Chapter 4: Profit Planning

Glossary
Budget A detailed plan for the future that is usually expressed in formal quantitative terms.

Budget committee A group of key managers who are responsible for overall budgeting
policy and for coordinating the preparation of the budget.

Cash budget A detailed plan showing how cash resources will be acquired and used over a
specific time period.

Continuous budget A 12-month budget that rolls forward one month as the current month
is completed.

Control The process of gathering feedback to ensure that a plan is being properly executed
or modified as circumstances change.

Direct labor budget A detailed plan that shows the direct labor-hours required to fulfill
the production budget.

Direct materials budget A detailed plan showing the amount of raw materials that must
be purchased to fulfill the production budget and to provide for adequate inventories

Ending finished goods inventory budget A budget showing the dollar amount of unsold
finished goods inventory that will appear on the ending balance sheet.

Manufacturing overhead budget A detailed plan showing the production costs, other
than direct materials and direct labor, that will be incurred over a specified time period.

Master budget A number of separate but interdependent budgets that formally lay out the
company’s sales, production, and financial goals and that culminates in a cash budget,
budgeted income statement, and budgeted balance sheet.

Merchandise purchases budget A detailed plan used by a merchandising company that

shows the amount of goods that must be purchased from suppliers during the period.

Participative budget See Self-imposed budget.

Perpetual budget See Continuous budget.

Planning Developing goals and preparing budgets to achieve those goals.

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Production budget A detailed plan showing the number of units that must be produced
during a period in order to satisfy both sales and inventory needs.

Responsibility accounting A system of accountability in which managers are held

responsible for those items of revenue and cost—and only those items—over which they
can exert significant control. The managers are held responsible for differences between
budgeted and actual results.

Sales budget A detailed schedule showing expected sales expressed in both dollars and
units.

Self-imposed budget A method of preparing budgets in which managers prepare their own
budgets. These budgets are then reviewed by higher-level managers, and any issues are
resolved by mutual agreement.

Selling and administrative expense budget A detailed schedule of planned expenses that
will be incurred in areas other than manufacturing during a budget period.

EXERCISE 4–1 Schedule of Expected Cash Collections [LO2]

Midwest Products is a wholesale distributor of leaf rakes. Thus, peak sales occur in August
of each year as shown in the company’s sales budget for the third quarter, given below:

July August September Total

Budgeted sales (all on account) . . . . . $600,000 $900,000 $500,000 $2,000,000

From past experience, the company has learned that 20% of a month’s sales are collected
in the month of sale, another 70% are collected in the month following sale, and the
remaining 10% are collected in the second month following sale. Bad debts are negligible
and can be ignored. May sales totaled $430,000, and June sales totaled $540,000.

Required:

1. Prepare a schedule of expected cash collections from sales, by month and in total, for the
third quarter.

2. Assume that the company will prepare a budgeted balance sheet as of September 30.
Compute the accounts receivable as of that date.

EXERCISE 4–2 Production Budget [LO3]

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Crystal Telecom has budgeted the sales of its innovative mobile phone over the next four
months as follows:

Sales in Units

July . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . 30,000

August . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,000

September . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000

October . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000

The company is now in the process of preparing a production budget for the third quarter.
Past experience has shown that end-of-month finished goods inventories must equal 10%
of the next month’s sales. The inventory at the end of June was 3,000 units.

Required:

Prepare a production budget for the third quarter showing the number of units to be
produced each month and for the quarter in total.

EXERCISE 4–3 Direct Materials Budget [LO4]

Micro Products, Inc., has developed a very powerful electronic calculator. Each calculator
requires three small “chips” that cost $2 each and are purchased from an overseas supplier.
Micro Products has prepared a production budget for the calculator by quarters for Year 2
and for the first quarter of Year 3, as shown below:

Year 2 Year 3

First Second Third Fourth First

Budgeted production, in calculators . . . . 60,000 90,000 150,000 100,000 80,000

The chip used in production of the calculator is sometimes hard to get, so it is necessary to
carry large inventories as a precaution against stockouts. For this reason, the inventory of
chips at the end of a quarter must equal 20% of the following quarter’s production needs. A
total of 36,000 chips will be on hand to start the first quarter of Year 2

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Required:

Prepare a direct materials budget for chips, by quarter and in total, for Year 2. At the
bottom of your budget, show the dollar amount of purchases for each quarter and for the
year in total.

EXERCISE 4–4 Direct Labor Budget [LO5]

The production manager of Junnen Corporation has submitted the following forecast of
units to be produced for each quarter of the upcoming fiscal year.

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Units to be produced . . . . . . 5,000 4,400 4,500 4,900

Each unit requires 0.40 direct labor-hours and direct labor-hour workers are paid $11 per
hour.

Required:

1. Construct the company’s direct labor budget for the upcoming fiscal year, assuming that
the direct labor workforce is adjusted each quarter to match the number of hours required
to produce the forecasted number of units produced.

2. Construct the company’s direct labor budget for the upcoming fiscal year, assuming that
the direct labor workforce is not adjusted each quarter. Instead, assume that the company’s
direct labor workforce consists of permanent employees who are guaranteed to be paid for
at least 1,800 hours of work each quarter. If the number of required direct labor-hours is
less than this number, the workers are paid for 1,800 hours anyway. Any hours worked in
excess of 1,800 hours in a quarter are paid at the rate of 1.5 times the normal hourly rate
for direct labor.

EXERCISE 4–5 Manufacturing Overhead Budget [LO6]

The direct labor budget of Krispin Corporation for the upcoming fiscal year includes the
following budgeted direct labor-hours.

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Budgeted direct labor-hours . . . . . 5,000 4,800 5,200 5,400

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The company’s variable manufacturing overhead rate is $1.75 per direct labor-hour and the
company’s fixed manufacturing overhead is $35,000 per quarter. The only noncash item
included in fixed manufacturing overhead is depreciation, which is $15,000 per quarter.

Required:

1. Construct the company’s manufacturing overhead budget for the upcoming fiscal year.

2. Compute the company’s manufacturing overhead rate (including both variable and fixed
manufacturing overhead) for the upcoming fiscal year. Round off to the nearest whole cent.

EXERCISE 4–6 Selling and Administrative Expense Budget [LO7]

The budgeted unit sales of Haerve Company for the upcoming fiscal year are provided
below:

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Budgeted unit sales . . . . . . . . . . . 12,000 14,000 11,000 10,000

The company’s variable selling and administrative expenses per unit are $2.75. Fixed
selling and administrative expenses include advertising expenses of $12,000 per quarter,
executive salaries of $40,000 per quarter, and depreciation of $16,000 per quarter. In
addition, the company will make insurance payments of $6,000 in the 2nd Quarter and
$6,000 in the 4th Quarter. Finally, property taxes of $6,000 will be paid in the 3rd Quarter.

Required:

Prepare the company’s selling and administrative expense budget for the upcoming fiscal
year.

EXERCISE 4–7 Cash Budget [LO8]

Forest Outfitters is a retailer that is preparing its budget for the upcoming fiscal year.
Management has prepared the following summary of its budgeted cash flows:

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

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 Total cash receipts . . . . . . . . . . . . . $340,000 $670,000 $410,000 $470,000

Total cash disbursements . . . . . . . . $530,000 $450,000 $430,000 $480,000

The company’s beginning cash balance for the upcoming fiscal year will be $50,000. The
company requires a minimum cash balance of $30,000 and may borrow any amount
needed from a local bank at a quarterly interest rate of 3%. The company may borrow any
amount at the beginning of any quarter and may repay its loans, or any part of its loans, at
the end of any quarter. Interest payments are due on any principal at the time it is repaid.

Required:

Prepare the company’s cash budget for the upcoming fiscal year.

EXERCISE 4–8 Budgeted Income Statement [LO9]

Seattle Cat is the wholesale distributor of a small recreational catamaran sailboat.

Management has prepared the following summary data to use in its annual budgeting
process:

Budgeted unit sales . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . 380

Selling price per unit . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,850

Cost per unit . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . $1,425

Variable selling and administrative expenses (per unit) . . . . . . . . . . . . . .. . . $85

Fixed selling and administrative expenses (per year) . . . . . . . . . . . . . . . . . . . $105,000

Interest expense for the year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $11,000

Required:

Prepare the company’s budgeted income statement using an absorption income statement
format as shown in Schedule 9.

EXERCISE 4–9 Budgeted Balance Sheet [LO10]

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The management of Academic Copy, a photocopying center located on University Avenue,
has compiled the following data to use in preparing its budgeted balance sheet for next
year:

Ending Balances

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . .?

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . $6,500

Supplies inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,100

Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . $28,000

Accumulated depreciation . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . $9,000

Accounts payable . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . .. . . . $1,900

Common stock . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . $4,000

Retained earnings . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . ?

The beginning balance of retained earnings was $21,000, net income is budgeted to be
$8,600, and dividends are budgeted to be $3,500.

Required:

Prepare the company’s budgeted balance sheet.

EXERCISE 4–10 Sales and Production Budgets [LO2, LO3]

The marketing department of Graber Corporation has submitted the following sales
forecast for the upcoming fiscal year.

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Budgeted unit sales . . . . . . . . 16,000 15,000 14,000 15,000

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The selling price of the company’s product is $22.00 per unit. Management expects to
collect 75% of sales in the quarter in which the sales are made, 20% in the following
quarter, and 5% of sales are expected to be uncollectible. The beginning balance of
accounts receivable, all of which is expected to be collected in the first quarter, is $66,000.

The company expects to start the first quarter with 3,200 units in finished goods inventory.
Management desires an ending finished goods inventory in each quarter equal to 20% of
the next quarter’s budgeted sales. The desired ending finished goods inventory for the
fourth quarter is 3,400 units.

Required:

1. Prepare the company’s sales budget and schedule of expected cash collections.

2. Prepare the company’s production budget for the upcoming fiscal year.

EXERCISE 4–11 Direct Materials and Direct Labor Budgets [LO4, LO5]

The production department of Priston Company has submitted the following forecast of
units to be produced by quarter for the upcoming fiscal year.

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Units to be produced . . . . . . . . 6,000 7,000 8,000 5,000

In addition, the beginning raw materials inventory for the 1st Quarter is budgeted to be
3,600 pounds and the beginning accounts payable for the 1st Quarter is budgeted to be
$11,775.

Each unit requires three pounds of raw material that costs $2.50 per pound. Management
desires to end each quarter with a raw materials inventory equal to 20% of the following
quarter’s production needs. The desired ending inventory for the 4th Quarter is 3,700
pounds. Management plans to pay for 70% of raw material purchases in the quarter
acquired and 30% in the following quarter.

Each unit requires 0.50 direct labor-hours and direct labor-hour workers are paid $12 per
hour.

Required:

1. Prepare the company’s direct materials budget and schedule of expected cash
disbursements for purchases of materials for the upcoming fiscal year.

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2. Prepare the company’s direct labor budget for the upcoming fiscal year, assuming that
the direct labor workforce is adjusted each quarter to match the number of hours required
to produce the forecasted number of units produced.

EXERCISE 4–12 Direct Labor and Manufacturing Overhead Budgets [LO5, LO6]

The Production Department of Harveton Corporation has submitted the following forecast
of units to be produced by quarter for the upcoming fiscal year.

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Units to be produced . . . . . . . . . . . 16,000 15,000 14,000 15,000

Each unit requires 0.80 direct labor-hours and direct labor-hour workers are paid $11.50
per hour.

In addition, the variable manufacturing overhead rate is $2.50 per direct labor-hour. The
fixed manufacturing overhead is $90,000 per quarter. The only noncash element of
manufacturing overhead is depreciation, which is $34,000 per quarter.

Required:

1. Prepare the company’s direct labor budget for the upcoming fiscal year, assuming that
the direct labor workforce is adjusted each quarter to match the number of hours required
to produce the forecasted number of units produced.

2. Prepare the company’s manufacturing overhead budget.

EXERCISE 4–13 Production and Direct Materials Budgets [LO3, LO4]

Tonga Toys manufactures and distributes a number of products to retailers. One of these
products, Playclay, requires three pounds of material A135 in the manufacture of each unit.
The company is now planning raw materials needs for the third quarter—July, August, and
September. Peak sales of Playclay occur in the third quarter of each year. To keep
production and shipments moving smoothly, the company has the following inventory
requirements:

a. The finished goods inventory on hand at the end of each month must be equal to 5,000
units plus 30% of the next month’s sales. The finished goods inventory on June 30 is
budgeted to be 17,000 units.

