I have the calculations done on an excel sheet but I need it to be written out as asked below. Specifically focus on the bold
I have the calculations done on an excel sheet but I need it to be written out as asked below. Specifically focus on the bold item, creating an appendix or exhibit that provides a walk-through description of how you calculated (i) one cost variance and (ii) one revenue variance. Basically an example of how it was done using the data I provided on the excel sheet "Berkshire Raw Data"
As far as this goes "your variance calculations should be clear, with all variances computed and organized appropriately. Further, you should include a sample of how you calculate cost variances and revenue variances." I need a sample of how you calculated the cost and revenue variance
- In responding to Question 1a, your variance calculations should be clear, with all variances computed and organized appropriately. Further, you should include a sample of how you calculate cost variances and revenue variances.
- Please note, a printout of the formulas from a spreadsheet is not acceptable.
- Rather, provide a walk-through description of how you calculated (i) one cost variance and (ii) one revenue variance. Feel free to do this in an appendix or exhibit.
- Your memo discussion should synthesize the results of your variance calculations. Focus on identifying key variances, and discuss their impact, interpretation, and (if appropriate) actions that would address these variances. Consider all three organizational areas.
- Be sure to communicate your recommendations for improving the incentive compensation plan. Provide a sufficient explanation of problems you identified, and justification for your solutions.
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Issues in Accounting Education Vol. 15, No. 2 May 2000 Budgeting and Performance Evaluation at the Berkshire Toy Company Dean Crawford and Eleanor G. Henry ABSTRACT: This case^ provides an opportunity to study budgets, budget variances, and performance evaluation at several levels. As a purely mechanical problem, the case asks for calculations of various price, efficiency, spending, and volume variances from a set of budgets and actual results. The case is also an interpretive exercise. After the variances have been computed, the next step is to develop plausible conjectures about their likely causes. Finally, it is a case about performance evaluation and responsibility accounting. The company has an incentive plan, based on the budget variances, that needs to be analyzed and critiqued. INTRODUCTION anet McKinley is employed by the Quality Products Corporation, a publicly traded conglomerate. The corporation manufactures and sells many different kinds of products, including luggage, music synthesizers, breakfast cereals, peanut butter, and children's toys. McKinley is Vice President in charge of the Berkshire Toy Company, a division of Quality Products. It is late July 1998 and McKinley has just received the preliminary income statement for her division for the year ended June 30, 1998 (see Table 1). The master (static) budget and master budget variances for the same period are included for comparison purposes. McKinley looks at the bottom line, a loss approaching a million dollars, then picks up the phone to call you. You are an accountant in the controller's office at the headquarters of Quality Products Corporation. You worked with McKinley when her company was acquired by Quality Products, J and now she has called you for advice. "I know the bottom line looks pretty bad," she says. "But we made great strides this year. Sales are higher than This case is based on field research at in existing toy company. The essential facts relating to production and sales have been retained. However, all names, dates, actual events, and identifying details have been concealed to protect the privacy and identity of the company. Thus, if any names used in this case are those of actual firms or individuals, then it is purely coincidental. Dean Crawford and Eleanor G. Henry are both Associate Professors at SUNY at Oswego. The valuable comments and suggestions on earlier versions of this casefromProfessors Jeffery Abarbanell, James Noel, Nicholas Schroeder, the editor, David E. Stout, and associate editor, Jeffrey Cohen, two anonymous reviewers, and the students of the Graduate School ofBusiness Administration at the University of Michigan and the College of Business Administration at the University of Toledo are gratefully acknowledged. 