Canton Company estimates sales of 12,000 units for the upcoming period. At this sales volume its budgeted income is as follows: Per Unit 12,000 UnitsSales$30 $360,000 Less variable costs: Manufacturing costs 16 192,000 Selling and administrative costs 8 96,000 Contribution margin$6 $72,000 Less fixed costs: Manufacturing costs 20,000 Selling and administrative costs 45,000 Net income $7,000 During the period the company actually produced and sold 14,000 units.Required:1) The manager now wants to evaluate the company's performance by comparing actual costs and revenues to those shown above, but you have advised against it. Explain your reasoning. 2) Prepare a flexible budget based on 14,000 units. 3) If
management compares actual revenues and costs to the appropriate flexible budget, will they be able to fully understand what went right and what went wrong with the operation during the period? Why or why not?
What will be an ideal response?
1) The problem with the comparison that the manager wants to make is that the static budget is based on a volume of 12,000 units, while the actual volume achieved was 14,000 units. In order to make meaningful comparisons, the static budget needs to be recast or stated at the 14,000-unit level.
2) Flexible budget based on 14,000 units:
| Per Unit | 14,000 Units | ||||||
| Sales | $ | 30 | $ | 420,000 | |||
| Less variable costs: | |||||||
| Manufacturing costs | 16 | 224,000 | |||||
| Selling and administrative costs | 8 | 112,000 | |||||
| Contribution margin | $ | 6 | $ | 84,000 | |||
| Less fixed costs: | |||||||
| Manufacturing costs | 20,000 | ||||||
| Selling and administrative costs | 45,000 | ||||||
| Net income | $ | 19,000 | |||||
3) Such a comparison will give an overall picture of how things went. For example, management will know whether actual variable manufacturing costs differed from standard variable manufacturing costs. However, in order to pinpoint specific problem areas it will be necessary to compute more detailed variances. For example, variances can be computed for each major cost category (materials, labor, overhead, and selling and general expenses). In addition, the variances for each cost category can be further divided into more detailed variances. For example, the overall materials and labor variances can be subdivided into price and usage variances. This is the level of detail management needs in order to plan specific responses for any problems that are identified.
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