THE UTEASE CORPORATION (p.1124)
THE UTEASE CORPORATION
The Utease Corporation has many production plants across the U.S. A newly opened plant, the
Bellingham plant, produces and sells one product. The plant is treated, for responsibility accounting purposes, as
a profit center. The unit standard costs for a production unit, with overhead applied based on direct labor hours,
are as follows:
STANDARD PRODUCTION COSTS
Manufacturing costs (per unit based on expected activity of 24,000 units or 36,000 direct labor hours):
Direct materials (2 pounds at $20)
$ 40.00
Direct labor (1.5 hours at $90)
$135.00
Variable overhead (1.5 hours at $20)
$ 30.00
Fixed overhead (1.5 hours at $30)
$ 45.00
Standard cost per unit
$250.00
Budgeted selling and administrative costs:
Variable
$5 per unit
Fixed
$1,800,000.00
Expected sales activity: 20,000 units at $425.00 per unit
Desired ending inventories: 10% of sales
ACTUAL PRODUCTION COSTS
Assume this is the first year of operations for the Bellingham plant. During the year, the company had the
following activity:
Units produced
Units sold
Unit selling price
Direct labor hours worked
Direct labor costs
Direct materials purchased
Direct materials costs
Direct materials used
Actual fixed overhead
Actual variable overhead
Actual selling and administrative costs
23,000 units
21,500 units (Inventory = 1,500)
$420.00
34,000hrs
$3,094,000.00
50,000 pounds
$1,000,000.00
50,000 pounds
$1,080,000.00
$620,000.00
$2,000,000.00
THE UTEASE CORPORATION (p.1124)
A. Prepare a production budget for the coming year based on the available standards, expected sales, and
desired ending inventories.
Production Budget
Expected (minimum) num. of units to be sold
20,000
Add: Closing inventory(10% of sales)
Less: Beginning Inventory(23,000 – 21,500)
2,000
1,500
Units to be produced
20,500
? The amount of unit that must be produced is 20,000 (standard) plus 10% inventory (2,000) minus
beginning inventory (1,500)
B. Prepare a budgeted responsibility income statement for the Bellingham plant for the coming year.
Budgeted Income statement for Responsibility centre
Number of units (to be sold)
20,000
Selling price / unit
425
Direct materials (2 pounds at $20)
Direct labor (1.5 hours at $90)
Variable overhead (1.5 hours at $20)
Fixed overhead (1.5 hours at $30)
40
135
30
45
8,500,000
800,000
2,700,000
600,000
900,000
Cost of goods sold ($250 x 20,000 units)
Gross Profit (revenue – COGS)
Less: Selling expenses ($5 x 20,000 units)
Administrative expenses
Net Income
5,000,000
3,500,000
5
100,000
1,800,000
1,900,000
1,600,000
? Net income is projected based on the available standard figures, buy subtracting Gross Profit
(Sales minus COGS) with Other Expenses.
THE UTEASE CORPORATION (p.1124)
C. Find the direct labor variances. Indicate if they are favorable or unfavorable and why they would be
considered as such.
Labor rate variance
= (Actual Rate – Standard Rate) x Actual Hours of Labor Used Variance
= (($3,094,000/34,000hrs) – $90) x 34,000hrs
= (91-90)*34000
= 34,000 (UNFAVORABLE)
? The labor rate variance is above allowed standard of 30,000hrs
D. Find the direct materials variances (materials price variance and quantity variance)
Direct material price variance
= (Actual price – Standard price) x Actual quantity
= ((1,000,000/50,000 pounds) -20) x 50,000 = 0 x 50,000
= (20-20)*50,000
= 0 (NO VARIANCE)
? The direct material price variance met the standard (has no change)
Materials quantity variance
= (actual quantity – standard quantity) x standard price per unit
= (50,000 – (20,000 x 2 pounds) x $20
= (50,000 – 40,000) * $20
= $200,000 (UNFAVORABLE)
? The materials quantity variance is unfavorable because it’s higher than standard of 40,000 pounds
of allowed material.
