Comprehensive Problem 6: CVP, Budgeting, Variances RYT

Comprehensive Problem 6: CVP/Budgeting/Variances RYT (aka RotYourTeeth) Candy Company sells lollipops

The problem focuses on a candy company that sells lollipops and involves calculating sales targets, budgeting, and variances analysis. The key details involve understanding the company's sales, costs, and profit goals, followed by analyzing variances that affect profitability.

Assignment Instructions

The company sold 10,000,000 lollipops last year for $1,000,000, with variable costs of $350,000 and net profits of $100,000. Management aims to double profits in the upcoming year. The task involves determining the number of lollipops that must be sold to reach this profit target, calculating the direct labor (DL) and direct materials (DM) budgets needed, and analyzing the variances based on actual and budgeted costs, providing explanations to the Board of Directors.

Paper For Above instruction

Introduction

The financial health and growth of manufacturing firms largely depend on their ability to analyze costs, set accurate budgets, and evaluate variances. The case of RYT (RotYourTeeth) Candy Company, which specializes in selling lollipops, exemplifies these crucial accounting practices. This paper aims to address the company's goal of doubling last year's net profit, calculate necessary sales volume, prepare budget estimates for direct materials and labor, and analyze variances to provide strategic insights to the Board of Directors.

Sales and Profit Analysis

Last year, RYT sold 10 million lollipops for $1,000,000, indicating an average selling price of $0.10 per lollipop. The total variable costs were $350,000, translating to a variable cost per unit of $0.035, and resulting in a contribution margin per unit of $0.065. The net profit of $100,000 reflects the company's profit after deducting fixed costs and variances from the contribution margin. The key objective is to determine the sales volume necessary to double the net profit, aiming for $200,000.

Part 1: Determining the Number of Lollipops to Achieve Double Profit

The target profit is $200,000, and utilizing the contribution margin per unit ($0.065), the calculation is as follows:

Number of units needed = (Fixed costs + Target profit) / Contribution margin per unit

Given that last year's profit was $100,000, and assuming fixed costs remained constant, the fixed costs are derived from last year's profit and contribution margin:

Fixed costs = Total contribution margin - Net profit = ($0.065 × 10,000,000) - $100,000 = $650,000 - $100,000 = $550,000

Therefore, the number of units to sell to reach a profit of $200,000:

Units required = ($550,000 + $200,000) / $0.065 ≈ 10,769,231 units

Thus, the company needs to sell approximately 10.77 million lollipops to double its profit.

Part 2: Budgeting for Direct Labor and Materials

The company's production of each unit requires 1/50 of a pound of DM at a cost of $1 per pound, and labor costs of $10 per hour with each unit requiring 0.0015 hours of labor.

Budgeted DM and DL Costs

  • Budgeted DM per unit: 1/50 pound = 0.02 pounds
  • Budgeted DM cost per unit: 0.02 pounds × $1 = $0.02
  • Budgeted DL per unit: 0.0015 hours
  • Budgeted DL cost per unit: 0.0015 hours × $10 = $0.015

Based on the calculated required sales units (~10.77 million units), the total budgeted DM and DL costs are:

  • Total DM cost: 10,769,231 units × $0.02 ≈ $215,385
  • Total DL cost: 10,769,231 units × $0.015 ≈ $161,539.69

Part 3: Variance Analysis and Explanations

Actual costs incurred were different from budgeted costs, leading to favorable or unfavorable variances. The actual data provided is:

  • DM: Actual cost = $1.50 per pound, 220,000 pounds used
  • DL: Actual cost = $12 per hour, 16,000 labor hours used

Direct Materials Variance

The variance in direct materials is calculated by comparing actual costs to budgeted costs based on actual usage:

Actual DM cost = 220,000 pounds × $1.50 = $330,000

Budgeted DM cost for actual usage (from previous calculations): 220,000 pounds × $1 = $220,000

Variance = Actual cost - Budgeted cost = $330,000 - $220,000 = $110,000 unfavorable

This unfavorable variance indicates higher actual material costs possibly due to increased market prices or inefficient purchasing.

Direct Labor Variance

The actual labor cost is:

Actual DL cost = 16,000 hours × $12 = $192,000

Budgeted DL cost for actual hours: 16,000 hours × $10 = $160,000

Variance = Actual - Budgeted = $192,000 - $160,000 = $32,000 unfavorable

This unfavorable variance suggests higher actual labor costs, potentially due to overtime, increased wages, or inefficiencies.

Explanations and Strategic Recommendations

The unfavorable variances in both DM and DL costs reflect higher real-world expenses than initially budgeted. These variances can erode profit margins despite successful sales volume increases. Management should analyze suppliers for better material pricing and review labor productivity. Investing in employee training or process improvements may reduce labor costs. Additionally, negotiating better supplier contracts or bulk purchasing could mitigate material cost increases.

Conclusion

The company's strategic goal of doubling profits requires selling approximately 10.77 million lollipops, with necessary budget allocations for direct materials and labor totaling approximately $215,385 and $161,539, respectively. The variances suggest cost control measures are essential. Regular variance analysis provides vital feedback for operational improvements, ensuring the company attains its profitability objectives effectively.

References

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  • Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2020). Managerial Accounting (8th ed.). McGraw-Hill Education.
  • Drury, C. (2013). Management and Cost Accounting. Cengage Learning.
  • Kaplan, R. S., & Atkinson, A. A. (2015). Advanced Management Accounting. Pearson.
  • Anthony, R., & Govindarajan, V. (2014). Management Control Systems (12th ed.). McGraw-Hill Education.
  • Horngren, C. T., Sundem, G. L., Stratton, W. O., Burgstahler, D., & Schatzberg, J. (2013). Introduction to Management Accounting. Pearson.
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  • Drury, C. (2018). Cost and Management Accounting. Cengage Learning.
  • Hilton, R. W., & Platt, D. (2013). Managerial Accounting: Creating Value in a Dynamic Business Environment. McGraw-Hill Education.

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