Questions are in attachment. Please answer questions using only text provided disregarding the assumption that this was part B of a previous case.

Rainier Fastener Although Richard Haney did not implement either of the suggestions Oliver Douglas made in Part (A), he did agree with Oliver's comment that it is important to find ways to improve profitability. Haney understood from the basic CVP model that there are three fundamental ways to improve profitability - increase selling price, decrease cost, or increase volume. Because Rainier operates in a highly competitive market where it is difficult to increase selling prices without losing market share or lower prices to increase market share, Haney decided to concentrate on costs. The accounting department had developed a budget for 2014 based on the assumption that costs per feu in 2014 should be equal to the costs per feu in 2013 (see Exhibit 3 in Rainier Fasteners Part A for the 2013 costs per feu). Exhibit 4 shows the budgeted profit and loss for 2014 by product line, where the budget is constructed by multiplying each of the costs per feu from 2013 times the actual volume of feus sold in 2014 for each of Rainier's three products. The next-tolast column of Exhibit 4 shows the actual costs for 2014, and the last column shows deviations of actual costs from budgeted costs (i.e., variances from the budget). Haney also received Exhibit 5, showing actual revenue and costs by product line for 2014, where revenue and direct costs have been traced to product lines and indirect costs have been allocated as described in Rainier Fastener (A). This statement showed an overall profit of $95,000 for 2014, an improvement from the $418,000 loss reported in 2013, and also much better than the budgeted loss of $481,000 shown in Exhibit 4. Oliver Douglas and Richard Haney reviewed the 2014 results. Oliver found several reasons for optimism: "First, we seem to be doing a really good job of running our operations. For some of our most significant costs, 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 2013, we lost $418,000 but in 2014 we made $95,000 so profitability improved by $513,000. Third, not only did we improve relative to last year's loss, we also did substantially better than the budget in Exhibit 4, which projected a loss of $481,000. Our actual profit of $95,000 is $576,000 better than the budgeted loss of $481,000." Rainier Fastener Company (B) page 2 Richard Haney found less reason for optimism in the 2014 results. "Now that I have seen the results, I realize that we made a fundamental error in the way we constructed the budget in Exhibit 4. As a result, those favorable variances do not mean what you think they mean. Second, while it is true that our profit in 2014 increased relative to 2013, 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 4). 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, I think we would see that we should have made far more than our actual profit of $95,000." Rainier Fastener Company (B) page 3 Case Questions Rainier Fastener (B) illustrates two main points: First, generalization of the single-product CVP model to a multiple-product firm requires separation of the prices, variable costs, and volumes related to each product line. A budget can be viewed as the CVP model for a multi-product firm. Second, the model used to generate a budget is critically important in evaluating projections from the budget and interpreting variances (i.e., differences between actual and budgeted amounts). A flawed budget model will result in flawed projections and misleading variances. For all questions, assume costs behave as described in Exhibit 2 of Rainier (A), i.e., each cost behaves simply as either fixed or variable. (Remember that Compensation Insurance represents a combination of a fixed cost and a variable cost because it is 5% of Direct Labor, a variable cost, plus 5% of Indirect Labor, a fixed cost.) 1. Explain Haney's statement that in the single-product CVP model "there are three fundamental ways to improve profitability - increase selling price, decrease cost, or increase volume." Haney is contending that under this CVP model assumption where total revenues and costs are equal, or the breakeven point, Rainier Fasteners would need to either increase prices, decrease costs or increase volume