Question: Identify two solutions to this issue

Bernard Mente, vice president of the Rattan Furniture Division of Oriole Furniture, Inc., was faced with a difficult decision in mid-June. He was wondering what he should do in light of his divisions failure to meet sales and profit goals during the first five months of the year. Despite the recession, the division had managed to meet the sales and profit budget for the first three months, but the deepening recession had severely affected the results of the following two months. The Company Oriole Furniture, Inc., was a 30-year old distributor of high-quality, imported furniture. The company was organized into four divisions: Teakwood, Antiques, Rosewood, and Rattan. Four centralized staff departments were organized to support the product groups: finance and control, marketing, purchasing, and engineering. Each of the four product divisions was a profit center. The Rattan Furniture Division The division was established four years ago after the company decided to import completely knocked down (CKD) rattan furniture for assembly and sales to the mid-Atlantic states. The division had been an immediate success. Indeed, the division had had an annual sales growth of 35% for the past three years and sales were $60 million last year. The division offered three main product lines: a living and dining room line, a bedroom line, and an outdoor patio line. Half of last years sales came from the living and dining room line with the remainder from the other two product lines. Mr. Mente was in charge of the sales and production activities of all three lines. His performance was measured by the profits earned by the division and he had always been pleased to receive a healthy year-end bonus based on his divisions performance.

-2- UV1718 The Profit Plan Each division vice president prepared an annual profit plan, starting about six months before the beginning of the plan year. The first step in the process involved estimating sales for the next year. Two sales estimates were prepared for each division: one by the field sales force and another by the product specialists. For the coming year, the individual product specialists estimated rattan furniture sales at $75,130,000 and the field sales force estimated sales at $77,010,000. After a discussion with the sales manager, Mente decided to use $77,010,000 as his divisions sales estimate even though there was a high degree of uncertainty about the direction of the economy. He was confident, however, that sales would continue to grow, although not at the same rate as in past years. The next step in the budget cycle had been estimating manufacturing costs. The production manager, Kay Gray, was given the rattan furniture sales estimate, and she then forecasted direct material, direct labor, variable manufacturing overhead, and fixed manufacturing overhead costs for each assembly area, or cost center. Gray organized production processes and work flow around three cost centers, one for each product line. Most of the direct materials (e.g., CKD rattan parts) were imported from Singapore. The Singapore suppliers had informed Oriole to expect a 6% increase in price for the coming year. Gray used this information to increase the budgeted cost of productions direct materials. She had then estimated the hourly labor cost for each of her cost centers. Using the most recent productivity data she had for the factory, Gray had estimated the budget years salaries and wages and then had reduced that figure by 5% to account for projected increased efficiencies (based on a learning curve tabulated for the division). For variable manufacturing overhead, she had assumed an historical percentage of direct production costs and reduced this by 5% to again account for planned, increased efficiencies. For fixed manufacturing overhead costs, she had used actual costs reported on the most recent monthly income statement and applied a 4% increase. As part of the budgeting process, the sales, administration, logistics support, and quality control departments in the Rattan Furniture Division had had to also estimate their expenses for the coming year. In addition to the expenses incurred directly by the Rattan Furniture Division, the division was also allocated a share of the corporations administrative costs. These costs were allocated to the divisions based on a divisions sales as a percentage of total corporate sales. A divisions own departmental fixed costs, plus the corporate allocated costs, comprised the fixed costs for the Rattan Furniture division. Using the data described above, the accountant, George Jeffrey, had prepared the Rattan Furniture Division profit plan. The result was an estimated division operating profit of $22,720,000 on a sales volume of $77,010,000. This plan was submitted to Mr. Mensan, the company president, right on schedule for his review. (Generally, this review occurred three

