Chapter 12, Problem 25P

Novo, Inc., wants to develop an activity flexible budget for the activity of moving materials. Novo uses eight forklifts to move materials from receiving to stores. The forklifts are also used to move materials from stores to the production area. The forklifts are obtained through an operating lease that costs $18,000 per year per forklift. Novo employs 25 forklift operators who receive an average salary of $50,000 per year, including benefits. Each move requires the use of a crate. The crates are used to store the parts and are emptied only when used in production. Crates are disposed of after one cycle (two moves), where a cycle is defined as a move from receiving to stores to production. Each crate costs $1.80. Fuel for a forklift costs $3.60 per gallon. A gallon of gas is used every 20 moves. Forklifts can make three moves per hour and are available for 280 days per year, 24 hours per day (the remaining time is downtime for various reasons). Each operator works 40 hours per week and 50 weeks per year.

Required:

1. 1. Prepare a flexible budget for the activity of moving materials, using the number of cycles as the activity driver.
2. 2. Calculate the activity capacity for moving materials. Suppose Novo works at 80 percent of activity capacity and incurs the following costs:

Prepare the budget for the 80 percent level and then prepare a performance report for the moving materials activity.

1. 3. Calculate and interpret the volume variance for moving materials.
2. 4. Suppose that a redesign of the plant layout reduces the demand for moving materials to one-third of the original capacity. What would be the budget formula for this new activity level? What is the budgeted cost for this new activity level? Has activity performance improved? How does this activity performance evaluation differ from that described in Requirement 2? Explain.

To determine

Construct a flexible budget for N Company for the activity of moving materials using number of cycles as the activity driver.

Explanation of Solution

Flexible budget: A flexible budget is a statement of estimate regarding revenues and expenses for a future period that can be modified depending on the level of output.

Resource	Fixed ($)	Variable
Salaries	1,250,000 (1)	-
Lease	144,000 (2)	-
Crates	-	$1.80
Fuel	-	(3) $0.36
Total	1,394,000	$2.16

Table (1)

Working notes:

(1) Calculate the total salary expenses.

$\begin{array}{c}\text{Salaries}\text{=}\text{Number of forklift operators}\times \text{Average salary per year}\\ \text{=}\text{25}\times \text{\$50,000}\\ \text{=}\text{1,250,000}\end{array}$

(2) Calculate the total lease payable.

$\begin{array}{c}\text{Salaries}\text{=}\text{Number of forklift}\times \text{Lease rent payable per year per forklift}\\ \text{=}8\times \text{\$18,000}\\ \text{=}\text{144,000}\end{array}$

(3) Calculate the fuel consumption per machine per cycle.

$\begin{array}{c}\text{Fuel consumption}=\frac{\text{Fuel expense per gallon}}{\text{Number of cycles}}\\ =\frac{\$3.60}{10}\\ =\$0.36\end{array}$

To determine

Compute the activity capacity of N Company for moving materials assuming that N Company works at 80 percentage activity capacity. Construct a budget for 80 percent capacity level and also prepare a performance report for the moving materials activity if N Company incurred the following cost.

Salaries - $1,290,000

Lease - $144,000

Crates - $118,000

Fuel - $24,000

Explanation of Solution

Prepare a flexible budget for N Company at 80 percentage activity capacity.

Resource	Fixed ($)	Variable ($)	Activity output 60,000 cycles (6) ($)
Salaries	1,250,000 (1)	-	1,250,000
Lease	144,000 (2)	-	144,000
Crates	-	$1.80	108,000 (4)
Fuel	-	$0.36 (3)	21,600 (5)
Total	1,394,000	$2.16	1,523,600

Table (2)

Working notes:

(4) Calculate the total activity output with respect to crates.

$\begin{array}{c}\text{Salaries}\text{=}\text{Crate cost per unit}\times \text{Capacity cycles}\\ \text{=}\$1.80\times \text{60,000}\\ \text{=}108\text{,000}\end{array}$

(5) Calculate the total activity output with respect to fuel.

$\begin{array}{c}\text{Salaries}\text{=}\text{Fuel expense per gallon}\times \text{Output capacity}\\ \text{=}0.36\times \text{\$60,000}\\ \text{=}\text{21,600}\end{array}$

(6) Compute the 80 percent activity capacity of N Company.

