Chapter 11 HW

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Problem 11-36 Standard Hours Allowed; Flexible Budget; Multiple Products; Insurance Company (LO 11- 1, 11-2, 11-4) Gibralter Insurance Company uses a flexible overhead budget for its application-processing department. The firm offers five types of policies, with the following standard hours allowed for clerical processing. Automobile 1 hour Renter's 1 hour Homeowner's 2 hours Health 2 hours Life 5 hours The following numbers of insurance applications were processed during July. Automobile 310 Renter's 260 Homeowner's 160 Health 460 Life 260 The controller estimates that the variable-overhead rate in the application- processing department is $3.00 per clerical hour, and that fixed-overhead costs will amount to $2,600 per month. Required: 1. How many standard clerical hours are allowed in July, given actual application activity? 2. Why would it not be sensible to base the company’s flexible budget on the number of applications processed instead of the number of clerical hours allowed? 3. Construct a formula flexible overhead budget for the company. 4. What is the flexible budget for total overhead cost in July?

Explanation 1. Standard Hours per Standard Policy type Application Actual ActivityHours Allowed Automobile 1 310 310

Renter's 1 260 260 Homeowner's 2 160 320 Health 2 460 920 Life 5 260 1,300 Total 3,110 2. The different types of applications require different amounts of clerical time, and variable overhead cost is related to the use of clerical time. Therefore, basing the flexible budget on the number of applications would give a misleading estimate of overhead costs. For example, processing 160 life insurance applications will entail much more overhead cost than processing 160 automobile insurance applications. 3. Formula flexible budget: Total budgeted monthly overhead cost = (budgeted variable overhead cost per clerical hour) × (total clerical hours) + budgeted fixed overhead cost per month Total budgeted monthly overhead cost = ($3.00 × X ) + $2,600 where X denotes total clerical time in hours. 4. Budgeted overhead cost for July = ($3.00 × 3,110) + $2,600 = $11,930

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Problem 11-39 Budgets and Performance Evaluation (LO 11-1, 11-6) Johnson Electrical produces industrial ventilation fans. The company plans to manufacture 78,000 fans evenly over the next quarter at the following costs: direct material, $1,950,000; direct labor, $546,000; variable production overhead, $581,100; and fixed production overhead, $930,000. The $930,000 amount includes $93,000 of straight-line depreciation and $117,000 of supervisory salaries. Shortly after the conclusion of the quarter’s first month, Johnson reported the following costs: Direct material $ 573,500 Direct labor 174,600 Variable production overhead 198,000 Depreciation 31,000 Supervisory salaries 42,500 Other fixed production overhead 239,000 Total $1,258,600 Dave Kellerman and his crews turned out 22,000 fans during the month—a remarkable feat given that the firm’s manufacturing plant was closed for several days because of storm damage and flooding. Kellerman was especially pleased with the fact that overall financial performance for the period was favorable when compared with the budget. His pleasure, however, was very short-lived, as Johnson’s general manager issued a stern warning that performance must improve, and improve quickly, if Kellerman had any hopes of keeping his job. Required: 2. Which of the two budgets would be more useful when planning the company’s cash needs over a range of activity? 3. Prepare a performance report that compares static budget and actual costs for the period just ended (i.e., the report that Kellerman likely used when assessing his performance). 4. Prepare a performance report that compares flexible budget and actual costs for the period just ended (i.e., the report that the general manager likely used when assessing Kellerman’s performance).

5-a. Which of the following two reports is preferred? 5-b. Which of the following statements is false?

Explanation 2. Given the focus on a range of activity, a flexible budget would be more useful because it incorporates several different activity levels. 3.&4. Direct material used: $1,950,000 ÷ 78,000 units = $25 per unit Direct labor:$546,000 ÷ 78,000 units = $7 per unit Variable production overhead:$581,100 ÷ 78,000 units = $7.45 per unit Depreciation:$93,000 ÷ 3 months = $31,000 per month Supervisory salaries:$117,000 ÷ 3 months = $39,000 per month Other fixed production overhead:($930,000 – $93,000 – $117,000) ÷ 3 months = $240,000 per month 5. A performance report based on flexible budgeting is preferred. The report compares budgeted and actual performance at the same volume level, eliminating any variations in activity. In essence, everything is placed on a “level playing field.” The general manager’s warning is appropriate because of the sizable variances that have arisen. With the static budget, performance appears favorable, especially with respect to variable costs. Bear in mind, though, that volume was below the original monthly expectation of 26,000 units, presumably because of the plant closure. A reduced volume will likely lead to lower variable costs than anticipated (and resulting favorable variances). When the volume differential is removed, variable cost variances total $78,200U ($23,500U + $20,600U + $34,100U), or 9.01% of budgeted variable costs ($550,000 + $154,000 + $163,900). The variable cost incurrence appears excessive with respect to all components of the total: direct material, direct labor, and variable production overhead.

