Month1 Month2
8,000 7,200 8,400
Units Units Units
Fixed overhead ........................................... $ 4,000* $ 4,000 $ 4,000
Variable overhead ($1.50 per unit).............. 12,000 10,800 12,600

Total............................................................ $ 16,000 $ 14,800 $ 16,600

* $0.50 × 8,000

Month 1 Month 2

Budget Actual Variance Budget Actual Variance

$14,800 $14,700 $100 $16,600 $17,400 $800

Favorable Unfavorable
E7-14

Calculation of factory overhead allowed:

Standard Month1 Month2
10,000 9,500 11,000
Units Units Units
Fixed overhead ........................................... $ 10,000* $ 10,000 $ 10,000
Variable overhead ($2.00 per unit).............. 20,000 19,000 22,000

Total............................................................ $ 30,000 $ 29,000 $ 32,000

* $1.00 × 10,000

Month 1 Month 2

Budget Actual Variance Budget Actual Variance

$29,000 $30,500 $1,500 $32,000 $31,750 $250

Unfavorable Favorable

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 Chapter 07

PROBLEMS
P7-1

a. Minimus Manufacturing Company

Production Budget
For the Month Ended May 31, 2016

Sales…………………………………… 40,000

Plus desired end. inv., 5/31 ............... 6,000

Total…………………………………… 46,000

Less estimated beg. inv.,5/1 ............ 2,000

Total production……………………… 44,000

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Chapter 07

P7-1 Continued

b. Minimus Manufacturing Company

Direct Materials Budget
For the Month Ended May 31, 2016

Material X Material Y
Quantities required for production:

44,000 units × 1 gal……………… 44,000

44,000 units × 1 lb……………….. 44,000

Plus desired end. Inv., 5/31 ........ 2,000 2,000

Total……………………………….. 46,000 46,000

Less estimated beg. Inv.,5/1……. 1,000 2,000

Total quantity to be purchased…. 45,000 44,000

Unit price………………………….. × $4 × $2

Total direct materials purchases… $180,000 $88,000

c. Minimus Manufactng Company

Direct Labor Budget
For the Month Ended May 31, 2016

Forming Dept. Finishing Dept.

Hours required for production:

44,000 units × 0.50 hrs……………. 22,000

44,000 units × 1.00 hrs………….. 44,000

Hourly rate………………………… × $18 × $15

Total direct labor cost……………. $396,000 $660,000

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 Chapter 07

P7-2
1.
King Tire Company
Sales Budget
For the Year Ended December 31, 2016

Unit Unit Total

Product Sales Volume Selling Price Sales
Passenger car tires... 120,000 $65 $ 7,800,000
Truck tires................. 25,000 $200 5,000,000
Total....................... 145,000 $ 12,800,000

2.
King Tire Company
Production Budget
For the Year Ended December 31, 2016

Units
Passenger Truck
Car Tires Tires
Sales (from sales budget) .............................. 120,000 25,000
Plus desired ending inventory, Dec. 31 .......... 6,000 2,500
Total ............................................................... 126,000 27,500
Less estimated beginning inventory, Jan. 1 ... 5,000 2,000
Total production ............................................. 121,000 25,500

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Chapter 07

P7-2 Continued

3. King Tire Company

Direct Materials Budget
For the Year Ended December 31, 2016

Direct Materials Total

Rubber Steel Belts
(lbs.) (lbs.)
Quantities required for production:
Passenger car tires:
121,000 × 10 lbs ..................................... 1,210,000
121,000 × 1.5 lbs. ................................... 181,500
Truck tires:
25,500 × 30 lbs. ...................................... 765,000
25,500 × 4 lbs. ........................................ 102,000
Plus desired ending inventory, Dec. 31......... 60,000 6,000
Total.............................................................. 2,035,000 289,500
Less estimated beginning inventory, Jan. 1 .. 75,000 7,000
Total quantity to be purchased...................... 1,960,000 282,500
Unit price....................................................... $2 $3
Total direct materials purchases ................... $3,920,000 $847,500 $4,767,500