$\begin{array}{c}\text{Activity capacity}\text{=}\text{Production cycle}\times \text{Activity capacity}\\ \text{=}\text{75,000}\times 80\%\\ =75,000\left(7\right)\times 0.80\\ =60,000\text{cycles}\end{array}$

(7) Compute the operator capacity of N Company.

$\begin{array}{c}\text{Activity capacity}\text{=}\text{Moves per hour}\times \text{Number of operators}\times 2000\\ \text{=}\text{3}\times 25\times 2000\\ =150,000\text{moves or 75,000 cycles}\end{array}$

Compute the forklift capacity of N Company.

$\begin{array}{c}\text{Forklift capacity}\text{=}\left[\begin{array}{l}\text{Moves per hour}\times \text{Hours used per day}\\ \times \text{Available days in an year}\times \text{Total forklift}\end{array}\right]\\ \text{=}\text{3}\times 24\times 280\times 8\\ =161,280\text{moves or 80,640 cycles}\end{array}$

Capacity is determined by the minimum f forklift capacity and operator capacity. Therefore, 75,000 cycles is the output capacity.

Prepare a performance report for moving materials of N Company.

N Company

Performance report

Resource	Actual costs ($)	Budgeted cost ($)	Budget variance ($)
	(a)	(b)	$\left(\text{a}\right)-\left(\text{b}\right)$
Salaries	1,290,000	1,250,000	40,000
Lease	144,000	144,000	0
Crates	118,000	108,000	10,000
Fuel	24,000	21,600	2,400
Total	1,576,000	1,523,600	52,400

Table (3)

To determine

Compute the volume variance of N Company and interpret the results.

Explanation of Solution

Since standard quantity equals zero, the volume variance is the capacity acquisition cost.

The volume variance is $1,394,000.

To determine

Compute the budget formula and new activity level if a redesign of the plant layout reduces the demand for moving materials to one-third of the original capacity. Provide information and evaluate the calculated result with proper explanation.

Explanation of Solution

Resource	Fixed ($)	Variable ($)	Activity output 25,000 cycles ($)
Salaries	450,000	-	450,000 (8)
Lease	54,000	-	54,000 (9)
Crates	-	1.80	45,000 (12)
Fuel	-	0.36	9,000 (13)
Total	504,000	$2.16	558,000

Table (4)

Working notes:

(8) Compute the required operators for N Company for the need capacity.

$\begin{array}{c}\text{Operators}\text{=}\frac{\text{Demand cycle}}{\text{cycles}}\\ =\frac{25,000}{3000\left(10\right)}\\ =8.33\\ =9\text{operators}\\ \text{Salaries}\text{=}\text{\$50,000}\times \text{9}\\ \text{Salaries}\text{=}\text{\$450,000}\end{array}$

(9) Compute the actual forklifts that will be required by N Company.

$\begin{array}{c}\text{Forklifts required}\text{=}\frac{\text{Demand cycle}}{\text{Operator cycle}}\\ =\frac{25,000}{10,080\left(11\right)}\\ =2.48\\ =3\text{forklifts}\\ \text{Lease}\text{=}\text{\$18,000}\times \text{3}\\ \text{Lease}\text{=}\text{\$54,000}\end{array}$

(10)Compute the cycle capacity for N Company for the need capacity.

$\begin{array}{c}\text{Cycles}\text{=}\frac{\text{Total hours}\times \text{Moves per hour}}{2}\\ =\frac{\left(2,000\times 3\right)}{2}\\ =3000\text{cycles}\end{array}$

(11) Compute the forklift capacity of N Company.

$\begin{array}{c}\text{Operators}\text{=}\frac{\text{Number of moves}\times \text{Hours per day}\times \text{Avaiable hours}}{2}\\ =\frac{\left(3\times 24\times 280\right)}{2}\\ =10,080\text{cycles}\end{array}$

(12) Compute the activity output for crate of N Company.

$\begin{array}{c}\text{Activity output}\text{=}\text{Crate}\times \text{Demand cycle}\\ \text{=}\text{1}\text{.8}\times 25,000\\ =\$45,000\end{array}$

(13) Compute the activity output for fuel consumption of N Company.

$\begin{array}{c}\text{Activity output}\text{=}\text{Fuel per gallon}\times \text{Demand cycle}\\ \text{=}0.\text{36}\times 25,000\\ =\$9,000\end{array}$