Executive Summary In 1974 Berkshire Toy Company (BTC) was founded by Franklin Berkshire Janet McKinley?s farther. Janet was soon became the CEO of the company when her father retires on 1993. After two years BTC was acquired by Quality Products Corporation a manufacturer of different products for a common stock of $23.2 million. The preliminary statement of divisional operating income for the year ended June 30 1998 presented the actual values generated together with the master (static) budget and master budget variances for the period. The company obtained higher Total Revenue than their budget but it turned outBudgeting and Performance Evaluation at the Berkshire Toy Company to an Operating Loss near a million dollars. This paper aims to study the budgets from actual results and to compute the budget variances and to analyze its causes. After that the company performance will be evaluated to recommend alternative solutions for improvement. Introduction As a division of Quality Products Corporation Berkshire Toy Company produces the Berkshire Bear a fifteen-inch teddy bear which are fully jointed washable and dressed in various accessories. It is sold to customers like children and adult collectors with unconditional lifetime guarantee. The company is organized into three departments: purchasing (managed by David Hall) production (managed by Bill Willford) and marketing (managed by Rita Smith). An incentive compensation plan was implemented in 1997 intended to enhance the participation and teamwork of the managers. It provides bonuses for each department heads in the following conditions: Purchasing: 20% of net materials price variance assuming favourable Marketing: 10% of excess variance of net revenue assuming favourable Production: 3% of net variance in material labour variable overhead labour rate variance and the variable and fixed overhead spending assuming favourable variances. Statement of the Problem Obtaining a loss approaching a million dollars despite the increase in sales. Substantial unfavourable variances resulting from production department Effects of the incentive compensation plan to the performance of each departments Discussion Actual Master Budget Variance Units sold 325556.00 280000.00 45556.00 Total revenue 14446487.00 136000.00 1440487.00 (U) Total variable expenses 8484404 5968508 2515896 (U) Contribution margin 5962083 737492 175409 (U) Total fixed costs 6805828 6248920 556908 (U) Operating income -843745 788572 1632317 (U) Table 1. Preliminary Statement of Divisional Operating Income for the Year Ended June 30 1998 The following can be derived from the table: Revenue were 11% higher than the master budget Variable expenses were $2515896 higher than the master budget Fixed costs were $556908 higher than the master budget Actual (1) Master (Static) Budget (2) Flexible Master Budget (3) Sales Mix variance (1-3) Sales quantity variance (3-2) Units sold 325556.00 280000 325556.00 0 45556.00 (F) Retail & catalog 8573285.00 11662000.00 13559407.40 4986122.40 (U) 1897407.40 (F) Internet 4428018.00 0 0 4428018.00 (F) 0 Wholesale 1445184.00 1344000.00 1562668.80 117484.80 (U) 218668.80 (F) Total revenue 14446487.00 136000.00 15122076.20 675589.20 (U) 2116 067.20 (F) Table 2. Sales Analysis Schedule Sales volume quantity variance indicates an increase in profit by $2116067.20 if the budgeted sales mix is maintained for the actual sales volume of 325556. However there is an unfavourable variance of $675589.20 because the actual sales mix was not in accordance with the budgeted sales mix. If we would check the sales volume variance sales volume quantity variance plus sales mix variance is equal to favourable $1440487 which is the variance in table 1. Production costs Actual Master Static Budget Flexible Budget Master Budget Variance Flexible variance Total Direct Materials 1230840.00 115924.00 1181214.83 214916.00 (U) 49625.17 (U) Direct Labour 3668305.00 2688000.00 3125337.60 980305.00 (U) 542967.40 (U) Variable Production overhead 1725665.00 146304.00 1216537.66 679361.00 (U) 509127.34 (U) Fixed Manufacturing overhead 658897 661920 769614.38 3023 (F) -110717.38 (F) Table 3. Schedule of Production Variances Direct Material variance The budgeted price is higher than the actual resulting to a favourable material price variance. This is due to the price discounts of 7 to 10 percent of the three main inputs of the product namely acrylic pile fabric plastic joints and polyester fiber filling which contributed to some savings. However the actual quantity used in production is greater than the standard quantity allowed per unit that results to unfavourable material usage variance. This maybe because of substandard quality of materials used that more materials are needed to produce one unit of product. In addition there was an incident of thunderstorm that ruined the uninsured materials wherein the company doesn?t able to recover large amount of fiber filling. Another factor that would affect the direct material usage variance is the lifetime guarantee that the company offers which include the bear hospital since repairs or replacements of teddy bear are free. Also defects may be a factor for the material variances which are only traced after the production process. Direct Labour variance The actual number of hours used and the actual wage rate of BTC are higher than the standard rate allowed for the actual production. Since most part of the production of bear is labor-intensive the company