E. Find the total over- or under applied (both fixed and variable) overhead. Would cost of goods sold be a
larger or smaller expense item after the adjustment for over- or under applied overhead?
VARIABLE OVERHEAD VARIANCE
1. Variable overhead efficiency variance
= (actual labor-hours – standard labor-hours allowed for actual
production) x standard var. overhead rate
= (34,000 hrs – (23,000 units x 1.5hrs) ) x $20
= (34,000-34,500)*$20
= 10,000 (FAVORABLE)
? The labor force works more productive (more efficient) than standard rate.
2. Variable overhead spending variance
= actual var. overhead costs – (standard rate x actual hours of labor
used)
= 620,000 – ($20 x 34,000hrs)
= -60,000 (FAVORABLE)
? The Variable Overhead Spending Variance is favorable because the Actual overhead spent is lower
than the budgeted amount.
FIXED OVERHEAD VARIANCE
1. Fixed Overhead Spending Variance
THE UTEASE CORPORATION (p.1124)
= Actual Fixed Overhead – (Fixed Overhead Standard Rate x
Budgeted Hours)
=1,080,000 – ($30 x (1.5*20,000))
= 1,080,000 – (30*30,000)
= 180,000 (UNFAVORABLE)
? The actual fixed overhead cost is higher than standard. The common cause can be events such as
unexpected changes in rents, insurance, and property taxes.
2. Volume variance
= Budgeted ovrhd – (Standard input hrs * predetermined rate)
= 90,000 – (34,500*30)
= 135,000 (FAVORABLE)
? The actual production volume is higher than standard.
F. Calculate the actual plant operating profit for the year
ACTUAL OPERATING INCOME
Sales (21,500 unit sold x $420)
Cost of Goods Sold
Direct labor
3,094,000
Direct materials
1,000,000
Actual Fixed Overhead
1,080,000
Actual Variable Overhead
620,000
Actual selling & adm.cost
2,000,000
Total
Operating profit
9,030,000
7,794,000
1,236,000
? The operating profit is calculated by subtracting the total sales revenue with COGS.
THE UTEASE CORPORATION (p.1124)
G. Use a flexible budget to explain the difference between the budgeted operating profit and the actual
operating profit for the Bellingham plant for its first year of operation. What part of the difference do
you believe is the plant manager’s responsibility?
@uni
t
Direct materials
Direct labor
Variable overhead
Fixed overhead
Total manufacturing cost
40
135
30
45
250
Budgeted
20,000
units
800,000
2,700,000
600,000
900,000
5,000,000
Flexible
23,000
units
920,000
3,105,000
690,000
900,000
5,615,000
Actual
23,000
units
1,000,000
3,094,000
620,000
1,080,000
5,794,000
Actual cost Over
(under) Flexible
Budget
80,000.00
(11,000.00)
(70,000.00)
180,000.00
179,000.00
? From the table above, we can see that the Direct Labor and Actual Variable Overhead cost are
under (less than) Flexible Budget.
? We also see that the cost for Direct Materials and Fixed Overhead is above (more than) Flexible
Budget. The plant manager’s should lower them as they’re considered over budget.
? The Plant Manager has to find a cheaper material (without sacrificing the quality) to meet the
allowed standard costs. Usually, bigger raw material (bulk) order costs less.
THE UTEASE CORPORATION (p.1124)
H. Assume Utease Corporation is planning to change its evaluation of business operations in all plants
from the profit center format to the investment center format. If the average invested capital at the
Bellingham plant is $8,950,000, compute the return on investment (ROI) for the first year of operation.
Use the DuPont method of evaluation to compute the return on sales (ROS) and Capital turnover (CT)
for the plant.
