Chapter 12, Problem 30P

Douglas Davis, controller for Marston, Inc., prepared the following budget for manufacturing costs at two different levels of activity for 20X1:

During 20X1, Marston worked a total of 80,000 direct labor hours, used 250,000 machine hours, made 32,000 moves, and performed 120 batch inspections. The following actual costs were incurred:

Marston applies overhead using rates based on direct labor hours, machine hours, number of moves, and number of batches. The second level of activity (the right column in the preceding table) is the practical level of activity (the available activity for resources acquired in advance of usage) and is used to compute predetermined overhead pool rates.

Required:

1. 1. Prepare a performance report for Marston’s manufacturing costs in the current year.
2. 2. Assume that one of the products produced by Marston is budgeted to use 10,000 direct labor hours, 15,000 machine hours, and 500 moves and will be produced in five batches. A total of 10,000 units will be produced during the year. Calculate the budgeted unit manufacturing cost.
3. 3. One of Marston’s managers said the following: “Budgeting at the activity level makes a lot of sense. It really helps us manage costs better. But the previous budget really needs to provide more detailed information. For example, I know that the moving materials activity involves the use of forklifts and operators, and this information is lost when only the total cost of the activity for various levels of output is reported. We have four forklifts, each capable of providing 10,000 moves per year. We lease these forklifts for five years, at $10,000 per year. Furthermore, for our two shifts, we need up to eight operators if we run all four forklifts. Each operator is paid a salary of $30,000 per year. Also, I know that fuel costs about $0.25 per move.”

Assuming that these are the only three items, expand the detail of the flexible budget for moving materials to reveal the cost of these three resource items for 20,000 moves and 40,000 moves, respectively. Based on these comments, explain how this additional information can help Marston better manage its costs. (Especially consider how activity-based budgeting may provide useful information for non-value-added activities.)

To determine

Make a performance report for incorporation M manufacturing costs for the current year.

Explanation of Solution

Prepare a performance report for incorporation M.

Incorporation M
Performance Report
For the year 20X1
Particulars	Actual costs	Budgeted costs	Budget variance
Direct materials	$ 440,000	$ 480,000(1)	$40,000 F
Direct labour	355,000	320,000(2)	35,000 U
Depreciation	100,000	100,000	0
Maintaining equipment	425,000	435,000(3)	10,000 F
Machining	142,000	137,000(4)	5,000 U
Moving materials	232,500	240,000(5)	7,500 F
Inspecting products	160,000	145,000(6)	15,000 U
Total	$ 1,854,500	$ 1,857,000	$2,500 F

Table (1)

Therefore, the budget variance of incorporation M for the year 20X1 is $2,500 favourable.

Note: Budgeted costs are determined using the appropriate cost driver for each method, under the high-low method.

Working notes:

(1)

$\begin{array}{c}\begin{array}{l}\text{Budgeted cost of }\\ \text{direct material}\end{array}]\text{ =}\left[\begin{array}{l}\left(\frac{\text{Direct materials at highest level}-\text{Direct materials at lowest level }}{\text{Direct labor hours at highest level }-\text{Direct labor hours at lowest level }}\right)\\ \times \\ \text{Direct labor hours during 20X1}\end{array}\right]\\ \text{=}\frac{\left(\$600,000-\$300,000\right)}{\left(100,000\text{DLH}-50,000\text{DLH}\right)}\times 80,000\text{DLH}\\ \text{=\$6}\times \text{80,000 DLH}\\ \text{=\$480,000}\end{array}$

(2)

$\begin{array}{c}\begin{array}{l}\text{Budgeted cost of}\\ \text{ direct labor}\end{array})\text{=}\left[\begin{array}{l}\left(\frac{\text{Cost of direct labor at highest level}-\text{Cost of direct labor at lowest level}}{\text{Direct labor hours at highest level}-\text{Direct labor hours at lowest level}}\right)\\ \times \text{Direct labour hours}\text{}\text{during 20X}1\end{array}\right]\\ \text{=}\frac{\left(\$400,000-\$200,000\right)}{\left(100,000\text{ DLH}-50,000\text{DLH}\right)}\times 80,000\text{DLH}\\ \text{=\$4}\times 80,000\text{DLH}\\ \text{=\$320,000}\end{array}$