284 Issues in Accounting Education TABLE 1 Berkshire Toy Company A Division of Quality Products Corporation Preliminary Statement of Divisional Operating Income for the Year Ended June 30,1998 Actual Units sold Retail and catalog (174,965 units) Internet (105,429 units) Wholesale (45,162 units) Total revenue Variable production costs: Direct materials Acrylic pile fabric lO-mm acrylic eyes 45-mm plastic joints Polyester fiber filling Woven label Designer Box Accessories Total direct materials Direct labor Variable overhead Total variable production costs Variable selling expenses Total variable expenses Contribution margin Fixed costs: Manufacturing overhead Selling expenses Administrative expenses Total fixed costs Operating income^ Master (Static) Budget Master Budget Variance 325,556 280,000 45,556 F $ 8,573,285 4,428,018 1,445,184 14,446,487 $11,662,000 0 1,344,000 13,006,000 $ 3,088,715 4,428,018 101,184 1,440,487 U F F F 256,422 125,637 246,002 450,856 16,422 69,488 66.013 1,230,840 3,668,305 1,725,665 6,624,810 1,859,594 8,484,404 5,962,083 233,324 106,400 196,000 365,400 14,000 67,200 33.600 1,015,924 2,688,000 1,046,304 4,750,228 658,897 5,023,192 1,123,739 6,805,828 $ ( 843,745) 661,920 4,463,000 1,124,000 6,248,920 $ 788,572 1 91R 9Sn 7 n.7 a.Q9 23,098 U 19,237 U 50,002 u 85,456 u 2,422 u 2,288 u 32,413 u 214,916 u 980,305 u 679,361 u 1,874,582 u 641,314 u 2,515,896 u 1,075,409 TI 3,023 560,192 261 556,908 $ 1,632,317 F U F U U The actual operating income reported in Table 1 is a preliminary figure that has not been adjusted for fiscal 1998 bonuses, if any. Crawford and Henry ever. Customers love our product and respect our quality. There must be a way to make this business work and turn a profit, too. The budget variances should provide some insights. Could you do an analysis of the budget variances?" BACKGROUND The Berkshire Toy Company was founded by Franklin Berkshire, Janet McKinley's father, in 1974. Berkshire was an industrial artist who enjoyed making stuffed animals in his spare time. His first creation, a teddy bear that he presented to Janet on her seventh birthday, occupies a place of honor at Berkshire Toy Company's headquarters. In 1974, Frank Berkshire acquired an old pneumatic pump that had been used to fill life-jackets for the Navy during World War II. He modified the machine to mass produce stuffed animals, and the Berkshire Toy Company was born. The company started small at first, but grew quickly as Berkshire's reputation for quality spread. By 1986, annual sales exceeded a million dollars for the first time. Janet McKinley had learned the business fi-om the bottom up. She had started out with the company in the mail room as a part-time summer employee. As a college student, she had spent summers and Christmas vacations working on the production fioor, in the sales department, and finally in the accounting department. She was named Assistant to the President in 1988 after receiving her M.B.A.. In 1991, at her urging, the company launched an initial public offering (IPO) of common stock and became publicly traded on the NASDAQ. Janet McKinley became CEO of the company on July 1, 1993 when her father retired. On March 17, 1995, Berkshire Toys was acquired by the Quality Prod- 285 ucts Corporation in a friendly exchange of common stock valued at $23.2 million.^ The terms of the acquisition included an agreement to employ McKinley for no fewer than five years at an annual salary of $120,000. The Berkshire Toy Company produces the Berkshire Bear, a fifteen-inch teddy bear enjoyed by children and adult toy collectors around the world. The company touts the handcrafted features of the bear and advertises its product as the only teddy bear made in America. The bears are fully jointed, constructed of washable acrylic pile fabric, and stuffed with a polyester fiber filling. The toys are dressed in various accessories, such as bow ties, sports jerseys, or character and occupational costumes. Thus, the product can be personalized for numerous occasions. The Berkshire Bear is sold with an unconditional lifetime guarantee. In communicating with customers, the company refers to its repair center as the "bear hospital." A damaged bear may be returned by the customer and repaired (or replaced, at the company's discretion) fi-ee of charge. The Berkshire Toy Company's 241 employees are organized into three departments: purchasing, production, and marketing. The purchasing department consists of David Hall, the purchasing manager, and a staff of ten. The department is responsible for acquiring and maintaining the supply of production materials. Bill Wilford manages 174 employees in the production department, where the manufacture In a friendly acquisition, the terms of the exchemge are negotiated by the acquiring company and the incumbent management of the target (acquired) firm. This method of merging two companies is quite different from a "hostile takeover," which is initiated by the acquiring company over the objections of the target's incumbent management. 