4. King Tire Company

Direct Labor Budget
For the Year Ended December 31, 2016

Department Total
Molding Finishing
Hours required for production:
Passenger car tires:
121,000 × 0.10 .................. 12,100
121,000 × 0.05 .................. 6,050
Truck tires:
25,500 × 0.25 .................... 6,375
25,500 × 0.15 .................... 3,825
Total ........................................ 18,475 9,875
Hourly rate............................... $15 $13
Total direct labor cost .............. $ 277,125 $ 128,375 $405,500

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 Chapter 07

P7-2 Concluded

5. King Tire Company

Factory Overhead Budget
For the Year Ended December 31, 2016

Indirect materials ..................................... $198,500

Indirect labor............................................ 213,200
Depreciation of building and equipment .. 157,500
Power and light........................................ 122,900
Total factory overhead cost ..................... $692,100

6. King Tire Company

Cost of Goods Sold Budget
For the Year Ended December 31, 2016

Finished goods inventory, Jan. 1....................... $ 326,478

Direct materials inventory, Jan. 11 ..................... $ 171,000
Direct materials purchases................................ 4,767,500
Total direct materials available .......................... $4,938,500
Less direct materials inventory, Dec. 312 .......... 138,000
Cost of direct materials used............................. $4,800,500
Direct labor........................................................ 405,500
Factory overhead .............................................. 692,100
Cost of goods manufactured ............................. 5,898,100
Cost of goods available for sale ........................ $6,224,578
Less finished goods inventory, December 31.... 400,510
Cost of goods sold............................................. $ 5,824,068
1
Rubber: 75,000 lbs. × $2 $150,000
Steel belts: 7,000 lbs. × $3 21,000
$171,000
2
Rubber: 60,000 lbs. × $2 $120,000
Steel belts: 6,000 lbs. × $3 18,000
$138,000

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Chapter 07

P7-3

1. King Tire Company

Selling and Administrative Expenses Budget
For the Year Ended December 31, 2016

Selling expenses:
Advertising expense................................ $ 942,000
Sales salaries expense ........................... 868,000
Travel expense ....................................... 443,000
Total selling expenses............................. $2,253,000
Administrative expenses:
Office salaries expense............................ $ 821,000
Officers’ salaries expense ........................ 661,000
Office rent expense.................................. 125,000
Office supplies expense ........................... 45,500
Telephone and fax expense..................... 33,500
Total administrative expenses.................. 1,686,000
Total selling and administrative expenses ..... $3,939,000

2. King Tire Company

Budgeted Income Statement
For the Year Ended December 31, 2016

Sales..................................................... $ 12,800,000
Cost of goods sold ................................ 5,824,068
Gross profit ........................................... $ 6,975,932
Selling and administrative expenses ..... 3,939,000
Income from operations ........................ $ 3,036,932
Income tax ............................................ 1,214,773
Net income............................................ $ 1,822,159

P7-4

1.
Scottsdale Styles Inc.
Sales Budget
For the Year Ended December 31, 2016

Unit Unit Total

Product Sales Volume Selling Price Sales
Tables 30,000 $175 $ 5,250,000
Chairs 120,000 $75 9,000,000
Total 150,000 $ 14,250,000

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 Chapter 07

P7-4 Continued

2.
Scottsdale Styles, Inc.
Production Budget
For the Year Ended December 31, 2016

Units
Tables Chairs

Sales (from sales budget) .............................. 30,000 120,000

Plus desired ending inventory, Dec. 31 .......... 1,500 6,000
Total ............................................................... 31,500 126,000
Less estimated beginning inventory, Jan. 1 ... 1,000 4,000
Total production ............................................. 30,500 122,000