to realize incremental profits 2. To understand the fundamental error in the budget, consider an example of each of the two types of cost for Rainier, a variable cost (Direct Labor) and a fixed cost (Rent). For Direct Labor, the assumption used in constructing the budget says that 2013 direct labor costs of $2.5002, $4.0020, and $4.6403 per unit of CN, AG, and SS, respectively, are reasonable budgeted amounts for 2014. For Rent, the assumption used says that 2013 rent costs of $1.2753, $2.0412, and $2.3668 per unit of CN, AG, and SS, respectively, are reasonable budgeted amounts for 2014. That is, the budget was prepared under the assumption that, for both fixed and variable costs, if it cost $1 per unit to do something in 2013 it should cost $1 per unit in 2014. For every cost, the accounting department has budgeted the expected cost as the cost per unit from 2013 times the quantity produced in 2014. a) For a variable cost, such as Direct Labor, this assumption makes sense. For a fixed cost, such as Rent, this assumption does not make sense, which is the fundamental error to which Haney referred. Explain why. b) More specifically, how do you interpret the $672,000 unfavorable variance relative to budget for Direct Labor (an example of a variable cost)? (Note: The $672,000 total variance is the sum of the three direct labor variances for the three product lines.) c) How was the $7,335,000 budgeted amount for Rent computed? How does $7,335,000 compare with what you would expect for Rent based on the information in Exhibits 2 and 3? How do you interpret the $235,000 favorable variance relative to budget for Rent? d) Which type of costs (variable or fixed) is associated with the favorable variances that Oliver pointed out and which type of costs is associated with the unfavorable variances? Rainier Fastener Company (B) page 4 Do all those favorable variances that Oliver pointed out mean that Rainier is doing a good job of controlling those costs? 3. Now that you understand the problems with the budget prepared by the accounting department, prepare a flexible budget for 2014 that corrects the fundamental error made by the accounting department. Specifically, prepare a budget that assumes a reasonable standard for total fixed costs in 2014 is total fixed costs in 2013. To simplify the calculations, prepare your budget in summary form that combines all the individual variable costs for each product line into a single total variable cost for the product line and combines all the individual fixed costs into a single total fixed cost. i) Rather than list all the detail of the individual variable costs, combine all the variable costs for each product line into a 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, denoted below as Var(CN). Note that because the accounting department used a reasonable assumption for variable costs, you can just sum together all the variable costs shown in Exhibit 4 to get total variable cost for each product line. ii) Since fixed costs do not vary with product mix, combine all the total fixed costs across product lines and across fixed cost categories. Note that because your budget will assume that fixed costs in 2014 will be equal to fixed costs in 2013, you can compute budgeted Total Fixed Cost in 2014 by just adding together all the actual fixed costs in 2013. Your resulting summary budget for 2014 should be in the following format, where the top three lines reflect the familiar formula: Revenue-Variable Cost = Contribution Margin (by product line) and then total fixed costs (totaled across all three product lines) are subtracted to get total net income: Common(CN) Alloy(AG) Rev(CN) Rev(AG) Var(CN) Var(AG) CM(CN) CM(AG) Stainless(SS) Total Revenue Rev(SS) Rev(Total) Variable Costs Var(SS) Var(Total) Contribution Margin CM(SS) CM(Total) Fixed Cost Total Fixed Net Income Net Income Compute variances that compare the actual totals for 2014 in Exhibit 4 to your 2014 budgeted total revenue, total variable cost, and total fixed cost. Use these variances to: a) Evaluate Oliver's conclusion "...we seem to be doing a really good job of running our operations." Has Rainier done a good job of managing costs relative to your budget? b) Explain Haney's conclusion that \"... we should have made far more than our actual profit of $95,000.