Question

Binky Ltd manufactures one product, the Whirl.

Currently it is operating at a normal level of activity of 60% which represents an output of 10080 units.

However the sales director believes that a realistic forecast for the next budget period would be a level of activity of 45%

Information:

60%   70%   80%

Direct materials 70560 82320 94080

Direct wages   50400. 58800. 67200

Production overhead   50240. 55280. 60320

Administration overhead   40000. 40000. 40000

Selling overhead 53320. 60040 66760

Total cost   264520 296440. 328360

Profit is 25% of selling price.

Required:
Prepare a budget based on a level of activity of 45% which should show the contribution which can be expected.

Answer 1

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Binky Ltd
First we will identify the nature of costs i.e. if they are fixed, variable or mixed.
60% of capacity is 10,080 units.
100% of capacity is 16,800 units i.e. 10,080/60%
Number of units at 70%	11,760.00	i.e. 16,800*70%
Number of units at 80%	13,440.00	i.e. 16,800*80%
Capacity	60%	70%	80%
Number of units	10,080.00	11,760.00	13,440.00
Direct materials	70,560.00	82,320.00	94,080.00
Direct materials per unit	7.00	7.00	7.00	Cost per unit is same at every level. So it is a variable cost.
Direct wages	50,400.00	58,800.00	67,200.00
Direct wages per unit	5.00	5.00	5.00	Cost per unit is same at every level. So it is a variable cost.
Production overhead	50,240.00	55,280.00	60,320.00
Production overhead per unit	4.98	4.70	4.49	Cost per unit is not same at every level. Also total cost is also not same at every level. So it is a mixed cost.
We will use high low method to calculate the fixed and variable portion of Production overhead.
Variable cost=	(Highest activity cost- Lowest activity cost)/ (Highest activity units- Lowest activity units)
	Cost	Units
Highest units	60,320.00	13,440.00
Lowest units	50,240.00	10,080.00
Difference	10,080.00	3,360.00
Variable cost per unit	3.00
Fixed cost	Highest activity cost- (Highest units * Variable cost per unit)
Fixed cost	60320-(13440*3)
Fixed cost	20,000.00
Administration overhead	40,000.00	40,000.00	40,000.00
Administration overhead				Total cost is same at every level. So it is a fixed cost.
Selling overhead	53,320.00	60,040.00	66,760.00
Direct wages per unit	5.29	5.11	4.97	Cost per unit is not same at every level. Also total cost is also not same at every level. So it is a mixed cost.
We will use high low method to calculate the fixed and variable portion of Selling overhead.
Variable cost=	(Highest activity cost- Lowest activity cost)/ (Highest activity units- Lowest activity units)
	Cost	Units
Highest units	66,760.00	13,440.00
Lowest units	53,320.00	10,080.00
Difference	13,440.00	3,360.00
Variable cost per unit	4.00
Fixed cost	Highest activity cost- (Highest units * Variable cost per unit)
Fixed cost	66760-(13440*4)
Fixed cost	13,000.00
Number of units at 45%	7,560.00	i.e. 16,800*45%
Cost statement at 45% capacity
	Per unit	Variable amount	Fixed Cost	Total cost	Remarks
No. of units	7,560.00
Direct materials	7.00	52,920.00	-	52,920.00	It is calculated as $ 7* 7,560 units.
Direct wages	5.00	37,800.00	-	37,800.00	It is calculated as $ 5* 7,560 units.
Production overhead	3.00	22,680.00	20,000.00	42,680.00	It is calculated as $ 3* 7,560 units. $ 20,000 is a fixed cost and does not change with units.
Administration overhead	-	-	40,000.00	40,000.00	It is a fixed cost and does not change with units.
Selling overhead	4.00	30,240.00	13,000.00	43,240.00	It is calculated as $ 4* 7,560 units. $ 13,000 is a fixed cost and does not change with units.
Total		143,640.00	73,000.00	216,640.00
Now profit is 25% of sales. So, if sales is 100% then total cost is 75% of sales (100%-25%)
Total sales	288,853.33	i.e. 216,640/75%
Budgeted contribution income statement at 45% capacity
Sales	288,853.33
Less: Variable costs
Direct materials	52,920.00
Direct wages	37,800.00
Production overhead	22,680.00
Selling overhead	30,240.00
Total Variable costs	143,640.00
Contribution margin	145,213.33
Less: Fixed costs
Production overhead	20,000.00
Administration overhead	40,000.00
Selling overhead	13,000.00
Total Fixed costs	73,000.00
Profit	72,213.33
So, at level of activity of 45% budget contribution of $ 145,213.3 can be expected.