3. Scottsdale Styles, Inc.

Direct Materials Budget
For the Year Ended December 31, 2016

Direct Materials Total

Binding
Rattan cane
(yd.) (yd.)
Quantities required for production:
Tables:
30,500 × 10 yd. ....................................... 305,000
30,500 × 6 yd.. ........................................ 183,000
Chairs:
122,000 × 6 yd.. ........................................ 732,000
122,000 × 3 yd.. ........................................ 366,000
Plus desired ending inventory, Dec. 31 ........ 51,000 25,500
Total.............................................................. 1,088,000 574,500
Less estimated beginning inventory, Jan. 1 .. 34,000 17,000
Total quantity to be purchased...................... 1,054,000 557,500
Unit price....................................................... $5 $3
Total direct materials purchases ................... $5,270,000 $1,672,500 $6,942,500

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Chapter 07

P7-4 Continued

4. Scottsdale Styles, Inc.

Direct Labor Budget
For the Year Ended December 31, 2016

Department Total
Assembly Finishing
Hours required for production:
Tables:
30,500 × 0.5 ........................ 15,250
30,500 × 0.25 ...................... 7,625
Chairs:
122,000 × 0.25 .................. 30,500
122,000 × 0.10 .................. 12,200
Total ........................................ 45,750 19,825
Hourly rate............................... $15 $13
Total direct labor cost .............. $ 686,250 $ 257,725 $943,975

5. Scottsdale Styles, Inc.

Factory Overhead Budget
For the Year Ended December 31, 2016

Indirect materials ..................................... $ 98,500

Indirect labor ........................................... 132,200
Depreciation of building and equipment .. 57,500
Power and light ....................................... 92,200
Total factory overhead cost ..................... $380,400

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 Chapter 07

P7-4 Concluded

6. Scottsdale Styles, Inc.

Cost of Goods Sold Budget
For the Year Ended December 31, 2016

Finished goods inventory, Jan. 1....................... $ 240,000

Direct materials inventory, Jan. 11 ..................... $ 221,000
Direct materials purchases................................ 6,942,500
Total direct materials available .......................... $7,163,500
Less direct materials inventory, Dec. 312 .......... 331,500
Cost of direct materials used............................. $ 6,832,000
Direct labor........................................................ 943,975
Factory overhead .............................................. 380,400
Cost of goods manufactured ............................. 8,156,375
Cost of goods available for sale ........................ $8,396,375
Less finished goods inventory, December 31.... 360,000
Cost of goods sold............................................. $8,036,375
1
Rattan…. 34,000 lbs. × $5 $170,000
Binding cane 17,000 lbs. × $3 51,000
$221,000
2
Rattan….. 51,000 lbs. x $5 $255,000
Binding cane 25,500 lbs. x $3 76,500
$331,500

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Chapter 07

P7-5

1. Scottsdale Styles, Inc.

Selling and Administrative Expenses Budget
For the Year Ended December 31, 2016

Selling expenses:
Advertising expense................................ $ 429,000
Sales salaries expense ........................... 688,000
Travel expense ....................................... 244,000
Total selling expenses............................. $1,361,000
Administrative expenses:
$ 281,000
Office salaries expense............................
166,000
Officers’ salaries expense ........................
105,000
Office rent expense..................................
25,500
Office supplies expense ...........................
13,500
Telephone and fax expense.....................
591,000
Total administrative expenses..................
Total selling and administrative expenses ..... $1,952,000

2. Scottsdale Styles, Inc.

Budgeted Income Statement
For the Year Ended December 31, 2016

Sales..................................................... $ 14,250,000
Cost of goods sold ................................ 8,036,375
Gross profit ........................................... $ 6,213,625
Selling and administrative expenses ..... 1,952,000
Income from operations ........................ $ 4,261,625
Income tax ............................................ 1,278,488
Net income............................................ $ 2,983,137

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 Chapter 07

P7-6

29,000 units 31,000 units

Sales ($150 per unit)............................... $4,350,000 $4,650,000

Variable expenses:

Direct materials:

Lumber ($20 per unit) ............................. $ 580,000 $ 620,000

Paint ($4 per unit) ................................... 116,000 124,000

Direct labor:

Cutting ($3.75 per unit) ........................... 108,750 116,250

Assembly ($2.40 per unit) ....................... 69,600 74,400

Painting ($1.50 per unit).......................... 43,500 46,500

Variable factory overhead

($4.18 per unit) ....................................... 121,220 129,580

Variable selling and administrative

expenses ($25.79 per unit) ..................... 747,910 799,490

Total variable expense............................ $1,786,980 $1,910,220

Contribution margin…………………….. $2,563,020 $2,739,780

Total fixed expenses:

Fixed factory overhead ........................... $ 151,760 $ 151,760

Fixed selling and administrative………. 773,825 773,825

Total fixed expenses……………………. $ 925,585 $ 925,585

Operating income……………………… $1,637,435 $1,814,195

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Chapter 07

P7-7
1.
Leisure Exteriors, Inc.
Performance Report
For the Month Ended May 2016

Budgeted Actual
(31,000 units) (31,000 units) Variance

Sales ($150 per unit) .................... $4,650,000 $4,800,000 $150,000 F

Variable expenses:
Direct materials:
Lumber ($20 per unit) ................... $ 620,000 $ 633,000 $ 13,000 U
Paint ($4 per unit) ......................... 124,000 127,500 3,500 U
Direct labor:
Cutting ($3.75 per unit)................. 116,250 115,200 1,050 F
Assembly ($2.40 per unit)............. 74,400 75,300 900 U
Paint ($1.50 per unit) .................... 46,500 47,100 600 U
Variable factory overhead
($4.18 per unit) ............................. 129,580 137,655 8,075 U

Variable selling and admin.

expenses ($25.79 per unit)........... 799,490 777,400 22,090 F

Total variable expense ................. $1,910,220 $1,913,155 $ 2,935 U

Contribution margin ...................... $2,739,780 $2,886,845 $147,065 F

Fixed expenses:

Fixed factory overhead ................. $ 151,760 $ 154,435 $ 2,675 U

Fixed selling and administrative 773,825 765,800 8,025 F
Total fixed expenses……………. $ 925,585 $ 920,235 $ 5,350 F

Operating income ......................... $1,814,195 $1,966,610 $152,415 F

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 Chapter 07

P7-7 Continued

2. The master budget operating income at the 30,000 unit level was $1,725,815,
whereas the actual operating income at the 31,000 unit level was $1,966,610. This
difference of $240,795 was caused mostly by the difference between actual sales
revenue and master budget sales revenue--- selling 1,000 units (31,000 – 30,000)
more than budgeted and selling the units at an average selling price of $154.84
($4,800,000 / 31,000) as compared to the budgeted selling price of $150 per unit.

3. Its cost control was not especially good. The total variable expenses, which are the
ones that the company has the most control over, were $2,935 unfavorable. Most of
the variable manufacturing expenses were unfavorable, whereas the variable selling
expenses were favorable.

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Chapter 07

P7-8

1.
Leisure Exteriors, Inc.
Performance Report
For the Month Ended May 31, 2016

Budgeted (29,000 units) Actual (29,000 units) Variance

Sales ($150 per unit)……... $4,350,000 $4,200,000 $150,000 U
Variable expenses:
Direct materials:
Lumber ($20 per unit)…….. 580,000 565,000 15,000 F
Paint ($4 per unit)………… 116,000 121,000 5,000 U
Direct labor:
Cutting ($3.75 per unit)…... 108,750 110,000 1,250 U
Assembly ($2.40 per unit).. 69,600 71,200 1,600 U
Painting ($1.50 per unit)…. 43,500 44,600 1,100 U
Variable factory overhead
($4.18 per unit)……………. 121,220 122,250 1,030 U
Variable selling and admin-
istrative expense ($25.79
per unit)……………………. 747,910 741,300 6,610 F
Total variable expense $1,786,980 $1,775,350 $ 11,630 F
Contribution margin………. $2,563,020 $2,424,650 $138,370 U
Fixed expenses:
Fixed factory overhead…… 151,760 154,435 2,675 U
Fixed selling and adminis-
trative expense……………. 773,825 770,200 3,625 F
Total fixed expense……….. 925,585 924,635 950 F
Operating income…………. $1,637,435 $1,500,015 $137,420 U

2. The master budget operating income at the 30,000-unit level was $1,725,815,
whereas the actual operating income at the 29,000-unit level was $1,500,515. This
$225,300 difference was caused mostly by selling 1,000 units fewer (30,000 –
29,000) than the master budget called for and selling the units at an average selling
price of $144.83 ($4,200,000/29,000) rather than at the budgeted selling price of
$150 per unit.

