The Main Difference Between the Variable Income Statement and Absorption - Research Paper Example

Question 3 (a) Exhibit 1 presents expenses in the categories of raw materials, manufacturing overhead, and operating expenses. The factors that make each different are discussed as follows. (i) Raw materials are the ingredients that have actually been used in the production of the cookies. You can actually see these ingredients in the cookies. These are described as direct cost. In this case because of the capital intensive nature of production direct labor is included as a variable manufacturing overhead cost. (ii) Manufacturing overheads are the indirect costs of converting the raw materials into finished goods. They include fixed and variable costs. The cost of labor and utilities such as water, gas and electricity varies with their use. Therefore, they are described as variable costs. The machines used in the production of the cookies, the costs incurred in maintaining these machines and the persons involved in supervising the production process are basically fixed costs. (iii) Operating overheads relates to the expenses incurred for administration and distribution of the cookies. (b) Some costs are fixed and some are variable. (i) Maintenance is fixed because there is usually a maintenance schedule that is followed for equipment. Generally certain specific items will need to be replaced and the materials and labor used do not vary in the short run. It is a cost for the period. (ii) Depreciation costs are period costs which are apportioned on a monthly basis and does not vary in relation to the use of the fixed assets being depreciated. Depreciation is really an attempt to spread the cost of fixed asset over its useful life and does not involve the outflow/disbursement of funds. (iii) Supervision is fixed because the supervisor’s salary is generally fixed for a specific period. The annual salary is therefore apportioned. (iv) Sales Commission is variable because it depends on sales volume. If sales volume increases it also increases and if it decreases it also decreases. (v) Shipping costs relates to the number of times shipments are made and the volume involved. These will vary with the level of sales. (vi) Salaries are normally quoted at an annual rate for employees in the administrative department. This is a period cost as it is not expected to change within the short run. (vii) Depreciation of other fixed assets that the company uses outside of its production facility are period costs and therefore do not vary with production or sales. Part 2 Question 1 (a) Tasty Cookies Inc. Sales Budget/Cash Collections Budget First four digits of phone number 7752 Year of birth 1983 First four digits of social security number 911 Last four digits of social security number 48 The above information was used to determine the sales for each month. The units are linked to them. January February March April Total Units Sold (in dozens of cookies) 7752 1983 911 48 10694 Selling price ($) 9.63 9.63 9.63 9.63 9.63 Revenue ($) 74613 19086 8768 462 102930 Collections: Month of sale 40% 29845 7635 3507 185 41172 Next Month 60% 44768 11452 5261 61481 Total Collections 29845 52402 14959 5446 102653 Receivables at the end of March: Sales at the end of March 102468 Less: Collections at the end of March 97207 Total 5261 (b) Tasty Cookies Inc. Direct Materials Purchases Budget/Cash Disbursement Budget January February March April Total Units Produced 10% 7950 2074 916 53 10993 Units Sold 7752 1983 911 48 10694 Stock Balance (10% of next month's) 198 91 5 5 299 Direct cost of closing raw materials 322 148 8 8 486 Cost of Direct Materials purchased ($) 12919 3370 1488 86 17864 Disbursements: Month of sale ($) 25% 3230 843 372 21 4466 Next Month ($) 75% 9689 2528 1116 13333 Total Disbursements 3230 10532 2900 1138 17799 Payables at end of March: Purchases up to the end of March 17778 Less: Payments to Creditors up to March 16662 Total Payables 1116 (c) Tasty Cookies Inc. Manufacturing Overheads Budget January February March April Total Units Produced 7950 2074 916 53 10993 Variable Manufacturing Overheads: Utilities 3975 1037 458 26 5497 Other indirect materials and labor 5963 1556 687 40 8245 Total variable manufacturing overhead 9938 2593 1145 66 13741 Fixed Manufacturing Overheads: Maintenance 500 500 500 500 2000 Depreciation (does not involve ouflow of cash) 2000 2000 2000 2000 8000 Supervision 2500 2500 2500 2500 10000 Total Fixed Manufacturing Overhead   5000 5000 5000 5000 20000 Total