It can take some time to recover sales lost during an economic downturn, and given that sales were down 15% between year 7 and year 8, o go from a 15% decrease in sales to a 3. 2% increase in sales in the span of only two years may be an unrealistic goal. I would want to see a specific plan in place for how the company plans to accomplish this substantial increase in sales in such a challenging market (such as an increase in advertising budget, or R&D developing a new product feature that will help differentiate Cab’s bikes from the competition).
Another concern is the wide swings in the amount allocated to Research and Development (R) year to year. For the previous three years, the R budget has aired significantly: Year 6: $71,460 Year 7: $98,280 (increase of 37. 5% from year 6) Year 8: $82,284 (decrease of 16. 3% from year 7) In year 9 CB has allocated $85,861 to R. This budget line item should be analyzed and actions taken so there is not so much variance in the budget year to year. The advantage of this is it will be easier to manage and track. Variances will also be easier to identify and analyze.
The final concerns involve two line items within the Selling, General, and Administrative Budget. The first is the budget for Utilities in year 9 of $150,000. Since CB has increased production of bikes in the budget from 3,400 in year 8 to 3,510 in year 9, an increase in utilities associated with this increase in production would reasonably be expected. Also, looking at the Income Statement, utilities have been trending up year over year since year 6 (of particular note is the 11% increase between years 7 and 8).
Based on these points of data, the $1 50,000 budget may not be enough to cover expenses in this area. The other area to highlight is a line item that is described as “Other Utilities and Services. ” In prior years this line item did not exist. It’s not clear what this line item includes, and while it’s not a large expense (5. 2% of the budgeted total Facility and General Operations Level Expenses in year 9) it should still be examined further since Cab’s expenses have been rising year over year without an accompanying rise in revenue, and extra expenses that have not existed before should be flagged.
Perhaps this expense could be decreased, combined with overall utilities or eliminated altogether. Budgeting is essential for a company to succeed. A budget is required for efficient resource allocation across company departments. It’s also a helpful tool for valuating employee or group performance, by comparing their actual results with budgeted results. Without budgeting, management has no way to track how money is being spent, which can lead to waste or fraud.
A fixed budget, while easier to manage, can be inflexible and does not accommodate unforeseen circumstances that would affect production. These unforeseeable circumstances make it very difficult to implement an accurate fixed budget within a company. Business circumstances often change, and money often needs to be reallocated from one area of the company that may have a surplus to another squiring additional funds. To accommodate changing business circumstances, a flexible budget system was developed.
The major difference between a flexible budget and a fixed budget is how they are calculated. Fixed budgets are calculated with fixed sale level as a base, and only account for one sales scenario. A flexible budget calculates the budget by factoring in changes in activity throughout the year for variable factors such as sales level or production costs. Companies can collect data throughout the year and compare it to the budgets they have set. They compare this actual spending to their gutted amounts for all line items, and variances are calculated.
Variances are the differences between the what was budget and what was actually spent. Activity Variances Within the Flexible Budget Performance Report for Year 9, we begin with units sold and net sales. Net Sales Planning Budget: 3,510 units, Net sales Flexible Budget: 3,423 Units, Net Sales $5,1 17,385 (unfavorable net sales variance of $130,065). This clearly shows that CB overestimated their sales goal in light of unfavorable economic conditions. Given these conditions, the fact that they still sold ore bikes than in year 8 should be considered a positive result.
Within the Variable Costs section, all of the line items included favorable variances: Direct materials Planning Budget: Flexible Budget: $2,235,219 (favorable variance of $56,809) Direct Labor Planning Budget: $1 Flexible Budget: $1 (favorable variance of $26,100) Manufacturing Overhead – Variable Planned Budget: $331,798 Flexible Budget: $323,574 (favorable variance of $8,224) Variable Selling Expenses Planned Budget: $157,424 Flexible Budget: $1 53,522 (favorable variance of $3,902) Planned Budget: $28,412
Flexible Budget: $27,708 (favorable variance of $704) Transportation Out Planned Budget: $105,300 Flexible Budget: $102,690 (favorable variance of $2,610) Given that variable costs are tied to production and they should move in tandem, with sales coming up short, it makes sense that these variable costs would be lower than anticipated as well. All of these favorable variances can be attributed to adjustments to the flexible budget when lower bike sales were factored in. This is one of the advantages of a flexible budget. Contribution Margin Planning Budget: $1,279,489
Flexible Budget: $1,247,773 (unfavorable variance of $31 ,716) Contribution Margin measures profitability and is calculated by subtracting variable costs from revenue, then dividing by revenue. This unfavorable variance means that Cab’s profit per unit in the Flexible budget was less than planned for in the Planning Budget. This makes sense given that CB produced fewer bikes than anticipated. Revenue and Spending Variances Reviewing Cab’s actual output against their flexible budget for variable costs reveals a mixed bag of favorable and unfavorable variances as noted here: Direct Materials Flexible Budget: $2,235,219
Actual Output: $2,035,219 (favorable variance of $200,000) The favorable variance for Direct Materials was a net result of a $300,000 favorable price variance, minus a $100,000 unfavorable efficiency variance. CB likely used some of the substantial raw materials inventory they had on hand, and since bike production was lower than expected, and they reacted to the change in sales volume by ordering less than they had budgeted originally for additional raw materials (components and carbon strips).
