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# Prepare a production budget and variances

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Utease Corporation has many production plants across the midwestern United States. A newly opened plant, the Bellingham plant, produces and sells one product. The plant is treated, for responsibility accounting purposes, as a profit center. The unit standard costs for a production unit, with overhead applied based on direct labor hours, are as follows:

Direct labor hours worked 34,000
Direct labor costs \$3,094,000.00
Direct materials purchased 50,000 pounds
Direct materials costs \$1,000,000.00
Direct materials used 50,000 pounds
Actual fixed overhead \$1,080,000.00
Actual variable overhead \$620,000.00
Actual selling and administrative costs \$2,000,000.00

In addition, all over- or underapplied overhead and all product cost variances are adjusted to cost of goods sold.

Instructions
a) Prepare a production budget for the coming year based on the available standards, expected sales, and desired ending inventories.
b) Prepare a budgeted responsibility income statement for the Bellingham plant for the coming a year.
c) Find the direct labor variances. Indicate if they are favorable or unfavorable and why they would be considered as such.
d) Find the direct materials variances (materials price variance and quantity variance)
e) Find the total over- or underapplied (both fixed and variable) overhead. Would cost of goods sold be a larger or smaller expense item after the adjustment for over- or underapplied overhead?
f) Calculate the actual plant operating profit for the year.
g) Use a flexible budget to explain the difference between the budgeted operating profit and the actual operating profit for the Bellingham plant for its first year of operations. What part of the difference do you believe is the plant manager's responsibility?
h) Assume Utease Corporation is planning to change its evaluation of business operations in all plants from the profit center format to the investment center format. If the average invest capital at the Bellingham plant is \$8,950,000, compute the return on investment (ROI) for the first year of operations. Use the Dupont method of evaluation to compute the return on sales (ROS) and capital turnover (CT) for the plant.
i) Assume that under the investment center evaluation plan the plant manager will be awarded a bonus based on ROI. If the manger has the opportunity in the coming year to invest in new equipment for \$500,000 that will generate incremental earnings of \$75,000 per year, would the manager undertake the project? Why or why not? What other evaluation tools could Utease use for its plants that might be better?
j) The chief financial officer of Utease Corporation wants to include a charge in each investment center's income statement for corporatewide administrative expenses. Should the Bellingham plant manger's annual bonus be based on plant ROI after deducting the corporatewide administrative fee? Why or why not?

##### Solution Summary

The solution explains how to prepare a production budget and calculate the various variances.

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a) Prepare a production budget for the coming year based on the available standards, expected sales and desired ending inventories.

The budget is to be made for the next year. The ending inventory of this year which is
23,000-21,500=1,500 will be the beginning inventory of next year. The expected activity
is given as 20,000 units. The production budget is
Expected Sales (Units) 20,000
Opening Inventory 1,500
Ending Inventory 2,000 10% of sales
Units to be Produced 20,500

b) Prepare a budgeted responsibility income statement for the Bellingham plant for the coming a year.

In responsibility income statement, the costs are dividend into fixed and variable. The
budgeted income statement is shown below
Sales (20,000X425) 8,500,000
Variable Cost (40+135+30+5) X 20,000 4,200,000 Direct Material + Direct Labor + Variable Overhead + Variable Selling
Contribution Margin 4,300,000
Fixed Costs 2,880,000 Fixed overhead is on expected activity
Operating Income 1,420,000

c) Find the direct labor variances. Indicate if they are favorable or unfavorable and why they would be considered as such.

Direct Labor Rate Variance = (Actual Rate - Standard Rate) X Actual Hours
Actual Hours 34,000
Actual Rate \$91.00
Standard Rate 90
Rate Variance 34,000 Unfavorable
Direct Labor Efficiency Variance = (Actual Hours - Standard Hours) X Standard Rate
Actual Hours 34,000
Standard Hours 34,500 Units Produced X Standard Hours per unit
Standard Rate 90
Efficiency Variance 45,000 Favorable
A variance is considered favorable if the ...

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