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Chapter 6: Problem 16

\(\ln 2011,\) Rouse \(\&\) Sons, a small environmental-testing firm, performed 12,200 radon tests for \(\$ 290\) each and 16,400 lead tests for \(\$ 240\) each. Because newer homes are being built with lead-free pipes, lead-testing volume is expected to decrease by \(10 \%\) next year. However, awareness of radon- related health hazards is expected to result in a \(6 \%\) increase in radon- test volume each year in the near future. Jim Rouse feels that if he lowers his price for lead testing to \(\$ 230\) per test, he will have to face only a \(7 \%\) decline in lead-test sales in 2012. 1\. Prepare a 2012 sales budget for Rouse \(\&\) Sons assuming that Rouse holds prices at 2011 levels. 2\. Prepare a 2012 sales budget for Rouse \(\&\) Sons assuming that Rouse lowers the price of a lead test to \$230. Should Rouse lower the price of a lead test in 2012 if its goal is to maximize sales revenue?

Short Answer

Expert verified
Maintaining 2011 prices results in higher total sales revenue. Rouse should not lower the lead test price if the goal is to maximize revenue.

Step by step solution

01

Calculate Expected 2012 Radon Tests

Starting with the radon tests, the volume of tests is expected to increase by 6%. We had 12,200 radon tests in 2011, so we calculate the 2012 volume: \( 12,200 \times 1.06 = 12,932 \). Thus, we expect 12,932 radon tests in 2012.
02

Calculate Revenue from Radon Tests

Using the 2011 price of $290 per radon test, calculate the expected revenue from radon testing in 2012: \( 12,932 \times 290 = 3,750,280 \). This is the expected revenue from radon tests with the prices held at 2011 levels.
03

Calculate Expected 2012 Lead Tests (No Price Change)

With a forecasted 10% decrease in lead tests and maintaining the price at $240, compute the 2012 volume: \( 16,400 \times 0.90 = 14,760 \). This means we expect 14,760 lead tests in 2012 without changing the price.
04

Calculate Revenue from Lead Tests (No Price Change)

Calculate the expected revenue from lead tests in 2012 at the 2011 price: \( 14,760 \times 240 = 3,542,400 \). This is the revenue without changing the lead test price.
05

Calculate Total Sales Revenue for 2012 (No Price Change)

Add the revenues from radon and lead tests: \( 3,750,280 + 3,542,400 = 7,292,680 \). This is the total anticipated sales revenue for 2012 if 2011 prices are maintained.
06

Calculate Expected 2012 Lead Tests (Price Reduced)

If the lead test price is reduced to $230, we expect only a 7% decrease. Compute the 2012 volume: \( 16,400 \times 0.93 = 15,252 \). So, 15,252 lead tests are expected with the price reduced.
07

Calculate Revenue from Lead Tests (Price Reduced)

Calculate the expected revenue from lead tests in 2012 at the reduced price: \( 15,252 \times 230 = 3,508,240 \). This is the revenue with the reduced price of $230 per test.
08

Calculate Total Sales Revenue for 2012 (Price Reduced)

Add the revenues from the radon tests (holding at 3,750,280) and the lead tests with the reduced price: \( 3,750,280 + 3,508,240 = 7,258,520 \). This is the total anticipated sales revenue for 2012 with the reduced lead test price.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Revenue Calculation
Understanding revenue calculation is crucial for businesses to project their earnings accurately. Revenue is the total amount of money a company makes from its products or services. Consider it as the end product of all sales activities.

To calculate revenue, you multiply the number of units sold by the price per unit. For Rouse & Sons, this means calculating the revenue from both radon and lead tests separately.

When considering changes such as price adjustments, keeping tabs on how these changes affect the quantity sold is important. This ensures that revenue calculations reflect the actual financial health of the business. When the price of the lead test is reduced to $230, the quantity sold decreases less than initially expected, which affects overall revenue.