They might have gotten a price break from a supplier on raw materials also. Direct Labor Flexible Budget: Actual Output: $1 , 126,900 (unfavorable variance of $100,000) The unfavorable variance for Direct Labor likely stems from the fact that CB overestimated the number of bikes they would need to build, and this results in Direct Labor hours also being overestimated. Workers may have been on the Job but idle due to production being lower than expected.
Manufacturing Overhead – Variable Actual Output: $350,000 (unfavorable variance of $26,426) The unfavorable variance for this category is rather surprising, considering overhead costs are tied to production levels; given that production was lower than expected, overhead usually moves in tandem and that would result in favorable variance. CB should review their manufacturing overhead costs and determine areas where they are going over budget.
Advertising Expenses Flexible Budget: $27,708 Actual Output: $31 ,462 (unfavorable variance of $3,754) The unfavorable variance here might be explained by looking at the amount of advertising CB did throughout year 9. It’s possible that the company saw they weren’t on track to sell as many bikes as anticipated, and reacted to the decline in sales volume by purchasing additional advertising in an attempt to Jump start sales.
Flexible Budget: $102,690 Actual Output: $108,297 (unfavorable variance of $5,607) This unfavorable variance could be due to factors that CB can control (the vendors in their product delivery network may have raised their prices) as well as factors they cannot control (fuel costs). CB has a contract with their vendors that includes a fixed price per delivery for more bikes than were actually built. Given that the product delivery vendor was chosen for their reliability and superior handling of the product as noted in the storyline, the costs for delivery are likely higher than average.
Within the Fixed Expenses sections, there are a few unfavorable variances, but the majority are favorable: Distribution Network Contracted Support Flexible Budget: $50,830 Actual Output: $50,460 (favorable variance of $370) This favorable variance is likely to due to CB only using the support they needed throughout the year, and not paying for support they didn’t need. Since fewer bikes were sold than anticipated, having contract labor in this area provides more flexibility (adjusting the work hours when needed). Administrative Salaries Flexible Budget: $170,000 Actual Output: $171 ,OHO (unfavorable variance of $1,000)
This unfavorable variance could be the result of paying overtime to employees over Executive Compensation Flexible Budget: $220,000 Actual Output: $218,000 (favorable variance of $2,000) If CB tied executive compensation to company performance and sales (at least in part) that would explain this favorable variance. For example, executives would get a bonus if sales met or exceeded the goal set at the beginning of the year. Since sales did not meet the goal set, no bonus was paid out. Employment Taxes Flexible Budget: $29835 Actual Output: $29,758 (favorable variance of $77)
This variance is small and is likely Just the variance in taxes from year to year. Utilities Flexible Budget: $1 50,000 Actual Output: $148,223 (favorable variance of $1,777) This favorable variance is likely due to the fact that fewer bikes were built, therefore fewer utilities were needed. It’s good to see that CB reversed the trend in years 6-8 of rising utility costs year over year. Research and Development Flexible Budget: $85,238 (unfavorable variance of $2,397) Actual output: $82,841 This area of the budget is one I noted in my list of budgetary concerns, due to the amount of fluctuation in the budget.
CB may have taken money from the R budget to spend elsewhere, or management is not committed to developing new features or technological advances for their product. Other General and Administrative Expenses Actual Output: $172,000 (unfavorable variance of $2,000) The specific expenses that fall within this line item are not given. This expense has been increasing year over year since year 6. The increase between years 8 and 9, while not nearly as high as between years 7 and 8, is still a concern that should be addressed.
Overall Cab’s trend of rising expenses and declining or flat sales is a nakedness for the company, and is not sustainable if they want to be profitable and provide shareholder value. AAA. Corrective Actions current budget and analyze each item that has a variance, positive or negative. The goal of this is to get a better understanding of why the variance occurred in each case. Once CB understands why the variances occurred, they can then put a plan of action in place to address each one – ideally as part of the year 10 budget planning process.
My overall recommendation is for CB, in addition to creating a yearly budget, to also create a flexible budget for each quarter for year 10. This system will require more planning and effort (four additional budgets to create every year rather than one) but the benefits include more flexibility and the ability to factor in seasonal variances. CB likely sells more bikes in the spring and summer, and quarterly budgets will allow the company to be more nimble in factoring in a few different sales scenarios.
They can then review the sales results and other metrics each quarter, and use that information to inform the next quarter’s budget. Corrective actions to address each variance in the Flexible Budget Performance Report are listed below. Corrective actions – Activity Variances Net Sales $130,065). Corrective action: CB should take into account the market conditions and the economic downturn when estimating units sold and net sales for year 10. In their flexible budget they could factor in various sales scenarios, such as flat sales, a 2% increase and a 5% increase.