286 and assembly of the product takes place. The marketing department is headed by Rita Smith. She is responsible for all aspects of marketing and she supervises the nine sales clerks and 42 sales representatives that make up Berkshire's sales force. The remaining three employees are McKinley, her secretary, and her secretary's assistant. Production Production begins with a large press that cuts the acrylic pile fabric into the required pattern pieces. The press-cutter machine applies 23,000 pounds per square inch of pressure to a tray of pattern stainless steel dies^ that are stamped into the fabric. The bolts^ of fabric are rolled out and layered on the cutting table. The fabric is measured at this time for length and width and inspected for fabric flaws, tears, and soiled areas. Fabric flaws create waste. Shortages in length or width may require a different cutting set-up and increase fabric waste. Additional cutting set-ups increase production time. The press-cutter machine cuts 14 layered bolts at a time, enough for 588 units. The machine produces a clean, crisp, cut edge that will not fray or ravel. The fabric is also inspected for trueness of color. The Berkshire Bear is advertised as a honey bear. Thus, fabric dye lots are important for matching shades of brown. The toy animal is available also in off-white and dark brown. Off-color fabric must be scrapped or returned to the supplier. Because the toy is designed to be washable, the fabric must be colorfast. Berkshire obtains the most economical price for specified colors by timing its fabric orders with the production runs of its suppliers. Rush orders almost always increase substantially the price of the required fabric. Issues in Accounting Education In the next stage of production, operators of industrial sewing machines construct the six parts of the finished unit: two arms, two legs, the head, and the torso. Each piece is sewn insideout and then turned right-side-out for assembly. Sewing is the most labor-intensive phase of the production process. Any additional sewing steps, such as appliqu6s^ or monograms, require additional production time. In the next step, two optical-grade, acrylic eyes are attached to the head with plastic rivets. Ifthe rivet posts are too short, the eyes may fall off later. If the rivet posts are too long, the eyes will stand out from the head, giving a nonstandard appearance. Eye color is also somewhat important. Acrylic eyes are purchased from vendors in "dark brown," but the exact shade may vary from supplier to supplier. Defects are not discovered until the eyes are used in production. At that point, defective eyes are discarded and replaced with ones that meet specifications. After the cut pieces have been sewn together and eyes attached, the company's unique pneumatic stuffing machine^ is used to blow the polyester fiber filling into the unassembled parts. ^ Dies are heavy-duty, three-dimensional patterns used to cut the fabric into parts for the bear. Dies function in a manner similar to cookie cutters. Fabric is shipped from the manufacturer wrapped around a cylindrical core or "bolt." A standard bolt of fabric is ten yards long and 72 inches wide. ^ Appliqu6s are descriptive or ornamental features made from contrasting materials that are applied to the outside surface ofthe bear. The alligator emblem used by Izod on sweaters and polo shirts is a common example of an appliqu6. Another example is an identifying patch applied to pockets of iiniforms bearing the employer's name and logo. ^ Berkshire Toy Company adapted technology used by the Navy. The stuffing machine is not patented. Crawford and Henry Except for two replacements of the electric motor and a new power COrd, this is the same machine that Franklin Berkshire acquired from Navy surplus in 1974. Bags of filling are loaded into the machine hopper and mechanically fluffed to the proper loft.'' An operator places the empty arm, leg, hody, or head over a stationary nozzle and uses a foot pedal to control the flow of filling. The machine operator judges whether the part has been filled correctly. Too littlefillingaffects the firmness of the hear; too much filling