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b. The raw materials inventory on hand at the end of each month must be equal to one-half
of the following month’s production needs for raw materials. The raw materials inventory
on June 30 for material A135 is budgeted to be 64,500 pounds.

c. The company maintains no work in process inventories.

A sales budget for Playclay for the last six months of the year follows.

Budgeted Sales

in Units

July . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . .. . . 40,000

August . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . 50,000

September . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . 70,000

October. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . 35,000

November . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . 20,000

December. . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000

Required:

1. Prepare a production budget for Playclay for the months July, August, September, and
October.

2. Examine the production budget that you prepared. Why will the company produce more
units than it sells in July and August and less units than it sells in September and October?

3. Prepare a direct materials budget showing the quantity of material A135 to be purchased
for July, August, and September and for the quarter in total.

EXERCISE 4–14 Schedules of Expected Cash Collections and Disbursements;

Income Statement; Balance Sheet [LO2, LO4, LO9, LO10]

Colerain Corporation is a merchandising company that is preparing a profit plan for the
third quarter of the calendar year. The company’s balance sheet as of June 30 is shown
below:

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 Colerain Corporation

Balance Sheet

June 30

Assets

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 80,000

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . 126,000

Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52,000

Plant and equipment, net of depreciation. . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . 200,000

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . .
$458,000

Liabilities and Stockholders’ Equity

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . $ 61,100

Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300,000

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96,900

Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$458,000

Colerain’s managers have made the following additional assumptions and estimates:

1. Estimated sales for July, August, September, and October will be $200,000, $220,000,
210,000, and $230,000, respectively.

2. All sales are on credit and all credit sales are collected. Each month’s credit sales are
collected 30% in the month of sale and 70% in the month following the sale. All of the
accounts receivable at June 30 will be collected in July.

3. Each month’s ending inventory must equal 40% of the cost of next month’s sales. The
cost of goods sold is 65% of sales. The company pays for 50% of its merchandise
purchases in the month of the purchase and the remaining 50% in the month following the
purchase. All of the accounts payable at June 30 will be paid in July.

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4. Monthly selling and administrative expenses are always $65,000. Each month $5,000 of
this total amount is depreciation expense and the remaining $60,000 relates to expenses
that are paid in the month they are incurred.

5. The company does not plan to borrow money or pay or declare dividends during the
quarter ended September 30. The company does not plan to issue any common stock or
repurchase its own stock during the quarter ended September 30.

Required:

1. Prepare a schedule of expected cash collections for July, August, and September. Also
compute total cash collections for the quarter ended September 30th.

2. a. Prepare a merchandise purchases budget for July, August, and September. Also
compute total merchandise purchases for the quarter ended September 30th.

b. Prepare a schedule of expected cash disbursements for merchandise purchases for July,
August, and September. Also compute total cash disbursements for merchandise purchases
for the quarter ended September 30th.

3. Prepare an income statement for the quarter ended September 30th. Use the absorption
format shown in Schedule 9.

4. Prepare a balance sheet as of September 30th.

EXERCISE 4–15 Cash Budget Analysis [LO8]

A cash budget, by quarters, is shown on the following page for a retail company (000
omitted). The company requires a minimum cash balance of $5,000 to start each quarter.

Quarter

1 2 3 4 Year

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 Cash balance, beginning . . . . . . . . . . . . . . . . . . $ 9 $? $? $? $?

Add collections from customers . . . . . . . . . . . . . ? ? 125 ? 391

Total cash available . . . . . . . . . . . . . . . . . . . . . . 85 ? ? ? ?

Less disbursements:

Purchases of inventory . . . . . . . . . . . . . . . . . . 40 58 ? 32 ?

Operating expenses . . . . . . . . . . . . . . . . . . . . ? 42 54 ? 180

Equipment purchases . . . . . . . . . . . . . . . . . . . 10 8 8 ? 36

Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2 2 2 ?

Total disbursements . . . . . . . . . . . . . . . . . . . . . . ? 110 ? ? ?

Excess (defi ciency) of cash available over

disbursements. . . . . . . . . . . . . . . . . . . . . . . . . (3) ? 30 ? ?

Financing:

Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . ? 20 — — ?

Repayments (including interest)*. . . . . . . . . . . — — (?) (7) (?)

Total fi nancing . . . . . . . . . . . . . . . . . . . . . . . . . . ? ? ? ? ?

Cash balance, ending . . . . . . . . . . . . . . . . . . . . $ ? $? $? $? $?

*Interest will total $4,000 for the year.

PROBLEM 4–16 Schedules of Expected Cash Collections and Disbursements [LO2,

LO4, LO8]

Calgon Products, a distributor of organic beverages, needs a cash budget for September.
The following information is available:

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a. The cash balance at the beginning of September is $9,000.

b. Actual sales for July and August and expected sales for September are as follows:

July August September

Cash sales. . . . . . . . . . . . . . . . . $ 6,500 $ 5,250 $ 7,400

Sales on account . . . . . . . . . . . . 20,000 30,000 40,000

Total sales. . . . . . . . . . . . . . . . . . $26,500 $35,250 $47,400

Sales on account are collected over a three-month period as follows: 10% collected in the
month of sale, 70% collected in the month following sale, and 18% collected in the second
month following sale. The remaining 2% is uncollectible.

c. Purchases of inventory will total $25,000 for September. Twenty percent of a month’s
inventory purchases are paid for during the month of purchase. The accounts payable
remaining from August’s inventory purchases total $16,000, all of which will be paid in
September.

d. Selling and administrative expenses are budgeted at $13,000 for September. Of this
amount, $4,000 is for depreciation.

Equipment costing $18,000 will be purchased for cash during September, and dividends
totaling $3,000 will be paid during the month.

f. The company maintains a minimum cash balance of $5,000. An open line of credit is
available from the company’s bank to bolster the cash balance as needed.

Required:

1. Prepare a schedule of expected cash collections for September.

2. Prepare a schedule of expected cash disbursements for inventory purchases for

September.

3. Prepare a cash budget for September. Indicate in the financing section any borrowing
that will be needed during September. Assume that any interest will not be paid until the
following month.

PROBLEM 4–17 Cash Budget with Supporting Schedules [LO2, LO4, LO8]

Janus Products, Inc., is a merchandising company that sells binders, paper, and other
school supplies. The company is planning its cash needs for the third quarter. In the past,
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Janus Products has had to borrow money during the third quarter to support peak sales of
back-to-school materials, which occur during August. The following information has been
assembled to assist in preparing a cash budget for the quarter:

a. Budgeted monthly absorption costing income statements for July–October are as

follows:

July August September October

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $40,000 $70,000 $50,000 $45,000

Cost of goods sold . . . . . . . . . . . . . . . . . . . . . ….24,000 42,000 30,000 27,000

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . ….16,000 28,000 20,000 18,000

Selling and administrative expenses:

Selling expense . . . . . . . . . . . . . . . . . . . . . . ……. 7,200 11,700 8,500 7,300

Administrative expense* . . . . . . . . . . . . . . . . ……5,600 7,200 6,100 5,900

Total selling and administratire expenses . . . . …12,800 18,900 14,600 13,200

Net operating income . . . . . . . . . . . . . . . . . . . ….$3,200 $ 9,100 $5,400 $ 4,800

*Includes $2,000 depreciation each month.

b. Sales are 20% for cash and 80% on credit.

c. Credit sales are collected over a three-month period with 10% collected in the month of
sale, 70% in the month following sale, and 20% in the second month following sale. May
sales totaled $30,000, and June sales totaled $36,000.

d. Inventory purchases are paid for within 15 days. Therefore, 50% of a month’s inventory
purchases are paid for in the month of purchase. The remaining 50% is paid in the
following month. Accounts payable for inventory purchases at June 30 total $11,700.

e. The company maintains its ending inventory levels at 75% of the cost of the
merchandise to be sold in the following month. The merchandise inventory at June 30 is
$18,000.

f. Land costing $4,500 will be purchased in July.

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g. Dividends of $1,000 will be declared and paid in September.

h. The cash balance on June 30 is $8,000; the company must maintain a cash balance of at
least this amount at the end of each month.

i. The company has an agreement with a local bank that allows it to borrow in increments
of $1,000 at the beginning of each month, up to a total loan balance of $40,000. The
interest rate on these loans is 1% per month, and for simplicity, we will assume that interest
is not compounded. The company would, as far as it is able, repay the loan plus
accumulated interest at the end of the quarter.

Required:

1. Prepare a schedule of expected cash collections for July, August, and September and for
the quarter in total.

2. Prepare the following for merchandise inventory:

a.A merchandise purchases budget for July, August, and September.

b. A schedule of expected cash disbursements for merchandise purchases for July, August,
and September and for the quarter in total.

3. Prepare a cash budget for July, August, and September and for the quarter in total.

PROBLEM 4–18 Cash Budget with Supporting Schedules; Changing Assumptions

[LO2, LO4, LO8]

Refer to the data for Janus Products, Inc., in Problem 8–17 . The company’s president is
interested in knowing how reducing inventory levels and collecting accounts receivable
sooner will impact the cash budget. He revises the cash collection and ending inventory
assumptions as follows:

1. Sales continue to be 20% for cash and 80% on credit. However, credit sales from July,
August, and September are collected over a three-month period with 25% collected in the
month of sale, 60% collected in the month following sale, and 15% in the second month
following sale. Credit sales from May and June are collected during the third quarter using
the collection percentages specified in Problem 8–17 .

2. The company maintains its ending inventory levels for July, August, and September at
25% of the cost of merchandise to be sold in the following month. The merchandise
inventory at June 30 remains $18,000 and accounts payable for inventory purchases at June
30 remains $11,700.

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All other information from Problem 8–17 that is not referred to above remains the same.

Required:

1. Using the president’s new assumptions in (1) above, prepare a schedule of expected cash
collections for July, August, and September and for the quarter in total.

2. Using the president’s new assumptions in (2) above, prepare the following for
merchandise inventory:

a. A merchandise purchases budget for July, August, and September.

b. A schedule of expected cash disbursements for merchandise purchases for July, August,
and September and for the quarter in total.

3. Using the president’s new assumptions, prepare a cash budget for July, August,
September,and for the quarter in total.

4. Prepare a brief memorandum for the president explaining how his revised assumptions
affect the cash budget.

PROBLEM 4–19 Integration of Sales, Production, and Direct Materials Budgets

[LO2, LO3, LO4]

Crydon, Inc., manufactures an advanced swim fin for scuba divers. Management is now
preparing detailed budgets for the third quarter, July through September, and has
assembled the following information to assist in preparing the budget:

a. The Marketing Department has estimated sales as follows for the remainder of the year
(in pairs of swim fins):

The selling price of the swim fins is $50 per pair.

July . . . . . . . . . . . . . . . . . . .6,000 October. . . . . . . . . . . . . . . . 4,000

August . . . . . . . . . . . . . . . . 7,000 November . . . . . . . . . . . . . . 3,000

September . . . . . . . . . . . . . 5,000 December. . . . . . . . . . . . . . 3,000

b. All sales are on account. Based on past experience, sales are expected to be collected in
the following pattern:

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 40% in the month of sale

50% in the month following sale

10% uncollectible

The beginning accounts receivable balance (excluding uncollectible amounts) on July 1

will be $130,000.

c. The company maintains finished goods inventories equal to 10% of the following
month’s sales. The inventory of finished goods on July 1 will be 600 pairs.

d. Each pair of swim fins requires 2 pounds of geico compound. To prevent shortages, the
company would like the inventory of geico compound on hand at the end of each month to
be equal to 20% of the following month’s production needs. The inventory of geico
compound on hand on July 1 will be 2,440 pounds.

e. Geico compound costs $2.50 per pound. Crydon pays for 60% of its purchases in the
month of purchase; the remainder is paid for in the following month. The accounts payable
balance for geico compound purchases will be $11,400 on July 1.

Required:

1. Prepare a sales budget, by month and in total, for the third quarter. (Show your budget in
both pairs of swim fins and dollars.) Also prepare a schedule of expected cash collections,
by month and in total, for the third quarter.

2. Prepare a production budget for each of the months July through October.

3. Prepare a direct materials budget for geico compound, by month and in total, for the
third quarter. Also prepare a schedule of expected cash disbursements for geico compound,
by month and in total, for the third quarter.

PROBLEM 4–20 Cash Budget; Income Statement; Balance Sheet [LO2, LO4, LO8,
LO9, LO10]

The balance sheet of Phototec, Inc., a distributor of photographic supplies, as of May 31 is

given below:

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 Phototec, Inc.