(3)

The fixed and variable costs portions of maintaining equipment is calculated using high-low method as follows:

$\begin{array}{c}\begin{array}{l}\text{Budgeted fixed cost}\\ \text{of maintaining equipment}\\ \left(\text{A}\right)\end{array}\}=\left[\begin{array}{l}\left(\frac{\begin{array}{l}\text{Cost of maintaining equipment at highest level}-\\ \text{Cost of maintaining equipment}\text{at lowest level}\end{array}}{\begin{array}{l}\text{Machine hours at highest level}-\\ \text{Machine hours at lowest level}\end{array}}\right)\\ \times \text{Machine hours during 20X1}\end{array}\right]\\ =\left[\begin{array}{l}\frac{\left(\$510,000-\$360,000\right)}{\left(300,000\text{machine hours}-200,000\text{machine hours}\right)}\\ \times 250,000\text{machine hours}\end{array}\right]\\ \text{=}\frac{\$150,000}{100,000\text{machine hours}}\times 250,000\text{machine hours}\\ \text{=\$1}\text{.50}\times \text{250,000 machine hours}\\ \text{=\$375,000}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Budgeted varriable cost }\\ \text{of maintaining equipment}\\ \left(\text{B}\right)\end{array}\}=\left[\begin{array}{l}\text{Cost of maintaining equipment}-\\ \left(\begin{array}{l}\text{Budgeted fixed cost of maintainig equipment}\text{per machine hour}\times \\ \text{machine hours}\end{array}\right)\end{array}\right]\\ =\$510,000-\left(\$1.50\times 300,000\text{machine hours}\right)\\ =\$510,000-\$450,000\\ =\$60,000\end{array}$

Therefore,

$\begin{array}{c}\text{Budgeted cost of maintaining equipment}\text{=}(\text{A)}\text{+}(\text{B)}\\ \text{=\$375,000}\text{+}\text{\$}\text{60,000}\\ \text{=\$435,000}\end{array}$

(4)

The fixed and variable costs portion of machining is calculated using high-low method as follows:

$\begin{array}{c}\begin{array}{l}\text{Budgeted fixed cost}\\ \text{of machining}\\ \left(\text{A}\right)\end{array}\}=\left[\begin{array}{l}\left(\frac{\text{Cost of machining at highest level}-\text{Cost of machining}\text{at lowest level}}{\text{Machine hours at highest level}-\text{Machine hours at lowest level}}\right)\\ \times \text{Machine hours during 20X1}\end{array}\right]\\ =\left[\begin{array}{l}\frac{\left(\$162,000-\$112,000\right)}{\left(300,000\text{machine hours}-200,000\text{machine hours}\right)}\\ \times 250,000\text{machine hours}\end{array}\right]\\ \text{=}\frac{\$50,000}{100,000\text{machine hours}}\times 250,000\text{machine hours}\\ \text{=\$0}\text{.50}\times \text{250,000 machine hours}\\ \text{=\$125,000}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Budgeted varriable cost }\\ \text{of machining}\\ \left(\text{B}\right)\end{array}\}=\left[\begin{array}{l}\text{Cost of machining}-\\ \left(\begin{array}{l}\text{Budgeted fixed cost of machining}\text{per machine hour}\times \\ \text{machine hours}\end{array}\right)\end{array}\right]\\ =\$162,000-\left(\$0.50\times 300,000\text{machine hours}\right)\\ =\$162,000-\$150,000\\ =\$12,000\end{array}$

Therefore,

$\begin{array}{c}\text{Budgeted cost of machining}\text{=}\text{(A)+(B)}\\ \text{=\$125,000}\text{+}\text{\$}12\text{,000}\\ \text{=\$137,000}\end{array}$

