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  Cost-Volume-Profit Analysis (CVP) [WLOs: 1, 2, 3] [CLOs: 1, 2, 3, 5]

Prior to beginning work on this discussion, please read the article A Case Method Approach of Teaching How Cost-Volume-Profit Analysis is connected to the Flexible Budgeting Process and Variance Analysis (Links to an external site.).

The authors, Machuga and Smith (2013), present in the article a multidisciplinary case-method approach to help students who want to start a successful business understand the steps necessary to achieve their desired profits using cost-volume-profit (CVP) analysis. The case-method emphasizes on the importance of CVP analysis and how it ties directly into the planning and control processes any management must take to start a potentially successful business.

After reading the aforementioned Machuga and Smith article, in an initial post of at least 200 words, discuss how cost-volume-profit (CVP) analysis and flexible budgeting can enable students to understand the different stages involved in starting up a business, projecting out results, and monitoring business performance (Machuga & Smith. 2013).

Guided Response: Review several of your peers’ posts. In a minimum post of at least 100 words, respond to at least two of your peers’ posts in a substantive manner. Provide information that they may have missed or may not have considered in regard to how CVP analysis directly ties into the planning and control processes management must take to start a potentially successful business. Do you agree with your peers’ findings? Why or why not?

You are encouraged to post your required replies earlier in the week to promote more meaningful and interactive discourse in this discussion forum.

Post by classmate 1

 

Hello Class!

This week’s discussion is very interesting.  Many of us have once thought of a starting or running a business, (which is why I am pursuing my Bachelors in Business Management) and in the scenario presented in the reading provides glimpse of the requirements to start, manage, and predict.

According to our textbook, “Cost-volume-profit (CVP) analysis is the examination of the relationships among selling prices, sales and production volume, costs, expenses, and profits” (Warren. 2018).  Cost-Volume-Profit analysis is a method to figure out how a business can be profitable with its service or sales. Achieving consistent profitability is how a business can be sustainable.

The scenario from the text describes a startup business of selling milk shakes at a resort in Hawaii. The approach of CVP analysis requires one to be as detailed as possible as its presented in the data from the text. One of the details that caught my eye is that initially the prediction is that 3,135 milk shakes (1,254 small/1,881 large) have to sale monthly to break even. Dividing total milk shakes by 30, I estimate that 105 shakes need to sell daily. This can be useful for any startup business to implement control measure to analyze if their business is meeting minimal requirements to be sustainable. To counteract this strict requirement to be sustainable a flexible budget is key.

A flexible budget is adjusting business financial predictions based on changing costs and revenue.  The Flexible budget allows them to understand the reason-planned results differ from actual results in terms of activity variances versus revenues and spending variances.  In this case, imagine the milk shake business oversells small size shakes. The business need to re-evaluate its predictions to breakeven.

Reference:

Warren, C.S. (2018). Survey of accounting (8th ed.). Retrieved from http://www.cengage.com

Post by classmate 2

 

Good Morning Class,

            Before we can describe how CVP is beneficial to students, we must first understand what CVP analysis is. According to the textbook, it “is the examination of the relationships among selling prices, sales and production volume, costs, expenses, and profits. Cost-volume-profit analysis is useful for managerial decision making” (Warren, C.S. 2018). It is essential that CVP analysis and flexible budgeting used is used for all aspects of business. This is because CVP analysis allows a company to identify their fixed and variable costs. These fixed costs can be things like leases of building space, business insurance, LLC costs (if applicable), and overhead. These fixed costs are likely going to remain constant. The variable costs will include things such as materials and employee pay. These kind of costs are likely be different every month, or every time period that the company bases its information off of. Once you have your fixed and variable costs, then you can take this information and create your flexible budget. Creating a flexible budget is of the utmost importance because this will allow your business to make changes to the budget as needed to best continue to operate. If a hard budget is made, then it will require much more time and effort in order to change any information. This will end up costing more and making it so the company makes less profit. CVP analysis is important to understand because it breaks down fixed and variable costs into simple to understand equations.

Reference(s):

Warren, C.S. (2018). Survey of accounting (8th ed.). http://www.cengage.com

A Case Method Approach of Teaching How Cost-Volume-Profit Analysis is
Connected to the Flexible Budgeting Process and Variance Analysis

Susan Machuga

University of Hartford

Carl Smith
University of Hartford

To start a successful business, students need to understand the steps necessary to achieve their desired
profits. While Managerial textbooks teach each step independently, we demonstrate how these steps are
integrated. We present a Multi-Disciplinary Case-Method approach to teaching Cost-Volume-Profit
(CVP) Analysis. Students use their own assumptions to simulate a real-life business startup analysis to
calculate the number of units necessary to achieve their desired profits. Students are required to build
upon their CVP analyses to develop budgets necessary for planning and control purposes. Finally,
students prepare a Flexible Budget demonstrating the importance of distinguishing between activity and
revenue/spending variances.