Important Points:
  • Revenue = Price per unit 脳 Number of units sold
  • Changes in price can affect the number of units sold and, in turn, revenue
  • Separate calculations may be necessary for different products or services
Price Elasticity
Price elasticity helps us understand how sensitive the demand for a product is to price changes. It is an essential concept for determining how a change in price could influence sales volume.

In the case of Rouse & Sons, they needed to determine how reducing the lead test price would affect their sales. Price elasticity can often determine if a price change will result in increased revenue, decreased revenue, or have no significant effect.

If the demand is elastic, significant changes in sales volume may result from minor price changes. Conversely, inelastic demand implies that sales volume remains relatively stable regardless of price changes.

Key Factors:
  • Elastic demand means consumers are sensitive to price changes
  • Inelastic demand means sales are relatively unaffected by price changes
  • Knowing the price elasticity helps optimize pricing strategies
Sales Forecasting
Sales forecasting is the practice of estimating future sales to make informed business decisions. It involves analyzing various factors such as historical data, market conditions, and changes in consumer behavior.

Rouse & Sons utilized sales forecasting to predict changes in the demand for radon and lead tests for the following year. With a forecast of a 6% increase in radon tests due to rising health awareness, and a decrease in lead test sales due to market trends, they employed this method to prepare financially for these changes.

Having an accurate sales forecast aids in planning for production, budgeting, and identifying potential market challenges. It's like having a roadmap that helps the company stay on track to reach its financial goals.

Essential Elements:
  • Uses historical sales data
  • Considers external factors such as market trends and consumer behavior
  • Assists in making informed business and financial decisions

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Most popular questions from this chapter

Describe how nonoutput-based cost drivers can be incorporated into budgeting.

The Mahoney Company has prepared a sales budget of 45,000 finished units for a three-month period. The company has an inventory of 16,000 units of finished goods on hand at December 31 and has a target finished goods inventory of 18,000 units at the end of the succeeding quarter. It takes three gallons of direct materials to make one unit of finished product. The company has an inventory of 60,000 gallons of direct materials at December 31 and has a target ending inventory of 50,000 galIons at the end of the succeeding quarter. How many gallons of direct materials should be purchased during the three months ending March \(31 ?\)