Balance Sheet

May 31

Assets

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . ….. $ 8,000

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...72,000

Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...30,000

Buildings and equipment, net of depreciation . . . . . . . . . . . . . . . . . . . . .. . . . . . ..500,000

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . ..$610,000

Liabilities and Stockholders’ Equity

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 90,000

Note payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . …. 15,000

Capital stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . …420,000

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . ……85,000

Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$610,000

The company is in the process of preparing a budget for June and has assembled the
following data:

a. Sales are budgeted at $250,000 for June. Of these sales, $60,000 will be for cash; the
remainder will be credit sales. One-half of a month’s credit sales are collected in the month
the sales are made, and the remainder is collected the following month. All of the May 31
accounts receivable will be collected in June.

b. Purchases of inventory are expected to total $200,000 during June. These purchases will
all be on account. Forty percent of all inventory purchases are paid for in the month of
purchase; the remainder are paid in the following month. All of the May 31 accounts
payable to suppliers will be paid during June.

c. The June 30 inventory balance is budgeted at $40,000.

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d. Selling and administrative expenses for June are budgeted at $51,000, exclusive of
depreciation. These expenses will be paid in cash. Depreciation is budgeted at $2,000 for
the month.

e. The note payable on the May 31 balance sheet will be paid during June. The company’s
interest expense for June (on all borrowing) will be $500, which will be paid in cash.

f. New warehouse equipment costing $9,000 will be purchased for cash during June.

g. During June, the company will borrow $18,000 from its bank by giving a new note
payable to the bank for that amount. The new note will be due in one year.

Required:

1. Prepare a cash budget for June. Support your budget with a schedule of expected cash
collections from sales and a schedule of expected cash disbursements for inventory
purchases.

2. Prepare a budgeted income statement for June. Use the absorption costing income
statement format as shown in Schedule 9.

3. Prepare a budgeted balance sheet as of June 30.

PROBLEM 4–21 Schedule of Expected Cash Collections; Cash Budget [LO2, LO8]

Natural Care Corp., a distributor of natural cosmetics, is ready to begin its third quarter, in
which peak sales occur. The company has requested a $60,000, 90-day loan from its bank
to help meet cash requirements during the quarter. Because Natural Care has experienced
difficulty in paying

off its loans in the past, the bank’s loan officer has asked the company to prepare a cash
budget for the quarter. In response to this request, the following data have been assembled:

a. On July 1, the beginning of the third quarter, the company will have a cash balance of
$43,000.

b. Actual sales for the last two months and budgeted sales for the third quarter follow (all
sales are on account):

May (actual) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $360,000

June (actual) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..$280,000

July (budgeted) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $350,000

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 August (budgeted) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . … $420,000

September (budgeted) . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . …. $360,000

Past experience shows that 25% of a month’s sales are collected in the month of sale, 70%
in the month following sale, and 2% in the second month following sale. The remainder is
uncollectible.

c. Budgeted merchandise purchases and budgeted expenses for the third quarter are given
below:

July August September

Merchandise purchases . . . . . . . . . . . . $170,000 $155,000 $165,000

Salaries and wages . . . . . . . . . . . . . . . $70,000 $70,000 $65,000

Advertising . . . . . . . . . . . . . . . . . . . . . . $80,000 $90,000 $100,000

Rent payments . . . . . . . . . . . . . . . . . . . $30,000 $30,000 $30,000

Depreciation . . . . . . . . . . . . . . . . . . . . . $40,000 $40,000 $40,000

Merchandise purchases are paid in full during the month following purchase. Accounts

payable for merchandise purchases on June 30, which will be paid during July, total
$160,000.

d. Equipment costing $25,000 will be purchased for cash during July.

e. In preparing the cash budget, assume that the $60,000 loan will be made in July and
repaid in September. Interest on the loan will total $2,000.

Required:

1. Prepare a schedule of expected cash collections for July, August, and September and for
the quarter in total.

2. Prepare a cash budget, by month and in total, for the third quarter.

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3. If the company needs a minimum cash balance of $20,000 to start each month, can the
loan be repaid as planned? Explain.

PROBLEM 4–22 Behavioral Aspects of Budgeting; Ethics and the Manager [LO1]

Granger Stokes, managing partner of the venture capital firm of Halston and Stokes, was
dissatisfied with the top management of PrimeDrive, a manufacturer of computer disk
drives. Halston and Stokes had invested $20 million in PrimeDrive, and the return on their
investment had been unsatisfactory for several years. In a tense meeting of the board of
directors of PrimeDrive, Stokes exercised his firm’s rights as the major equity investor in
PrimeDrive and fired PrimeDrive’s chief executive officer (CEO). He then quickly moved
to have the board of directors of PrimeDrive appoint himself as the new CEO.

Stokes prided himself on his hard-driving management style. At the first management
meeting, he asked two of the managers to stand and fired them on the spot, just to show
everyone who was in control of the company. At the budget review meeting that followed,
he ripped up the departmental budgets that had been submitted for his review and yelled at
the managers for their “wimpy, do nothing targets.” He then ordered everyone to submit
new budgets calling for at least a 40% increase in sales volume and announced that he
would not accept excuses for results that fell below budget.

Keri Kalani, an accountant working for the production manager at PrimeDrive, discovered
toward the end of the year that her boss had not been scrapping defective disk drives that
had been returned by customers. Instead, he had been shipping them in new cartons to
other customers to avoid booking losses. Quality control had deteriorated during the year
as a result of the push for increased volume, and returns of defective TRX drives were
running as high as 15% of the new drives shipped. When she confronted her boss with her
discovery, he told her to mind her own business. And then, to justify his actions, he said,
“All of us managers are finding ways to hit Stokes’s targets.”

Required:

1. Is Granger Stokes using budgets as a planning and control tool?

2. What are the behavioral consequences of the way budgets are being used at PrimeDrive?

3. What, if anything, do you think Keri Kalani should do?

PROBLEM 4–23 Schedule of Expected Cash Collections; Cash Budget [LO2, LO8]

Jodi Horton, president of the retailer Crestline Products, has just approached the company’s
bank with a request for a $30,000, 90-day loan. The purpose of the loan is to assist the
company in acquiring inventories in support of peak April sales. Because the company has
22
had some difficulty in paying off its loans in the past, the loan officer has asked for a cash
budget to help determine whether the loan should be made. The following data are
available for the months April–June, during which the loan will be used:

a. On April 1, the start of the loan period, the cash balance will be $26,000. Accounts
receivable on April 1 will total $151,500, of which $141,000 will be collected during April
and $7,200 will be collected during May. The remainder will be uncollectible.

b. Past experience shows that 20% of a month’s sales are collected in the month of sale,
75% in the month following sale, and 4% in the second month following sale. The other
1% represents bad debts that are never collected. Budgeted sales and expenses for the
three-month period follow:

April May June

Sales (all on account). . . . . . . . . $200,000 $300,000 $250,000

Merchandise purchases . . . . . . . $120,000 $180,000 $150,000

Payroll. . . . . . . . . . . . . . . . . . . . . $9,000 $9,000 $8,000

Lease payments . . . . . . . . . . . . . $15,000 $15,000 $15,000

Advertising . . . . . . . . . . . . . . . . . $70,000 $80,000 $60,000

Equipment purchases . . . . . . . . . $8,000 — —

Depreciation . . . . . . . . . . . . . . . . $10,000 $10,000 $10,000

c. Merchandise purchases are paid in full during the month following purchase. Accounts
payable for merchandise purchases on March 31, which will be paid during April, total
$108,000.

d. In preparing the cash budget, assume that the $30,000 loan will be made in April and
repaid in June. Interest on the loan will total $1,200.

Required:

1. Prepare a schedule of expected cash collections for April, May, and June and for the
three months in total.

2. Prepare a cash budget, by month and in total, for the three-month period.

23
3. If the company needs a minimum cash balance of $20,000 to start each month, can the
loan be repaid as planned? Explain.

PROBLEM 4–24 Cash Budget with Supporting Schedules [LO2, LO4, LO7, LO8]

The president of Univax, Inc., has just approached the company’s bank seeking short-term
financing for the coming year, Year 2. Univax is a distributor of commercial vacuum
cleaners. The bank has stated that the loan request must be accompanied by a detailed cash
budget that shows the quarters in which financing will be needed, as well as the amounts
that will be needed and the quarters in which repayments can be made.

To provide this information for the bank, the president has directed that the following data
be gathered from which a cash budget can be prepared:

a. Budgeted sales and merchandise purchases for Year 2, as well as actual sales and
purchases for the last quarter of Year 1, are as follows:

The company typically collects 33% of a quarter’s sales before the quarter ends and
another 65% in the following quarter. The remainder is uncollectible. This pattern of
collections is now being experienced in the actual data for the Year 1 fourth quarter.

c. Some 20% of a quarter’s merchandise purchases are paid for within the quarter. The
remainder is paid in the following quarter.

d. Selling and administrative expenses for Year 2 are budgeted at $90,000 per quarter plus
12% of sales. Of the fixed amount, $20,000 each quarter is depreciation.

e. The company will pay $10,000 in cash dividends each quarter.

f. Land purchases will be made as follows during the year: $80,000 in the second quarter
and $48,500 in the third quarter.

24
g. The Cash account contained $20,000 at the end of Year 1. The company must maintain a
minimum cash balance of at least $18,000.

h. The company has an agreement with a local bank that allows the company to borrow in
increments of $10,000 at the beginning of each quarter, up to a total loan balance of
$100,000. The interest rate on these loans is 1% per month, and for simplicity, we will
assume that interest is not compounded. The company would, as far as it is able, repay the
loan plus accumulated interest at the end of the year.

i. At present, the company has no loans outstanding.

Required:

1. Prepare the following, by quarter and in total, for Year 2:

a. A schedule of expected cash collections on sales.

b. A schedule of expected cash disbursements for merchandise purchases.

2. Compute the expected cash disbursements for selling and administrative expenses, by
quarter and in total, for Year 2.

3. Prepare a cash budget by quarter and in total for Year 2.

PROBLEM 4–25 Behavioral Aspects of Budgeting [LO1]

Five years ago, Jack Cadence left his position at a large company to start Advanced
Technologies Co.(ATC), a software design company. ATC’s first product was a unique
software package that seam lessly integrates networked PCs. Robust sales of this initial
product permitted the company to begin development of other software products and to
hire additional personnel. The staff at ATC quickly grew from three people working out of
Cadence’s basement to over 70 individuals working in leased spaces at an industrial park.
Continued growth led Cadence to hire seasoned marketing, distribution, and production
managers and an experienced accountant, Bill Cross.

Recently, Cadence decided that the company had become too large to run on an informal
basis and that a formalized planning and control program centered around a budget was
necessary. Cadence asked the accountant, Bill Cross, to work with him in developing the
initial budget for ATC.

Cadence forecasted sales revenues based on his projections for both the market growth for
the initial software and successful completion of new products. Cross used this data to
25
construct the master budget for the company, which he then broke down into departmental
budgets. Cadence and Cross met a number of times over a three-week period to hammer
out the details of the budgets.

When Cadence and Cross were satisfied with their work, the various departmental budgets
were distributed to the department managers with a cover letter explaining ATC’s new
budgeting system. The letter requested everyone’s assistance in working together to
achieve the budget objectives.

Several of the department managers were displeased with how the budgeting process was
undertaken. In discussing the situation among themselves, they felt that some of the budget
projections were overly optimistic and not realistically attainable.

Required:

1. How does the budgeting process Cadence and Cross used at ATC differ from
recommended practice?

2. What are the behavioral implications of the way Cadence and Cross went about
preparing the master budget?

PROBLEM 4–26 Completing a Master Budget [LO2, LO4, LO7, LO8, LO9, LO10]

The following data relate to the operations of Picanuy Corporation, a wholesale distributor
of consumer goods:

Current assets as of December 31:

Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. …….. $6,000

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . …$36,000

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . ……$9,800

Buildings and equipment, net . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . $110,885

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . … $32,550

Capital stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . $100,000

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $30,135

a. The gross margin is 30% of sales. (In other words, cost of goods sold is 70% of sales.)