INTRODUCTION

“We first present an alternative, more comprehensive teaching approach, for Cost-Volume-Profit
(CVP) analysis from the commonly used approach which simply teaches students how to use a series of
equations to solve various questions related to CVP analysis, in which unit selling price, total fixed costs,
and unit variable costs are assumed to remain constant (Garrison et al., 2010; Choo and Tan, 2010). We
use a multi-disciplinary approach in the context of a realistic case-analysis. We believe this approach
offers useful insights and provides a useful learning tool for students pursuing an advanced Master’s
Degree.” (Machuga, 2012). This case requires students to: (a) make assumptions about cost behavior in a
dynamic and interactive way, and (b) research a variety of marketing issues for the proposed business that
simulates a real life business situation, and (c) use the information from their CVP analysis for planning
purposes, applying what they typically learn when they read about budgeting, and (d) compare the results
of their business venture using the Income Statement prepared based on their planned level of sales
volume to the results that should have occurred based on the actual level of sales volume, as well as the
actual results we provide in the case. This allows students to see how budgets are used to develop goals,
as well as to determine if actual results were achieved. This paper’s approach emphasizes the importance
of CVP analysis and how it ties directly into planning and control processes management must take in
order to start a potentially successful business. More importantly, we show students the importance of
these key practical yet very relevant management-accounting tools, all done in one integrative setting
instead of teaching those concepts separately.

178 Journal of Accounting and Finance vol. 13(6) 2013

We assume students will already have a basic understanding of concepts learned in core courses in
their MBA program such as Finance, Financial Accounting, Marketing and Management. In addition to
being familiar with concepts of fixed versus variable costs, students are assumed to be familiar with how
changes in these costs interact with changes in sales revenue to determine net income, as well as
understand the budgeting process, concepts which should have already been covered in their Managerial
Accounting course. “An additional benefit of this case is that students can treat it as a simulation exercise
in which they vary assumptions about different variables such as: sales price, direct materials’ quality,
total fixed costs, depreciation lives, and sales mix, etc. to see how all variables, individually and
collectively, affect their break-even points. This point is often overlooked in textbooks that focus more on
an equation approach in a static rather than a dynamic analytical approach” (Machuga, 2012).

A very important concept for students to understand is whether they have accomplished profit goals
they set in their CVP analysis. In other words, they need to understand how to take their assumptions
from the first part of the case and use them to develop the necessary budgets in order to finally prepare a
projected Income Statement. Budgets force management to plan for the future as does CVP analysis. In
addition, preparing a number of budgets allows students to understand that in order accomplish their
profit goal they must also prepare budgets to coordinate activities throughout the company. This case will
allow students to understand how budgets can help them coordinate activities throughout the entire
company by integrating material purchases’ plans, and labor use, etc. Even more importantly, students
will learn the importance of budgets and their use for evaluation and control purposes. Because the actual
level of activity will most likely differ from the planned level of activity, we also require the students to
prepare a Flexible budget. The Flexible budget allows them to understand the reason planned results
differ from actual results in terms of activity variances versus revenues and spending variances (Horngren
et al., 2012).

DEVELOPMENT OF THE CASE

“The case assumes students will open a milkshake shack on the beach of a resort on the “big Island”
of Hawaii. I have studied existing restaurants, read industry reports, and have done some research on
expected minimum costs to be incurred in operating the business. A unique feature of my milkshakes is
that I will serve them with flavored straws that match the flavor of the chosen milkshakes by customers.
My research embeds the following assumptions:” (see Machuga, 2012)

Sales prices of milkshakes ($7.00 for small, and $10.00 for large)

Cost of materials needed to make milkshakes:
DIRECT MATERIAL INGREDIENTS Small (8 oz. size) Large (12 oz. size)
Whole Milk ($15 for a 5 gallon=640 oz.) (need 2 oz. of milk) (need 3 oz. of milk)
Cream ($20 for 1 gallon=128 oz.) (need 2 oz. of cream) (need 3 oz. of cream)
Sugar ($10 for a 15 lb. bag=30 cups) (need ½ cup of sugar) (need ¾ cup of sugar)
Premium Vanilla Ice Cream ($24 for 600 oz.) (need 6 oz. of ice cream) (need 9 oz. of ice cream)
Flavorings .25 per shake .40 per shake
Flavored specialty straws .75 per straw .75 per straw
Cups (500 8 oz. cups @ a cost of $200) ——————————-
Cups (500 12 oz. cups @ a cost of $250) —————————-

Fixed costs:

• Shack rental: $500 a month
• Cleaning and other miscellaneous supplies: $100 a month
• Equipment: Industrial Milk Shake Maker: $72 per machine x 10 machines=$720

Journal of Accounting and Finance vol. 13(6) 2013 179

• Equipment: Industrial Refrigerator/freezer: $480
• Countertops: $1,200
• Tables and benches for customers to sit outside: $108 per bench-set x 10=$1,080
• Annual insurance: $600 a year
• Sign: use your marketing knowledge to think of a good name= $100
• Advertising expenses: $5,000 a month
• Accounting and bookkeeping costs: $500 a month
• Owner’s salary: $96,000 a year
• Dues and membership fees: $2,000 a year.
• Licenses and permit fees: $600 a year.
• Maintenance services: $400 a month.
• Office supplies: $300 a month.

Employees:

• Two part-time employees: each receiving a monthly salary of $800 (including benefits).

Total Start-up Costs = $20,247 for which students are assumed to take out a non-owner loan for the first
months expenses and cost of long-term assets, which consist of the following amounts:
($500+$100+$720+$480+$1,200+$1,080+$50+$100+$5,000+$500+$8,000+$167+$50+$400+$300
+1,600=$20,247). A self-amortizing loan is assumed to be obtained from a bank, and carries an annual
interest rate of 6% payable over 2 years with monthly payments (each monthly payment consists of both
principal and interest). The loan amortization schedule is included in the appendix of this case study (first
months interest expense is $101.24).