3. Given the level that it operated at, the company’s control of variable expenses was
quite good. The total variable expenses, which are the ones that the company has
the most control over, were $11,630 favorable. This was mostly due to the large fa-
vorable variances for lumber and variable selling expenses.

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 Chapter 07

P7-9

1. Factory Overhead Cost Budget

Percent of normal capacity ....................................... 80% 90% 110%
Number of units......................................................... 4,000 4,500 5,500
Number of standard direct labor hours...................... 16,000 18,000 22,000
Budgeted factory overhead:
Fixed cost:
Depreciation on building and machinery.......... $ 1,200 $ 1,200 $ 1,200
Taxes on building and machinery .................... 500 500 500
Insurance on building and machinery .............. 500 500 500
Superintendent’s salary ................................... 3,000 3,000 3,000
Supervisors’ salaries ....................................... 4,600 4,600 4,600
Maintenance wages......................................... 2,000 2,000 2,000
Total fixed cost ............................................ $11,800 $11,800 $11,800
Variable cost *:
Repairs ($0.02 / direct labor hour) ................... $ 320 $ 360 $ 440
Maintenance supplies ($0.015 / dlh)................ 240 270 330
Other supplies ($0.01 / dlh) ............................. 160 180 220
Payroll taxes ($0.04 / dlh) ................................ 640 720 880
Small tools ($0.015 / dlh)................................. 240 270 330
Total variable cost ....................................... $ 1,600 $ 1,800 $ 2,200
Total factory overhead cost....................................... $13,400 $13,600 $14,000
* The variable cost per direct labor hour was determined by dividing the amount of each
variable cost at normal capacity by 20,000 direct labor hours.

The predetermined factory overhead rate is $2.76 per unit ($13,800 ÷ 5,000 units) or
$0.69 per direct labor hour ($13,800 ÷ 20,000 hours) at all levels, because the prede-
termined overhead rate is based on normal capacity.

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Chapter 07

P7-9 Continued
2. Factory Overhead Cost Budget
Percent of normal capacity ........................................ 80% 90% 110%
Number of units ......................................................... 4,000 4,500 5,500
Budgeted factory overhead:
Fixed cost:
Taxes on building and machinery..................... $ 500 $ 500 $ 500
Insurance on building and machinery............... 500 500 500
Superintendent’s salary.................................... 3,000 3,000 3,000

Total fixed cost ............................................. $ 4,000 $ 4,000 $ 4,000

Semivariable cost:
Depreciation of building and machinery ........... $ 1,200 $ 1,200 $ 1,300*
Supervisors’ salaries ........................................ 4,600 4,600 6,600**
Maintenance wages ......................................... 1,167*** 2,000 2,000
Repairs............................................................. 200**** 360 440
Total semivariable cost................................. $ 7,167 $ 8,160 $ 10,340
Variable cost:

Other supplies .................................................. $ 160 $ 180 $ 220

Payroll taxes..................................................... 640 720 880
Small tools........................................................ 240 270 330
Maintenance supplies....................................... 240 270 330
Total variable cost ........................................ $ 1,280 $ 1,440 $ 1,760
Total factory overhead cost ....................................... $12,447 $13,600 $16,100