\" Rainier Fastener Company (B) page 5 Exhibit 4 Rainier Fastener Company Budgeted Proft and Loss by Product For Year Ending December 31, 2014 Common Alloy Grade Stainless Steel Total Budget Budget (000s) Rent Total Budget Budget Budget Budget Budget $ per feu (000s) $ per feu (000s) $ per feu (000s) Actual (000s) Variance 2,104 1.2753 2,907 2.0412 2,324 2.3668 7,335 7,100 Property taxes 765 0.4638 1,057 0.7423 845 0.8607 2,668 2,582 86 Compensation insurance 322 0.1949 444 0.3119 355 0.3617 1,121 1,142 -21 Direct labor 4,125 2.5002 5,699 4.0020 4,557 4.6403 14,381 15,053 -672 Indirect labor 2,306 1.3974 3,185 2.2367 2,547 2.5935 8,038 7,790 248 Power 135 0.0818 268 0.1882 231 0.2351 634 680 -46 Light and heat 217 0.1315 300 0.2104 240 0.2440 756 755 1 5,076 3.0766 5,051 3.5471 3,705 3.7730 13,832 13,976 -144 814 0.4936 880 0.6176 615 0.6261 2,309 2,282 27 15,865 9.615 19,790 13.898 15,419 15.701 51,074 51,360 -287 Selling expense 4,535 2.7486 5,680 3.9890 4,245 4.3230 14,461 14,124 337 General administration 2,288 1.3864 2,865 2.0120 2,141 2.1805 7,294 7,114 180 Depreciation 3,092 1.8737 4,271 2.9992 3,415 3.4776 10,777 10,432 345 Total expense 25,779 15.6237 32,606 22.8978 25,220 25.6824 83,606 83,030 576 Actual Sales 26,070 15.8000 32,652 22.9300 24,403 24.8500 83,125 83,125 0 291 0.176 46 0.032 -817 -0.832 Materials Repairs Subtotal Profit (loss) Unit sales (thousands of feu) 1,650 1,424 982 -481 0 95 0 235 576 Rainier Fastener Company (B) page 6 Exhibit 5 Rainier Fastener Company Actual Proft and Loss by Product Year Ending December 31, 2014 Common Alloy Grade Stainless Steel Total $ thousands $ thousands $ thousands $ thousands 2,070 2,852 2,178 7,100 Property taxes 753 1,037 792 2,582 Compensation insurance 333 459 350 1,142 Direct labor 4,389 6,046 4,618 15,053 Indirect labor 2,272 3,129 2,390 7,790 Power 132 268 280 680 Light and heat 220 303 232 755 4,894 5,004 4,078 13,976 827 905 550 2,282 Rent Materials Repairs 15,890 20,002 15,468 51,360 Selling expense Total 4,430 5,548 4,146 14,116 General administrative 2,231 2,794 2,088 7,120 Depreciation 3,042 4,190 3,200 10,432 Total expense 25,593 32,535 24,902 83,030 Sales 26,070 32,652 24,403 83,125 477 118 -500 95 Profit (loss) Unit sales (thousands of feu) 1,650 1,424 982 Rainier Fastener Although Richard Haney did not implement either of the suggestions Oliver Douglas made in Part (A), he did agree with Oliver's comment that it is important to find ways to improve profitability. Haney understood from the basic CVP model that there are three fundamental ways to improve profitability - increase selling price, decrease cost, or increase volume. Because Rainier operates in a highly competitive market where it is difficult to increase selling prices without losing market share or lower prices to increase market share, Haney decided to concentrate on costs. The accounting department had developed a budget for 2014 based on the assumption that costs per feu in 2014 should be equal to the costs per feu in 2013 (see Exhibit 3 in Rainier Fasteners Part A for the 2013 costs per feu). Exhibit 4 shows the budgeted profit and loss for 2014 by product line, where the budget is constructed by multiplying each of the costs per feu from 2013 times the actual volume of feus sold in 2014 for each of Rainier's three products. The next-tolast column of Exhibit 4 shows the actual costs for 2014, and the last column shows deviations of actual costs from budgeted costs (i.e., variances from the budget). Haney also received Exhibit 5, showing actual revenue and costs by product line for 2014, where revenue and direct costs have been traced to product lines and indirect costs have been allocated as described in Rainier Fastener (A). This statement showed an overall profit of $95,000 for 2014, an improvement from the $418,000 loss reported in 2013, and also much better than the budgeted loss of $481,000 shown in Exhibit 4. Oliver Douglas and Richard Haney reviewed the 2014 results. Oliver found several reasons for optimism: "First, we seem to be doing a really good job of running our operations. For some of our most significant costs, 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 2013, we lost $418,000 but in 2014 we made $95,000 so profitability improved by $513,000. Third, not only did we improve relative to last year's loss, we also did substantially better than the budget in Exhibit 4, which projected a loss of $481,000. Our actual profit of $95,000 is $576,000 better than the budgeted loss of $481,000." Rainier Fastener Company (B) page 2 Richard Haney found less reason for optimism in the 2014 results. "Now that I have seen the results, I realize that we made a fundamental error in the way we constructed the budget in Exhibit 4. As a result, those favorable variances do not mean what you think they mean. Second, while it is true that our profit in 2014 increased relative to 2013, 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 4). 