^{Although Richard Haney did not implement either of the suggestions Oliver Douglas made in Rainier Fastener (A & B), he did agree with Oliver's comment that it is important to find ways to improve profitability. From the basic CVP model, Haney understood that there are three fundamental ways to improve profitability - increase selling price, decrease cost, or increase volume. Rainier operates in a highly competitive market where market share is determined primarily by selling prices. It is difficult to increase selling prices without losing market share because customers shift quickly to lower cost providers. At the same time, it is difficult to increase market share by lowering price because competitors quickly match lowered prices. Therefore, to improve profitability, Haney decided to concentrate on lowering costs.}

^{Exhibit 4 shows profit or loss by product line for 2017, where direct costs were traced to product lines and indirect costs were allocated as described in Rainier Fastener (B). Overall profit for 2017 is $95,000, an improvement from the $418,000 loss reported in 2016.}

^{Exhibit 5 presents a flexible budget for 2017 developed by the accounting department. This budget was constructed by multiplying the actual volume of feus sold in 2017 for each of Rainier's three product lines by the cost per feu from 2016, based on the assumption that costs per feu in 2017 should be the same as the costs per feu in 2016 (as shown in Exhibit 3). The next-to-last column of Exhibit 5 shows the actual total costs for 2017 (as also shown in Exhibit 4), and the last column shows variances for each cost, where favorable variances are labelled with F and unfavorable variances with U.}

^{Oliver Douglas and Richard Haney reviewed the actual and budgeted results in Exhibits 4 and 5. Oliver found several reasons for optimism: "First, we seem to be doing a really good job of running our operations. For many of the categories where our costs are large, such as rent, property taxes, selling expense, general administrative expense, and depreciation, our actual costs were much lower than budgeted costs, resulting in large favorable variances. Second, it looks like we have turned the corner on profitability. In 2016, we lost $418,000 but in 2017 we made $95,000 so profitability was $513,000 higher in 2017 than in 2016. Third, not only did we improve relative to last year's loss, we also did substantially better than the budget. Our actual profit of $95,000 is $576,000 better than the projected loss of $481,000 in Exhibit 5."}

^{Richard Haney found less reason for optimism in the 2017 results. "Now that I have seen the budget and results, I realize that we made a fundamental error in the way we constructed the budget in Exhibit 5. As a result, those favorable variances do not mean what you think they mean. Second, while it is true that our profit in 2017 increased relative to 2016, we also had a substantial shift in product mix, selling more units of our more expensive alloy grade fasteners that sell for $22.93 per feu, and fewer units of common fasteners that sell for only $15.80 per feu. The way we constructed our budget suggests that with the changed product mix, we should have expected a loss of $481,000 (as shown in Exhibit 5). However, because of our fundamental error in constructing the budget, this was not a reasonable expectation. If we corrected the error in our budget construction, we would see that we should have made far more than our actual profit of $95,000."}

^Questions:

1. ^{Prepare a flexible budget for 2017 that corrects the fundamental budgeting error identified by Haney. Following the description in Exhibit 2, assume each cost is either fixed or variable with respect to volume. Also assume that in 2017, the amounts for each cost are expected to be the same as in 2016. That is, for each fixed cost, the expected total cost in 2017 is the same as the actual total fixed cost in 2016 and for each variable cost, the expected variable cost per unit produced is the same as the actual cost per unit in 2016.}

^{To simplify the calculations and presentation, prepare your budget using the following summary format:}

^{For each product line, sum together all the variable costs per unit shown in Exhibit 5 and then multiply the sum of the variable costs per unit by the number of units (fastener equivalent units, or feus) produced to get total variable cost for the product line. For example, combine all the variable costs per unit for common (CN) grade fasteners into a total variable cost per unit for CN and then multiply by the number of common grade feus produced to get total variable cost for CN, denoted below as VCost(CN).}

^{The top three lines of your summary budget will reflect the familiar formula: RevenueVariable Cost = Contribution Margin. Total fixed costs (totaled across all three product lines) are subtracted from CM(Total) to find net income:}