Other costs:
10% of gross sales must be given to resort where shack will be located on its premises.
Owner’s capital will be used to cover direct materials’ costs.

REQUIREMENTS OF THE FIRST PART OF THE CASE

In order to answer the questions below, you may make additional assumptions, and add/change
fixed and variable costs (please clearly indicate all assumptions made).

1) Using the above information, determine the number of milkshakes you will need to sell to break
even. In order to do this, you will need to set a sales price as well as classify the above costs into
fixed or variable. (Hint: keep all costs on either a weekly, monthly or yearly basis throughout
your analysis). You also will need to vary assumption such as sales price, depreciable lives, and
sales mix.

2) Should you leave your job to open the milkshake shack?

Presented below is one possible answer to this case using only information provided in the case with
the following assumptions: 1) the milkshake’s sales-mix will be 60% large and 40% small, 2) the
suggested sales prices are used to be competitive with other vendors, and 3) the milkshake makers, tables
and benches are assumed to last for 3 years, but the refrigerator/freezer and counter tops are assumed to
last for 10 years and the sign is assumed to last only one year. Since this is a simulation exercise, the case
allows students to see how the break-even sales volume changes depending upon different assumptions
about product sales-mix, sale prices, depreciable lives of long-term assets as well as variable costs, and
allows them to add other necessary fixed costs to the cost structure of the business conditional on their
own unique business strategy. Consequently, their answers may vary.

ANSWERS TO THE FIRST PART OF THE CASE:

Monthly fixed costs:

180 Journal of Accounting and Finance vol. 13(6) 2013

• Salary of 2 part-time workers 1,600.00
• Rental 500.00
• Supplies 100.00
• Milk Shake Maker depreciation 20.00 (720/ 36months)
• Refrigerator/freezer depreciation 4.00 (480/120 months)
• Counter tops depreciation 10.00 (1,200/120months)
• Tables and benches depreciation 30.00 (1,080/36 months)
• Annual insurance 50.00 (600/12months)
• Interest on loan 101.24
• Advertising expense 5,000.00
• Accounting and bookkeeping expense 500.00
• Owner’s salary and benefits 8,000.00
• Dues and membership fees 167.00
• Licenses and permit fees 50.00
• Maintenance services 400.00
• Office supplies 300.00
• Sign 8.37 (100/12months)

Total monthly Fixed Costs $16,840.61

Variable Costs per unit:

Ingredient Cost Small Large
Whole milk $15 for 640 oz. 0.02344 per oz. 0.05 0.07
Cream $20 for 128 oz. 0.15625 per oz. 0.31 0.47
Sugar $10 for 30 cups 0.33333 per cup 0.17 0.25
Premium Vanilla Ice Cream $24 for 600 oz. 0.04000 per oz. 0.24 0.36
Flavorings 0.25 0.40
Flavored Specialty Straws 0.75 0.75
Cups-8 ounces $200 for 500 cups 0.40000 per cup 0.40
Cups-12 ounces $250 for 500 cups 0.50000 per cup 0.50
TOTAL DIRECT MATERIAL COST PER UNIT $2.17 $2.80

Variable Cost Income Statement: using a 40% (small) and 60% (large) sales-mix in determining the
break-even sales volume:
Small (40%) Large (60%) Weighted total
Sales after taking out the 10% owed
to resort

$7*90%=6.3*40%=
2.520

$10*90%=$9*60%=
5.400

7.920 per unit

Variable cost 2.17*40%=.868 2.80*60%=1.680 2.548 per unit
Contribution margin 1.652 3.720 5.372 per unit
Total Fixed costs 16,840.61 per month

1) You will need to sell 3,135 milkshakes/month to break even = ($16,840.61/5.372) 1,254 (3,135*40%)
will be small and 1,881 (3,135*60%) will be large.

Journal of Accounting and Finance vol. 13(6) 2013 181

Variable Cost Income Statement: using 40% (small) and 60% (large) sales-mix in determining the
break-even sales volume (no salary allowance for owner):
Small (40%) Large (60%) Weighted total
Sales after taking out 10%
owed to resort

$6.30*1,254milkshakes
$7,900.20

$9*1,881milkshakes
$16,929.00

$24,829.20

– Variable cost $2.17*1,254milkshakes
$2,721.18

$2.80*1,881milkshakes
$5,266.80

$ 7,987.98

Contribution margin $5,179.02 $11,662.20 $16,841.22
Total Fixed costs $16,840.61
Net Income 0.61 rounding error
Note: The break even sales volume is 3,134.89 milkshakes. The Variable Cost Income Statement uses the breakeven
quantity of 3,135 milkshakes. A small gain is shown due to rounding error since you cannot sell fractional
milkshakes.

REQUIREMENTS OF THE SECOND PART OF THE CASE

The second part of this case is intended to demonstrate the importance of using a BUDGET process to
plan, direct and control the organization. As stated in the answers to the first part of the case, since this is
a simulation exercise emulating a real-life business start-up analysis, their budgets may vary based on
assumptions they selected in the first part of the case. In addition, assumptions made with respect to
“safety stock” or ending inventory in production and raw materials budgets will also most likely vary.