Planned Budget: Planned Budget: $1 Planned Budget: $105Гџ00 Corrective action for these variable cost variances: Implementing a quarterly budget with more realistic sales budgets would help decrease the number of variances within Cab’s variable costs. Flexible Budget: $1 (unfavorable variance of $31 ,716) Corrective action: This variance could be improved by finding ways to make each unit of product be more profitable. Possibilities include streamlining processes within their supply chain (manufacturing, production, delivery) to get more profit out of each bike.
The other option would be to increase the sales price – however, given the current economic conditions, this might be a long-term strategy to pursue when conditions improve, or if CB develops a bike with features/technology better than what their competitors are offering. Corrective Actions – Revenue and Spending Variances Corrective action: CB should review their raw materials costs on a yearly basis, working with their suppliers to get the best price possible (this would possibly involve changing suppliers).
They should also work on optimizing the amount of inventory they have on hand, perhaps by planning a bit more inventory when they are building product for the spring/summer busy season and having less during off-peak periods. Actual Output: $1 , 126,900 (unfavorable variance of $100,000) Corrective action: CB could consider changing their labor policy, perhaps by changing schedule of their errors to be a more flexible one with variable hours – they work more hours during the busy season and less during other times of year.
Another option would be to use contract labor in addition to their regular workers during the busy season. This would be more expensive but would likely result in less resistance and more loyalty from the workers. Flexible Budget: $323,574 determine areas where they are going over budget, then work on trimming those expenses. Actual Output: $31,462 (unfavorable variance of $3,754) Corrective Action: Planning the advertising spend for each quarter (instead of once re year) should allow for more flexibility because seasonal needs are taken into account.
If sales are lagging, advertising spend can be increased. This is a proactive approach instead of a reactive one. Corrective action: CB should review the contracts for vendors who handle delivery of the product to see where some cost savings can be gained. Perhaps rather than a fixed charge per unit, another option such as a sliding scale dependent on delivery distance could be explored. Corrective action: Moving to a quarterly budget should help CB more accurately forecast support needs and should help eliminate this variance.
Corrective action: CB should carefully monitor administrative budgets and workload to ensure that no overtime is taken that would cause a variance. Corrective action: With shorter-term budgeting, CB should be able to more accurately forecast sales numbers tied to executive compensation and bonuses, helping eliminate variances. The variance in taxes from year to year. Flexible Budget: $150,000 Corrective action: CB could offset utility rate fluctuations affecting their budgets but pre-paying for utilities where possible.
They could also do an energy audit of their manufacturing facilities to see where efficiencies could be gained. Corrective action: Since fluctuation is the issue with this line item, CB should review their short- and long-term strategy for R&D and implement a plan for how they want their product to evolve over time. The quarterly budget should feature a more consistent number for R&D so that workers in that area can better plan how they are going to contribute to the company’s goals.
Corrective action: CB should audit all expenses within this line item and consolidate them with other line items or eliminate them where possible. Quarterly budget planning should help offset variances here as well. Baby. Management by Exception When creating and monitoring flexible budgets and variances, one important part of the process is the concept of management by exception. The basis behind this idea is that managers do not have the time or the inclination to investigate every variance in a budget; however, they do take the time to investigate significant budget variances.
This frees them up to do other management tasks and prevents budgeting from taking up all of their time. Departments can work with accounting to define a variance threshold’, and managers will only follow up on variances that exceed that threshold. How this threshold is decided is subjective and usually decided by management. This can be a dollar amount, or a percentage variance. Managers usually use historical costs as a guideline, as well as researching and knowing how much materials (as well as the finished good) should cost.
They also take into account how often the variance is occurring and the overall trend of the budget by viewing income statements and balance sheets from prior years, to spot potential areas of concern. Relative size of the variance is also important: A manager is more likely to investigate a $20,000 eternal quantity variance that is 20 percent of the standard direct-material cost of $100,000 than a $50,000 labor efficiency variance is only 2 percent of the standard Incorporating the idea of management by exception at CB, managers could choose to set the variance threshold for variable costs at 5% of the total amount in the fixed budget.
For year 9, it would be calculated as follows: Year 9 total variable costs budget: $3,869,612 x . 05 = $193,480. 60 This could be broken down further into individual line items within variable costs – for example, direct materials. Applying the same percentage: x . 05 = $1 11,760. 95. If these thresholds are exceeded, the accounting department would inform the relevant department manager, and that person would then investigate the variance.
Management by exception can be a useful tool for keeping budgets from spiraling out of control. Companies benefit when managers implement cost-saving and efficiency measures as a result of investigating variances. REFERENCES Hilton, R. (2011). Managerial accounting: Creating value in a dynamic business environment (9th De. ). McGraw-Hill. Hardcover ISBN: 9780073526928.