Photo AI
9. Flexible Budgeting Henry Ltd manufactures a component for the medical industry - Leaving Cert Accounting - Question 9 - 2021
Question 9
9. Flexible Budgeting Henry Ltd manufactures a component for the medical industry. The following flexible budgets have already been prepared for 55%, 75% and 95% of... show full transcript
Worked Solution & Example Answer:9. Flexible Budgeting Henry Ltd manufactures a component for the medical industry - Leaving Cert Accounting - Question 9 - 2021
Step 1
Separate production overheads into fixed and variable elements.
Answer
To determine the fixed and variable components of production overheads, we first calculate the variable cost per unit using the data provided:
- High level (47,500 units): €217,000
- Low level (27,500 units): €129,000
The difference in units is: 47,500 - 27,500 = 20,000 units
The difference in total costs is: €217,000 - €129,000 = €88,000
Thus, the variable cost per unit = ( \frac{€88,000}{20,000} = €4.40 )
Now, we can separate the fixed overheads:
Total overhead at high level = €217,000 Less variable costs (47,500 units at €4.40) = €217,000 - €209,000 = €8,000
Hence, fixed production overheads = €8,000.
Step 2
Separate other overhead costs into fixed and variable elements.
Answer
For other overheads, we analyze as follows:
- High level (47,500 units): €255,875
- Low level (27,500 units): €150,875
The variable cost is calculated:
Difference in total costs = €255,875 - €150,875 = €105,000 for a difference in units of 20,000. Thus, the variable cost per unit = ( \frac{€105,000}{20,000} = €5.25 )
Now, total fixed costs can be calculated:
Total overhead at high level = €255,875 Less variable costs (47,500 units at €5.25) = €255,875 - €249,875 = €6,500
Fixed other overhead costs = €6,500.
Step 3
Prepare a flexible budget for 90% activity level using marginal costing principles, and show the contribution.
Answer
To prepare the flexible budget for 90% activity level (42,750 units):
Sales (Calculation):
- Total sales = 90% of 95% output level
- Sales = 42,750 units * selling price
Variable costs:
- Direct materials = 42,750 units * €5.50
- Direct wages = 42,750 units * €6.70
- Production overheads = 42,750 units * €4.40
- Other overheads = 42,750 units * €5.25
Total variable costs = Sum of the variable costs calculated above.
Contribution is calculated as:
Contribution = Sales - Total variable costs
Then, fixed costs are subtracted from the contribution to find profit.
Step 4
Prepare flexible budgets, using marginal costing principles and showing contributions, for both options.
Answer
For Option 1:
- Sales: €1,375,000 (estimate based on unit price)
- Variable costs (calculated for 50,000 units)
- Direct materials at €5.50
- Updating production overheads considering the supervisor's salary savings of €1.40 per unit.
For Option 2:
- Sales: €1,633,406.25 (based on the increased capacity of 115%)
- Calculate all variable costs with the new production structure and reduced fixed overheads.
- Choose Option 2 due to a higher profit margin of €647,806.25.
Step 5
What is meant by the term sensitivity analysis?
Answer
Sensitivity Analysis, also known as what-if analysis, is a technique used to assess how different values of an independent variable impact a particular dependent variable under a given set of assumptions. It can be used to evaluate:
- Selling price
- Sales volume
- Variable costs
- Fixed costs
The purpose here is to determine how changes in these factors affect profitability.
Step 6
Outline why Henry Ltd would prepare a flexible budget.
Answer
Henry Ltd would prepare a flexible budget for several reasons:
- To manage costs: A flexible budget helps in controlling and comparing actual costs against variable levels of output.
- Accurate planning: It allows the management to adjust to varying levels of activity and helps in planning resource usage more effectively.
- Performance evaluation: It provides a better framework to assess performance against budgeted targets, considering actual output levels.