26
b. Actual and budgeted sales data are as follows:

December (actual) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . $60,000

January. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $70,000

February . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . $80,000

March . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . $85,000

April . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$55,000

c. Sales are 40% for cash and 60% on credit. Credit sales are collected in the month
following sale. The accounts receivable at December 31 are the result of December credit
sales.

d. Each month’s ending inventory should equal 20% of the following month’s budgeted
cost of goods sold.

e. One-quarter of a month’s inventory purchases is paid for in the month of purchase; the
other three-quarters is paid for in the following month. The accounts payable at December
31 are the result of December purchases of inventory.

f. Monthly expenses are as follows: commissions, $12,000; rent, $1,800; other expenses
(excluding depreciation), 8% of sales. Assume that these expenses are paid monthly.
Depreciation is $2,400 for the quarter and includes depreciation on new assets acquired
during the quarter.

g. Equipment will be acquired for cash: $3,000 in January and $8,000 in February.

h. Management would like to maintain a minimum cash balance of $5,000 at the end of
each month. The company has an agreement with a local bank that allows the company to
borrow in increments of $1,000 at the beginning of each month, up to a total loan balance
of $50,000. The interest rate on these loans is 1% per month, and for simplicity, we will
assume that interest is not compounded. The company would, as far as it is able, repay the
loan plus accumulated interest at the end of the quarter.

Schedule of Expected Cash Collections

January February March Quarter

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 Cash sales . . . . . . . . . . $28,000

Credit sales . . . . . . . . . .36,000

Total collections. . . . . .$64,000

2. Complete the following:

Merchandise Purchases Budget

January February March Quarter

Budgeted cost of goods sold . . . . . . . . . $49,000*

Add desired ending inventory . . . . . . . . .11,200*

Total needs. . . . . . . . . . . . . . . . . . . . . . . 60,200

Less beginning inventory . . . . . . . . . . . . 9,800

Required purchases . . . . . . . . . . . . . . . $50,400

*$70,000 sales × 70% = $49,000.

*$80,000 × 70% × 20% = $11,200.

Schedule of Expected Cash Disbursements—Merchandise Purchases

January February March Quarter

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 December purchases . . . . . . . . . . . . . . $32,550* $32,550

January purchases . . . . . . . . . . . . . . . . . 12,600 $37,800 50,400

February purchases . . . . . . . . . . . . . . . .

March purchases . . . . . . . . . . . . . . . . . .

Total disbursements . . . . . . . . . . . . . . $45,150

*Beginning balance of the accounts payable.

3. Complete the following schedule:

Schedule of Expected Cash Disbursements—Selling and Administrative Expenses

January February March Quarter

Commissions . . . . . . . . . . . . . . . . . . . $12,000

Rent . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,800

Other expenses . . . . . . . . . . . . . . . . . . . 5,600

Total disbursements . . . . . . . . . . . . . . 19,400

4. Complete the following cash budget:

29
 Cash Budget

January February March Quarter

Cash balance, beginning . . . . . . . . . . . . $ 6,000

Add cash collections . . . . . . . . . . . . . . . 64,000

Total cash available . . . . . . . . . . . . . . . . 70,000

Less cash disbursements:

For inventory . . . . . . . . . . . . . . . . . . . 45,150

For operating expenses. . . . . . . . . . . . 19,400

For equipment . . . . . . . . . . . . . . . . . . 3,000

Total cash disbursements . . . . . . . . . . 67,550

Excess (deficiency) of cash. . . . . . . . . . . 2,450

Financing

Etc.

5. Prepare an absorption costing income statement, similar to the one shown in Schedule 9
in the chapter, for the quarter ended March 31.

6. Prepare a balance sheet as of March 31.

PROBLEM 4–27 Completing a Master Budget [LO2, LO4, LO7, LO8, LO9, LO10]

Nordic Company, a merchandising company, prepares its master budget on a quarterly

basis. The following data have been assembled to assist in preparation of the master budget
for the second quarter.

a. As of March 31 (the end of the prior quarter), the company’s balance sheet showed
the following account balances:

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 Cash ...............................................................$9,000

Accounts receivable...................................... 48,000

Inventory........................................................12,600

Buildings and equipment (net) ....................214,100

Accounts payable ..................................................... $ 18,300

Capital stock ............................................................. 190,000

Retained earnings...................................................... 75,400

$283,700 $283,700

b. Actual sales for March and budgeted sales for April–July are as follows:

March (actual) .......................................................................$60,000

April...................................................................................... $70,000

May ...................................................................................... $85,000

June .......................................................................................$90,000

July........................................................................................ $50,000

c. Sales are 20% for cash and 80% on credit. All payments on credit sales are collected in
the month following the sale. The accounts receivable at March 31 are a result of March
credit sales.

d. The company’s gross margin percentage is 40% of sales. (In other words, cost of goods
sold is 60% of sales.)

e. Monthly selling and administrative expenses are budgeted as follows: salaries and
wages, $7,500 per month; shipping, 6% of sales; advertising, $6,000 per month; other
expenses, 4% of sales. Depreciation, including depreciation on new assets acquired during
the quarter, will be $6,000 for the quarter.

f. Each month’s ending inventory should equal 30% of the following month’s cost of goods
sold.

31
g. Half of a month’s inventory purchases are paid for in the month of purchase and half in
the following month.

h. Equipment purchases during the quarter will be as follows: April, $11,500; and May,
$3,000.

i. Dividends totaling $3,500 will be declared and paid in June.

j. Management wants to maintain a minimum cash balance of $8,000. The company has an
agreement with a local bank that allows the company to borrow in increments of $1,000 at
the beginning of each month, up to a total loan balance of $20,000. The interest rate on
these loans is 1% per month, and for simplicity, we will assume that interest is not
compounded.

The company would, as far as it is able, repay the loan plus accumulated interest at the end
of the quarter.

Required:

Using the data above, complete the following statements and schedules for the second
quarter:

1. Schedule of expected cash collections:

April May June Total

Cash sales. . . . . . . . . . . . . . . . . . . . . . . . . . . $14,000

Credit sales. . . . . . . . . . . . . . . . . . . . . . . . . . . 48,000

Total collections . . . . . . . . . . . . . . . . . . . . . .$62,000

2. a. Merchandise purchases budget:

April May June Total

32
Budgeted cost of goods sold . . . . . . . . . . . . . . $42,000* $51,000

Add desired ending inventory . . . . . . . . . . . . . . 15,300*

Total needs . . . . . . . . . . . . . . . . . . . . . . . . . . . . .57,300

Less beginning inventory . . . . . . . . . . . . . . . . . 12,600

Required purchases . . . . . . . . . . . . . . . . . . . . $44,700

*$70,000 sales × 60% = $42,000.

*$51,000 × 30% = $15,300.

b. Schedule of expected cash disbursements for merchandise purchases:

April May June Total

For March purchases . . . . . . . . . . . . . . . . . . . . $18,300 $18,300

For April purchases. . . . . . . . . . . . . . . . . . . . . . 22,350 $22,350 44,700

For May purchases . . . . . . . . . . . . . . . . . . . . . .

For June purchases . . . . . . . . . . . . . . . . . . . . .

Total cash disbursements for

purchases . . . . . . . . . . . . . . . . . . . . . . .$40,650

3. Schedule of expected cash disbursements for selling and administrative expenses:

April May June Total

Salaries and wages . . . . . . . . . . . . . . . . . . . .$ 7,500

Shipping . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,200

Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,000

Other expenses . . . . . . . . . . . . . . . . . . . . . . . 2,800

Total cash disbursements for

33
 selling and administrative expenses . . . $20,500

4. Cash budget:

April May June Total

Cash balance, beginning............................... $ 9,000

Add cash collections........................................62,000

Total cash available ........................................71,000

Less cash disbursements:

For inventory purchases ..................................40,650

For selling and administrative expenses......... 20,500

For equipment purchases ................................11,500

For dividend

Total cash disbursements ................................72,650

Excess (deficiency) of cash............................ (1,650)

Financing

Etc.

5.Prepare an absorption costing income statement for the quarter ending June 30 as shown
in Schedule 9 in the chapter.

6. Prepare a balance sheet as of June 30.

34
Chapter 5 Flexible Budgets and Performance
Analysis
Glossary
Activity variance The difference between a revenue or cost item in the static planning
budget and the same item in the flexible budget. An activity variance is due solely to the
difference between the level of activity assumed in the planning budget and the actual level
of activity used in the flexible budget.

Flexible budget A report showing estimates of what revenues and costs should have been,
given the actual level of activity for the period.

Planning budget A budget created at the beginning of the budgeting period that is valid
only for the planned level of activity.

Revenue variance The difference between how much the revenue should have been, given
the actual level of activity, and the actual revenue for the period. A favorable (unfavorable)
revenue variance occurs because the revenue is higher (lower) than expected, given the
actual level of activity for the period.

Spending variance The difference between how much a cost should have been, given the
actual level of activity, and the actual amount of the cost. A favorable (unfavorable)
spending variance occurs because the cost is lower (higher) than expected, given the actual
level of activity for the period.

35
EXERCISE 5–1 Prepare a Flexible Budget [LO1]

Gator Divers is a company that provides diving services such as underwater ship repairs to
clients in the Tampa Bay area. The company’s planning budget for March appears below:

Gator Divers

Planning Budget

For the Month Ended March 31

Budgeted diving-hours (q)................................................................................ 200

Revenue ($380.00q)................................................................................... $76,000

Expenses:

Wages and salaries ($12,000 + $130.00q) ..........................................38,000

Supplies ($5.00q)...................................................................................1,000

Equipment rental ($2,500 + $26.00q) ...................................................7,700

Insurance ($4,200) .................................................................................4,200

Miscellaneous ($540 + $1.50q) ................................................................840

Total expense............................................................................................... 51,740

Net operating income .................................................................................$24,260

Required:

During March, the company’s activity was actually 190 diving-hours. Prepare a flexible
budget for that level of activity.

36
EXERCISE 5–2 Prepare a Report Showing Activity Variances [LO2]

Air Meals is a company that prepares in-flight meals for airlines in its kitchen located next
to the local airport. The company’s planning budget for December appears below:

Air Meals

Planning Budget

For the Month Ended December 31

Budgeted meals (q)............................................................................................. 20,000

Revenue ($3.80q) .............................................................................................$76,000

Expenses:

Raw materials ($2.30q) ...............................................................................46,000

Wages and salaries ($6,400 + $0.25q) ........................................................11,400

Utilities ($2,100 + $0.05q) ............................................................................3,100

Facility rent ($3,800)......................................................................................3,800

Insurance ($2,600)......................................................................................... 2,600

Miscellaneous ($700 + $0.10q) .....................................................................2,700

Total expense...................................................................................................... 69,600

Net operating income ........................................................................................$ 6,400

In December, 21,000 meals were actually served. The company’s flexible budget for this
level of activity is as follows:

Air Meals

Flexible Budget

For the Month Ended December 31

37
 Budgeted meals (q) ...........................................................................................21,000

Revenue ($3.80q)............................................................................................ $79,800

Expenses:

Raw materials ($2.30q) ................................................................................48,300

Wages and salaries ($6,400 + $0.25q) .........................................................11,650

Utilities ($2,100 + $0.05q) ............................................................................3,150

Facility rent ($3,800) .....................................................................................3,800

Insurance ($2,600) .........................................................................................2,600

Miscellaneous ($700 + $0.10q) .....................................................................2,800

Total expense.................................................................................................... 72,300

Net operating income .......................................................................................$ 7,500

Required:

1. Prepare a report showing the company’s activity variances for December.

2. Which of the activity variances should be of concern to management? Explain.

EXERCISE 5–3 Prepare a Report Showing Revenue and Spending Variances [LO3]

Olympia Bivalve farms and sells oysters in the Pacific Northwest. The company harvested
and sold 7,000 pounds of oysters in July. The company’s flexible budget for July appears
below:

Olympia Bivalve

Flexible Budget

For the Month Ended July 31

Actual pounds (q) .................................................................................................7,000

Revenue ($4.20q)............................................................................................. $29,400

Expenses:

38
 Packing supplies ($0.40q) ...............................................................................2,800

Oyster bed maintenance ($3,600) ...................................................................3,600

Wages and salaries ($2,540 + $0.50q) ............................................................6,040

Shipping ($0.75q) ...........................................................................................5,250

Utilities ($1,260) .............................................................................................1,260

Other ($510 + $0.05q) ........................................................................................860

Total expense ......................................................................................................19,810

Net operating income ........................................................................................$ 9,590

The actual results for July appear below:

Olympia Bivalve

Income Statement

For the Month Ended July 31

Actual pounds.......................................................................................................7,000

Revenue........................................................................................................... $28,600

Expenses:

Packing supplies ........................................................................................... 2,970

Oyster bed maintenance..................................................................................3,460

Wages and salaries ........................................................................................6,450

Shipping......................................................................................................... 4,980

Utilities...........................................................................................................1,070

Other........................................................................................................................1,480

Total expense ........................................................................................................20,410

Net operating income ..........................................................................................$ 8,190

Required:

39
Prepare a report showing the company’s revenue and spending variances for July.

EXERCISE 5–4 Prepare a Flexible Budget Performance Report [LO4]

Mt. Hood Air offers scenic overflights of Mt. Hood and the Columbia River gorge. Data
concerning the company’s operations in August appear below:

Mt. Hood Air

Operating Data

For the Month Ended August 31

Planning Flexible Actual

Budget Budget Results

Flights (q) ...............................................................50 52 52

Revenue ($360.00q) ................................... $18,000 $18,720 $16,980

Expenses:

Wages and salaries ($3,800 + $92.00q)........... 8,400 8,584 8,540

Fuel ($34.00q) ..................................................1,700 1,768 1,930

Airport fees ($870 + $35.00q) .........................2,620 2,690 2,690

Aircraft depreciation ($11.00q) . ........................550 572 572

Office expenses ($230 + $1.00q) ........................280 282 450

Total expense .................................................13,550 13,896 14,182

Net operating income ....................................$ 4,450 $ 4,824 $ 2,798

The company measures its activity in terms of flights. Customers can buy individual tickets
for overflights or hire an entire plane for an overflight at a discount.