Manufacturing Overheads 14938 7593 6145 5066 33741 Included in closing stock 198 91 5 Variable Manuf. overheads in inventory 248 114 6 (d) Tasty Cookies Inc. Operating Expenses Budget January February March April Total Units Produced 7950 2074 916 53 10993 Variable Operating Expenses: Sales Commission 3975 1037 458 26 5497 Shipping Cost 7950 2074 916 53 10993 Total Variable Operating Expenses 11925 3111 1374 79 16490 Fixed Operating Expenses: Salaries 5000 5000 5000 5000 20000 Depreciation(does not involve an outflow of cash) 200 200 200 200 800 Other 1800 1800 1800 1800 7200 Total Fixed Operating Expenses   7000 7000 7000 7000 28000 Total Operating Expenses 18925 10111 8374 7079 44490 Question 2 (a) It is important to begin the master budget process with an accurate sales budget. The reason is that, the sales budget forms the basis for the production budget and therefore impacts on the direct materials budget (direct materials required to meet the sales forecasted), the manufacturing overheads and the operating expenses budgets. Information obtained from all of these budgets (mentioned above) will then be used to prepare the cash budget, forecast income statements, and the forecast balance sheet. According to Horngren et al, (2000): “A revenue budget is usually the starting point for budgeting…because production (and hence costs) and inventory levels generally depend on the forecasted level of unit sales or revenues. (b) Some important factors that a manager should consider when developing a sales budget are: (i) the volume of sales expected; (ii) the volume of sales necessary to breakeven; (iii) the cost of the materials required to meet the projected sales level and to provide a buffer against higher demand; and (iv) the timing of receipts (c) Operating expenses are expenses relating to the company’s operations that have been incurred during a period. Disbursements for operating expenses on the other hand are payments that have actually been made. These payments/disbursements may be equal to or less than the actual expense incurred for the period. Depreciation does not involve the disbursement or outflow of funds. However, it is an expense of the business and is really a means of spreading the cost of the asset over its useful life. The figure for depreciation should therefore not be included in the cash budget. Part 3 Question 1 (a) Tasty Cookies Inc. Proforma Variable Costing Income Statement $ $ Revenue 102468 Variable Costs: Opening Inventory 0 Direct Material Costs 17778 Variable Manufacturing Costs 13675 Cost of goods available for sale 31453 Closing inventory 14 Variable Manufacturing cost of goods sold 31439 Variable operating expenses 16410 Total Variable Cost 47850 Contribution Margin 54618 Fixed Costs Maintenance 1500 Salaries 22500 Depreciation 6600 Other 5400 Total Fixed Costs 36000 Operating income 18618 Interest Expense 843 Profit before Tax 17775 Income Tax 4444 Profit after Tax 13332 (b) Tasty Cookies Inc. Proforma Absorption Costing Income Statement $ $ Revenue 102468 Cost of goods sold: Opening Inventory 0 Direct Material Cost 17778 Variable Manufacturing costs 13675 Fixed Manufacturing costs 15000 Cost of goods available for sale 46453 Closing inventory 14 Cost of goods sold 46467 Contribution Margin 56001 Operating Costs: Sales Commission 5470 Shipping costs 10940 Salaries 15000 Depreciation 600 Other 5400 Total Operating Costs 37410 Operating income/(loss) 18591 Interest Expense 843 Net Income 17748 Income Tax 4437 Profit after Tax 13311 (c) Tasty Cookies Inc. Cash Budget January February March Total Cash Receipts $ $ $ $ Capital Introduced 50000 50000 Sales 29845 52402 14959 97207 Bank Loan 50000 50000 Total Inflows 129845 52402 14959 197207 Cash Disbursements Raw Materials 3230 10532 2900 16662 Acquisition of Fixed Assets 90000 90000 Interest Expense 550 292 843 Manufacturing Overheads 12938 5593 4145 22675 Operating Expenses 18725 9911 8174 36810 Income Tax 4444 4444 Total Outflows 124893 26586 19954 171434 Cash b/f 0 10000 10000 20000 Net Cash Inflow/(Outflow) 4952 25816 (4995) 25773 Additional Bank Loan/Repayment 5048 (25816) 4995 (15773) Cash c/f 10000 10000 10000 30000 Bank Loan Outstanding 55,048 29,232 34,227 Interest Expense (Monthly) 1.00% 550.479 292.319 342.272 Income tax VC Inc. Statement 25% 4444 Income tax AC Inc. Statement 25% 4437 (d) Tasty Cookies Inc. Forecast Balance Sheet for Perod Ending March Cost ($) Accum. Dep. ($) NBV ($) Fixed Assets 90,000 6,600 83,400 Current Assets Inventory 14 Receivables 5,261 cash at