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JET2 Task 2 Budgeting Bonnie Wilson Western Governors University

JET2 TASK 2 A.1. Operational Strengths and Weaknesses A.1. Budget Concerns

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Revenue from sales is budgeted too high. In year 8 Competition Bikes experienced a 15% decline in sales revenue, and yet for year 9, they have budgeted for a 3.2% increase. This is likely to be an overly optimistic projection and relies heavily on economic factors outside of the company’s control. Inaccuracy in this projection will have a negative impact on the rest of the budget. Advertising is budgeted too low. The year 9 budgeted amount of $28,412 represents a 3.5% increase over year 8, but it is still almost 20% shy of the amount spent on advertising in year 7 when sales were at an all time high. If the company is to have any hope of realizing its revenue projection, then the amount budgeted for advertising is too low. Executive compensation is budgeted too high. In year 7 executive compensation increased by $50,000 dollars. This made sense then because sales had increased by 33%. However, holding that number steady in year 8 when there was a 15% decrease, and again in year 9 when even a 3.2% increase is optimistic, is not a financially sound budgeting decision. Research and development is budgeted too low. The budgeted amount for year 9 is $85,237. While this represents the same 1.6% of sales revenue that Competition Bikes consistently allots, research and development is an investment in the company’s future. To be forward thinking, the company needs to allocate more funds now in order to stay competitive in the future.

JET2 TASK 2 Other general and administrative expenses are budgeted too high. In year 7 at peak production the amount budgeted was $158,000. In year 8 this amount went up to $170,000, and remains the same for year 9. The company needs to require greater

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specificity under this heading to determine the source of increasing costs, with a goal to return to the year seven budgeted amount. A.2. Evaluation of Flexible Budget and Variances A.2.a. Corrective actions for areas of concern based on a variance analysis Activity variances. All of the items listed under variable costs show a favorable variance because the company did not meet its production forecast. The planning budget allotted for 3,510 units to be produced, but the actual output was only 3,423. Since 87 fewer units were produced than expected, the variable costs associated with production are also less, creating favorable variances. Likewise, since fewer units were produced, net sales also decreased, creating an unfavorable variance. Revenue and spending variances. The following table evaluates all of the variances found when comparing Competition Bikes’ flexible budget with actual output. Budget item Variance Evaluation and Recommended Corrective Action Net sales should equal number of units x cost per unit minus 50% that goes to distributors. Competition Bikes could ask distributors for sales information to explain this unfavorable variance. It may represent discounted prices at point of sale by distributors in order to sell more bikes. Even after accounting for decreased production, the direct materials price variance was $300,000 less than anticipated. However, the company lost a third of that in a $100,000 unfavorable efficiency variance. The purchasing manager may have negotiated better prices, which should be praised, but the efficiency variance suggests there was significant waste, which should be investigated. Each unit requires 15 hours of skilled labor, which was budgeted at $20/hour. Since we see a favorable

Net Sales

(20,538) U

Direct materials

(200,000) F

Direct Labor

100,000 U

JET2 TASK 2

4 efficiency variance of $50,000, we can assume that the direct labor variance was caused by an hourly labor rate that was higher than what was budgeted, creating an unfavorable direct labor variance. Competition Bikes can avoid this in the future by using accurate hourly wage information when making the budget and anticipating increases for raises as appropriate. The production manager should also look at the skill mix of the staff and use cheaper labor where appropriate. Both price and efficiency variances were unfavorable, creating an overall unfavorable variance for manufacturing overhead. CB could find the root cause by looking into any increases in raw materials cost, unexpected equipment repairs or replacements, facility maintenance, etc. For advertising, we see an overall unfavorable variance after accounting for a favorable efficiency variance of $1246. Perhaps the company bought more expensive advertising, but some of the cost was made up because the advertising was more effective. As mentioned earlier in the budget analysis, Competition Bikes would benefit from increasing its budget for advertising; however, it should also live within the budget allotted. The advertising manager should be held accountable for overages beyond the budgeted amount. Transportation out is contracted at $30 per unit shipped. An unfavorable variance of $5607 means that Competition Bikes paid for the shipping of 186 bikes that weren’t even built. The company should discuss this discrepancy with its carrier and get a refund or a credit toward next year. The overall variance in total variable costs is favorable, and relates to the decreased number of bikes produced. The unfavorable variance in net sales resulted in a lower contribution margin. However, since the total variable costs were favorable, we still see an overall favorable contribution margin. Minimal favorable variance. No corrective action needed. A small unfavorable variance here could represent extra hours worked by administrative staff, or perhaps a new person was hired at a higher wage. Competition Bikes could use the human resources department to budget more accurately for salaries. Executive compensation came in $2000 under budget,

Manufacturing Overhead

26,426 U

Advertising Expenses

3,754 U

Transportation Out

5,607 U

Total Variable Costs Contribution Margin Dist. Network Contracted Support Administrative Salaries Executive

(64,212) F 43,674 F

(370) F

1,000 U

(2,000) F

JET2 TASK 2 Compensation

5 which is good, but overall compensation may still be budgeted too high when the company is still not meeting its sales and production forecast. (77) F Minimal favorable variance. No corrective action needed. Competition Bikes could review its use of lights, water, waste removal, recycling, heating, and cooling to identify any process changes that could sustain this favorable variance in the future. The research and development departments did not exceed their allotted budget, which is commendable, but they should use everything in their budget because R&D significantly impacts the future of the company. Competition Bikes should discuss expectations with the R&D manager and make sure that all budgeted dollars are being used to improve the company’s products. Competition Bikes should identify the items that make up this category to identify the cause of the unfavorable variance. It is relatively small but adds up over time, so it may be beneficial to monitor. Minimal favorable variance. No corrective action needed. Overall favorable variance means that overall operating expenses were less than expected. This is commendable; no corrective action needed. Operating income actual output exceeded the flexible budget amount by almost double, largely because of the decreased costs due to decreased production. This decrease in expenses resulted in a favorable variance of $47,795.

Employment Taxes Utilities

(1,777) F

Research and Development

(2,397) F

General and Admin Other services Total Operating Expenses Operating Income

2,000 U (500) F (4,121) F

47,795 F

A.2.b. Management by exception To help managers and executives prioritize their time, Competition Bikes uses management by exception. This strategy allows them to focus primarily on the budget areas that show a significant deviation from what was budgeted for each line item. The deviation can be an absolute dollar amount, a percentage, or even a trend over time. (Hilton, 2011). For example, if Competition Bikes chooses the value of $10,000 to identify significant variances, the number of line items brought to management’s

JET2 TASK 2 attention drastically decreases. The table above includes eighteen different variances. Applying management by exception and the threshold of $10,000, management only needs to focus on seven variances. These are listed in the table below.

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Budget item Net Sales Direct materials Direct Labor Manufacturing Overhead Total Variable Costs Contribution Margin Operating Income

Variance (20,538) U (200,000) F 100,000 U 26,426 U (64,212) F 43,674 F 47,795 F

Using management by exception allows managers and executives to easily see the items where their time and efforts will have the greatest impact.

JET2 TASK 2 References Hilton, R.W. (2011). Managerial Accounting: Creating value in a dynamic business environment (9th ed.). p. 416. New York, NY: McGraw-Hill/Irwin.

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