Required:

1. Prepare a flexible budget performance report for August.

2. Which of the variances should be of concern to management? Explain.

40
EXERCISE 5–5 Prepare a Flexible Budget with More Than One Cost Driver [LO5]

Icicle Bay Tours operates day tours of coastal glaciers in Alaska on its tour boat the
Emerald Glacier. Management has identified two cost drivers—the number of cruises and
the number of passengers—that it uses in its budgeting and performance reports. The
company publishes a schedule of day cruises that it may supplement with special sailings if
there is sufficient demand.

Up to 80 passengers can be accommodated on the tour boat. Data concerning the

company’s cost formulas appear below:

Fixed Cost Cost per Cost per

per Month Cruise Passenger

Vessel operating costs .................................$6,800 $475.00 $3.50

Advertising ..................................................$2,700

Administrative costs ....................................$5,800 $36.00 $1.80

Insurance .....................................................$3,600

For example, vessel operating costs should be $6,800 per month plus $475.00 per cruise
plus $3.50 per passenger. The company’s sales should average $28.00 per passenger. The
company’s planning budget for August is based on 58 cruises and 3,200 passengers.

Required:

Prepare the company’s planning budget for August.

41
EXERCISE 5–6 Analyze a Performance Report [LO6]

The Exterminator Inc. provides on-site residential pest extermination services. The
company has several mobile teams who are dispatched from a central location in company-
owned trucks. The company uses the number of jobs to measure activity. At the beginning
of May, the company budgeted for 200 jobs, but the actual number of jobs turned out to be
208. A report comparing the budgeted revenues and costs to the actual revenues and costs
appears below:

The Exterminator Inc.

Variance Report

For the Month Ended May 31

Planning Actual

Budget Results Variances

Jobs ......................................................................200 208

Revenue .......................................................$37,000 $36,400 $600 U

Expenses:

Mobile team operating costs .....................16,900 17,060 160 U

Exterminating supplies ...............................4,000 4,350 350 U

Advertising ....................................................900 1,040 140 U

Dispatching costs ........................................2,700 2,340 360 F

Office rent...................................................2,300 2,300 0

Insurance ....................................................3,600 3,600 0

Total expense .................................................30,400 30,690 290 U

Net operating income ....................................$ 6,600 $ 5,710 $890 U

Required:

Is the above variance report useful for evaluating how well revenues and costs were
controlled during May? Why or why not?

42
EXERCISE 5–7 Critique a Variance Report [LO6]

Refer to the data for The Exterminator Inc. in Exercise 9–6 . A management intern has
suggested that the budgeted revenues and costs should be adjusted for the actual level of
activity in May before they are compared to the actual revenues and costs. Because the
actual level of activity was 4% higher than budgeted, the intern suggested that all budgeted
revenues and costs should be adjusted upward by 4%. A report comparing the budgeted
revenues and costs, with this adjustment, to the actual revenues and costs appears below:

The Exterminator Inc.

Variance Report

For the Month Ended May 31

Adjusted Actual

Planning Budget Results Variances

Jobs ......................................................................208 208

Revenue ........................................................$38,480 $36,400 $2,080 U

Expenses:

Mobile team operating costs .....................17,576 17,060 516 F

Exterminating supplies ................................4,160 4,350 190 U

Advertising..................................................... 936 1,040 104 U

Dispatching costs ........................................2,808 2,340 468 F

Office rent ...................................................2,392 2,300 92 F

Insurance .....................................................3,744 3,600 144 F

Total expense .................................................31,616 30,690 926 F

Net operating income ...................................$ 6,864 $ 5,710 $ 1,154 U

Required:

43
Is the above variance report useful for evaluating how well revenues and costs were
controlled during May? Why or why not?

EXERCISE 5–8 Flexible Budgets and Activity Variances [LO1, LO2]

Harold’s Roof Repair has provided the following data concerning its costs:

Fixed Cost per Month Cost per Repair-Hour

Wages and salaries ...................................................$21,380 $15.80

Parts and supplies................................................................... $7.50

Equipment depreciation .............................................$2,740 $0.60

Truck operating expenses...........................................$5,820 $1.90

Rent .............................................................................$4,650

Administrative expenses.............................................$3,870 $0.70

For example, wages and salaries should be $21,380 plus $15.80 per repair-hour. The
company expected to work 2,500 repair-hours in June, but actually worked 2,400 repair-
hours. The company expects its sales to be $43.50 per repair-hour.

Required:

Prepare a report showing the company’s activity variances for June.

EXERCISE 5–9 Flexible Budget [LO1]

Auto Lavage is a Canadian company that owns and operates a large automatic carwash
facility near Quebec. The following table provides data concerning the company’s costs:

Fixed Cost per Month Cost per Car Washed

44
 Cleaning supplies .......................................................... $0.70

Electricity ..........................................................$1,400 $0.10

Maintenance................................................................... $0.30

Wages and salaries..............................................$4,700 $0.40

Depreciation .......................................................$8,300

Rent ....................................................................$2,100

Administrative expenses ....................................$1,800 $0.05

For example, electricity costs are $1,400 per month plus $0.10 per car washed. The
company expects to wash 8,000 cars in October and to collect an average of $5.90 per car
washed.

Required:

Prepare the company’s planning budget for October.

EXERCISE 5–10 Flexible Budget [LO1]

Refer to the data for Auto Lavage in Exercise 9–9 . The company actually washed 8,100
cars in October.

Required:

Prepare the company’s flexible budget for October.

EXERCISE 5–11 Prepare a Report Showing Activity Variances [LO2]

Refer to the data for Auto Lavage in Exercise 9–9 . The actual operating results for October
appear below:

45
 Auto Lavage

Income Statement

For the Month Ended October 31

Actual cars washed ...........................................................................................8,100

Revenue........................................................................................................ $49,300

Expenses:

Cleaning supplies.........................................................................................6,100

Electricity.................................................................................................... 2,170

Maintenance. ...............................................................................................2,640

Wages and salaries.......................................................................................8,260

Depreciation. ...............................................................................................8,300

Rent............................................................................................................. 2,300

Administrative expenses .............................................................................2,100

Total expense .................................................................................................31,870

Net operating income.................................................................................... $17,430

Required:

Prepare a report showing the company’s activity variances for October.

EXERCISE 5–12 Prepare a Report Showing Revenue and Spending Variances [LO3]

Refer to the data for Auto Lavage in Exercises 9–9 and 9–11 .

Required:

Prepare a report showing the company’s revenue and spending variances for October.

EXERCISE 5–13 Prepare a Flexible Budget Performance Report [LO4]

Refer to the data for Auto Lavage in Exercises 9–9 and 9–11 .

Required:

46
Prepare a flexible budget performance report that shows the company’s activity variances
and revenue and spending variances for October.

EXERCISE 5–14 Flexible Budget [LO1]

Pierr Manufacturing Inc. has provided the following information concerning its
manufacturing costs:

Fixed Cost Cost per

per Month Machine-Hour

Direct materials ......................................................... $5.70

Direct labor ...................................................$42,800

Supplies...................................................................... $0.20

Utilities ..........................................................$1,600 $0.15

Depreciation ................................................$14,900

Insurance ......................................................$11,400

For example, utilities should be $1,600 per month plus $0.15 per machine-hour. The
company expects to work 4,000 machine-hours in July. Note that the company’s direct
labor is a fixed cost.

Required:

Prepare the company’s planning budget for manufacturing costs for July.

EXERCISE 5–15 Critique a Report; Prepare a Performance Report [LO1, LO4,

LO6]

Wings Flight School offers flying lessons at a small municipal airport. The school’s owner
and manager has been attempting to evaluate performance and control costs using a
variance report that compares the planning budget to actual results. A recent variance
report appears below:

47
 Wings Flight School

Variance Report

For the Month Ended August 31

Planning Actual

Budget Results Variances

Lessons.................................................................... 200 210

Revenue .........................................................$45,000 $47,300 $2,300 F

Expenses:

Instructor wages...........................................12,400 12,910 510 U

Aircraft depreciation ...................................11,400 11,970 570 U

Fuel ................................................................4,200 5,150 950 U

Maintenance...................................................3,270 3,470 200 U

Ground facility expenses ...............................2,440 2,350 90 F

Administration ...............................................4,410 4,340 70 F

Total expense ....................................................38,120 40,190 2,070 U

Net operating income .......................................$ 6,880 $ 7,110 $ 230 F

After several months of using such variance reports, the owner has become frustrated. For
example, she is quite confident that instructor wages were very tightly controlled in
August, but the report shows an unfavorable variance.

The planning budget was developed using the following formulas, where q is the number
of lessons sold:

48
 Revenue ........................................................................................................$225q

Instructor wages.............................................................................................. $62q

Aircraft depreciation....................................................................................... $57q

Fuel..................................................................................................................$21q

Maintenance ........................................................................................$670 + $13q

Ground facility expenses ...................................................................$1,640 + $4q

Administration....................................................................................$4,210 + $1q

Required:

1. Should the owner feel frustrated with the variance reports? Explain.

2. Prepare a flexible budget performance report for the school for August.

3. Evaluate the school’s performance for August.

EXERCISE 5–16 Working with More Than One Cost Driver [LO4, LO5]

The Toque Cooking Academy runs short cooking courses at its small campus. Management
has identified two cost drivers that it uses in its budgeting and performance reports—the
number of courses and the total number of students. For example, the school might run four
courses in a month and have a total of 60 students enrolled in those four courses. Data
concerning the company’s cost formulas appear below:

Fixed Cost Cost per Cost per

per month Course Student

Instructor wages ............................................... $2,980

Classroom supplies........................................... $310

Utilities ................................................$1,230 $85

Campus rent ..........................................$5,100

Insurance ...............................................$2,340

Administrative expenses.......................$3,940 $46 $7

49
For example, administrative expenses should be $3,940 per month plus $46 per course plus
$7 per student. The company’s sales should average $850 per student.

The actual operating results for October appear below:

Actual

Revenue .................................................................................................$48,100

Instructor wages .....................................................................................$11,200

Classroom supplies.................................................................................$18,450

Utilities.....................................................................................................$1,980

Campus rent............................................................................................. $5,100

Insurance ..................................................................................................$2,480

Administrative expenses...........................................................................$3,970

Required:

1. The Toque Cooking Academy expects to run four courses with a total of 60 students in
October. Prepare the company’s planning budget for this level of activity.

2. The school actually ran four courses with a total of 58 students in October. Prepare the
company’s flexible budget for this level of activity.

3. Prepare a flexible budget performance report that shows both activity variances and
revenue and spending variances for October.

EXERCISE 5–17 Flexible Budgets and Revenue and Spending Variances [LO1, LO3]

Gelato Supremo is a popular neighborhood gelato shop. The company has provided the
following data concerning its operations:

50
 Fixed Variable Actual

Element Element Total for

per Month per Liter July

Revenue...................................................................... $13.50 $69,420

Raw materials ........................................................... $5.10 $26,890

Wages ........................................................... $4,800 $1.20 $11,200

Utilities ..........................................................$1,860 $0.15 $2,470

Rent ................................................................$3,150 $3,150

Insurance .........................................................$1,890 $1,890

Miscellaneous ..................................................$540 $0.15 $1,390

While gelato is sold by the cone or cup, the shop measures its activity in terms of the total
number of liters of gelato sold. For example, wages should be $4,800 plus $1.20 per liter of
gelato sold, and the actual wages for July were $11,200. Gelato Supremo expected to sell
5,000 liters in July, but actually sold 4,900 liters.