Bank 10,000 15,275 Current Liabilities Payables 1,116 Working Capital 14,159 Net Assets 97,559 Financed by: Capital: Owner 50,000 Profit 13,332 63,332 Long Term Liabilities Bank Loan 34,227 97,559 Question 2 (a) The main difference between the variable income statement and absorption income statement is centered on accounting for fixed manufacturing costs. While absorption costing includes fixed manufacturing overheads as part of the cost of goods sold variable costing does not. Variable costing only include variable elements of costs. They include: direct cost of material, labor and other expenses, as well as variable elements of manufacturing overhead costs such as utilities. (b) The major benefits of budgeting are: (i) it provides a basis that enables proper planning; (ii) provides a means of controlling expenses; (iii) the expenses of major importance or with high priority may be placed at the top of the list of expected outflows for the period; (iv) it highlights when funds may be needed as well as when excess funds may become available, therefore you can look to other sources of financing the budget; (v) it can be revised based on changes in the environment; (vi) it is used to compare actual against planned income and expenses and so variances can be analyzed to determine the reasons for differences. (vii) “they compel planning including the implementation of plans; (viii) they provide performance criteria; and (ix) they promote coordination and communication within the organization” (Horngren et al 2000), between the different departments so the sales department will communicate with the production department and the production department with the buying department as it relates to procurement, production and sales. (c) Sensitivity analysis is “a what-if technique that examines how a result will change if the original predicted data are not achieved or if an underlying assumption changes” (Horngren et al (2000). This means that you can vary the assumptions or figures in a model to determine what impact it will have on the other variables that are dependent on it. Spreadsheets provide this facility. Formulas are input to the cells to facilitate this. Therefore, when preparing budgets or deciding how much to produce or to sell the spreadsheet can provide results (from the formulas that are input) on how these variables impact on profits. The variable items in the spreadsheet which are influenced by other variables will change. References Horngren, C. T., Foster, G. & Datar, S. M. 10th ed. Cost Accounting: A Managerial Emphasis. USA: Prentice Hall, 2000. Print. Appendix Grandma’s Recipe Gingerbread Men: 3 cups (390 grams) all purpose flour 1/4 teaspoons salt 3/4 teaspoon baking soda 2 teaspoons ground ginger 1 teaspoon ground cinnamon 1/4 teaspoon ground nutmeg 1/4 teaspoon ground cloves 1/2 cup (113 grams) unsalted butter, room temperature 1/2 cup (100 grams) granulated white sugar 1 large egg 2/3 cup (160 ml) unsulphured molasses (To prevent molasses from sticking to the measuring cup, first spray the cup with a non stick vegetable spray.) Instructions: 1. In a large bowl, sift or whisk together the flour, salt, baking soda, and spices.  2. In the bowl of your electric mixer (or with a hand mixer), with the paddle attachment, beat the butter and sugar until light and fluffy. 3. Add the egg and molasses and beat until well combined. Gradually add the flour mixture beating until incorporated. 4. Divide the dough in half, and wrap each half in plastic wrap and refrigerate for at least two hours or overnight.  5. Preheat oven to 350 degrees F (177 degrees C) and place rack in center of oven.  6. Line 2 baking sheets with parchment paper and set aside while you roll out the dough. 7. On a lightly floured surface, roll out the dough to a thickness of about 1/4 inch. Use a gingerbread cutter to cut out the cookies.  8. With an offset spatula lift the cut out cookies onto the baking sheet, placing the cookies about 1 inch (2.54 cm) apart. If you are hanging the cookies or using as gift tags, make a hole at the top of the cookies with a straw or end of a wooden skewer. 9. Bake for about 8 - 12 minutes depending on the size of the cookies. Small ones will take about 8 minutes; larger cookies will take about 12 minutes. They are done when they are firm and the edges are just beginning to brown.  10. Remove the cookies from the oven and cool on the baking sheet for about 1 minute. When they are firm enough to move, transfer to a wire rack to cool completely. Read More