Question

Flaming Foliage Sky Tours is a small sightseeing tour company in New Hampshire. The firm specializes in aerial tours of the New England countryside during September and October, when the fall color is at its peak. Until recently, the company had not had an accounting department. Routine bookkeeping tasks, such as billing, had been handled by an individual who had little formal training in accounting. As the business began to grow, however, the owner recognized the need for more formal accounting procedures. Jacqueline Frost has recently been hired as the new controller, and she will have the authority to hire an assistant.

During her first week on the job, Frost was given the following performance report. The report was prepared by Red Leif, the company’s manager of aircraft operations, who was planning to present it to the owner the next morning. “Look at these favorable variances for fuel and so forth,” Leif pointed out, as he showed the report to Frost. “My operations people are really doing a great job.” Later that day, Frost looked at the performance report more carefully. She immediately realized that it was improperly prepared and would be misleading to the company’s owner.

FLAMING FOLIAGE SKY TOURS
Performance Report
For the Month of September
	Formula Flexible Budget (per air mile)					Actual (38,000 air miles)					Static Budget (40,000 air miles)					Variance
Passenger revenue		$	10.50				$	399,000				$	420,000				$	21,000	U
Less: Variable expenses:
Fuel		$	1.40				$	56,900				$	56,000				$	-900	F
Aircraft maintenance			2.15					79,700					86,000					6,300	F
Flight crew salaries			1.40					54,200					56,000					1,800	F
Selling and administrative			2.50					92,400					100,000					7,600	F
Total variable expenses		$	7.45				$	283,200				$	298,000				$	14,800	F
Contribution margin		$	3.05				$	115,800				$	122,000				$	6,200	U
Less: Fixed expenses:		Per Month
Depreciation on aircraft		$	10,000				$	10,000				$	10,000				$	0
Landing fees			4,000					4,100					4,000					100	U
Supervisory salaries			37,000					34,000					37,000					3,000	F
Selling and administrative			46,000					51,500					46,000					5,500	U
Total fixed expenses		$	97,000				$	99,600				$	97,000				$	2,600	U
Operating income							$	16,200				$	25,000				$	8,800	U

Required:
1. Prepare a columnar flexible budget for Flaming Foliage Sky Tours’ expenses, using air miles as the cost driver at the following activity levels: 38,000 air miles, 40,000 air miles, and 43,000 air miles.
2. In spite of several favorable expense variances shown on the report above, the company’s September operating income was only about two-thirds of the expected level. Identify some of the possible reasons.
4. Prepare a revised expense variance report for September, which is based on the flexible budget prepared in part (1).
5. Jacqueline Frost presented the revised expense report to Leif along with the memo explaining why the original performance report was misleading. Leif did not take it well. He complained of Frost’s “interference” and pointed out that the company had been doing just fine without her. “I’m taking my report to the owner tomorrow,” Leif insisted. “Yours just makes us look bad.” What are Frost’s ethical obligations in this matter?

Answer 1

1.

	Activity Level (Air Miles)
	38,000	40,000	43,000
Variable expenses:
Fuel	53,200	56,000	60,200
Aircraft maintenance	81,700	86,000	92,450
Flight crew salaries	53,200	56,000	60,200
Selling and administrative	95,000	100,000	107,500
Total variable expenses	283,100	298,000	320,350
Fixed expenses:
Depreciation on aircraft	10,000	10,000	10,000
Landing fees	4,000	4,000	4,000
Supervisory salaries	37,000	37,000	37,000
Selling and administrative	46,000	46,000	46,000
Total fixed expenses	97,000	97,000	97,000
Total expenses	380,100	395,000	417,350

2.

The variance report is misleading because the activity levels used for the comparison differ.
There is a large unfavorable variance in passenger revenue.
Favorable expense variances have no impact on operating income.
There are unfavorable variances in fixed expenses.

4.

	Formula Flexible Budget (per air mile)	Actual (38,000 air miles)	Flexible Budget (38,000 air miles)	Variance
Variable expenses:
Fuel	$                     1.40	56,900	53,200	3,700	Unfavorable
Aircraft maintenance	$                     2.15	79,700	81,700	2,000	Favorable
Flight crew salaries	$                     1.40	54,200	53,200	1,000	Unfavorable
Selling and administrative	$ 2.50	92,400	95,000	2,600	Favorable
Total variable expenses	$ 7.45	283,200	283,100	100	Unfavorable
Fixed expenses:	Per Month
Depreciation on aircraft	10,000	10,000	10,000	0	None
Landing fees	4,000	4,100	4,000	100	Unfavorable
Supervisory salaries	37,000	34,000	37,000	3,000	Favorable
Selling and administrative	46,000	51,500	46,000	5,500	Unfavorable
Total fixed expenses	97,000	99,600	97,000	2,600	Unfavorable
Total expenses		382,800	380,100	2,700	Unfavorable

5.

Frost should let Leif decide on the best course of action.
Frost should resign in protest.
Frost should show the owner her memo to Leif as well as the revised expense variance report.
Frost has an ethical obligation to make the owner aware that she believes Leif's analysis is faulty.