may have set a low standard for the number of hours required to produce a unit. Additional sewing steps and inspection of the fabric color may have contributed to the actual labor hours used. Moreover shortages of length in the cutting stage may require additional cutting set-ups which increase production time. Considering the production of the company they have operated near to maximum capacity that the people are tired and some of them quit and had to be replaced at higher-than-standard wage rates that may lead to higher cost when unskilled workers are employed. Variable Overhead Due to the effect of the increased in labor requirements the company also incurred increased payroll taxes and fringes. Employees need to have overtime to meet the actual demanded product volume which is higher than the budgeted that consequently increase the overtime premiums paid by BTC. Since the company has been using the same machine since it was established frequent breakdowns occurred that maintenance work have contributed to the increase in the variable expenses. This includes the maintenance labor and supplies needed. Fixed Overhead The increase in utilities expense was related to the overtime of employees in the production as the demand of teddy bear boost. Incentive Plan David Hall With the favourable net materials price variance of $295144 David Hall the Purchasing Manager will have a bonus of $59028.72. Rita Smith Marketing Manager Since the Actual Net Revenue is a loss the marketing manager will not have bonus even if she manage to increase the company sales. Bill Wilford Production Manager Direct Labour Variable Overhead Fixed Overhead Direct Material Efficiency Variance $ 122790 (U) Direct Labor Efficiency Variance 466638.40 (U) Direct Labor rate Variance 76329.00 (U) Variable Overhead spending variance 327488.34 (U) Variable Overhead Efficiency Variance 181639.00 (U) Fixed Overhead spending variance (3023.00) (F) Total Variance 1171862 (U) Bonus Zero Advantages and Disadvantages of Incentive Compensation Plan Advantages Disadvantages The incentive plan will motivate department heads Marketing Department focuses on less profitable distribution mix. Increase the morale of employees as their efforts will be rewarded Production Department: uses low quality materials forced to work overtime Performance of the company will attract positive results Purchasing Department bought discounted materials which may sacrifice the quality of production. Conclusion Though the company may have increased their number of sales for the current period they still have incurred losses due to the unfavourable variances that have resulted from their production. Substantial increase in the number of bears sold is noted for the year?s performance. It can be assumed of a good performance of the marketing department. However loss still occurred. The figures of sales may post a good performance conversely the current sales might give the lowest possible sales due to wrong sales mix. The marketing department has focused too much on the Internet Sales whereas it gives a lower contribution than the Retail Sales. Variances in the production of the product are due to the wrong focused of the department head because of the new incentive compensation program. Favourable direct material price variance occurred due to lower prices and discounts on the materials purchased. However unfavourable material usage variance have occurred probably due to substandard materials were used to the production. Direct labour on the hand have resulted to unfavourable variances on both efficiency and rate. Focused of the manager may be on the efficiency of labour due to the incentive program which gives the need to hire more skilled workers. This resulted to unfavourable labour rate variance. However due to substandard materials were used the workers may have needed additional time to work on the teddy bears which still resulted to unfavourable variance. The incentive program may have good intentions but this lead the department heads on the wrong direction and have resulted to unfavourable variances. Other factors that may have affected the variances are the spoilage due to the thunderstorms that have occurred. Machine maintenance is another factor especially in the overhead variances where frequent breakdowns happened. Alternative solutions obtain First solution that we recommend is the revision of the incentive compensation plan. The objective of the plan is good and should be maintained however some computation for the said bonus should be changed. Computation of Bonus for the Marketing Manager could be retained as net revenue is a good measure not only in the performance of the marketing department but as well as the performance of the company. Computation for the Purchasing Manager should have also considered the Material Usage Variance as quality of the materials purchased in also a key factor in their production. Bonus for the production manager may have been a good computation as it may have covered different factors to assess the performance of the department. On the other hand some overhead expenses should be observed by the company as it continuously increase overtime. They may need to consider purchasing new machine as maintenance cost has been a big part of their cost. A new machine may also address the issue of frequent overtime of employees and the increasing maintenance supplies expenses.”
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