Logo Specialties manufactures, among other things, woolen blankets for the athletic teams of the two local high schools. The company sews the blankets from fabric and sews on a logo patch purchased from the licensed logo store site. The teams are as follows: Knights, with red blankets and the Knights logo Raiders, with black blankets and the Raider logo Also, the black blankets are slightly larger than the red blankets. The budgeted direct-cost inputs for each product in 2012 are as follows: $$\begin{array}{lcc} & \text { Knights Blanket } & \text { Raiders Blanket } \\ \hline \text { Red wool fabric } & 3 \text { yards } & 0 \\ \text { Black wool fabric } & 0 & 3.3 \text { yards } \\ \text { Knight logo patches } & 1 & 0 \\ \text { Raider logo patches } & 0 & 1 \\ \text { Direct manufacturing labor } & 1.5 \text { hours } & 2 \text { hours } \end{array}$$ Unit data pertaining to the direct materials for March 2012 are as follows: $$\begin{array}{lcc} & \text { Knights Blanket } & \text { Raiders Blanket } \\ \hline \text { Red wool fabric } & 30 \text { yards } & 0 \\ \text { Black wool fabric } & 0 & 10 \text { yards } \\ \text { Knight logo patches } & 40 & 0 \\ \text { Raider logo patches } & 0 & 55 \end{array}$$ $$\begin{array}{lcc} & \text { Knights Blanket } & \text { Raiders Blanket } \\ \hline \text { Red wool fabric } & 20 \text { yards } & 0 \\ \text { Black wool fabric } & 0 & 20 \text { yards } \\ \text { Knight logo patches } & 20 & 0 \\ \text { Raider logo patches } & 0 & 20 \end{array}$$ Unit cost data for direct-cost inputs pertaining to February 2012 and March 2012 are as follows: $$\begin{array}{lcc} & \text { February 2012 (actual) } & \text { March 2012 (budgeted) } \\ \hline \text { Red wool fabric (per yard) } & \$ 8 & \$ 9 \\ \text { Black wool fabric (per yard) } & 10 & 9 \\ \text { Knight logo patches (per patch) } & 6 & 6 \\ \text { Raider logo patches (per patch) } & 5 & 7 \\ \text { Manufacturing labor cost per hour } & 25 & 26 \end{array}$$ Manufacturing overhead (both variable and fixed) is allocated to each blanket on the basis of budgeted direct manufacturing labor-hours per blanket. The budgeted variable manufacturing overhead rate for March 2012 is \(\$ 15\) per direct manufacturing labor-hour. The budgeted fixed manufacturing overhead for March 2012 is \(\$ 9,200 .\) Both variable and fixed manufacturing overhead costs are allocated to each unit of finished goods. Data relating to finished goods inventory for March 2012 are as follows: $$\begin{array}{lcc} & \text { Knights Blankets } & \text { Raiders Blankets } \\ \hline \text { Beginning inventory in units } & 10 & 15 \\ \text { Beginning inventory in dollars (cost) } & \$ 1,210 & \$ 2,235 \\ \text { Target ending inventory in units } & 20 & 25 \end{array}$$ Budgeted sales for March 2012 are 120 units of the Knights blankets and 180 units of the Raiders blankets. The budgeted selling prices per unit in March 2012 are \(\$ 150\) for the Knights blankets and \(\$ 175\) for the Raiders blankets. Assume the following in your answer: Work-in-process inventories are negligible and ignored. Direct materials inventory and finished goods inventory are costed using the FIF0 method. Unit costs of direct materials purchased and finished goods are constant in March 2012 . 1\. Prepare the following budgets for March 2012 : a. Revenues budget b. Production budget in units c. Direct material usage budget and direct material purchases budget d. Direct manufacturing labor budget e. Manufacturing overhead budget f. Ending inventories budget (direct materials and finished goods) g. cost of goods sold budget 2\. Suppose Logo Specialties decides to incorporate continuous improvement into its budgeting process. Describe two areas where it could incorporate continuous improvement into the budget schedules in requirement 1.

Delma Company manufactures a variety of products in a variety of departments, and evaluates departments and departmental managers by comparing actual cost and output relative to the budget. Departmental managers help create the budgets, and usually provide information about input quantities for materials, labor, and overhead costs. Wert Mimble is the manager of the department that produces product Z. Wert has estimated these inputs for product \(Z\): $$\begin{array}{lc} \text { Input } & \text { Budget Quantity per Unit of 0utput } \\ \hline \text { Direct material } & 4 \text { pounds } \\ \text { Direct manufacturing labor } & 15 \text { minutes } \\ \text { Machine time } & 12 \text { minutes } \end{array}$$ The department produces about 100 units of product \(Z\) each day. Wert's department always gets excellent evaluations, sometimes exceeding budgeted production quantities. Each 100 units of product \(Z\) uses, on average, about 24 hours of direct manufacturing labor (four people working six hours each), 395 pounds of material, and 19.75 machine-hours. Top management of Delma Company has decided to implement budget standards that will challenge the workers in each department, and it has asked Wert to design more challenging input standards for product Z. Wert provides top management with the following input quantities: $$\begin{array}{lc} \text { Input } & \text { Budget Quantity per Unit of 0utput } \\ \hline \text { Direct material } & 3.95 \text { pounds } \\ \text { Direct manufacturing labor } & 14.5 \text { minutes } \\ \text { Machine time } & 11.8 \text { minutes } \end{array}$$ Discuss the following: 1\. Are these standards challenging standards for the department that produces product Z? 2\. Why do you suppose Wert picked these particular standards? 3\. What steps can Delma Company's top management take to make sure Wert's standards really meet the goals of the firm?

"Cash budgets must be prepared before the operating income budget." Do you agree? Explain.
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