Question

Tohono Company’s 2017 master budget included the following fixed budget report. It is based on an expected production and sales volume of 20,000 units.

TOHONO COMPANY
Fixed Budget Report
For Year Ended December 31, 2017
Sales		\(3,000,000
Cost of goods sold
Direct materials	\)1,200,000
Direct labor	260,000
Machinery repairs (variable cost)	57,000
Depreciation-Machinery (Straight-line)	250,000
Utilities (25% is variable cost)	200,000
Plant manager salaries	140,000	2,107,000
Gross profit		893,000
Selling expenses
Packaging	80,000
Shipping	116,000
Sales salary (fixed annual amount)	160,000	356,000
General and administration expenses
Advertising	81,000
Salaries	241,000
Entertainment expense	90,000	412,000
Income from operations		\(125,000

Required

1. Classify all items listed in the fixed budget as variable or fixed. Also determine their amounts per unit or their amounts for the year, as appropriate.

2. Prepare flexible budgets (see Exhibit 21.3) for the company at sales volumes of 18,000 and 24,000 units.

3. The company’s business conditions are improving. One possible result is a sales volume of 28,000 units. The company president is confident that this volume is within the relevant range of existing capacity. How much would operating income increase over the 2017 budgeted amount of \)125,000 if this level is reached without increasing capacity?

4. An unfavorable change in business is remotely possible; in this case, production and sales volume for 2017 could fall to 14,000 units. How much income (or loss) from operations would occur if sales volume falls to this level?

Short answer

Income from operations at 28,000 units is $619,800.

Step-by-step solution

Meaning of Flexible Budget

A flexible budget refers to a report prepared on estimates of the management that facilitates the computation of thecontribution marginand determines theincome from operationsafter deducting all relevant costs.

Classification and determination of per unit amounts

TOHONO COMPANY

Fixed Budget Report

For Year Ended December 31, 2017

Particulars	Description	Amounts	Category	Per unit amount ($)
Sales		$3,000,000	Variable	3000000/20000=150
Cost of goods sold
Direct materials	$1,200,000		Variable	1200000/20000=60
Direct labor	260,000		Variable	260000/20000=13
Machinery repairs	57,000		Variable	57000/20000=2.85
Depreciation-Machinery	250,000		Fixed	-
Utilities (25% is variable cost)	200,000		Semi-variable	200000*25%/20000=2.5
Plant manager salaries	140,000	2,107,000	Fixed	-
Gross profit		893,000
Selling expenses
Packaging	80,000		Variable	80000/20000=4
Shipping	116,000		Variable	116000/20000=5.8
Sales salary	160,000	356,000	Fixed	-
General and administration expenses
Advertising	81,000		Fixed	-
Salaries	241,000		Fixed	-
Entertainment expense	90,000	412,000	Fixed	-
Income from operations		$125,000

Preparation of flexible budget

TOHONO COMPANY

Flexible Budget Report

For Year Ended December 31, 2017

	Units
Particulars	18,000	24,000
Sales	$2,700,000	$3,600,000
Cost of goods sold
Direct materials	1,080,000	1,440,000
Direct labor	234000	312000
Machinery repairs	51,300	68,400
Depreciation-Machinery	250,000	250,000
Utilities	195,000	210,000
Plant manager salaries	140,000	140,000
Gross profit	749,700	1,179,600
Selling expenses
Packaging	72,000	96,000
Shipping	104,400	139,200
Sales salary	160,000	160,000
General and administrative expenses
Advertising	81,000	81,000
Salaries	241,000	241,000
Entertainment expense	90,000	90,000
Income from operations	$1,300	$3,72,400

 Step 4: Preparation of flexible budget in improving business conditions

TOHONO COMPANY

Flexible Budget Report

For Year Ended December 31, 2017

	Units
Particulars	28,000	14,000
Sales	$4,200,000	$2,100,000
Cost of goods sold
Direct materials	1,680,000	840,000
Direct labor	364,000	182,000
Machinery repairs	79,800	39,900
Depreciation-Machinery	250,000	250,000
Utilities	220,000	185,000
Plant manager salaries	140,000	140,000
Gross profit	1,466,200	463,100
Selling expenses
Packaging	112,000	56,000
Shipping	162,400	81,200
Sales salary	160,000	160,000
General and administrative expenses
Advertising	81,000	81,000
Salaries	241,000	241,000
Entertainment expense	90,000	90,000
Income/(loss) from operations	$619,800	$(246,100)

Determination of profit or loss

• If the sales volume increase to 28,000 units then the profits will increase by $494,800. $\left(\$619,800-\$125,000\right)$

• If the sales volume decrease to 14,000 units then the company will incur the losses of $246,100.