is unnecessary and expensive. Inferior gradefiherfillingis less expensive hut can cause clumping and clogging in the hopper. When this happens, production is interrupted and the operator must unclog the vacuum hose and reset the machine. Next, the arms, legs, and head are attached to the torso using three-part, snap-on, hard plastic disc joints. The disc joints allow the head and limhs to rotate and ehminate the need for sewn attachment. The plastic joints are designed to he foolproof in production and dependahle for the life of the product. However, the joints cannot he removed without destroying them. Occasionally, after initial joint insertion, the parts do not fit together properly and they must he removed and replaced. At the end of the construction process, a woven satin lahel that states "Made in America hy the Berkshire Toy Company" is attached to the hack of each hear. More polyester filling is stuffed into the torso and the hack seam is hand-stitched, using essentially the same "shoelace" procedure practiced hy surgeons. Each seam is brushed hy hand to give the bear a seamless look. The production process is a continuous source of airborne polyester and acrylic fibers that must he controlled, both to protect the health and safety of 287 the employees and to safeguard the production equipment. The company has taken several steps to control the fibers. First, an air filtration system works constantly to remove dust and fibers from the factory. Second, production employees wear dust masks while they are working with fahric or filling. Finally, regular cleaning and maintenance ofthe sewing, cutting, and stuffing machines is performed to prevent the fibers from building up. Maintenance is especially important for the sewing machines. Machine oil and static electricity attract pile fahric lint. Lint buildup can cause lines of stitches that are uneven and seams that do not hold. The Berkshire Bear workmanship is guaranteed for life. Burst seams require rework during the production phase and during the lifetime of the product. All production employees are paid a regular wage for a 40-hour work week. They receive their regular wage plus an overtime premium of one-half the regular wage rate for overtime. The cost of fringe henefits and employer taxes, such as social security, health insurance, and vacation time, adds 20.55 percent to the cost of labor. The employees' regular wages are charged to direct lahor. The overtime premium and the fringe benefits are carried as variable overhead costs. Marketing Marketing of the product takes place at the retail level via catalogue sales and in the company's retail store '' Fiber filling is a loose material. Two pounds of bagged filling occupy approximately one cubic foot of space. Thefillingis loaded manually into a metal bin or "hopper." Rotating sets of fork-like tines separate the strands of filling and increase the volume by incorporating air. The proper mixture of air emd filling is the "loft." 288 adjacent to the factory. Retail Internet sales are a new addition to the overall marketing effort. The company also sells wholesale to department stores, toy boutiques, and other specialty retailers. The product can he delivered by two-to-five-day ground service, next-day air, or holiday express. The customer pays the insurance and delivei-y charges. Berkshire promises same or next-day shipment. Most orders are shipped the same day as received. When the company receives a customer's order, an employee takes a bear ofthe requested color and dresses it according to the customer's wishes. Then the bear is packaged with a protective air bag and complimentary piece of chocolate candy, and shipped in a designer box. The designer box contributes to the product image. It is reminiscent of the packaging used for a famous-name cologne and intended to lend an air of status and exclusivity to the product. The box is also important to toy collectors who expect to pay or receive a price premium in the secondary market for items that are in "mint-in-box" condition. Producing the box is a custom job involving a box manufacturer and a printing company. The unit cost ofthe box decreases with the size of the order that the company places with the manufacturer. Rush orders are more costly than normal orders. In July 1997, the purchasing manager placed an order for enough boxes to cover budgeted sales in the coming year. Berkshire's policy on sales commissions has remained stable over the past several years. Commissions of 3 percent are paid on retail store sales and sales to wholesale huyers. No