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a) Explain, using examples, why it is essential to create and use flexible budgets when evaluating past performance of a profit centre which manufactures and sells a product. What might be the objective of such a performance evaluation?
b) When preparing a cash budget for a manufacturing business for the following year, there may be many other budgets that will need to be produced before the cash budget is completed.
List three (3) other budgets that must be prepared at the same time or before the cash budget is prepared, and for each one, explain the likely timing of cash flows that will occur and how this will impact on a cash budget.
c) Why might a business decide to make a product internally when it could easily acquire it at a cheaper price from an external supplier? Explain.
d) Accounting isn't as important in the government organizations as it is in private enterprises, since the government does not have to worry about earning a profit. Do you agree? Explain.
e) What are the essential purposes of any costing system? Explain.
Wonder Products Pty Ltd builds beautiful things to order for customers. When quoting prices on jobs Wonder Products allocate manufacturing overheads on the basis of estimated machine hours to complete the job. They allocate administrative overhead costs on the basis of direct labour hours estimated to complete the job.
Below is a budget for the current year showing budget total figures.
Direct labour costs for the year $537,600
Manufacturing overheads for the year 598,080
Administrative overheads for the year 695,520
Direct labour hours for the year 14,000
Total machine hours for the year 7,000
a) Calculate a manufacturing overheads allocation rate for Wonder Products.
b) Calculate an administrative overhead allocation rate for Wonder Products.
c) Bushy George has asked Wonder Products Pty Ltd to make an especially wonderful creation to his specifications that will require the following inputs:
Direct materials $19,000
Direct labor 750 hours
Machine usage 400 hours
Assuming a markup of 40% on total costs, what price should be quoted to Bushy to build him this especially wonderful creation?
d) Why is it so important to carefully allocate overhead expenses when quoting on jobs or when generally deciding on prices? Discuss problems that are encountered with overhead allocation methods and alternative approaches that might be taken.
e) Why do companies use predetermined (budgeted) overhead allocation rates rather than using actual overhead costs in allocating overhead costs to units of product? Explain.
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A financial budget provides an approximate forecast with respect to the financial results that a company looks to obtain in the future. The budget can be made on a monthly, quarterly or an annual basis. A budget, which has been calculated, is thoroughly checked at the end of a particular period in order to understand the various issues associated with the financial results.
The actual results that are obtained during the operations of the company during that time period, then compares to the budget, which was forecasted, and the actions are taken accordingly with respect to the actual results obtained. As a result, the company understands the various issues within the different departments and acts accordingly.
When a company adopts a static budget, it tries to make an assumption with respect to the output of the business. However, the actual output would differ from the estimated number. Hence, in order to evaluate the performance of the profit center, a flexible budget is used. A flexible budget helps the company to understand all the line items in the income statement with the same number of outputs and thereby act on related issues. (Caplan, 2010)
The following example with respect to the income statement of Gloria Jeans would stress the importance of a flexible budget on performance evaluation.
On the basis of the budget given for Wonder Products Ltd, the following calculations would be done. (David.E.Platt, 2014)
The manufacturing overheads are allocated on the basis of the machine hours.
Manufacturing overheads for the year=598, 080
Total Machine hours for the year =7000.
Hence,
The manufacturing overhead rate for Wonder Products =598080/7000
=$85. 44 per machine hour
The administrative overheads are allocated on the basis of direct labor hours. (David. E. Platt, 2014)
Administrative overheads for the year=695, 520
Total direct labor hours for the year =14000.
Hence,
The administrative overhead rate for Wonder Products =695520/14000
=$49. 68 per direct labor hour
Bushy George has asked the company Wonder Products Pty Ltd to make a wonderful creation with the help of the below specifications:
Direct Materials=$19000
Direct Labor=750 hours
Machine Usage=400 hours
Cost due to Direct Labor= Direct Labor Hours* cost per direct labor hour=750*49. 68
=37260
Cost due to Machine Usage = Machine hours *per machine hour=400*85. 44
=34176
Total Cost= Direct Materials + Cost due to Direct Labor + Cost due to Machine Usage (David. E. Platt, 2014)
= 19000+37260+34176
=$90436
Now, Wonder Products would be applying a 40% markup on the total costs in order to calculate the selling price.
Hence,
Quoted Price= 1.4*90436
=126610.4