^{Common(CN) Alloy(AG) Stainless(SS) Total}

^{Revenue Rev(CN) Rev(AG) Rev(SS) Rev(Total)}

^{Less: Variable Costs VCost(CN) VCost(AG) VCost(SS) VCost(Total)}

^{Contribution Margin CM(CN) CM(AG) CM(SS) CM(Total)}

^{Less: Fixed Costs Total Fixed}

^{Net Income Net Income}

1. ^{Prepare a flexible budget for 2017 using the assumptions and format above.}
2. ^{Compute variances that compare the actual totals for 2017 in Exhibits 4 or 5 to your budgeted total revenue, total variable cost, and total fixed cost. Use these variances to evaluate Oliver's conclusion "...we seem to be doing a really good job of running our operations." What do the variances relative to your corrected flexible budget imply about whether Rainier Fastener is achieving Haneys goal of lowering costs?}
3. ^{Explain Haneys conclusion that ... we should have made far more than our actual profit of $95,000.}

   ^{Exhibit 2}

   ^{Accounting Department's Comments on Cost Behavior}

   ^{Rent: Fixed. The term of the lease runs for 15 more years. Allocated based on direct labor dollars.}

   ^{Property taxes: Fixed. Assessed valuation has been constant, the tax rate has risen slowly over time. Allocated based on direct labor dollars.}

   ^{Direct Labor: Varies directly with production volume. Labor is continually adjusted to match production volume by hiring temporary workers. Direct labor dollars is used as the measure of volume to allocate the costs of rent, property taxes, indirect labor, light and heat, and depreciation.}

   ^{Indirect Labor: Fixed. Allocated based on direct labor dollars.}

   ^{Compensation insurance: Five percent of direct labor and five percent of indirect labor.}

   ^{Power: Varies directly with production volume. Rates are not expected to change.}

   ^{Light and heat: Light and heat are fixed, regardless of level of production. Allocated based on direct labor dollars.}

   ^{Materials: Varies directly with production volume. Exhibit 3 figures include allowances for waste and rework.}

   ^{Repairs: Varies directly with production volume within normal operating range.}

   ^{General administrative, selling expense: Fixed. Allocated based on dollars of sales.}