commissions are paid on catalog sales. The companyowned retail outlets have proved unprofitahle, so all of them, except for the Issues in Accounting Education factory store, have been closed in previous years. The Accounting Problem "I think I know what some of the problems are, hut I would like a detailed analysis that provides confirmation from our accounting data," McKinley continues. "Did inventory change much?" you ask. "It's pretty negligible. Our peak selling time is from Christmas to Mother's Day, so we don't have much on hand at the Jvme 30 year-end. We started last year with almost nothing and it was all we could do to keep up with demand, so we ended up with almost nothing as well." You jot down a note to ignore changes in raw materials and finished goods inventories and to assume that production volume equals sales volume. "Didn't you put a new incentive compensation plan in place this year?" "As a matter of fact, we did. Perhaps it was a factor in what happened this year." The new incentive compensation plan was adopted effective July 1,1997. Under this plan, each of the three department heads is rewarded hased on the performance of his or her responsibility center. Performance is measured against the company's master budget and its standard cost system. The plan was the result of several meetings with McKinley and her managers who argued and bargained for a plan that rewarded the managers fairly for individual contributions and achievements. McKinley's plan was intended to promote participation and teamwork and the managers accepted the new program enthusiastically. The plan provides for the following: David Hall, the purchasing manager, will receive a honus equal to 20 percent of the net materials 289 Crawford and Henry price variance, assuming the net variance is favorable. Otherwise, the honus is zero. Rita Smith, the marketing manager, will receive a bonus equal to 10 percent of the excess, if any, of actual net revenues (revenues minus both variable and fixed selling expenses) over master budget net revenues. Bill Wilford, the production manager, will receive a bonus equal to 3 percent ofthe net of several variances: the efficiency (usage or quantity) variances for materials, labor, and variable overhead; the labor rate variance; and the variable and fixed overhead spending variances. Wilford receives no honus if his net variance is unfavorable. Intemet Sales Program "It seems that the incentive plan produced results," continues McKinley. "Smith had a terrific year this year. Unit sales were more than 16 percent above hudget (Tahle 1). She says one of the principal factors was the new Internet sales policy she instituted and the advertising campaign to support it. We've never had that kind of year in sales hefore." The Berkshire Toy Company began selling over the Internet in Novemher 1997. At the same time, the company launched a nationwide radio advertising campaign. All radio advertisements are tagged with a reference to the web site that, in turn, provides visual support for the radio advertising and an opportunity for customers to order online. As an additional incentive to attract Internet customers, Rita Smith proposed that Berkshire offer a substantial discount to customers who ordered over the Internet. Because the discounted Internet price ($42.00) was still greater than the price that Berkshire was charging its wholesale customers ($32.00), McKinley approved the price change. To boost its Internet sales, the company held special holiday sales. The Christmas and Valentine's Day sales featured the Berkshire Bear in special seasonal costumes. Both events were immediate successes not only with Internet customers, hut also with retail and wholesale customers who paid the customary prices. The greatest success was the Mother's Day campaign. For this event, the web site displayed an image of "Mama's Boy," a bear sporting sunglasses, jeans and T-shirt, and an appliqu^d tattoo on its upper arm that said "Mom." The 15-inch bears produced by the Berkshire Toy Company are identical except for their color and their accessories. Although the hears may he purchased with differing accessories, the unit cost of the accessories per bear has heen relatively stable over time. The average historical cost of accessories has heen a very small part of the total cost of the bear, and the standard cost of accessories is computed as an average. The price differences in the product reflect the company's discounting practices and not differences in accessories. The master (static) budget for the year ended June 30, 1998 was