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EXERCISE 1 Responsibility Report: Peak Outdoors produces and sells hiking gear. The production department reported the following information regarding its unique line of backpacks. Included are the static budget and actual results for the most recent year. Static Budget Actual Results Units Pruduced 24,000 units 27,000 units $144,000 $174,500 Direct Materials Direct Labor 216,000 236,250 Manufacturing OH- Variable 36,000 34,000 $396,000 $444,750 Total Variable Costs Manufacturing OH- Fixed 90,000 98,000 Total Manufacturing Cost $486,000 $542,750 Prepare a Flexible Budget for Peak based on the information above. To do so, you must first determine the cost per unit data of the Static Budget Static Budget / Budgeted Units Per Unit $144,000 24,000 units Direct Materials /24,000 units Direct Labor 216,000 Manufacturing OH- Variable /24,000 units 36,000 Remember that Total Fixed Manufacturing Overhead does not fluctuate with units produced, so the difference in the Static and Actual amounts is purely a Spending Variance. Now, use the per unit budgeted amounts to prepare a Flexible Budget (Actual units X Budget per unit) and calculate variances (Responsibility Report). Be sure to interpret each variance as either Favorable (F) or Unfavorable (U) Responsibility Report Calculations Flexible Budget Actual Results Variances Direct Materials Direct Labor Manufacturing Overhead- Variable Total Variable Costs Manufacturing Overhead- Fixed Total Manufacturing Cost EXERCISE 2 Return on Investment (ROI): Measures the level of operating income generating on the company's invested assets. Even though the current year's Responsibility Report indicates some unfavorable variances (previous pag). The backpack division at Peak Outdoors historically has delivered a positive Return on Investment (ROI) for Peak's overall operations. Calculate the current year's ROI for the backpack division using the following information: $925,000 $210,000 $600,000 Sales Operating Income Operating Assets Using the expanded ROI formula: ROI Operating Income X Sales Operating Assets Sales % ROI X The first calculation (Operating Income / Sales) represents the operating margin for the business and shows that total ROI can be increased by reducing expenses thereby increasing Operating Income. The second calculation (Sales/Operating Assets) is a turnover ratio which measures how efficiently Peak is using its operating assets in generating Sales. For instance, ROI would increase if Peak could produce the same (or better) sales while utilizing less assets to generate those sales. The ROI formula can also be simplified as follows: ROI Operating Income Operating Assets EXERCISE 3 Residual Income: Measures the ability to maximize earnings above some targeted level Company-wide, Peak Outdoor's Return on Investment (ROI) is approximately 25%. The backpack division consistently outperforms expectations (average ROI of 35%). However, assume that the production manager of the backpack division is presented with the opportunity to invest $300,000 of the company's assets to produce a new line of super-light-weight backpacks. The manager expects the backpack division to earn an ROI of approximately 30% on this new product 2 Page The ROI of 30% is higher than the company-wide desired ROI but far below the ROI currently being earned by the backpack division. This may result in the manager choos ing not to produce the new line, a condition known as "suboptimization". To avoid this, Residual Income should be calculated: Desired ROI) Operating Income - (Operating assets X Residual Income = Calculate the Residual Income for the backpack division before investing the $300,000: Operating Income Operating Assets X Desired ROI Residual Income X Next, calculate the new overall ROI for the backpack division if the $300,000 is invested: Previous Op. New Op. New Assets Invested X Expected Increase in Op. Income ROI Income Income $ $ X % 40 Now, calculate the new operating assets if the $300,000 is invested: New Assets Invested Previous Assets New Op. Assets + Calculate the new ROI: % ROI = Operating Income Operating Assets Investing in the new line would lower the backpack divisions ROI. However, the company should focus on Residual Income in making this decision Operating Assets X Desired ROI Residual Income New Operating Income X Should the backpack division adopt the new line of backpacks, Yes or No?

Answer 1

Exercise 1

we will prepare flexible budget for ACTUAL 27000 units.

fixed overhead would however remain constant as static budget.

cost per unit data of static budget

	Static Budget	BUDGETED UNITS	Cost per unit
material	$144000	24000 units	$6	144000/24000
Labor	$216000	24000 units	$9	216000/24000
Manufacturing OH	$36000	24000units	$1.5	36000/24000

If actual cost are more than flexible budget than the variance is UNFAVORABLE

if Actual budget is less than flexible budget than the variance is FAVORABLE

	calculation	flexible budget	Actual result	Variance	calculation
Direct material	[27000units*$6]	$162,000	$174,500	12500 U	[162000-174500]
Direct Labor	[27000units*$9]	$243,000	$236,250	6750 F	[243000-236250]
Manufacturing overhead variable	[27000units*$1.5]	$40,500	$34,000	6500 F	[40500-34000]
Total variable cost	[162000+243000+40500]	445,500	$444,750	750 F	[445500-444750]
manufacturing overhead fixed		$90,000	$98,000	8000 U	[90000-98000]
Total Manufacturing cost	[445,500+90000]	535,500	$542,750	7250 U	[535500-542750]