1) Using assumptions you made in the first part of the case regarding, sales price per unit, variable
costs per unit and total fixed costs, as well as the information about sales volume presented
below, prepare the following budgets for the first quarter:
• Sales budget
• Production budget
• Direct materials budget for each raw material necessary to make milk shakes
• Manufacturing Overhead budget
• Operating budget

2) Using the information from the budgets you prepared above, prepare a projected Income
Statement for the first month.

The Sales Budget must be prepared first as it affects all the other budgets. In order to prepare the

sales budget an estimate of the expected number of units to be sold and the expected sales price needs to
be determined. To prepare the sales budget we used the following assumptions. Statistics for tourism in
Hawaii are available from the www.hawaiitourismauthority.org and the Department of Business,
Economic Development and Tourism of the State of Hawaii ( Hawaii.gov/debdt ).

• Number of visitors to the island from January 2007 to May 2007 were 125,000, 125,000,
150,000, 125,000 and 125,000, respectively. (For simplicity, we assume each visitor, on average,
purchases one milk shake. (Students can get more elaborate and research the average number of
days visitors stay and the average number of couples, versus families with kids).

ANSWERS TO THE SECOND PART OF THE CASE:

Presented below is one possible answer to this case using only information provided in the case with
the same assumptions followed when we presented the answer to the first part of the case.

• The sales mix and the sales price will be consistent with the first part of the case at 40% small and
60% large with the sales price set at the competitors price of $10 for large and $7 for small (less
the resort fee of 10%).

182 Journal of Accounting and Finance vol. 13(6) 2013

SALES BUDGET for
1st qtr

January February March 1stqtr Total April May

Large shakes expected
to be sold:
(visitors*.60)

75,000 75,000 90,000 240,000 75,000 75,000

Expected sales price
($10*90%)

$ 9.00 $ 9.00 $ 9.00 $ 9.00 $ 9.00 $9.00

Total sales ($) $675,000 $675,000 $810,000 $2,160,000 $675,000 $675,000

Small shakes expected
to be sold: (visitors *
.40)

50,000 50,000 60,000 160,000 50,000 50,000

Expected sales price
($7*90%)

$ 6.30 $ 6.30 $ 6.30 $ 6.30 $ 6.30 $6.30

Total sales ($) $315,000 $315,000 $378,000 $1,008,000 $315,000 $315,000
TOTAL SALES $990,000 $990,000 $1,188,000 $3,168,000 $990,000 $990,000

The next budget to be prepared is the Production budget, where the number of milk shakes needed
to be produced (based on the sales budget) are determined. This will equal:

Number of milk shakes expected to be sold
+ safety stock (ending finished goods inventory) in case demand is higher than predicted
Total milk shakes needed
Less: Beginning finished goods inventory (which is zero at the start of business)
Milk shakes needed to be produced

To prepare the production budget we used the following assumptions:
• 10% of next month’s expected milk shake sales is desired to be left in ending inventory as a

safety cushion.
• Remember, beginning inventory is last months ending inventory.

Large Milk Shakes:
January’s ending inventory: February sales of 75,000 *.10 = 7,500
February’s ending inventory: March sales of 90,000 * .10 = 9,000
March’s ending inventory: April sales of 75,000 * .10 = 7,500
April’s ending inventory: May sales of 75,000 * .10 = 7,500

Small Milk Shakes:
January’s ending inventory: February sales of 50,000 * .10 = 5,000
February’s ending inventory: March sales of 60,000 * .10 = 6,000
March’s ending inventory: April sales of 50,000 * .10 = 5,000
April’s ending inventory: May sales of 50,000 * .10 = 5,000

PRODUCTION BUDGET – 1st QTR January February March 1st Qtr total April
Large shakes (sales budget) 75,000 75,000 90,000 240,000 75,000
+ desired ending inventory 7,500 9,000 7,500 7,500 7,500
Total needed 82,500 84,000 97,500 247,500 82,500
Less: beginning inventory -0- 7,500 9,000 -0- 7,500
Large shakes to produce 82,500 76,500 88,500 247,500 75,000

Journal of Accounting and Finance vol. 13(6) 2013 183

PRODUCTION BUDGET – 1st QTR January February March 1st Qtr total April
Small shakes (sales budget) 50,000 50,000 60,000 160,000 50,000
+ desired ending inventory 5,000 6,000 5,000 5,000 5,000
Total needed 55,000 56,000 65,000 165,000 55,000
Less: beginning inventory -0- 5,000 6,000 -0- 5,000
Small shakes to produce 55,000 51,000 59,000 165,000 50,000

After the number of milk shakes needed to be produced is determined, we can plan for the amount of
direct materials, direct labor and manufacturing overhead that will be needed.

