Flexible budget planning
Sam Yu, the president of Centech Computer Services, needs your help. He wonders about the potential effects on the firm's net income if he changes the service rate that the firm charges its customers. The following basic data pertains to fiscal year 2009.
Standard rate and variable costs:
Service rate per hour $83.00
Labor $40.00
Overhead $7.10
General, selling, and administrative $4.40
Expected fixed costs:
Facility repair $500,000.00
General, selling, and administrative $130,000.00
a. Prepare the pro forma income statement that would appear in the master budget if the firm expects to provide 27,000 hours of service in 2009.
b. A marketing consultant suggests to Mr. Yu that the service rate may affect the number of service hours that the firm can achieve. According to the consultant's analysis, if Centech charges customers $78 per hour, the firm can achieve 33,000 hours of service. Prepare a flexible budget using the consultant's assumptions.
c. The same consultant also suggests that if the firm raises its rate to $88 per hour, the number of service hours will decline to 22,000. Prepare a flexible budget using the new assumption.
d. Evaluate the three possible outcomes you determined in Requirements a, b, c and recommend a pricing strategy.
a. To prepare the pro forma income statement for the master budget, we need to calculate the fixed costs, variable costs, and the total revenue.
1. Fixed Costs:
- Facility repair: $500,000.00
- General, selling, and administrative: $130,000.00
2. Variable Costs:
- Labor: $40.00 per hour
- Overhead: $7.10 per hour
- General, selling, and administrative: $4.40 per hour
3. Total Variable Costs:
Total variable cost per hour = Labor + Overhead + General, selling, and administrative
Total variable cost per hour = $40.00 + $7.10 + $4.40
Total variable cost per hour = $51.50
4. Total Revenue:
Total revenue = Service rate per hour × Number of service hours
Total revenue = $83.00 × 27,000
Total revenue = $2,241,000.00
5. Net Income:
Net income = Total Revenue - Total Variable Costs - Total Fixed Costs
Net income = $2,241,000.00 - ($51.50 × 27,000) - ($500,000.00 + $130,000.00)
Net income = $2,241,000.00 - $1,390,500.00 - $630,000.00
Net income = $220,500.00
Therefore, the pro forma income statement for the master budget, assuming 27,000 hours of service, would have a net income of $220,500.00.
b. To prepare a flexible budget using the consultant's assumption that the service rate is $78 per hour and the firm can achieve 33,000 hours of service, we need to calculate the total revenue and net income using the new values.
1. Total Revenue:
Total revenue = Service rate per hour × Number of service hours
Total revenue = $78.00 × 33,000
Total revenue = $2,574,000.00
2. Net Income:
Net income = Total Revenue - Total Variable Costs - Total Fixed Costs
Net income = $2,574,000.00 - ($51.50 × 33,000) - ($500,000.00 + $130,000.00)
Net income = $2,574,000.00 - $1,700,500.00 - $630,000.00
Net income = $243,500.00
Therefore, the flexible budget, assuming a service rate of $78 per hour and 33,000 hours of service, would have a net income of $243,500.00.
c. To prepare a flexible budget using the consultant's assumption that the service rate is $88 per hour and the firm can achieve 22,000 hours of service, we need to calculate the total revenue and net income using the new values.
1. Total Revenue:
Total revenue = Service rate per hour × Number of service hours
Total revenue = $88.00 × 22,000
Total revenue = $1,936,000.00
2. Net Income:
Net income = Total Revenue - Total Variable Costs - Total Fixed Costs
Net income = $1,936,000.00 - ($51.50 × 22,000) - ($500,000.00 + $130,000.00)
Net income = $1,936,000.00 - $1,133,000.00 - $630,000.00
Net income = $173,000.00
Therefore, the flexible budget, assuming a service rate of $88 per hour and 22,000 hours of service, would have a net income of $173,000.00.
d. To evaluate the three possible outcomes and recommend a pricing strategy, we need to consider the net incomes from each scenario.
- Master Budget (27,000 hours, $83 per hour): Net income of $220,500.00.
- Flexible Budget (33,000 hours, $78 per hour): Net income of $243,500.00.
- Flexible Budget (22,000 hours, $88 per hour): Net income of $173,000.00.
By comparing the three scenarios, it can be observed that the highest net income is achieved in the scenario where the service rate is $78 per hour and the firm achieves 33,000 service hours.
Based on this analysis, the recommended pricing strategy would be to charge $78 per hour, as it results in the highest net income. However, it's important to consider market demand, competition, and other factors that may affect customer willingness to pay and the overall profitability of the firm.