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Problem 11-42 Flexible Budget; Performance Report (LO 11-1, 11-6) Mark Fletcher, president of SoftGro, Inc., was looking forward to seeing the performance reports for November because he knew the company’s sales for the month had exceeded budget by a considerable margin. SoftGro, a distributor of educational software packages, had been growing steadily for approximately two years. Fletcher’s biggest challenge at this point was to ensure that the company did not lose control of expenses during this growth period. When Fletcher received the November reports, he was dismayed to see the large unfavorable variance in the company’s Monthly Selling Expense Report that follows. SOFTGRO, INC. Monthly Selling Expense Report For the Month of November Annual Budget November Budget November Actual November Variance Unit sales 2,060,000 292,000 322,000 30,000 Dollar sales $ 148,320,00 0 $ 21,024,00 0 $ 23,184,00 0 $ 2,160,00 0 Orders processed 90,000 9,500 8,800 (700) Sales personnel per month 90 90 96 (6) Advertisin g $ 32,400,000 $ 2,700,000 $ 2,720,000 $ 20,000 U Staff salaries 2,880,000 240,000 240,000 Sales salaries 3,024,000 252,000 269,500 17,500 U Commission s 5,932,800 840,960 927,360 86,400 U Per diem expense 3,402,000 283,500 309,200 25,700 U Office expenses 9,000,000 750,000 786,600 36,600 U Shipping expenses 11,872,000 1,591,000 1,713,000 122,000 U Total expenses $ 68,510,800 $ 6,657,460 $ 6,965,660 $ 308,200 U

Fletcher called in the company’s new controller, Susan Porter, to discuss the implications of the variances reported for November and to plan a strategy for improving performance. Porter suggested that the company’s reporting format might not be giving Fletcher a true picture of the company’s operations. She proposed that SoftGro implement flexible budgeting. Porter offered to redo the Monthly Selling Expense Report for November using flexible budgeting so that Fletcher could compare the two reports and see the advantages of flexible budgeting. Porter discovered the following information about the behavior of SoftGro’s selling expenses.  The total compensation paid to the sales force consists of a monthly base salary and a commission; the commission varies with sales dollars.  Sales office expense is a semivariable cost with the variable portion related to the number of orders processed. The fixed portion of office expense is $5,400,000 annually and is incurred uniformly throughout the year.  Subsequent to the adoption of the annual budget for the current year, SoftGro decided to open a new sales territory. As a consequence, approval was given to hire six additional salespeople effective November 1. Porter decided that these additional six people should be recognized in her revised report.  Per diem reimbursement to the sales force, while a fixed amount per day, is variable with the number of sales personnel and the number of days spent traveling. SoftGro’s original budget was based on an average sales force of 90 people throughout the year with each salesperson traveling 15 days per month.  The company’s shipping expense is a semivariable cost with the variable portion, $5.00 per unit, dependent on the number of units sold. The fixed portion is incurred uniformly throughout the year. Required: 1. Why would Susan Porter propose that SoftGro use flexible budgeting in this situation? 2. Prepare a revised Monthly Selling Expense Report for November that would permit Mark Fletcher to more clearly evaluate SoftGro’s control over selling expenses.

Explanation 1. Susan Porter recommended that SoftGro use flexible budgeting in this situation because a flexible budget would allow Mark Fletcher to compare SoftGro's actual selling expenses (based on current month's actual activity) with budgeted selling expenses. In general, flexible budgets:  Provide management with the tools to evaluate the effects of varying levels of activity on costs, revenues, and profits.  Enable management to improve planning and decision making.  Improve the analysis of actual results. 2. Supporting calculations: Sales salaries: Monthly salary for salesperson $252,000 ÷ 90 = $2,800. Budgeted amount $2,800 × 96 = $268,800. Commissions: Commission rate $840,960 ÷ $21,024,000 = 0.04.

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Budgeted amount $23,184,000 × 0.04 = $927,360. Per diem expense: ($283,500 ÷ 90) ÷ 15 days = $210 per day. ($210 × 15) × 96 = $302,400. Office expenses: ($9,000,000 – 5,400,000) ÷ 90,000 = $40 per order. ($5,400,000 ÷ 12) + ($40 × 8,800) = $802,000. Shipping expenses: [$11,872,000 – ($5 × 2,060,000)] ÷ 12 = $131,000 monthly fixed expense. $131,000 + ($5 × 322,000) = $1,741,000.