(5)

The fixed and variable costs portion of moving materials is calculated using high-low method as follows:

$\begin{array}{c}\begin{array}{l}\text{Budgeted fixed cost}\\ \text{of moving materials}\\ \left(\text{A}\right)\end{array}\}=\left[\begin{array}{l}\left(\frac{\begin{array}{l}\text{Cost of moving materials at highest level}-\\ \text{Cost of moving materials}\text{at lowest level}\end{array}}{\begin{array}{l}\text{Material moves at highest level}-\\ \text{Material moves at lowest level}\end{array}}\right)\\ \times \text{Material moves during 20X1}\end{array}\right]\\ =\left[\begin{array}{l}\frac{\left(\$290,000-\$165,000\right)}{\left(40,000\text{material moves}-20,000\text{material moves}\right)}\\ \times 32,000\text{material moves}\end{array}\right]\\ \text{=}\frac{\$125,000}{20,000\text{material moves}}\times 32,000\text{material moves}\\ \text{=\$6}\text{.25}\times 32\text{,000 material moves}\\ \text{=\$200,000}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Budgeted varriable cost }\\ \text{of moving materials}\\ \left(\text{B}\right)\end{array}\}=\left[\begin{array}{l}\text{Cost of moving materials}-\\ \left(\begin{array}{l}\text{Budgeted fixed cost of }\text{per material moves}\times \\ \text{material moves}\end{array}\right)\end{array}\right]\\ =\$290,000-\left(\$6.25\times 40,000\text{material moves}\right)\\ =\$290,000-\$250,000\\ =\$40,000\end{array}$

Therefore,

$\begin{array}{c}\text{Budgeted cost of machining}\text{=}\text{(A)+(B)}\\ \text{=\$200,000}\text{+}\text{\$}40\text{,000}\\ \text{=\$240,000}\end{array}$

(6)

The fixed and variable costs portion of inspecting products is calculated using high-low method as follows:

$\begin{array}{c}\begin{array}{l}\text{Budgeted fixed cost}\\ \text{of inspecting products}\\ \left(\text{A}\right)\end{array}\}=\left[\begin{array}{l}\left(\frac{\begin{array}{l}\text{Cost of inspecting products at highest level}-\\ \text{Cost of inspecting products}\text{at lowest level}\end{array}}{\begin{array}{l}\text{Number of batches inspected at highest level}-\\ \text{Number of batches inspected at lowest level}\end{array}}\right)\\ \times \text{Number of batches inspected during 20X1}\end{array}\right]\\ =\left[\begin{array}{l}\frac{\left(\$225,000-\$125,000\right)}{\left(200\text{batch}\text{inspections}-100\text{batch inspections}\right)}\\ \times 120\text{batch inspections}\end{array}\right]\\ \text{=}\frac{\$100,000}{100\text{batch inspections}}\times 120\text{batch inspections}\\ \text{=\$1,000}\times 120\text{batch inspections}\\ \text{=\$120,000}\end{array}$

$\begin{array}{c}\begin{array}{l}\text{Budgeted varriable cost }\\ \text{of inspecting products}\\ \left(\text{B}\right)\end{array}\}=\left[\begin{array}{l}\text{Cost of inspecting products}-\\ \left(\begin{array}{l}\text{Budgeted fixed cost of }\text{per batch inspctions}\times \\ \text{number of batches inspected}\end{array}\right)\end{array}\right]\\ =\$225,000-\left(\$1000\times 200\text{batch inspections}\right)\\ =\$225,000-\$200,000\\ =\$25,000\end{array}$

Therefore,

$\begin{array}{c}\text{Budgeted cost of machining}\text{=}\text{(A)+(B)}\\ \text{=\$120,000}\text{+}\text{\$}25\text{,000}\\ \text{=\$145,000}\end{array}$

To determine

Determine the budgeted unit manufacturing cost for Incorporation M.