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, I think we would see that we should have made far more than our actual profit of $95,000." Rainier Fastener Company (B) page 3 Case Questions Rainier Fastener (B) illustrates two main points: First, generalization of the single-product CVP model to a multiple-product firm requires separation of the prices, variable costs, and volumes related to each product line. A budget can be viewed as the CVP model for a multi-product firm. Second, the model used to generate a budget is critically important in evaluating projections from the budget and interpreting variances (i.e., differences between actual and budgeted amounts). A flawed budget model will result in flawed projections and misleading variances. For all questions, assume costs behave as described in Exhibit 2 of Rainier (A), i.e., each cost behaves simply as either fixed or variable. (Remember that Compensation Insurance represents a combination of a fixed cost and a variable cost because it is 5% of Direct Labor, a variable cost, plus 5% of Indirect Labor, a fixed cost.) 1. Explain Haney's statement that in the single-product CVP model "there are three fundamental ways to improve profitability - increase selling price, decrease cost, or increase volume." Haney is contending that under this CVP model assumption where total revenues and costs are equal, or the breakeven point, Rainier Fasteners would need to either increase prices, decrease costs or increase volume to realize incremental profits 2. To understand the fundamental error in the budget, consider an example of each of the two types of cost for Rainier, a variable cost (Direct Labor) and a fixed cost (Rent). For Direct Labor, the assumption used in constructing the budget says that 2013 direct labor costs of $2.5002, $4.0020, and $4.6403 per unit of CN, AG, and SS, respectively, are reasonable budgeted amounts for 2014. For Rent, the assumption used says that 2013 rent costs of $1.2753, $2.0412, and $2.3668 per unit of CN, AG, and SS, respectively, are reasonable budgeted amounts for 2014. That is, the budget was prepared under the assumption that, for both fixed and variable costs, if it cost $1 per unit to do something in 2013 it should cost $1 per unit in 2014. For every cost, the accounting department has budgeted the expected cost as the cost per unit from 2013 times the quantity produced in 2014. a) For a variable cost, such as Direct Labor, this assumption makes sense. For a fixed cost, such as Rent, this assumption does not make sense, which is the fundamental error to which Haney referred. Explain why. b) More specifically, how do you interpret the $672,000 unfavorable variance relative to budget for Direct Labor (an example of a variable cost)? (Note: The $672,000 total variance is the sum of the three direct labor variances for the three product lines.) c) How was the $7,335,000 budgeted amount for Rent computed? How does $7,335,000 compare with what you would expect for Rent based on the information in Exhibits 2 and 3? How do you interpret the $235,000 favorable variance relative to budget for Rent? d) Which type of costs (variable or fixed) is associated with the favorable variances that Oliver pointed out and which type of costs is associated with the unfavorable variances? Rainier Fastener Company (B) page 4 Do all those favorable variances that Oliver pointed out mean that Rainier is doing a good job of controlling those costs? 