A DIRECT MATERIALS budget will need to be produced for each ingredient used to make the

milk shakes. The direct materials budget for whole milk was prepared using the following assumptions:
• 10% of next month’s expected milk needs are desired to be left in ending inventory as a safety

cushion.
• Remember, beginning inventory is last months ending inventory.
• Cost of whole milk was determined to be $0.02344 per ounce

Milk Purchases Budget – 1st quarter

January February March Total April
Large Milk Shake Production 82,500 76,500 88,500 247,500 75,000
Milk required per shake (ounces) 3 ounces 3 ounces 3 ounces 3 ounces 3 ounces
Ounces Needed for Large Milk Shake
Production

247,500 229,500 265,500 742,500 225,000

Small Milk Shake Production 55,000 51,000 59,000 165,000 50,000
Milk required per shake (ounces) 2 ounces 2 ounces 2 ounces 2 ounces 2 ounces
Ounces needed for Small Milk Shake
Production

110,000 102,000 118,000 330,000 100,000

Total Ounces Required for Production 357,500 331,500 383,500 1,072,500 325,000
Plus: Desired ending Inventory 33,150 38,350 32,500 32,500 32,500
Total Ounces Available 390,650 369,850 416,000 1,105,000 357,500
Less: Beginning Inventory -0- 33,150 38,350 -0- 32,500
Total Ounces to be Purchased 390,650 336,700 377,650 1,105,000 325,000
Cost per Ounce $0.02344 $0.02344 $0.02344 $0.02344 $0.02344
Total Cost of Milk to be Purchased $9,156.84 $7,892.25 $8,852.12 $25,901.21 $7,618.00

DIRECT MATERIALS BUDGET – CREAM.

The direct materials budget for cream was prepared using the following assumptions:
• 10% of next month’s expected cream needs are desired to be left in ending inventory as a safety

cushion.
• Remember, beginning inventory is last months ending inventory.
• Cost of cream was determined to be $0.15625 per ounce

184 Journal of Accounting and Finance vol. 13(6) 2013

Cream Purchases budget – 1st Quarter
January February March Total April
Large Milk Shake production 82,500 76,500 88,500 247,500 75,000
Cream required per shake(ounces) 3 ounces 3 ounces 3 ounces 3 ounces 3 ounces
Ounces Needed for Large Milk Shake
Production

247,500 229,500 265,500 742,500 225,000

Small Milk Shake Production 55,000 51,000 59,000 165,000 50,000
Cream required per shake(ounces) 2 ounces 2 ounces 2 ounces 2 ounces 2 ounces
Ounces Needed for Small Milk Shake
Production

110,000 102,000 118,000 330,000 100,000

Total Ounces Required for Production 357,500 331,500 383,500 1,072,500 325,000
Plus: Desired Ending Inventory 33,150 38,350 32,500 32,500 32,500
Total Ounces Available 390,650 369,850 416,000 1,105,000 357,500
Less: Beginning Inventory -0- 33,150 38,350 -0- 32,500
Total Ounces to be Purchased 390,650 336,700 377,650 1,105,000 325,000
Cost per Ounce $0.15625 $0.15625 $0.15625 $0.15625 $0.15625
Total Cost of Cream to be Purchased $61,039.06 $52,609.38 $59,007.81 $172,656.25 $50,781.25

DIRECT MATERIALS BUDGET – SUGAR.

The direct materials budget for sugar was prepared using the following assumptions:
• 10% of next month’s expected sugar needs are desired to be left in ending inventory as a safety

cushion.
• Remember, beginning inventory is last months ending inventory.
• Cost of sugar was determined to be $0.33333 per cup.

Sugar Purchases Budget – 1st Quarter

January February March Total April
Large Milk Shake Production 82,500 76,500 88,500 247,500 75,000
Sugar required per shake (in cups) ¾ cup ¾ cup ¾ cup ¾ cup ¾ cup
Cups Needed for Large Milk Shake
Production

61,875 57,375 66,375 185,625 56,250

Small Milk Shake Production 55,000 51,000 59,000 165,000 50,000
Sugar required per shake (in cups) ½ cup ½ cup ½ cup ½ cup ½ cup
Cups Needed for Small Milk Shake
Production

27,500 25,500 29,500 82,500 25,000

Total Cups Required for Production 89,375 82,875 95,875 268,125 81,250
Plus: Desired Ending Inventory 8,288 9,588 8,125 8,125 8,125
Total Cups Available 97,663 92,463 104,000 276,250 89,375
Less: Beginning Inventory -0- 8,288 9,588 -0- 8,125
Total Cups to be Purchased 97,663 84,175 94,412 276,250 81,250
Cost per Cup $ 0.33333 $ 0.33333 $ 0.33333 $ 0.33333 $ 0.33333
Total Cost of Sugar to be Purchased $32,554.01 $28,058.05 $31,470.35 $92,082.41 $27,083.06

DIRECT MATERIALS BUDGET – ICE CREAM.

The direct materials budget for ice cream was prepared using the following assumptions:
• 10% of next month’s expected ice cream needs are desired to be left in ending inventory as a

safety cushion.
• Remember, beginning inventory is last months ending inventory.
• Cost of ice cream was determined to be $0.04 per ounce.

Journal of Accounting and Finance vol. 13(6) 2013 185

Ice Cream Purchases Budget – 1st Quarter
January February March Total April

Large Milk Shake Production 82,500 76,500 88,500 247,500 75,000
Ice Cream Required per shake 9 ounces 9 ounces 9 ounces 9 ounces 9 ounces
Ounces needed for Large Milk
Shake Production

742,500 688,500 796,500 2,227,500 675,000

Small Milk Shake Production 55,000 51,000 59,000 165,000 50,000
Ice Cream Required per shake 6 ounces 6 ounces 6 ounces 6 ounces 6 ounces
Ounces needed for Small Milk
Shake Production

330,000 306,000 354,000 990,000 300,000

Total Ounces Required for
Production

1,072,500 994,500 1,150,500 3,217,500 975,000

Plus: Desired Ending Inventory 99,450 115,050 97,500 97,500 97,500
Total Ounces Available 1,171,950 1,109,550 1,248,000 3,315,000 1,072,500
Less: Beginning -0- 99,450 115,050 -0- 97,500
Total Ounces to be Purchased 1,171,950 1,010,100 1,132,950 3,315,000 975,000
Cost per ounce $ 0.04 $ 0.04 $ 0.04 $ 0.04 $ 0.04
Total Cost of Ice Cream to be
Purchased

$46,878.00 $40,404.00 $45,318.00 $132,600.00 $39,000.00

DIRECT MATERIALS BUDGET – FLAVORINGS.