Required:

Prepare a report showing Gelato Supremo revenue and spending variances for July.

EXERCISE 4–18 Flexible Budget Performance Report [LO1, LO4]

Air Assurance Corporation provides on-site air quality testing services. The company has
provided the following data concerning its operations:

51
 Fixed Variable Actual

Component Component Total for

per Month per Job March

Revenue . . . . . . . . . . . . . . . . . . . . . . . .............................. $275 $24,750

Technician wages . . . . . . . . . . . . . . . . .................$8,600 $8,450

Mobile lab operating expenses . . . . . . .................$4,900 $29 $7,960

Office expenses . . . . . . . . . . . . . . . . . ...................$2,700 $3 $2,850

Advertising expenses . . . . . . . . . . . . . ..................$1,580 $1,650

Insurance . . . . . . . . . . . . . . . . . . . . . . ...................$2,870 $2,870

Miscellaneous expenses . . . . . . . . . . .......................$960 $2 $465

The company uses the number of jobs as its measure of activity. For example, mobile lab
operating expenses should be $4,900 plus $29 per job, and the actual mobile lab operating
expenses for March were $7,960.

The company expected to work 100 jobs in March, but actually worked 98 jobs.

Required:

Prepare a flexible budget performance report showing AirAssurance Corporation’s activity

variances and revenue and spending variances for March.

EXERCISE 5–19 Flexible Budget Performance Report in a Cost Center [LO1, LO4]

Triway Packaging Corporation manufactures and sells a wide variety of packaging

products. Performance reports are prepared monthly for each department. The planning
budget and flexible budget for the Production Department are based on the following
formulas, where q is the number of direct labor-hours worked in a month:

52
 Direct labor . . . . . . . . . . . . . . . . . . . . . ..............................................................$16.30q

Indirect labor. . . . . . . . . . . . . . . . . . . . .................................................$4,300 + $1.80q

Utilities . . . . . . . . . . . . . . . . . . . . . . . . .................................................$5,600 + $0.70q

Supplies . . . . . . . . . . . . . . . . . . . . . . ................................................... $1,400 + $0.30q

Equipment depreciation . . . . . . . . . . ................................................ $18,600 + $2.80q

Factory rent . . . . . . . . . . . . . . . . . . . .................................................................. $8,300

Property taxes. . . . . . . . . . . . . . . . . . .................................................................. $2,800

Factory administration . . . . . . . . . . . ................................................ $13,400 + $0.90q

The actual costs incurred in November in the Production Department are listed below:

Actual Cost Incurred

in November

Direct labor ....................................................................................$63,520

Indirect labor...................................................................................$10,680

Utilities .............................................................................................$8,790

Supplies ............................................................................................$2,810

Equipment depreciation..................................................................$29,240

Factory rent ......................................................................................$8,700

Property taxes ................................................................................. $2,800

Factory administration....................................................................$16,230

Required:

1. The company had budgeted for an activity level of 4,000 labor-hours in November.
Prepare the Production Department’s planning budget for the month.

53
2. The company actually worked 3,800 labor-hours in November. Prepare the Production
Department’s flexible budget for the month.

3. Prepare the Production Department’s flexible budget performance report for November,
including both the activity and spending variances.

4. What aspects of the flexible budget performance report should be brought to

management’s attention? Explain.

PROBLEM 5–20 Activity and Spending Variances [LO1, LO2, LO3]

You have just been hired by Securi Door Corporation, the manufacturer of a revolutionary
new garage door opening device. The president has asked that you review the company’s
costing system and “do what you can to help us get better control of our manufacturing
overhead costs.” You find that the company has never used a flexible budget, and you
suggest that preparing such a budget would be an excellent first step in overhead planning
and control.

After much effort and analysis, you determined the following cost formulas and gathered
the following actual cost data for April:

Actual Cost

Cost Formula in April

Utilities . . . . . . . . . . . . . . . . . $16,500 plus $0.15 per machine-hour $21,300

Maintenance . . . . . . . . . . . . . $38,600 plus $1.80 per machine-hour $68,400

Supplies . . . . . . . . . . . . . . . . $0.50 per machine-hour $9,800

Indirect labor. . . . . . . . . . . . . $94,300 plus $1.20 per machine-hour $119,200

Depreciation . . . . . . . . . . . . .$68,000 $69,700

During April, the company worked 18,000 machine-hours and produced 12,000 units. The
company had originally planned to work 20,000 machine-hours during April.

Required:

1. Prepare a report showing the activity variances for April. Explain what these variances
mean.

2. Prepare a report showing the spending variances for April. Explain what these variances
mean.
54
PROBLEM 5–21 More Than One Cost Driver [LO4, LO5]

Verona Pizza is a small neighborhood pizzeria that has a small area for in-store dining as
well offering takeout and free home delivery services. The pizzeria’s owner has determined
that the shop has two major cost drivers—the number of pizzas sold and the number of
deliveries made.

Data concerning the pizzeria’s costs appear below:

Fixed Cost Cost per Cost per

per Month Pizza Delivery

Pizza ingredients . . . . . . . . . ........................................ $4.20

Kitchen staff . . . . . . . . . . . . . . ..........................$5,870

Utilities . . . . . . . . . . . . . . . . . .............................. $590 $0.10

Delivery person . . . . . . . . . . . ...................................... $2.90

Delivery vehicle . . . . . . . . . . .............................. $610 $1.30

Equipment depreciation . . . . . .............................$384

Rent . . . . . . . . . . . . . . . . . . . ............................ $1,790

Miscellaneous . . . . . . . . . . . . .............................$710 $0.05

In October, the pizzeria budgeted for 1,500 pizzas at an average selling price of $13.00 per
pizza and for 200 deliveries.

Data concerning the pizzeria’s operations in October appear below:

Actual Results
55
 Pizzas. . . . . . . . . . . . . . . . . . . . ................................................................... 1,600

Deliveries . . . . . . . . . . . . . . . . . . ...................................................................180

Revenue . . . . . . . . . . . . . . . . . . .............................................................. $21,340

Pizza ingredients . . . . . . . . . . . . . .............................................................$6,850

Kitchen staff . . . . . . . . . . . . . . . . . ............................................................$5,810

Utilities . . . . . . . . . . . . . . . . . . . . ................................................................ $875

Delivery person. . . . . . . . . . . . . . .................................................................$522

Delivery vehicle . . . . . . . . . . . . . ................................................................ $982

Equipment depreciation. . . . . . . .................................................................. $384

Rent . . . . . . . . . . . . . . . . . . . . . . ............................................................ . $1,790

Miscellaneous . . . . . . . . . . . . . . .................................................................. $778

Required:

1. Prepare a flexible budget performance report that shows both activity variances and
revenue and spending variances for the pizzeria for October.

2. Explain the activity variances.

PROBLEM 5–22 Performance Report for a Nonprofit Organization [LO1, LO4,

LO6]

The KGV Blood Bank, a private charity partly supported by government grants, is located
on the Caribbean island of St. Lucia. The blood bank has just finished its operations for
September, which was a particularly busy month due to a powerful hurricane that hit
neighboring islands causing many injuries. The hurricane largely bypassed St. Lucia, but
residents of St. Lucia willingly donated their blood to help people on other islands. As a
consequence, the blood bank collected and processed over 20% more blood than had been
originally planned for the month.

A report prepared by a government official comparing actual costs to budgeted costs for
the blood bank appears on the following page. (The currency on St. Lucia is the East
56
Caribbean dollar.) Continued support from the government depends on the blood bank’s
ability to demonstrate control over its costs.

KGV Blood Bank

Cost Control Report

For the Month Ended September 30

Planning Actual

Budget Results Variances

Liters of blood collected . . . . . . . . . ....................600 780

Medical supplies. . . . . . . . . . . . . . . ...............$ 7,110 $ 9,252 $2,142 U

Lab tests. . . . . . . . . . . . . . . . . . . . . ..................8,610 10,782 2,172 U

Equipment depreciation . . . . . . . . . ..................1,900 2,100 200 U

Rent . . . . . . . . . . . . . . . . . . . . . . . . ...................1,500 1,500 0

Utilities . . . . . . . . . . . . . . . . . . . . . . ...................300 324 24 U

Administration. . . . . . . . . . . . . . . . . ..............14,310 14,575 265 U

Total expense . . . . . . . . . . . . . . . . .............. $33,730 $38,533 $4,803 U

The managing director of the blood bank was very unhappy with this report, claiming that
his costs were higher than expected due to the emergency on the neighboring islands. He
also pointed out that the additional costs had been fully covered by payments from grateful
recipients on the other islands. The government official who prepared the report countered
that all of the figures had been submitted by the blood bank to the government; he was just
pointing out that actual costs were a lot higher than promised in the budget.

The following cost formulas were used to construct the planning budget:

57
 Liters of blood collected . . . . . . . . . ............................................................600 780

Medical supplies. . . . . . . . . . . . . . . ............................................................ $11.85q

Lab tests. . . . . . . . . . . . . . . . . . . . ............................................................ . $14.35q

Equipment depreciation . . . . . . . .............................................................. . . $1,900

Rent . . . . . . . . . . . . . . . . . . . . . . . .............................................................. . $1,500

Utilities . . . . . . . . . . . . . . . . . . . . ................................................................ . . $300

Administration. . . . . . . . . . . . . . . . ........................................... . $13,200 + $1.85q

Required:

1. Prepare a new performance report for September using the flexible budget approach.

2. Do you think any of the variances in the report you prepared should be investigated?
Why?

PROBLEM 5–23 Critiquing a Variance Report; Preparing a Performance Report

[LO1, LO4, LO6]

Several years ago, Shipley Corporation developed a comprehensive budgeting system for
profit planning and control purposes. While departmental supervisors have been happy
with the system, the factory manager has expressed considerable dissatisfaction with the
information being generated by the system.

A typical departmental cost report for a recent period follows:

58
After receiving a copy of this cost report, the supervisor of the Assembly Department
stated, “These reports are super. It makes me feel really good to see how well things are
going in my department. I can’t understand why those people upstairs complain so much
about the reports.”

For the last several years, the company’s marketing department has chronically failed to
meet the sales goals expressed in the company’s monthly budgets.

Required:

1. The company’s president is uneasy about the cost reports and would like you to evaluate
their usefulness to the company.

2. What changes, if any, should be made in the reports to give better insight into how well
departmental supervisors are controlling costs?

3. Prepare a new performance report for the quarter, incorporating any changes you
suggested in question (2) above.

4. How well were costs controlled in the Assembly Department in March?

PROBLEM 5–24 Critiquing a Cost Report; Preparing a Performance Report [LO1,

LO4, LO6]

Sue Jaski, supervisor of the Karaki Corporation’s Machining Department, was visibly upset
after being reprimanded for her department’s poor performance over the prior month. The
department’s cost control report is given below:

59
 Karaki Corporation—Machining Department

Cost Control Report

For the Month Ended June 30

Planning Actual

Budget Results Variances

Machine-hours . . . . . . . . . ..............................40,000 42,000

Direct labor wages . . . . . ............................. $70,000 $71,400 $1,400 U

Supplies . . . . . . . . . . . . . . ...............................20,000 21,300 1,300 U

Maintenance. . . . . . . . . . . ...............................20,100 20,100 0

Utilities . . . . . . . . . . . . . . . .............................18,800 19,000 200 U

Supervision . . . . . . . . . . . . .............................41,000 41,000 0

Depreciation . . . . . . . . . . . ..............................67,000 67,000 0

Total . . . . . . . . . . . . . . . . . ..........................$236,900 $239,800 $2,900 U

“I just can’t understand all the red ink,” Jaski complained to the supervisor of another
department. “When the boss called me in, I thought he was going to give me a pat on the
back because

I know for a fact that my department worked more efficiently last month than it has ever
worked before. Instead, he tore me apart. I thought for a minute that it might be over the
supplies that were stolen out of our warehouse last month. But they only amounted to a
couple of hundred dollars, and just look at this report. Everything is unfavorable.”

Direct labor wages and supplies are variable costs; supervision and depreciation are fixed
costs; and maintenance and utilities are mixed costs. The fixed component of the budgeted
maintenance cost is $12,100; the fixed component of the budgeted utilities cost is $12,800.

Required:

1. Evaluate the company’s cost control report and explain why the variances were all
unfavorable.

60
2. Prepare a performance report that will help Ms. Jaski’s superiors assess how well costs
were controlled in the Machining Department.