prepared before the Internet program and price change were adopted. It called for the sale of 280,000 units, allocated as follows: Retail and mail order Wholesale Total 238,000 units x $49.00 = 42,000 units x $32.00 = 280.000 units $11,662,000 1.344,000 $13.006.000" 290 Issues in Accounting Education The expected distribution of 85 percent retail and 15 percent wholesale was based on the company's experience in prior years. Thus, the budgeted average selling price was $46.45. Actual sales for the year were as follows: Retail and catalog 174,965 units X $49.00 = $ 8,573,285 4,428,018 105,429 units X $42.00 = Internet 45,162 units X $32.00 = 1,445,184 Wholesale 325,556 units $14,446,487 Total Materials and Production "Hall had a few triumphs of his own this year," said McKinley. "He managed to get some substantial price discounts on acrylic pile fabric, plastic joints, and polyester fiber filling. Price discounts of 7 to 10 percent on our three main inputs add up to some real savings." Berkshire Toy Company's schedule of standard manufacturing costs is reproduced in Table 2. The schedule of actual manufacturing costs for the year ended June 30, 1998 is in Table 3. "So," McKinley continues, "at least on the surface, it looks like marketing and purchasing had a good year, but production is another story. Bill Wilford was not part of the original Berkshire team. Headquarters sent him bere from Hercules (the luggage division) to learn the ropes after Jack Johnson left. Jack joined a competitor last July." "During Bill's first week on the job, we had a freak thunderstorm and the storm drain backed up, ruining a large amount of fiber filling. The loss was uninsured. Since then, I have gotten plenty of feedback from Bill who has been struggling to keep up with production. He has complained about the substandard direct materials, deviations from standard production plans, and the amount of overtime required to meet sales demand. The plant has been operating at near to maximum capacity of 350,000 units. His people are tired. Some of them quit and had to be replaced at higher-than-standard wage rates. Bill also said that extra maintenance was required on the machinery and that, even so, they've experienced frequent breakdowns. He's been vehement about stock-outs of some of the imported accessories. At one point, sales commitments made it necessary to schedule overtime to copy some of the bear outfits and make them inhouse. But he tries to be fair and responsible. He admitted that he was the person who moved some of the plastic parts to an empty box marked 'refuse' that was hauled away later by the trash collectors. This is a small place and I hear almost everything that goes on." "By the way," McKinley winds up, "did you get the information I faxed you?" "Let's see," you reply. "I have the 1997-98 income statement (prior to bonus calculations), the breakdown of budgeted and actual revenues, and schedules of standard and actual direct production costs. I do need some more detailed information about manufacturing overhead and selling costs. After that, I'll get back to you as soon as I can." McKinley agrees to send you details of actual overhead expenditures for the last five years and actual selling expenses for 1997 and 1998. These are shown in Tables 4 and 5. REQUIRED 1 a Using the information in the case and Tables 1-5, prepare a 291 Crawford and Henry TABLE 2 Berkshire Toy Company A Division of Quality Products Corporation Schedule of Standard Costs: Fifteen-Inch Berkshire Bear Normal Capacity: 280,000 units Direct materials Acrylic pile fabric^ 10-mm acrylic eyes 45-mm plastic joints Polyester fiber filling Woven label Designer box Accessories'* Total direct materials Direct labor Sewing Stuffing and cutting*^ Assembly Dressing and packaging Total direct labor Variable manufacturing overhead"* Quantity Allowed Per Unit 0.02381 bolts 2 eyes 5 joints 0.90 lbs. 1 label lbox various Input Price Standard Cost Per Unit $35.00/bolt $0.19/eye $0.14/joint $1.45/lb. $0.05/each $0.24/each $ 0.8333 0.3800 0.7000 1.3050 .0500 .2400 .1200 3.6283 0.50 hours 0.30 hours 0.30 hours 0.10 hours 1.20 hours $8.00/hour 9.6000 1.20 DLH $3.1140/DLH 3.7368 16.9651 Fixed manufacturing overhead 1.20 DLH $1.9700/DLH 2.3640 $19.3291 * One bolt of fabric is 10 yards long by 72 inches wide. Fabric for 42 finished units can be cut from one bolt. '' The cost of accessories varies from 7 cents per unit for a bow tie to 45 cents per unit for fisherman's gear. The standard of 12 cents per xinit reflects the historical assortment of accessories chosen by customers.