The direct materials budget for flavorings was prepared using the following assumptions:
• 10% of next month’s expected flavoring needs are desired to be left in ending inventory as a

safety cushion.
• Remember, beginning inventory is last months ending inventory.
• Cost of flavorings was $ 0.40 for a large shake and $ 0 .25 for a small shake.

Flavorings Purchases Budget – 1st Quarter

January February March Total April
Large Milk Shake Production 82,500 76,500 88,500 247,500 75,000
Plus: Desired Ending Inventory 7,650 8,850 7,500 7,500 7,500
Total Available 90,150 85,350 96,000 255,000 82,500
Less: Beginning Inventory -0- 7,650 8,850 -0- 7,500
Total to be Purchased 90,150 77,700 87,150 255,000 75,000
Cost per unit $ 0.40 $ 0.40 $ 0.40 $ 0.40 $ 0.40
Total Cost of Flavorings to be
Purchased for Large Milk Shakes

$36,060.00 $31,080.00 $34,860.00 $102,000.00 $30,000.00

Small Milk Shake Production 55,000 51,000 59,000 165,000 50,000
Plus: Desired Ending Inventory 5,100 5,900 5,000 5,000 5,000
Total Available 60,100 56,900 64,000 170,000 55,000
Less: Beginning Inventory -0- 5,100 5,900 -0- 5,000
Total to be Purchase 60,100 51,800 58,100 170,000 50,000
Cost per unit $ 0.25 $ 0.25 $ 0.025 $ 0.25 $ 0.25
Total Cost of Flavorings to be
Purchased for Small Milk Shakes

$15,025.00 $12,950.00 $14,525.00 $42,500.00 $12,500.00

Total Cost of Flavorings to be
Purchased for ALL Milk Shakes

$51,085.00 $44,030.00 $49,385.00 $144,500.00 $42,500.00

186 Journal of Accounting and Finance vol. 13(6) 2013

DIRECT MATERIALS BUDGET – STRAWS.
The direct materials budget for straws was prepared using the following assumptions:
• 10% of next month’s expected straw needs are desired to be left in ending inventory as a safety

cushion.
• Remember, beginning inventory is last months ending inventory.
• Cost per straw is $ 0.75.

Straws Purchases Budget – 1st Quarter

January February March Total April
Large Milk Shake Production 82,500 76,500 88,500 247,500 75,000
Small milk shake Production 55,000 51,000 59,000 165,000 50,000
Total straws Required for Production 137,500 127,500 147,500 412,500 125,000
Plus: Desired Ending Inventory 12,750 14,750 12,500 12,500 12,500
Total Available 150,250 142,250 160,000 425,000 137,500
Less: Beginning Inventory -0- 12,750 14,750 -0- 12,500
Total Straws to be Purchased 150,250 129,500 145,250 425,000 125,000
Cost per straw $ 0.75 $ 0.75 $ 0.75 $ 0.75 $ 0.75
Total cost of straws to be Purchased $112,687.50 $97,125.00 $108,937.50 $318,750.00 $93,750.00

DIRECT MATERIALS BUDGET –CUPS.
The direct materials budget for cups was prepared using the following assumptions:

• 10% of next month’s expected cup needs are desired to be left in ending inventory as a safety
cushion.

• Remember, beginning inventory is last months ending inventory.
• Cost per cup is $ 0.50 for a large shake and $ 0.40 for a small shake.

Cups Purchases Budget – 1st Quarter

January February March Total April
Large Milk Shake Production 82,500 76,500 88,500 247,500 75,000
Plus: Desired Ending Inventory 7,650 8,850 7,500 7,500 7,500
Total Available 90,150 85,350 96,000 255,000 82,500
Less: Beginning Inventory -0- 7,650 8,850 -0- 7,500
Total cups to be Purchased 90,150 77,700 87,150 255,000 75,000
Cost per Cup $ 0.50 $ 0.50 $ 0.50 $ 0.50 $ 0.50
Total Cost of Cups to be Purchased $45,075.00 $38,850.00 $43,575.00 $127,500.00 $37,500.00

Cups Purchases Budget – 1st Quarter
January February March Total April
Small Milk Shake Production 55,000 51,000 59,000 165,000 50,000
Plus: Desired Ending Inventory 5,100 5,900 5,000 5,000 5,000
Total Available 60,100 56,900 64,000 170,000 55,000
Less: Beginning Inventory -0- 5,100 5,900 -0- 5,000
Total cups to be Purchased 60,100 51,800 58,100 170,000 50,000
Cost per Cup $ 0.40 $ 0.40 $ 0.40 $ 0.40 $ 0.40
Total Cost of Cups to be Purchased $24,040.00 $20,720.00 $23,240.00 $68,000.00 $20,000.00

Journal of Accounting and Finance vol. 13(6) 2013 187

MANUFACTURING OVERHEAD BUDGET
First, we need to determine whether each manufacturing overhead expense is variable or fixed. It has

been determined that all the manufacturing overhead costs are fixed, although salary of part-time workers
and utilities can be variable or mixed expenses as well.