* $1,200 + ($12,000/120 months) = $1,300

** $4,600 + ($24,000/12 months) = $6,600
*** $2,000 - ($10,000/12 months) = $1,167
**** ½ × $400

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 Chapter 07

P7-10

1. Factory Overhead Cost Budget

Percent of normal capacity ....................................... 80% 90% 110%
Number of units......................................................... 8,000 9,000 11,000
Number of standard direct labor hours...................... 24,000 27,000 33,000
Budgeted factory overhead:
Fixed cost:
Depreciation on building and machinery.......... $ 1,800 $ 1,800 $ 1,800
Taxes on building and machinery .................... 750 750 750
Insurance on building and machinery .............. 800 800 800
Superintendent’s salary ................................... 4,400 4,400 4,400
Supervisors’ salaries ....................................... 6,200 6,200 6,200
Maintenance wages......................................... 1,500 1,500 1,500
Total fixed cost ............................................ $15,450 $ 15,450 $15,450

Variable cost:
Repairs ($0.02 / direct labor hour) ................... $ 480 $ 540 $ 660
Maintenance supplies ($0.015 / dlh)................ 360 405 495
Other supplies ($0.01 / dlh) ............................. 240 270 330
Payroll taxes ($0.04 / dlh) ................................ 960 1,080 1,320
Small tools ($0.02 / dlh)................................... 480 540 660
Total variable cost ....................................... $ 2,520 $ 2,835 $ 3,465
Total factory overhead cost....................................... $17,970 $ 18,285 $18,915

* The variable cost per direct labor hour was determined by dividing the amount of each
variable cost at normal capacity by 30,000 direct labor hours.

The predetermined factory overhead rate is $1.86 per unit ($18,600 ÷ 10,000 units) or
$0.62 per direct labor hour ($18,600 ÷ 30,000 hours) at all levels, because the prede-
termined overhead rate is based on normal capacity.

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Chapter 07

P7-10 Continued
2. Factory Overhead Cost Budget
Percent of normal capacity ........................................ 80% 90% 110%
Number of units ......................................................... 8,000 9,000 11,000
Budgeted factory overhead:
Fixed cost:
Taxes on building and machinery..................... $ 750 $750 $ 750
Insurance on building and machinery............... 800 800 800
Superintendent’s salary.................................... 4,400 4,400 4,400

Total fixed cost ............................................. $ 5,950 $5,950 $5,950

Semi-variable/fixed cost:
Depreciation of building and machinery ........... $ 1,800 $ 1,800 $ 1,950*
Supervisors’ salaries ........................................ 6,200 6,200 8,450**
Maintenance wages ......................................... 750*** 1,500 1,500
Repairs............................................................. 300**** 540 660

Total semi-variable/fixed cost........................... $ 9,050 $10,040 $12,560

Variable cost:
Other supplies ................................................. $ 240 $ 270 $ 330
Payroll taxes..................................................... 960 1,080 1,320
Small tools........................................................ 480 540 660
Maintenance supplies ........................................ 360 405 495
Total variable cost ........................................ $ 2,040 $ 2,295 $ 2,805
Total factory overhead cost ....................................... $17,040 $ 18,285 $ 21,315

* $1,800 + ($18,000 / 120 months) = $1,950

** $6,200 + ($27,000 / 12 months) = $8,450
*** $1,500 - ($9,000/12 months) = $750
**** ½ × $600

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 Chapter 07

P7-11

1. Total factory overhead per unit.............................................................. $ 32

Variable factory overhead per unit ........................................................ $ 24*
Fixed factory overhead per unit............................................................. 8*
Total factory overhead per unit.......................................................... $ 32
2. Variable factory overhead rate per direct labor hour
($24 ÷ 4 direct labor hours per unit) .................................................. $6
Fixed factory overhead rate per direct labor hour
($8 ÷ 4 direct labor hours per unit) .................................................... $2

3. Total fixed factory overhead ($2 × 2,400 direct labor hours) or

($8 × 600 units) ................................................................................. $4,800
* ratio of variable costs to fixed costs of 3:1; therefore:
Variable costs = ¾ × $32 = $24
Fixed costs = ¼ × $32 = $8

