Explain why the operating incomes are different

Reference no: EM132603662

Question 1:

Hill Bikes Unlimited uses a flexible budget and standard costs to aid planning and control of its bicycle production. You recently accepted a position with Hill Bikes and as part of your duties, you must review the variances and make a presentation to the company's executive committee (which is not made up of trained accountants).

As in the real world, sometimes things happen. Assume that the material you prepared was placed on top of some papers going into the shredder. (You know where this story is going.....) After you realize your mistake, you rush into the shredding room to find that some of your pages and data have been shredded. This is all that is left:

Standard or budgeted costs and quantities:

Direct materials 2.0 meters of aluminum at $16 per meter

Direct labor 2 hours at $15 per hour

Variable OH Based on DL hrs, the standard or budgeted VOH rate is $9

Fixed OH Based on DL hrs, the standard or budgeted FOH rate is $23

Total Costs allowed for the actual quantity of output (flexible budget)

Direct Materials $608,000

Direct Labor $570,000

Variable OH $342,000

Variances Price (or spending) variance Efficiency variance

Direct Materials $25,000 Fav $ 32,000 Unfav

Direct Labor $30,000 Unf $30,000 Unfav

Variable OH $8,000 Fav ????

Fixed OH $6,000 Fav ????

Direct Materials price var per meter = $0.50 Fav

The Budgeted quantity of bikes is 20,000 units.

Given that you presentation is coming up soon, prepare a variance analysis using the 4-way chart / table (see attached template). Be sure to complete all totals along with the variances clearly marked as unfav or fav. Submit that template along with answers to the following questions.

1. What was the actual quantity of bikes produced?
2. How many meters of direct materials were actually purchased? (Hint: Use the variance and your knowledge of the budgeted price for materials to solve for actual price; then solve for the quantity.)
3. Is VOH underapplied or overapplied? By how much? Is FOH underapplied or overapplied? By how much?
4. Explain the Production volume variance (PVV)?
5. Identify at least 3 of the variances (not the PVV) and explain to the executive board what the variances indicate. How is the firm doing?

Chpt 7 & 8 HW

Actual

Flexible Budget

OH Applied

(This column only for OH)

Dir Mat

(AQ_I x AP)

(AQ_I x BP)

( x )

(AQ_I x BP)

( x )

[(AQ_O x BQ_I) x BP]

Dir Lab

(AQ_I x AP)

( x )

(AQ_I x BP)

( x )

[(AQ_O x BQ_I) x BP]

VOH

Q_I= how we 'apply' OH

(AQ_I x AP)

Actual

(AQ_I x BP)

[(AQ_O x BQ_I) x BP]

Applied

[(AQ_O x BQ_I) x BP]

FOH

Q_I= how we 'apply' OH

Actual

Master Budget

Flexible Budget

Applied

[(AQ_O x BQ_I) x BP]

VOH or FOH Rate = $ Budgeted OH/(BQO x BQI)

BQO = Budgeted number of units EXPECTED to be made

BQI = Budgeted quantity of INPUTS for each units; INPUTS are whatever we use to "apply" or "allocate" OH. (Most likely DL hrs or MHrs.)

Question 2:

Joan Hill, President of Hill & Hill Pens, was looking forward to receiving the company's second quarter income statement. She knew that the sales budget of 20,000 units sold had been met during the second quarter and that this was an increase of 25% over the first quarter sales units. She was happy about the increase in sales, since Hill & Hill Pens was about to approach its bank for additional loan money for expansion purposes. She anticipated the strong second-quarter results would be a real plus in persuading the bank to extend the additional credit.

For this reason, Joan was shocked when she saw the first two quarters income statement below. Instead of increasing operating income, there was a decrease.

Hill & Hill Pens Income Statements For the First Two Quarters
	First Quarter		Second Quarter
Sales		$1,600,000		$2,000,000
-COGS
Beg Inv	$ 210,000		490,000
COGM	1,400,000		980,000
-End Inv	<490,000>		< 70,000>
+/- Adj for PVV	0		240,000
		1,120,000		1,640,000
= Gross margin		$ 480,000		$ 360,000
-Selling & Admin
Variable		80,000		100,000
Fixed		230,000		230,000
Operating Income		$ 170,000		$ 30,000

Joan was certain there had to be an error somewhere and immediately called the controller into her office to find the problem. The controller stated, "The operating income is correct, Joan. Sales went up during the second quarter, but the problem is in production. You see, we budgeted to produce 20,000 units each quarter, but a strike in one of our supplier's plants forced us to cut production back to only 14,000 units in the second quarter. That's what caused the drop in operating income."

Joan replied, "I don't understand this! I know sales increased, yet you talk about production to explain the drop in income! What does this have to do with the sales that we made? If sales go up, then income ought to go up."

Budgeted production and sales for the year, along with actual production and sales for the first two quarters are given below:

	1^st Quarter	2^nd Quarter	3^rd Quarter	4^th Quarter
Planned (budgeted) sales	16,000	20,000	20,000	24,000
Actual sales	16,000	20,000	-	-

Planned (budgeted) production	20,000	20,000	20,000	20,000
Actual production	20,000	14,000	-	-

The company's plant is heavily automated, so fixed manufacturing overhead costs total $800,000 per quarter. Variable manufacturing costs are $30 per unit. The fixed manufacturing overhead cost is applied to units at the rate of $40 per unit (based on the budgeted production shown above → $800,000/20,000 units = $40 per unit). Any Production Volume Variance is closed directly to COGS for the quarter.

The company had 3,000 units in inventory at the start of the first quarter. Variable selling and administrative expenses are $5 per unit.

Required:

1. Prepare a variable cost (contribution format) income statement for the first two quarters.

2. Explain why the operating incomes are different.

3. Explain why the first quarter has a $ 0 Production Volume Variance (PVV) and the second quarter has a $240,000 PVV. Why is the $240,000 PVV added to COGS?

4. Given that you may need to consult with owners of small-sized business in the future, what are some of the advantages and disadvantages of preparing a variable costing method income statement for them?

Reference no: EM132603662

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