Budgeting for control

No PIN: optional lecture

Frosty plc manufactures a single product. Budgeted production and sales are 20,000 units
for October 2019. It is expected that 30,000 kg of raw material will be required at a cost of
£4.00 per kg. Production workers are expected to be paid £12.00 an hour and 10,000
production labour hours are expected to be required. Fixed overheads are expected to be
£40,000.
The sales price is expected to be £30 per unit.

No PIN: optional lecture

Frosty plc manufactures a single product. Budgeted production and sales are 20,000 units for
October 2019. It is expected that 30,000 kg of raw material will be required at a cost of £4.00
per kg. Production workers are expected to be paid £12.00 an hour and 10,000 production
labour hours are expected to be required. Fixed overheads are expected to be £40,000.
The sales price is expected to be £30 per unit.

20,000 units x £30

fixed
revenue budget
600,000
materials 120,000 30,000 x £4
labour 120,000
overheads 40,000 280,000 10,000 hours x £12
profit 320,000

Given in question
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The actual results were:

Sales number of units 19,500

Sales revenue £600,000

Materials £118,000

Labour £125,000

Fixed production overheads £38,000.

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 Apart from fixed overheads all other numbers are multiplied by the (actual
output/expected output), that is, (19,500/20,000) = 0.975
The actual results were: Number of units sold 19,500
Sales number of units 19,500
fixed
revenue budget flexed
budget
600,000
585,000
materials 120,000
labour 120,000 117,000
117,000
overheads 40,000 280,000
40,000 274,000
profit 320,000
311,000

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 Actual profit
Sales revenue £600,000
Materials £118,000
Labour £125,000
Fixed production
overheads £38,000
£319,000
fixed Actual profit
flexed
revenue budget budget 600,000
600,000 585,000
118,000
materials 120,000 117,000 125,000
labour 120,000 117,000 38,000 281,000
overheads 40,000 280,000 40,000 274,000 319,000
profit 320,000 311,000

No PIN: optional lecture

 fixed flexed Actual profit
revenue budget budget
600,000 585,000 600,000
materials 120,000 117,000 118,000
labour 120,000 117,000 125,000
overheads 40,000 280,000 40,000 274,000 38,000 281,000
profit 320,000 311,000 319,000

volume variance 311,000 -320,000 = 9,000 A Sum of Difference

sales price variance 600,000 - 585,000 = 15,000 F variances between
Subtract the actual amount from the amount in the flexed budget -9,000 fixed and
materials -1,000A 15,000 actual
labour -8,000A 320,000
overheads 2,000F -1,000
-8,000 319,000
2,000 -1,000
Comment on the variances
-1,000
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Trice plc manufactures wooden boxes. The variance analysis shown below has been produced
for the production department for the last accounting period.
F = favourable variance, A = adverse variance
In response to the variance analysis the production manager has made the following comments
•We were experiencing poor staff morale and a high staff turnover so I increased wage rates
during the period. I believe that this has improved staff morale and produced a positive benefit
to the company.
•We had been having problems with material wastage, hence we are buying from a different
supplier. The cost is slightly higher but the reduction in wastage will compensate for this.
•We had a light sanding machine which I thought was not being sufficiently used and was
therefore costing the business too much money. I sold this machine and hired a sander only
when we needed one

Material price variance 2,000 A

material usage variance 3,000 F
labour rate variance 1,000 F
labour efficiency variance 1,000 F
variable overhead expenditure variance 2,000 A
variable overhead efficiency variance 1,000 F
fixed overhead expenditure variance 3,000 F

No PIN: optional lecture

 A division with total assets of £200,000 currently earns a ROI of 10%. It can make an
additional investment of £20,000 for a 5 year life with nil residual value. The average
operating income per annum from this investment would be £4,000. The division’s
cost of capital is 11%.
 
Required
 
a. Compute and comment on the Return on Investment and the Residual Income, with
and without the additional investment, and then advise the company whether it should
make the additional investment. (10 marks)

ROI £000 assets profit (profit/total assets) x 100 = ROI

existing 200 20 0.1 (20/200) x 100 = 10%
extra 20 4 (24/220) x 100 = 10.9%
combined 220 24 0.109
ROI
Without the investment 10%
With the investment 10.9%
No PIN: optional lecture
 A division with total assets of £200,000 currently earns a ROI of 10%. It can make an
additional investment of £20,000 for a 5 year life with nil residual value. The
average operating income per annum from this investment would be £4,000. The
division’s cost of capital is 11%.
 
Residual income = profit – (cost of capital x total assets)
Without the investment -£2,000
With the investment -£200

residual income £000

cost of capital 11% profit charge RI
existing 200 20 200x0.11 =22 -2

combined 220 24 220x0.11=24.2 -0.2

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Critique the relative advantages of ROI and RI for measuring divisional
performance.

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