   ^{Depreciation: Fixed. Allocated based on direct labor dollars.}

Exhibit 5 Rainier Fastener Company Budgeted Profit and Loss by Product For Year Ending December 31, 2017 Common Alloy Grade Stainless Steel Budget (000s) 2,104 765 4,125 Budget per feu 1.2753 0.4638 2.5002 1.3974 Budget (000s) 2,907 1,057 5,699 Budget $ per feu 2.0412 0.7423 4.0020 2.2367 Budget (000s) 2,324 845 4,557 2,547 Budget $ per feu 2.3668 0.8607 4.6403 2.5935 Total Budget (000s) 7,335 2.668 14,381 8,038 138**39***** Total Actual (000s) 7,100 2,582 15,053 7,790 Variance 235 F 86 F 672U 248 F 2,306 3,185 444 355 21 U 46 U 268 Rent Property taxes Direct labor Indirect labor Compensation insurance Power Light and heat Materials Repairs Subtotal Selling expense General administration Depreciation 231 1F 322 135 217 5,076 814 15,865 4,535 2,288 3,092 25,779 26,070 291 0.1949 0.0818 0.1315 3.0766 0.4936 9.615 2.7486 1.3864 1.8737 15.6237 15.8000 0.176 0 300 5,051 880 19,790 5,680 2,865 4,271 3 2,606 32,652 46 0.3119 0.1882 0.2104 3.5471 0.6176 13.898 3.9890 2.0120 2.9992 22.8978 22.9300 0.032 0 240 3,705 615 15,419 4,245 2,141 3,415 25,220 24,403 -817 0.3617 0.2351 0.2440 3.7730 0.6261 15.701 4.3230 2.1805 3.4776 1,121 634 756 13,832 2,309 51,074 14,461 7.294 10,777 83,606 83,125 481 0 1,142 680 755 13,976 2,282 51,360 14.116 7,120 10,432 83,030 83,125 9 50 144 U 27 F 287 U 345 F 174 F 345 F 576 F Total expense Actual Sales Profit (loss) 25.6824 24.8500 -0.832 0 576 F Unit sales (thousands of feu) 1.650 1,424 982 Common Alloy Grade Stainless Steel Total thousands thousands 2,178 2,852 1,037 6,046 792 thousands 2,070 753 4,389 2,272 333 132 220 4,894 827 Rent Property taxes Direct labor Indirect labor Compensation insurance Power Light and heat Materials Repairs 3,129 $ thousands 7,100 2,582 15,053 7,790 1,142 680 755 13,976 2,282 4,618 2,390 350 280 232 4,078 550 459 268 303 5,004 905 15,890 4,430 2,231 20,002 5,548 2,794 4,190 15,468 4,146 2,088 3,200 51,360 14,116 7,120 10,432 3,042 Subtotal Selling expense General administrative Depreciation Total expense Sales Profit (loss) 25,593 26,070 32,535 32,652 118 24,902 24,403 (500) 83,030 83,125 477 - 95 Unit sales (thousands of feu) 1,650 1,424 982 Exhibit 5 Rainier Fastener Company Budgeted Profit and Loss by Product For Year Ending December 31, 2017 Common Alloy Grade Stainless Steel Budget (000s) 2,104 765 4,125 Budget per feu 1.2753 0.4638 2.5002 1.3974 Budget (000s) 2,907 1,057 5,699 Budget $ per feu 2.0412 0.7423 4.0020 2.2367 Budget (000s) 2,324 845 4,557 2,547 Budget $ per feu 2.3668 0.8607 4.6403 2.5935 Total Budget (000s) 7,335 2.668 14,381 8,038 138**39***** Total Actual (000s) 7,100 2,582 15,053 7,790 Variance 235 F 86 F 672U 248 F 2,306 3,185 444 355 21 U 46 U 268 Rent Property taxes Direct labor Indirect labor Compensation insurance Power Light and heat Materials Repairs Subtotal Selling expense General administration Depreciation 231 1F 322 135 217 5,076 814 15,865 4,535 2,288 3,092 25,779 26,070 291 0.1949 0.0818 0.1315 3.0766 0.4936 9.615 2.7486 1.3864 1.8737 15.6237 15.8000 0.176 0 300 5,051 880 19,790 5,680 2,865 4,271 3 2,606 32,652 46 0.3119 0.1882 0.2104 3.5471 0.6176 13.898 3.9890 2.0120 2.9992 22.8978 22.9300 0.032 0 240 3,705 615 15,419 4,245 2,141 3,415 25,220 24,403 -817 0.3617 0.2351 0.2440 3.7730 0.6261 15.701 4.3230 2.1805 3.4776 1,121 634 756 13,832 2,309 51,074 14,461 7.294 10,777 83,606 83,125 481 0 1,142 680 755 13,976 2,282 51,360 14.116 7,120 10,432 83,030 83,125 9 50 144 U 27 F 287 U 345 F 174 F 345 F 576 F Total expense Actual Sales Profit (loss) 25.6824 24.8500 -0.832 0 576 F Unit sales (thousands of feu) 1.650 1,424 982 Common Alloy Grade Stainless Steel Total thousands thousands 2,178 2,852 1,037 6,046 792 thousands 2,070 753 4,389 2,272 333 132 220 4,894 827 Rent Property taxes Direct labor Indirect labor Compensation insurance Power Light and heat Materials Repairs 3,129 $ thousands 7,100 2,582 15,053 7,790 1,142 680 755 13,976 2,282 4,618 2,390 350 280 232 4,078 550 459 268 303 5,004 905 15,890 4,430 2,231 20,002 5,548 2,794 4,190 15,468 4,146 2,088 3,200 51,360 14,116 7,120 10,432 3,042 Subtotal Selling expense General administrative Depreciation Total expense Sales Profit (loss) 25,593 26,070 32,535 32,652 118 24,902 24,403 (500) 83,030 83,125 477 - 95 Unit sales (thousands of feu) 1,650 1,424 982