PROBLEM 5–25 Critiquing a Report; Preparing a Performance Budget [LO1, LO4,

LO6]

Facilitator Corp. is a company that acts as a facilitator in tax-favored real estate swaps.
Such swaps, known as 1031 exchanges, permit participants to avoid some or all of the
capital gains taxes that would otherwise be due. The bookkeeper for the company has been
asked to prepare a report for the company to help its owner/manager analyze performance.
The first such report appears below:

Facilitator Corp Analysis of Revenues

and Costs For the Month Ended May 31
Planning Budget Actual Unit Variances
Unit Revenues Revenues and
and Costs Costs
Exchanges completed . . . . . . . . 20 25

Revenue . . . . . . . . . . . . . . . . .$550 $500 $50 U

Expenses:

Legal and search fees . . . . . . 155 161 6U

Office expenses . . . . . . . . . . . 209 172 37 F

Equipment depreciation . . . . . 30 24 6F

Rent . . . . . . . . . . . . . . . . . . . . 75 60 15 F

Insurance . . . . . . . . . . . . . . . . 15 12 3F

Total expense . . . . . . . . . . . . . 484 429 55 F

Net operating income . . . . . . $ 66 $ 71 $5F

Note that the revenues and costs in the above report are unit revenues and costs. For
example, the average office expense is $209 per exchange completed on the planning
budget; whereas, the average actual office expense is $172 per exchange completed.

Legal and search fees is a variable cost; office expenses is a mixed cost; and equipment
depreciation, rent, and insurance are fixed costs. In the planning budget, the fixed
component of office expenses was $4,100.

61
All of the company’s revenues come from fees collected when an exchange is completed.

Required:

1. Evaluate the report prepared by the bookkeeper.

2. Prepare a performance report that would help the owner/manager assess the
performance ofthe company in May.

3. Using the report you created, evaluate the performance of the company in May.

62
 Chapter 6 Standard Costs and Variances
Glossary
Ideal standards Standards that assume peak efficiency at all times.

Labor efficiency variance The difference between the actual hours taken to complete a
task and the standard hours allowed for the actual output, multiplied by the standard hourly
labor rate.

Labor rate variance The difference between the actual hourly labor rate and the standard
rate, multiplied by the number of hours worked during the period.

Management by exception A management system in which standards are set for various
activities, with actual results compared to these standards. Significant deviations from
standards are flagged as exceptions.

Materials price variance The difference between the actual unit price paid for an item
and the standard price, multiplied by the quantity purchased.

Materials quantity variance The difference between the actual quantity of materials used
in production and the standard quantity allowed for the actual output, multiplied by the
standard price per unit of materials.

Practical standards Standards that allow for normal machine downtime and other work
interruptions and that can be attained through reasonable, though highly efficient, efforts
by the average worker.

Price variance A variance that is computed by taking the difference between the actual
price and the standard price and multiplying the result by the actual quantity of the input.

Quantity variance A variance that is computed by taking the difference between the
actual quantity of the input used and the amount of the input that should have been used for
the actual level of output and multiplying the result by the standard price of the input.

Standard cost card A detailed listing of the standard amounts of inputs and their costs
that are required to produce one unit of a specific product.

63
 Standard cost per unit The standard quantity allowed of an input per unit of a specific
product, multiplied by the standard price of the input.

Standard hours allowed The time that should have been taken to complete the period’s
output. It is computed by multiplying the actual number of units produced by the standard
hours per unit.

Standard hours per unit The amount of direct labor time that should be required to
complete a single unit of product, including allowances for breaks, machine downtime,
cleanup, rejects, and other normal inefficiencies.

Standard price per unit The price that should be paid for an input.

Standard quantity allowed The amount of an input that should have been used to
complete the period’s actual output. It is computed by multiplying the actual number of
units produced by the standard quantity per unit.

Standard quantity per unit The amount of an input that should be required to complete a
single unit of product, including allowances for normal waste, spoilage, rejects, and other
normal inefficiencies.

Standard rate per hour The labor rate that should be incurred per hour of labor time,
including employment taxes and fringe benefits.

Variable overhead efficiency variance The difference between the actual level of
activity (direct labor-hours, machine-hours, or some other base) and the standard activity
allowed, multiplied by the variable part of the predetermined overhead rate.

Variable overhead rate variance The difference between the actual variable overhead
cost incurred during a period and the standard cost that should have been incurred based on
the actual activity of the period.

64
All applicable exercises are available with McGraw-Hill’s Connect™ Accounting .

EXERCISE 6–1 Material Variances [LO1]

Harmon Household Products, Inc., manufactures a number of consumer items for general
household use. One of these products, a chopping board, requires an expensive hardwood.
During a recent month, the company manufactured 4,000 chopping boards using 11,000
board feet of hardwood. The hardwood cost the company $18,700.

The company’s standards for one chopping board are 2.5 board feet of hardwood, at a cost
of $1.80 per board foot.

Required:

1. According to the standards, what cost for wood should have been incurred to make
4,000 chopping blocks? How much greater or less is this than the cost that was incurred?

2. Break down the difference computed in (1) above into a materials price variance and a
materials quantity variance.

EXERCISE 6–2 Direct Labor Variances [LO2]

AirMeals, Inc., prepares in-flight meals for a number of major airlines. One of the
company’s products is stuffed cannelloni with roasted pepper sauce, fresh baby corn, and
spring salad. During the most recent week, the company prepared 6,000 of these meals
using 1,150 direct labor-hours.

The company paid these direct labor workers a total of $11,500 for this work, or $10 per
hour. According to the standard cost card for this meal, it should require 0.20 direct labor-
hours at a cost of $9.50 per hour.

Required:

1. According to the standards, what direct labor cost should have been incurred to prepare
6,000 meals? How much does this differ from the actual direct labor cost?

2. Break down the difference computed in (1) above into a labor rate variance and a labor
efficiency variance.

EXERCISE 6–3 Variable Overhead Variances [LO3]

Order Up, Inc., provides order fulfillment services for dot.com merchants. The company
maintains warehouses that stock items carried by its dot.com clients. When a client
receives an order from a customer, the order is forwarded to Order Up, which pulls the

65
item from storage, packs it, and ships it to the customer. The company uses a
predetermined variable overhead rate based on direct labor-hours.

In the most recent month, 140,000 items were shipped to customers using 5,800 direct
laborhours. The company incurred a total of $15,950 in variable overhead costs.

According to the company’s standards, 0.04 direct labor-hours are required to fulfill an
order for one item and the variable overhead rate is $2.80 per direct labor-hour.

Required:

1. According to the standards, what variable overhead cost should have been incurred to
fill the orders for the 140,000 items? How much does this differ from the actual variable
overhead cost?

2. Break down the difference computed in (1) above into a variable overhead rate variance
and a variable overhead efficiency variance.

EXERCISE 6–4 Labor and Variable Manufacturing Overhead Variances [LO2,

LO3]

Hollowell Audio, Inc., manufactures military-specification compact discs. The company

uses standards to control its costs. The labor standards that have been set for one disc are as
follows:

Standard Hours Standard Rate per Hour Standard Cost

6 minutes $24.00 $2.40

During July, 2,125 hours of direct labor time were required to make 20,000 discs. The
direct labor cost totaled $49,300 for the month.

Required:

1. According to the standards, what direct labor cost should have been incurred to make
the 20,000 discs? By how much does this differ from the cost that was incurred?

2. Break down the difference in cost from (1) above into a labor rate variance and a labor
efficiency variance.

3. The budgeted variable manufacturing overhead rate is $16.00 per direct labor-hour.
During July, the company incurred $39,100 in variable manufacturing overhead cost.
Compute the variable overhead rate and efficiency variances for the month.
66
EXERCISE 6–5 Working Backwards from Labor Variances [LO2]

The Worldwide Credit Card, Inc., uses standards to control the labor time involved in
opening mail from card holders and recording the enclosed remittances. Incoming mail is
gathered into batches, and a standard time is set for opening and recording each batch. The
labor standards relating to one batch are as follows:

Standard Hours Standard Rate Standard Cost

Per batch . . . . . . . . 1.25 $12.00 $15.00

The record showing the time spent last week in opening batches of mail has been
misplaced. However, the batch supervisor recalls that 168 batches were received and
opened during the week, and the controller recalls the following variance data relating to
these batches:

Total labor spending variance . . . . . . . $330 U

Labor rate variance . . . . . . . . . . . . . . . $150 F

Required:

1. Determine the number of actual labor-hours spent opening batches during the week.

2. Determine the actual hourly rate paid to employees for opening batches last week.

(Hint: A useful way to proceed would be to work from known to unknown data either by
using the variance formulas or by using the columnar format shown in Exhibit 10–6 .)

EXERCISE 6–6 Material and Labor Variances [LO1, LO2]

Sonne Company produces a perfume called Whim. The direct materials and direct labor
standards for one bottle of Whim are given below:

67
 Standard Quantity Standard Price Standard

or Hours or Rate Cost

Direct materials . . . . . . . .7.2 ounces $2.50 per ounce $18.00

Direct labor . . . . . . . . . . . 0.4 hours $10.00 per hour $4.00

During the most recent month, the following activity was recorded:

a. Twenty thousand ounces of material were purchased at a cost of $2.40 per ounce.

b. All of the material was used to produce 2,500 bottles of Whim.

c. Nine hundred hours of direct labor time were recorded at a total labor cost of $10,800.

Required:

1. Compute the direct materials price and quantity variances for the month.

2. Compute the direct labor rate and efficiency variances for the month.

EXERCISE 6–7 Material Variances [LO1]

Refer to the data in Exercise 10–6. Assume that instead of producing 2,500 bottles of
Whim during the month, the company produced only 2,000 bottles using 16,000 ounces of
material. (The rest of the material purchased remained in raw materials inventory.)

Required:

Compute the direct materials price and quantity variances for the month.

EXERCISE 6–8 Material and Labor Variances [LO1, LO2]

Topper Toys has developed a new toy called the Brainbuster. The company has a standard
cost system to help control costs and has established the following standards for the
Brainbuster toy:

Direct materials: 8 diodes per toy at $0.30 per diode

Direct labor: 0.6 hours per toy at $14.00 per hour

During August, the company produced 5,000 Brainbuster toys. Production data on the toy
for August follow:

68
 Direct materials: 70,000 diodes were purchased at a cost of $0.28 per diode. 20,000
of these diodes were still in inventory at the end of the month.

Direct labor: 3,200 direct labor-hours were worked at a cost of $48,000.

Required:

1. Compute the following variances for August:

a. Direct materials price and quantity variances.

b. Direct labor rate and efficiency variances.

2. Prepare a brief explanation of the possible causes of each variance.

All applicable problems are available with McGraw-Hill’s Connect™ Accounting .

PROBLEM 6–9 Comprehensive Variance Analysis [LO1, LO2, LO3]

Portland Company’s Ironton Plant produces precast ingots for industrial use. Carlos
Santiago, who was recently appointed general manager of the Ironton Plant, has just been
handed the plant’s contribution format income statement for October. The statement is
shown below:

69
 Budgeted Actual

Sales (5,000 ingots) . . . . . . . . . . . . . . $250,000 $250,000

Variable expenses:

Variable cost of goods sold* . . . . . . . . 80,000 96,390

Variable selling expenses . . . . . . . . . . 20,000 20,000

Total variable expenses . . . . . . . . . . . . 100,000 116,390

Contribution margin . . . . . . . . . . . . . . .150,000 133,610

Fixed expenses:

Manufacturing overhead . . . . . . . . . . . 60,000 60,000

Selling and administrative . . . . . . . . . . 75,000 75,000

Total fixed expenses . . . . . . . . . . . . . .135,000 135,000

Net operating income (loss) . . . . . . . . . . $ 15,000 $ (1,390)

*Contains direct materials, direct labor, and variable manufacturing overhead.

Mr. Santiago was shocked to see the loss for the month, particularly because sales were
exactly as budgeted. He stated, “I sure hope the plant has a standard cost system in
operation. If it doesn’t, I won’t have the slightest idea of where to start looking for the
problem.”

The plant does use a standard cost system, with the following standard variable cost per
ingot:

70
 Standard Quantity Standard Price Standard

or Hours or Rate Cost

Direct materials . . . . . . . . . . . . . . . . . . . . 4.0 pounds $2.50 per pound $10.00

Direct labor . . . . . . . . . . . . . . . . . . . . . . . 0.6 hours $9.00 per hour 5.40

Variable manufacturing overhead . . . . . . 0.3 hours* $2.00 per hour 0.60

Total standard variable cost . . . . . . . . . . $16.00

*Based on machine-hours.