P7-12

1. Total factory overhead per unit.............................................................. $ 24

Variable factory overhead per unit ........................................................ $ 16*
Fixed factory overhead per unit............................................................. 8*
Total factory overhead per unit.......................................................... $ 24
2. Variable factory overhead rate per direct labor hour
($16 ÷ 2 direct labor hours per unit) .................................................. $8
Fixed factory overhead rate per direct labor hour
($8 ÷ 2 direct labor hours per unit) .................................................... $4

3. Total fixed factory overhead ($4 × 2,700 direct labor hours) or

($8 × 1,350 units) ............................................................................ $10,800
* ratio of variable costs to fixed costs of 2:1; therefore:
Variable costs = 2/3 × $24 = $16
Fixed costs = 1/3 × $24 = $8

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Chapter 07

MINI-CASE
1. No, the production manager is not accurate when he says that manufacturing did a
good job controlling costs. This is an “apples to oranges” comparison because mas-
ter budget unit volume was 50,000, whereas actual results were based on the pro-
duction and sale of 45,000 units. One would expect the cost variances to be favor-
able, given this type of comparison.
2.
Flexible budget 45,000 50,000 55,000
per unit Units Units Units
Sales $ 25.00 $1,125,000 $1,250,000 $1,375,000

Less variable expenses:

Direct materials.................. $ 4.50 $ 202,500 $ 225,000 $ 247,500

Direct labor ........................ 3.75 168,750 187,500 206,250

Variable factory overhead.. 2.25 101,250 112,500 123,750

Variable selling and

administrative expenses .... 1.50 67,500 75,000 82,500

Total variable expense....... $ 12.00 $ 540,000 $ 600,000 $ 660,000

Contribution margin ........... $ 13.00 $ 585,000 $ 650,000 $ 715,000

Less fixed expenses:

Fixed factory overhead

expense ............................. $ 100,000 $ 100,000 $ 100,000

Fixed selling and

administrative expenses .... 150,000 150,000 150,000

Total fixed expenses.......... $ 250,000 $ 250,000 $ 250,000

Income from operations ..... $ 335,000 $ 400,000 $ 465,000

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 Chapter 07

MINI-CASE Continued
3.
Montevideo Manufacturing Inc.
Performance Report
For the Month Ended May 31, 2016
Actual Flexible
Flexible Results Budget
Budget (45,000 (45,000
per Unit units) units) Variance
Sales.................................... $ 25.00 $1,125,000 $1,125,000 -0-

Less variable expenses:

Direct materials .................... $ 4.50 $ 212,500 $ 202,500 $10,000 U

Direct labor .......................... 3.75 175,750 168,750 7,000 U

Variable factory overhead .... 2.25 110,250 101,250 9,000 U

Variable selling and

administrative expenses ...... 1.50 70,500 67,500 3,000 U
Total variable expense......... $ 12.00 $ 569,000 $ 540,000 $29,000 U

Contribution margin.............. $ 13.00 $ 556,000 $ 585,000 $29,000 U

Less fixed expenses:

Fixed factory overhead

expense ............................. $ 95,000 $ 100,000 $ 5,000 F
Fixed selling and
administrative expenses .... 160,000 $ 150,000 10,000 U
Total fixed expense............ $ 255,000 $ 250,000 $ 5,000 U

Income from operations ..... $ 301,000 $ 335,000 $34,000 U

4. Manufacturing did not do a good job controlling costs. The variances for direct
materials, direct labor, and variable factory overhead totaled $26,000 unfavorable.
The variance for fixed factory overhead was $5,000 favorable, but that was
probably due to a budgeting misestimate.

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Chapter 07

MINI-CASE Concluded
5. The accountant’s responsibilities, using the IMA Statement of Ethical Professional
Practice include:
Under “Competence”: (3.) Provide decision support information and recommenda-
tions that are accurate, clear, concise, and timely.
Under “Credibility”: (1.) Communicate information fairly and objectively, (2.) Dis-
close all relevant information that could reasonably be expected to influence an
intended user’s understanding of the reports, analyses, or recommendations.

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