Question

Phoenix Company’s 2017 master budget included the following fixed budget report. It is based on an expected production and sales volume of 15,000 units.

PHOENIX COMPANY
Fixed Budget Report
For Year Ended December 31, 2017
Sales		\(3,000,000
Cost of goods sold
Direct materials	\)975,000
Direct labor	225,000
Machinery repairs (variable cost)	60,000
Depreciation-Plant equipment (straight-line)	300,000
Utilities (\(45,000 is variable)	195,000
Plant management salaries	200,000	1,955,000
Gross profit		1,045,000
Selling expenses
Packaging	75,000
Shipping	105,000
Sales salary (fixed annual amount)	250,000	430,000
General and administrative expenses
Advertising expense	125,000
Salaries	241,000
Entertainment expense	90,000	456,000
Income from operations		\)159,000

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 14,000 and 16,000 units.

3. The company’s business conditions are improving. One possible result is a sales volume of 18,000 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 $159,000 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 12,000 units. How much income (or loss) from operations would occur if sales volume falls to this level?

Short answer

Income from operations at 18,000 units is$462,000.

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 margin and determines theincome from operations after deducting all relevant costs.

Classification and determination of per unit amounts

PHOENIX COMPANY
Fixed Budget Report
For Year Ended December 31, 2017
Particulars	Description	Amounts	Category	Per unit amount ($)
Sales		$3,000,000	Variable	3000000/15000=200
Cost of goods sold
Direct materials	$975,000		Variable	975000/15000=65
Direct labor	225,000		Variable	225000/15000=15
Machinery repairs	60,000		Variable	60000/15000=4
Depreciation-Machinery	300,000		Fixed	-
Utilities ($45,000 is variable)	195,000		Semi-variable	45000/15000=3
Plant manager salaries	200,000	1,955,000	Fixed	-
Gross profit		1,045,000
Selling expenses
Packaging	75,000		Variable	75000/15000=5
Shipping	105,000		Variable	105000/15000=7
Sales salary	250,000	430,000	Fixed	-
General and administration expenses
Advertising	125,000		Fixed	-
Salaries	241,000		Fixed	-
Entertainment expense	90,000	456,000	Fixed	-
Income from operations		$159,000

Preparation of flexible budget

PHOENIX COMPANY
Flexible Budget Report
For Year Ended December 31, 2017
	Units
Particulars	14,000	16,000
Sales	$2,800,000	$3,200,000
Cost of goods sold
Direct materials	910,000	1,040,000
Direct labor	210,000	240,000
Machinery repairs	56,000	64,000
Depreciation-Machinery	300,000	300,000
Utilities	192,000	198,000
Plant manager salaries	200,000	200,000
Gross profit	932,000	1,158,000
Selling expenses
Packaging	70,000	80,000
Shipping	98,000	112,000
Sales salary	250,000	250,000
General and administrative expenses
Advertising	125,000	125,000
Salaries	241,000	241,000
Entertainment expense	90,000	90,000
Income from operations	$58,000	$260,000

Preparation of flexible budget to improve business conditions

PHOENIX COMPANY
Flexible Budget Report
For Year Ended December 31, 2017
	Units
Particulars	18,000	12,000
Sales	$3,600,000	$2,400,000
Cost of goods sold
Direct materials	1,170,000	780,000
Direct labor	270,000	180,000
Machinery repairs	72,000	48,000
Depreciation-Machinery	300,000	300,000
Utilities	204,000	186,000
Plant manager salaries	200,000	200,000
Gross profit	1,384,000	706,000
Selling expenses
Packaging	90,000	60,000
Shipping	126,000	84,000
Sales salary	250,000	250,000
General and administrative expenses
Advertising	125,000	125,000
Salaries	241,000	241,000
Entertainment expense	90,000	90,000
Income/(loss) from operations	$462,000	$(144,000)

Determination of profit or loss

• If the sales volume increases to 18,000 units, the profits will increase by$303,000.
• If the sales volume decreases to 12,000 units, the company will incur losses of$144,000.