3. Now that you understand the problems with the budget prepared by the accounting department, prepare a flexible budget for 2014 that corrects the fundamental error made by the accounting department. Specifically, prepare a budget that assumes a reasonable standard for total fixed costs in 2014 is total fixed costs in 2013. To simplify the calculations, prepare your budget in summary form that combines all the individual variable costs for each product line into a single total variable cost for the product line and combines all the individual fixed costs into a single total fixed cost. i) Rather than list all the detail of the individual variable costs, combine all the variable costs for each product line into a 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, denoted below as Var(CN). Note that because the accounting department used a reasonable assumption for variable costs, you can just sum together all the variable costs shown in Exhibit 4 to get total variable cost for each product line. ii) Since fixed costs do not vary with product mix, combine all the total fixed costs across product lines and across fixed cost categories. Note that because your budget will assume that fixed costs in 2014 will be equal to fixed costs in 2013, you can compute budgeted Total Fixed Cost in 2014 by just adding together all the actual fixed costs in 2013. Your resulting summary budget for 2014 should be in the following format, where the top three lines reflect the familiar formula: Revenue-Variable Cost = Contribution Margin (by product line) and then total fixed costs (totaled across all three product lines) are subtracted to get total net income: Common(CN) Alloy(AG) Rev(CN) Rev(AG) Var(CN) Var(AG) CM(CN) CM(AG) Stainless(SS) Total Revenue Rev(SS) Rev(Total) Variable Costs Var(SS) Var(Total) Contribution Margin CM(SS) CM(Total) Fixed Cost Total Fixed Net Income Net Income Compute variances that compare the actual totals for 2014 in Exhibit 4 to your 2014 budgeted total revenue, total variable cost, and total fixed cost. Use these variances to: a) Evaluate Oliver's conclusion "...we seem to be doing a really good job of running our operations." Has Rainier done a good job of managing costs relative to your budget? b) Explain Haney's conclusion that \"... we should have made far more than our actual profit of $95,000.\" Rainier Fastener Company (B) page 5 Exhibit 4 Rainier Fastener Company Budgeted Proft and Loss by Product For Year Ending December 31, 2014 Common Alloy Grade Stainless Steel Total Budget Budget (000s) Rent Total Budget Budget Budget Budget Budget $ per feu (000s) $ per feu (000s) $ per feu (000s) Actual (000s) Variance 2,104 1.2753 2,907 2.0412 2,324 2.3668 7,335 7,100 Property taxes 765 0.4638 1,057 0.7423 845 0.8607 2,668 2,582 86 Compensation insurance 322 0.1949 444 0.3119 355 0.3617 1,121 1,142 -21 Direct labor 4,125 2.5002 5,699 4.0020 4,557 4.6403 14,381 15,053 -672 Indirect labor 2,306 1.3974 3,185 2.2367 2,547 2.5935 8,038 7,790 248 Power 135 0.0818 268 0.1882 231 0.2351 634 680 -46 Light and heat 217 0.1315 300 0.2104 240 0.2440 756 755 1 5,076 3.0766 5,051 3.5471 3,705 3.7730 13,832 13,976 -144 814 0.4936 880 0.6176 615 0.6261 2,309 2,282 27 15,865 9.615 19,790 13.898 15,419 15.701 51,074 51,360 -287 Selling expense 4,535 2.7486 5,680 3.9890 4,245 4.3230 14,461 14,124 337 General administration 2,288 1.3864 2,865 2.0120 2,141 2.1805 7,294 7,114 180 Depreciation 3,092 1.8737 4,271 2.9992 3,415 3.4776 10,777 10,432 345 Total expense 25,779 15.6237 32,606 22.8978 25,220 25.6824 83,606 83,030 576 Actual Sales 26,070 15.8000 32,652 22.9300 24,403 24.8500 83,125 83,125 0 291 0.176 46 0.032 -817 -0.832 Materials Repairs Subtotal Profit (loss) Unit sales (thousands of feu) 1,650 1,424 982 -481 0 95 0 235 576 Rainier Fastener Company (B) page 6 Exhibit 5 Rainier Fastener Company Actual Proft and Loss by Product Year Ending December 31, 2014 Common Alloy Grade Stainless Steel Total $ thousands $ thousands $ thousands $ thousands 2,070 2,852 2,178 7,100 Property taxes 753 1,037 792 2,582 Compensation insurance 333 459 350 1,142 Direct labor 4,389 6,046 4,618 15,053 Indirect labor 2,272 3,129 2,390 7,790 Power 132 268 280 680 Light and heat 220 303 232 755 4,894 5,004 4,078 13,976 827 905 550 2,282 Rent Materials Repairs 15,890 20,002 15,468 51,360 Selling expense Total 4,430 5,548 4,146 14,116 General administrative 2,231 2,794 2,088 7,120 Depreciation 3,042 4,190 3,200 10,432 Total expense 25,593 32,535 24,902 83,030 Sales 26,070 32,652 24,403 83,125 477 118 -500 95 Profit (loss) Unit sales (thousands of feu) 1,650 1,424 982