-3- UV1718 months before the start of the year being budgeted.) When Mr. Mensan reviewed the divisions plan in relation to the specific sales and profit goals which he had established for the company at large, the combined plans of the four divisions had not met his profit expectations. In a heated discussion with Mr. Mensan, Mente had agreed to revise his divisions sales up to $81,060,000 and operating profit to $23,900,000 (Exhibit 1). He had no real plan for reaching the new sales budget, but he realized that Mr. Mensan was not going to budge from his adamant push for continued sales growth at least equal to past levels. Thus, he had agreed to the upward revision, trusting that he had time to figure out how to get the division to that level. Actual Performance The past eight months had flown by. As Mente was looking at his January through May results, the actual performance of the division was disappointing. A comparison of actual performance with the budget showed that sales were about 11% below plan, the backlog was down 20%, and profit was roughly 18% below plan (Exhibit 2). Mente knew his salespeople were working harder than ever and he believed they were doing a good job in view of the poor economic picture. Improving sales would not be easyif it could be done at all. Mr. Mensan had told all the division managers, as recently as two weeks ago, that he still expected to reach the profit objective set for the year. He said, We have been successful for 20 years and I expect us to continue our growth in sales and profits. Over the years, our profit plans have helped in achieving our success. They tell us where we want to go and how we will get there. Its tough sometimes, and that is when we have to buckle down and plow ahead. Mentes relatively new division had always been fast growing and very profitable. Thus, he had no experience in managing during a slowdown in sales. He realized, however, that he must come up with a plan, one that he had not yet been able to work out, for reaching the divisions profit objective. One idea he was contemplating was to delay the purchase of some new machinery which was scheduled for delivery in September. This machinery, which cost $500,000, would replace some existing machinery that broke down frequently and led to overtime labor and, sometimes, late delivery schedules. Another possibility he thought of was to forego hiring two new furniture designers he had been looking for all year, without any success. If he didnt hire the designers, this would save about $100,000 in salary for the rest of the year. What will I tell Mr. Mensan if he stops by today? mumbled Mente, as he continued to ponder a new plan and wonder if his days were numbered with Oriole Furniture.

-4- UV1718 Exhibit 1 ORIOLE FURNITURE, INC. (A) Rattan Furniture Division This Years Original and Revised Annual Profit Plans Original Revised Sales (Net) $77,010,000 $81,060,000 Variable Costs Direct Material 23,100,000 24,320,000 Direct Labor 11,550,000 12,020,000 Variable Manufacturing Overheads 2,310,000 2,430,000 Total Variable Costs $36,960,000 $38,770,000 Contribution $40,050,000 $42,290,000 Fixed Costs Manufacturing Overheads 2,690,000 2,810,000 Sales and Marketing 9,050,000 9,550,000 Administration 2,350,000 2,400,000 Engineering and Purchasing 3,240,000 3,630,000 Total Fixed Costs $17,330,000 $18,390,000 Operating Profits $22,720,000 $23,900,000 Average Assets $23,000,000 $24,000,000 Source: Created by case writer.

-5- UV1718 Exhibit 2 ORIOLE FURNITURE, INC. (A) Rattan Furniture Division Comparison of Actual Performance with Budget JanuaryMay Actual Budget * Sales $30,060,000 $33,780,000 11% Variable Costs Direct Material 8,990,000 10,130,000 Direct Labor 4,470,000 5,010,000 Variable Manufacturing Overheads 900,000 1,010,000 Total Variable Costs $14,360,000 $16,150,000 Contribution $15,700,000 $17,630,000 Fixed Costs Manufacturing Overheads 1,040,000 1,170,000 Sales and Marketing 3,920,000 3,980,000 Administration 1,020,000 1,000,000 Engineering and Purchasing 1,520,000 1,510,000 Total Fixed Costs $ 7,500,000 $ 7,660,000 Operating Profits $ 8,200,000 $ 9,970,000 18% Average Assets $23,000,000 $24,000,000 Backlog $28,520,000 $35,650,000 20% * Amounts are rounded to equal 5/12 of the amounts of the final annual budget.