Manufacturing Overhead Budget – 1st Quarter
January February March Total
Fixed manufacturing overhead costs:
Salary of 2 part-time workers 1,600.00 1,600.00 1,600.00 4,800.00
Rent and utilities expense 500.00 500.00 500.00 1,500.00
Supplies for making milk shakes 100.00 100.00 100.00 300.00
Depreciation – milk shake maker 20.00 20.00 20.00 60.00
Depreciation – refrigerator/freezer 4.00 4.00 4.00 12.00
Depreciation – counter tops 10.00 10.00 10.00 30.00
TOTAL FIXED COSTS $2,234.00 $2,234.00 $2,234.00 $6,702.00

OPERATING BUDGET
First we need to determine whether each operating budget expense is variable or fixed. It has been
determined that all the operating costs are fixed.

Operating Budget – 1st Quarter
January February March Total
Fixed operating expenses:
Depreciation – tables and benches 30.00 30.00 30.00 90.00
Insurance expense 50.00 50.00 50.00 150.00
Interest expense 23.90 22.96 22.02 68.88
Advertising expense 5,000.00 5,000.00 5,000.00 15,000.00
Accounting and bookkeeping expense 500.00 500.00 500.00 1,500.00
Owner’s salary expense 8,000.00 8,000.00 8,000.00 24,000.00
Dues and membership expense 167.00 167.00 166.00 500.00
Licenses and Permits expense 50.00 50.00 50.00 150.00
Maintenance expense 400.00 400.00 400.00 1,200.00
Office supplies expense 300.00 300.00 300.00 900.00
Depreciation – sign 8.37 8.33 8.33 25.03
TOTAL FIXED COSTS $14,529.27 $14,528.29 $14,526.35 $43,583.91

188 Journal of Accounting and Finance vol. 13(6) 2013

So what is the BUDGETED MANUFACTURING COST FOR ONE UNIT:

Direct Materials Variable Costs per unit:

Ingredient Cost Small Large
Whole milk $15 for 640 oz. 0.02344 per oz. 0.05 0.07
Cream $20 for 128 oz. 0.15625 per oz. 0.31 0.47
Sugar $10 for 30 cups 0.33333 per cup 0.17 0.25
Premium Vanilla Ice Cream $24 for 600 oz. 0.04000 per oz. 0.24 0.36
Flavorings 0.25 0.40
Flavored Specialty Straws 0.75 0.75
Cups-8 ounces $200 for 500 cups 0.40000 per cup 0.40
Cups-12 ounces $250 for 500 cups 0.50000 per cup 0.50
TOTAL DIRECT MATERIAL COST PER UNIT $2.17 $2.80

LARGE MILK SHAKES – per the PRODUCTION budget we expect to produce 1,580,000 in the first
Year: (125,000+125,000+150,000+125,000+125,000+150,000+160,000+150,000+110,000+110,000
+110,000+140,000).

(1) Direct materials cost per milk shake: = 2.80

(2) Manufacturing overhead:
Fixed ($2,234.00 *12months * 60% per quarter)/ 1,580,000 =
milk shakes = 0.01

Cost of manufacturing each large milk shake = $2.81

SMALL MILK SHAKES – per the PRODUCTION budget we expect to produce 165,000 in the first
quarter.

(1) Direct materials cost per milk shake: = 2.17

(2) Manufacturing overhead:
Fixed ($2,234.00 * 12 months * 40% per quarter)/ 1,580,000 =
milk shakes = 0.01

Cost of manufacturing each small milk shake = $2.18

Journal of Accounting and Finance vol. 13(6) 2013 189

PROJECTED INCOME STATEMENT
MONTH OF JANUARY

Large (60%) Small (40%) Total
Number of milk shakes expected to be sold 75,000 50,000 125,000
Sales price per milk shake (less resort fee) $9.00 $6.30
Cost of goods sold per milk shake $2.81 $2.18

Sales $675,000 $315,000 $990,000
Less: cost of goods sold $211,500 $109,500 $321,000
Gross Profit $463,500 $205,500 $669,000
Less: Operating expenses 26,150 17,434 43,584
Operating Income $437,350 $188,066 $625,416
Income tax expense (income tax rate = 35%) $153,073 $ 65,823 $218,896
Net Income $284,277 $122,243 $406,520

Due to global warming, demand for milk shares was much larger than expected. The amount of large milk
shakes actually sold in January were 85,000 (10,000 over budget) while the amount of small milk shakes
actually sold in January were 45,000 (5,000 under budget). The budgets prepared above were planned
prior to the beginning of the year and are valid for the planned level of sales activity. If the actual level of
sales activity differs from the planned level, comparing our budgets above with actual results may lead to
incorrect conclusions about performance. Therefore we must prepare a FLEXIBLE budget that adjusts
revenues and expenses given the actual level of sales activity that occurred.