Explanation of Solution

Compute the pool rates:

$\begin{array}{c}\left(\text{a}\right)\text{ Pool rate for direct labour hour = }\frac{\left(\text{Direct materials + direct labor + depreciation}\right)}{\text{Direct labour hours}}\\ =\frac{\left(\$600,000+\$400,000+\$100,000\right)}{100,000\text{DLH}}\\ =\frac{\$1,100,000}{100,000\text{DLH}}\\ =\$11\text{per direct labor hour}\end{array}$

$\begin{array}{c}\left(\text{b}\right)\text{Pool rate for machine hour = }\frac{\left(\text{Cost of maintaining equipment}\text{+}\text{cost of machining}\right)}{\text{Machine hours}}\\ =\frac{\left(\$510,000+\$162,000\right)}{300,000\text{machine hours}}\\ =\$2.24\text{per machine hour}\end{array}$

$\begin{array}{c}\left(\text{c}\right)\text{Pool rate for material moves = }\frac{\text{Cost of moving materials}}{\text{Number of material moves}}\\ =\frac{\$290,000}{40,000\text{material moves}}\\ =7.25\text{per material moves}\end{array}$

$\begin{array}{c}\left(\text{d}\right)\text{Pool rate for inspecting products = }\frac{\text{Cost of inspecting products}}{\text{Number of batches inspected}}\\ =\frac{\$225,000}{200\text{batch inspections}}\\ =\$1,125\text{per batch}\end{array}$

Note: The pool (a) incorporates both material and labor costs. The total for each pool represents the appropriate costs related to the given driver in the flexible budget. The totals represent the second activity level of the budget.

Ascertain the unit cost:

Pool	Calculation	Amount ($)
a	$\begin{array}{l}\text{Pools rate}\times \text{direct labor hours}\\ \text{\$11}\times \text{10,000}\text{DLH}\end{array}$	$ 110,000
b	$\begin{array}{l}\text{Pool rate }\times \text{machine hours}\\ \text{\$2}\text{.24}\times \text{15,000 machine hours}\end{array}$	$ 33,600
c	$\begin{array}{l}\text{Pool rate }\times \text{moves}\\ \text{\$7}\text{.25}\times \text{500 moves}\end{array}$	$ 3,625
d	$\begin{array}{l}\text{Pool rate }\times \text{batch inspections}\\ \text{\$1,125}\times \text{5}\text{batch inspections}\end{array}$	$ 5,625
Total		$ 152,850
Divide: Units		10,000 units
Unit cost	$\frac{\$152,850}{10,000\text{units}}$	$ 15.29 (rounded off)

Table (1)

Thus, the unit cost for the incorporation M is $15.29.

To determine

Describe how activity-based budgeting may provide useful information for non-value-added activities.

Explanation of Solution

To provide more insight into controlling the activity and its associated cost, it is necessary to have significant knowledge about how the resource costs change with activity drivers and the consumption of resources by each activity.

Example: - The moving material is deemed to be a non-value-added activity, and efforts should be made to diminish the demands for this activity. If the number of moves can able to decrease to 20,000 from the expected 40,000, then the costs can be reduced by not only eliminating the need for the four operators, but also by decreasing the demand to lease from four to two forklifts. Whereas, while considering in the short run, if the demand for their service is reduced, then the cost of leasing forklifts may insist.    

Particulars	20,000 moves	40,000 moves
Materials handling:
Forklifts	$ 40,000	$ 40,000
Operators	$ 120,000	$ 240,000
Fuel	$ 5,000	$ 10,000
Total	$ 165,000	$ 290,000

Table (2)

The information assumes that the forklift leases has to be continued in the short run, but the number of operators should be cut down and it is assumed that each operator can do 5,000 moves per year. An extra benefit of $20,000 can be achieved by subleasing the two forklifts. Therefore, the budget, points out that by reducing the requirement for materials handling to 20,000 moves will enable to save between $125,000 and $145,000 relative to the 40,000-move level. If the activity requirement is reduced to nil, an additional amount of up to $165,000 can able to save.