During October the plant produced 5,000 ingots and incurred the following costs:

a. Purchased 25,000 pounds of materials at a cost of $2.95 per pound. There were no raw
materials in inventory at the beginning of the month.

b. Used 19,800 pounds of materials in production. (Finished goods and work in process
inventories are insignificant and can be ignored.)

c. Worked 3,600 direct labor-hours at a cost of $8.70 per hour.

d. Incurred a total variable manufacturing overhead cost of $4,320 for the month. A total
of 1,800 machine-hours was recorded.

It is the company’s policy to close all variances to cost of goods sold on a monthly basis.

Required:

1. Compute the following variances for October:

a. Direct materials price and quantity variances.

b. Direct labor rate and efficiency variances.

c. Variable overhead rate and efficiency variances.

2. Summarize the variances that you computed in (1) above by showing the net overall
favorable or unfavorable variance for October. What impact did this figure have on the
company’s income statement?

3. Pick out the two most significant variances that you computed in (1) above. Explain to
Mr. Santiago possible causes of these variances.
71
PROBLEM 6–10 Variance Analysis in a Hospital [LO1, LO2, LO3]

“What’s going on in that lab?” asked Derek Warren, chief administrator for Cottonwood
Hospital, as he studied the prior month’s reports. “Every month the lab teeters between a
profit and a loss. Are we going to have to increase our lab fees again?”

“We can’t,” replied Lois Ankers, the controller. “We’re getting lots of complaints about
the last increase, particularly from the insurance companies and governmental health units.
They’re now paying only about 80% of what we bill. I’m beginning to think the problem is
on the cost side.”

To determine if lab costs are in line with other hospitals, Mr. Warren has asked you to
evaluate he costs for the past month. Ms. Ankers has provided you with the following
information:

a. Two basic types of tests are performed in the lab—smears and blood tests. During the
past month, 2,700 smears and 900 blood tests were performed in the lab.

b. Small glass plates are used in both types of tests. During the past month, the hospital
purchased 16,000 plates at a cost of $38,400. This cost is net of a 4% purchase discount. A
total of 2,000 of these plates were unused at the end of the month; no plates were on hand
at the beginning of the month.

c. During the past month, 1,800 hours of labor time were used in performing smears and
blood tests. The cost of this labor time was $18,450.

d. The lab’s variable overhead cost last month totaled $11,700.

Cottonwood Hospital has never used standard costs. By searching industry literature,
however, you have determined the following nationwide averages for hospital labs:

Plates: Three plates are required per lab test. These plates cost $2.50 each and are disposed
of after the test is completed.

Labor: Each smear should require 0.3 hours to complete, and each blood test should
require0.6 hours to complete. The average cost of this lab time is $12 per hour.

Overhead: Overhead cost is based on direct labor-hours. The average rate of variable
overhead is $6 per hour.

Required:

1. Compute the materials price variance for the plates purchased last month, and compute
a materials quantity variance for the plates used last month.
72
2. For labor cost in the lab:

a. Compute a labor rate variance and a labor efficiency variance.

b. In most hospitals, three-fourths of the workers in the lab are certified technicians
and one-fourth are assistants. In an effort to reduce costs, Cottonwood Hospital
employs only one-half certified technicians and one-half assistants. Would you
recommend that this policy be continued? Explain.

3. Compute the variable overhead rate and efficiency variances. Is there any relation
between the variable overhead efficiency variance and the labor efficiency variance?
Explain.

PROBLEM 6-11 Basic Variance Analysis [LO1, LO2, LO3]

Barberry, Inc., manufactures a product called Fruta. The company uses a standard cost
system and has established the following standards for one unit of Fruta:

During June, the company recorded this activity related to production of Fruta:

a. The company produced 3,000 units during June.

b. A total of 8,000 pounds of material were purchased at a cost of $46,000.

c. There was no beginning inventory of materials; however, at the end of the month, 2,000
pounds of material remained in ending inventory.

d. The company employs 10 persons to work on the production of Fruta. During June, they
worked an average of 160 hours at an average rate of $12.50 per hour.

e. Variable manufacturing overhead is assigned to Fruta on the basis of direct labor-hours.

Variable manufacturing overhead costs during June totaled $3,600.

The company’s management is anxious to determine the efficiency of Fruta production

activities.
73
Required:

1. For direct materials:

a. Compute the price and quantity variances.

b. The materials were purchased from a new supplier who is anxious to enter into a
longterm purchase contract. Would you recommend that the company sign the
contract? Explain.

2. For labor employed in the production of Fruta:

a. Compute the rate and efficiency variances.

b. In the past, the 10 persons employed in the production of Fruta consisted of 4

senior workers and 6 assistants. During June, the company experimented with 5
senior workers and 5 assistants. Would you recommend that the new labor mix be
continued? Explain.

3. Compute the variable overhead rate and efficiency variances. What relation can you see
between this efficiency variance and the labor efficiency variance?

PROBLEM 6–12 Basic Variance Analysis; the Impact of Variances on Unit Costs
[LO1, LO2, LO3]

Landers Company manufactures a number of products. The standards relating to one of

these products are shown below, along with actual cost data for May

74
 Standard Actual

Cost per Cost

Unit per Unit

Direct materials:

Standard: 1.80 feet at $3.00 per foot . . . . $ 5.40

Actual: 1.75 feet at $3.20 per foot . . . . . . . . . . . . . . . $ 5.60

Direct labor:

Standard: 0.90 hours at $18.00 per hour. . 16.20

Actual: 0.95 hours at $17.40 per hour . . . . . . . . . . . . 16.53

Variable overhead:

Standard: 0.90 hours at $5.00 per hour. . . .4.50

Actual: 0.95 hours at $4.60 per hour . . . . . . . . . . . . . 4.37

Total cost per unit . . . . . . . . . . . . . . . . . $26.10 $26.50

Excess of actual cost over standard cost per unit . . $0.40

The production superintendent was pleased when he saw this report and commented: “This
$0.40 excess cost is well within the 2 percent limit management has set for acceptable
variances. It’s obvious that there’s not much to worry about with this product.”

Actual production for the month was 12,000 units. Variable overhead cost is assigned to
products on the basis of direct labor-hours. There were no beginning or ending inventories
of materials.

Required:

1. Compute the following variances for May:

a. Materials price and quantity variances.

b. Labor rate and efficiency variances.

75
 c. Variable overhead rate and efficiency variances.

2. How much of the $0.40 excess unit cost is traceable to each of the variances computed
in (1) above.

3. How much of the $0.40 excess unit cost is traceable to apparent inefficient use of labor
time?

4. Do you agree that the excess unit cost is not of concern?

PROBLEM 6–13 Materials and Labor Variances; Computations from Incomplete

Data [LO1, LO2]

Topaz Company makes one product and has set the following standards for materials and
labor:

Direct Direct

Materials Labor

Standard quantity or hours per unit . . . . ? pounds 2.5 hours

Standard price or rate . . . . . . . . . . . . . . ? per pound $9.00 per hour

Standard cost per unit . . . . . . . . . . . . . . ? $22.50

During the past month, the company purchased 6,000 pounds of direct materials at a cost of
$16,500. All of this material was used in the production of 1,400 units of product. Direct
labor cost totaled $28,500 for the month. The following variances have been computed:

Materials quantity variance . . . . . . . . . . . . . . . $1,200 U

Total materials spending variance . . . . . . . . . . $300 F

Labor efficiency variance . . . . . . . . . . . . . . . . . $4,500 F

Required:

1. For direct materials:

a. Compute the standard price per pound for materials.

b. Compute the standard quantity allowed for materials for the month’s production.

c. Compute the standard quantity of materials allowed per unit of product.

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2. For direct labor:

a. Compute the actual direct labor cost per hour for the month.

b. Compute the labor rate variance.

(Hint: In completing the problem, it may be helpful to move from known to unknown data
either by using the variance formulas or by using the columnar format shown in Exhibits
5–5 and 5–6 .)

PROBLEM 6–14 Comprehensive Variance Analysis [LO1, LO2, LO3]

Vitalite, Inc., produces a number of products, including a body-wrap kit. Standard variable
costs relating to a single kit are given below:

Standard Quantity Standard Price Standard

or Hours or Rate Cost

Direct materials. . . . . . . . . . . . . . . . ? $6 per yard $?

Direct labor . . . . . . . . . . . . . . . . . . . ? ? ?

Variable manufacturing overhead . . .? $2 per direct labor-hour ?

Total standard cost per kit . . . . . . . . . . . . . . $42

During August, 500 kits were manufactured and sold. Selected information relating to the

month’s production is given below:

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 Materials Direct Variable Manufacturing

Used Labor Overhead

Total standard cost*. . . . . . . . . . . . . .? $8,000 $1,600

Actual costs incurred . . . . . . . . . . $10,000 ? $1,620

Materials price variance . . . . . . . . . . ?

Materials quantity variance . . . . . .$600 U

Labor rate variance . . . . . . . . . . . . . . . . . . . ?

Labor efficiency variance . . . . . . . . . . . . . . ?

Variable overhead rate variance . . . . . . . . . ?

Variable overhead efficiency variance . . . . . ?

*For the month’s production.

The following additional information is available for August’s production of kits:

Actual direct labor-hours . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 900

Difference between standard and actual cost per kit produced

during August . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $0.14 U

Required:

1. What was the total standard cost of the materials used during August?

2. How many yards of material are required at standard per kit?

3. What was the materials price variance for August if there were no beginning or ending
inventories of materials?

4. What is the standard direct labor rate per hour?

5. What was the labor rate variance for August? The labor efficiency variance?

6. What was the variable overhead rate variance for August? The variable overhead
efficiency variance?

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7. Complete the standard cost card for one kit shown at the beginning of the problem.

PROBLEM 6–15 Comprehensive Variance Analysis [LO1, LO2, LO3]

Helix Company produces several products in its factory, including a karate robe. The
company uses a standard cost system to assist in the control of costs. According to the
standards that have been set for the robes, the factory should work 780 direct labor-hours
each month and produce 1,950 robes. The standard costs associated with this level of
production are as follows:

Total Per Unit

of Product

Direct materials. . . . . . . . . . . . . . . . . . . . . . . . $35,490 $18.20

Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . $7,020 3.60

Variable manufacturing overhead (based on

direct labor-hours) . . . . . . . . . . . . . . . . . . . . $2,340 1.20

$23.00

During April, the factory worked only 760 direct labor-hours and produced 2,000 robes.
The following actual costs were recorded during the month:

Total Per Unit

Of Product

Direct materials (6,000 yards) . . . . . .$36,000 $18.00

Direct labor . . . . . . . . . . . . . . . . . . . . . $7,600 3.80

Variable manufacturing overhead . . . .$3,800 1.90

$23.70

At standard, each robe should require 2.8 yards of material. All of the materials purchased
during the month were used in production.

Required:
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Compute the following variances for April:

1. The materials price and quantity variances.

2. The labor rate and efficiency variances.

3. The variable manufacturing overhead rate and efficiency variances.

PROBLEM 6–16 Multiple Products, Materials, and Processes [LO1, LO2]

Monte Rosa Corporation produces two products, Alpha8s and Zeta9s, which pass through
two operations, Sintering and Finishing. Each of the products uses two raw materials, X342
and Y561. The company uses a standard cost system, with the following standards for each
product (on a per unit basis):

Raw Material Standard Labor Time

Product X342 Y561 Sintering Finishing

Alpha8 . . . . .1.8 kilos 2.0 liters 0.20 hours 0.80 hours

Zeta9 . . . . . . 3.0 kilos 4.5 liters 0.35 hours 0.90 hours

Information relating to materials purchased and materials used in production during May

follows:

Material Purchases Purchase Cost Standard Price Used in Production

X342 . . . . . 14,000 kilos $51,800 $3.50 per kilo 8,500 kilos

Y561 . . . . . 15,000 liters $19,500 $1.40 per liter 13,000 liters

The following additional information is available:

a. The company recognizes price variances when materials are purchased.

b. The standard labor rate is $20.00 per hour in Sintering and $19.00 per hour in Finishing.

c. During May, 1,200 direct labor-hours were worked in Sintering at a total labor cost of $27,000,
and 2,850 direct labor-hours were worked in Finishing at a total labor cost of $59,850.

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d. Production during May was 1,500 Alpha8s and 2,000 Zeta9s.

Required:

1. Prepare a standard cost card for each product, showing the standard cost of direct
materials and direct labor.

2. Compute the materials quantity and price variances for each material.

3. Compute the direct labor efficiency and rate variances for each operation.

---The end---

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