ACTUAL OPERATING INCOME
Sales
COGS
Direct labor
Direct materials
Actual FO
Actual variable
Actual selling & adm.cost
21,500 x 420
9,030,000
3,094,000
1,000,000
1,080,000
620,000
2,000,000
7,794,000
Op. Income
1,236,000
Avg. Invested Capital
8,950,000
FINANCIAL RATIOS
Return on Investment
Return on Sales
Capital Turnover
(Opr. Income / Avg. Inv. Capital))
(Opr. Income / Sales)
(Sales/Avg. Inv. Cap)
13.81%
13.69%
100.89%
? Return of Investment (ROI) is a performance measure used to evaluate the efficiency of an
investment or to compare the efficiency of a number of different investments. To calculate ROI, the
benefit (return) of an investment is divided by the cost of the investment; the result is expressed as
a percentage or a ratio. Since Utease Corp. has positive ROI, it tells us that this company’s asset
are generating positive return to its owners/stock holders.
? Return of Sales (ROS) provides insight into how much profit is being produced per dollar of sales.
As with many ratios, it is best to compare a company’s ROS over time to look for trends, and
compare it to other companies in the industry. An increasing ROS indicates the company is
growing more efficient, while a decreasing ROS could signal looming financial troubles.
? the Capital Turnover (CT) is good because it the company is generating a lot of sales compared to
the money it uses to fund the sales, thus the utilization of every Invested Capital is considered
effective.
? Note that the ROI, ROS, and CT cannot be judged alone, they must be compared in Year-on-Year
basis to be fully understood.
THE UTEASE CORPORATION (p.1124)
I. Assume that under the investment center evaluation plan the plant manager will be awarded a bonus
based on ROI. If the manager has the opportunity in the coming year to invest in new equipment for
$500,000 that will generate incremental earnings of $75,000 per year, would the manager undertake the
project? Why or why not? What other evaluation tools could Utease use for their plants that might be
better?
ACTUAL
OPERATING
INCOME
Sales
COGS
21,500 x 420
BUDGETED + NEW INVESTMENT
9,030,000
20,000 x 425
8,500,000
Direct labor
Direct
materials
3,094,000
2,
700,000
1,000,000
800,000
Actual FO
1,080,000
900,000
620,000
600,000
Actual variable
Actual selling
& adm.cost
2,000,000
7,794,000
1900000
6,900,00
0
5 x 20,000
Op. Income
1,236,000
Avg. Invested
Capital
Op. Income
Additional
Income
Avg. Inv.
Capital
Additional
Investment
8,950,000
1,600,000
75,000
1,675,000
8,950,000
500,000
9,450,000
FINANCIAL RATIOS
Return on
Investment
13.81%
>
17.72%
? The Plant Manager should accept the opportunity to invest new equipment since it will actually
increase the ROI (note that only if the next production year matches the standard cost)
? Other evaluation tools Utease could use is by calculating the Residual Income which is the
amount by which operating earnings exceed a minimum acceptable return on average invested
capital. Let’s say the minimum Acceptable Return is the current year ROI = 13.81%
WITHOUT THE ADDITIONAL INVESTMENT
Residual Income
= Operating Earnings – (Minimum Acceptable Returns x Invested Capital)
= 1,600,000 – (13.81% x 8,950,000)
= 365,005
WITH ADDITIONAL INVESTMENT
Residual Income
= Operating Earnings – (Minimum Acceptable Returns x Invested Capital)
= 1,675,000 – (13.81% x 9,450,000)
= 369,955
? An additional residual income of 5,950 with the new investment (favorable)
? Other methods are by using Economic Value Added (EVA) and Balance Scorecard.
J. The chief financial officer of Utease Corporation wants to include a charge in each investment center’s
income statement for corporate-wide administrative expenses. Should the Bellingham plant manager’s
THE UTEASE CORPORATION (p.1124)
annual bonus be based on plant ROI after deducting the corporate wide administrative fee? Why or
why not?
? The Plant Manager should accept the annual bonus to be based on Plant’s ROI only if the
Corporate wide administrative fee is below the residual income.
? Other method is by requesting to have Stock Options, since the Plant is generating positive ROI,
the stock’s valuation is expected to rise in the future.