Large Milk Shakes – Flexible Budget Performance Report for the Month ended January 31
Planned Budget

based on
budgeted sales
of 75,000 milk
shakes

Activity
and
Spending
Variances

Actual results
based on actual
sales of 85,000
milk shakes

Spending
Variances

Flexible budget
based on actual
sales of 85,000
milk shakes

Revenue ($9.00q) $675,000 90,000 F $765,000 $765,000
Less: Cost of goods
sold ($2.82q)

$211,500 8,500 U $220,000 19,700 F $239,700

Gross Profit $463,500 81,500 F $545,000 19,700 F $525,300
Less: Operating
expenses

26,150 1,600 U 27,750 1,600 U 26,150

Operating Income $437,350 79,900 F $517,250 18,100 F $499,150
Income tax expense
(tax rate = 35%)

$153,073 $181,038 $174,703

Net Income $284,277 $336,212 $324,447

190 Journal of Accounting and Finance vol. 13(6) 2013

Small Milk Shakes – Flexible Budget Performance Report for the Month ended January 31
Planned Budget

based on
budgeted sales
of 50,000 milk
shakes

Activity
and
Spending
Variances

Actual results
based on actual
sales of 45,000
milk shakes

Spending
Variances

Flexible budget
based on actual
sales of 45,000
milk shakes

Revenue ($6.30q) $315,000 31,500 U $283,500 $283,500
Less: Cost of goods
sold ($2.19q)

$109,500 9,000 F $100,500 1,950 U $98,550

Gross Profit $205,500 22,500 U $183,000 1,950 U $184,950
Less: Operating
expenses

17,434 116 U 17,550 116 U 17,434

Operating Income $188,066 22,616 U $165,450 2,066 U $167,516
Income tax expense
(tax rate = 35%)

$ 65,823 $57,907 $58,613

Net Income $122,243 $107,543 $108,885

CONCLUSION

This case integrates key concepts of Cost-Volume-Profit (CVP) analysis, and Flexible Budgeting in a
case study-setting to enable students to understand the different stages involved in starting up a business,
preparing required budgets, projecting out results, monitoring business performance, and reconciling
variances between projected and actual results. We show students the importance of these key practical
yet very relevant management-accounting tools, all done in one integrative setting instead of teaching
those concepts separately. Furthermore, our case study accomplishes these goals in a dynamic simulation-
style exercise that allows students to make their own assumptions about key input variables needed in the
analysis and witness firsthand how changes in these assumptions impact their business performance
results. Students often wonder how they can use and integrate concepts learned throughout different
accounting courses with other business courses in the areas of finance, management and marketing. This
case accomplishes precisely this very goal by enabling students who go through the exercise which the
case presents to apply what they learned in various business disciplines in an integrated and
comprehensible way. It is often viewed that flexible budgeting is a key starting point for developing a full
cost-accounting system and subsequent analyses of variances between budgeted and actual results in an
effort to improve cost control and operational performance. This case provides the necessary tools to both
business school students in general, as well as accounting students in particular who will move on to
higher-level accounting courses such as a cost-management class, typically taken in their major, to
understand the full picture needed to start and maintain a successful small business.

REFERENCES

Choo, F. & Tan K.B. (2011). An Income Statement Approach for Cost-Volume-Profit (CVP) Analysis by
Using a Company’s CVP Model. Journal of Accounting and Finance, 11(4), 23-36.

Garrison, R.H, Noreen E., & Brewer P.C. (2010). Managerial Accounting, 12th edition. New York:
Irwin/McGraw-Hill.

Horngren, C.T., Datar, S.M., & Rajan, M. (2012). Cost Accounting: A Managerial Emphasis, 14th edition.
New Jersey: Pearson Education, Inc.

Journal of Accounting and Finance vol. 13(6) 2013 191

Machuga. (2012). A Case Method Approach to Teaching Cost-Volume-Profit Analysis. Journal of
Accounting and Finance, 12(5), 104-109.

The Department of Business, Economic Development and Tourism of the State of Hawaii
(Hawaii.gov/debdt ). www.hawaiitourismauthority.org

APPENDIX: LOAN AMORTIZATION SCHEDULE:

Beginning
Balance Payment

Interest
Expense

Principle
reduction

Ending
balance

20,247.00 897.36 101.24 796.12 19,450.88
19,450.88 897.36 97.25 800.11 18,650.77
18,650.77 897.36 93.25 804.11 17,846.66
17,846.66 897.36 89.23 808.13 17,038.53
17,038.53 897.36 85.19 812.17 16,226.36
16,226.36 897.36 81.13 816.23 15,410.13
15,410.13 897.36 77.05 820.31 14,589.82
14,589.82 897.36 72.95 824.41 13,765.41
13,765.41 897.36 68.83 828.53 12,936.88
12,936.88 897.36 64.68 832.68 12,104.20
12,104.20 897.36 60.52 836.84 11,267.36
11,267.36 897.36 56.34 841.02 10,426.34
10,426.34 897.36 52.13 845.23 9,581.11
9,581.11 897.36 47.91 849.45 8,731.66
8,731.66 897.36 43.66 853.70 7,877.96
7,877.96 897.36 39.39 857.97 7,019.99
7,019.99 897.36 35.10 862.26 6,157.73
6,157.73 897.36 30.79 866.57 5,291.16
5,291.16 897.36 26.46 870.90 4,420.26
4,420.26 897.36 22.10 875.26 3,545.00
3,545.00 897.36 17.73 879.63 2,665.37
2,665.37 897.36 13.33 884.03 1,781.34
1,781.34 897.36 8.91 888.45 892.89

892.89 897.36 4.46 892.89 0.00

192 Journal of Accounting and Finance vol. 13(6) 2013