Question

Sam Smith, the laundry supervisor of the Toronto Street Shelter, stared at the memo that had just reached his desk:

The shelter had adopted a responsibility accounting system. From now on you will receive quarterly reports comparing the costs of operating your department with budgeted costs. The reports will highlight the differences (variances) so that you can zero in on the departure from budgeted costs. (This is called management by exception.) Responsibility accounting means you are accountable for keeping the costs in your department within budget. The variances from the budget will help you identify which costs are out of line, and the sizes of the variances will indicate the most important ones. Your first such report accompanies this announcement. [Exhibit 1]

As this report indicates, your costs are significantly above budget for the quarter. You need to pay particular attention to labor, supplies and maintenance. Please get back to me by the end of this week with a plan for making the needed reductions

Mr. Smith knew that he needed a plan, yet midwinter was the busiest time of the year at the shelter, and the laundry was piling up faster than his staff could wash it.

Background

Toronto Street Shelter was located in the heart of Toronto. Founded in the late 1800’s, it had been serving the homeless every since, providing hot meals, shelter, and companionship. Situated on a busy urban thoroughfare, it was a have of last resort for many of the city’s indigent, and “home” for many others. As might be expected, the demand for its services was especially high in the winter, when temperatures frequently dropped to below freezing, and life on the street became unbearable.

The shelter provide three services. Its most significant service activity was the Hot-Meal Program, where it served hundreds of meals a day. A meal of hot soup and a sandwich was available to anyone who arrived between the hours of noon and 2 pm and 5pm to 7pm. Its second program was its Overnight Hostel, where it had 150 beds that were available on a first-come, first-served basis. The linen was changed daily, and fresh towels were always available, so that the shelter’s clients could look forward to clean sheets and a hot shower. Finally, it had a counseling program, in which a staff of three full-time social workers assisted clients to cope with the difficulties that had brought them to the shelter, and in establishing themselves in a more self-sufficient lifestyle.

System Changes

In March, the shelter had hired a new administrator to improve it business activities. A business school graduate with prior experience in manufacturing and service companies in the private sector, one of his first steps had been to introduce what he called “responsibility accounting”. He had instituted a new budgeting system, along with the provision of quarterly cost reports to the shelter’s department heads. Previously, cost data had been presented to the department heads on a yearly basis.

The annual budget for the current fiscal year had been constructed by the new administrator, based on an analysis of the three prior year’s costs. The analysis show that all costs increased each year, with more rapid increases between the second and third year. He considered establishing the budget at an average of the three prior years’ costs hoping that the installation of the system would reduce costs to this level. However, in view of the rapidly increasing prices, he finally chose the prior fiscal year’s costs less 3% for the current year’s budget. He decided to measure activity by client nights, and to set the budget for pounds of laundry processed at last year’s level, which was approximately equal to the volume of the past three years.

Quarterly budgets were compiled as one-fourth of the annual budget. Mr. Smith had received the report show in Exhibit 1 in mid-January. He reflected on its content:

A lot of my costs don’t change, even if the number of pounds of laundry changes. I suppose laundry labor, supplies, water-related items, and maintenance vary with changes in pounds, but that’s about all. Nevertheless, shouldn’t my budget reflect those changes? Also, I hadn’t planned for the fact that I was given a salary increase as of October 1 – was I supposed to refuse it to help keep my budget in balance?

Finally, I think that it’s important to note that I had to pay overtime to the staff because the department became inundated with laundry during the cold snap we had back in mid-December. Because of this, my average hourly rate for the whole three months was $10.20 instead of the $9.00 that was in my budget. In fact, and maybe this is a little picky, the average number of minutes it took my staff to wash a pound of laundry actually dropped from $0.48, which was my budget target, to $0.47 for the quarter. Somehow, even though it’s pretty small, I think that should be taken into consideration.

Assignment

What is your assessment of the method the administrator used to construct the budget?

Prepare a flexible budget for the laundry department. What are the volume and spending variances?

What should you acting as Mr. Smith tell his boss about the budget variances by the end of the week?

Exhibit 1

						(Over)	% (Over)
						Under	Under
				Budget	Actual	Budget	Budget
Client nights				9500	12,000	-2,500	-26%
Pounds of laundry processed				125,000	155,000	-30,000	-24%
Costs
Laundry				9,000	12,385	-3,385	-38%
Supplies				1125	1785	-660	-59%
Water and water heating and softening				1750	2350	-600	-34%
Maintenance				1375	2075	-700	-51%
Supervisor's salary				3125	3750	-625	-20%
Allocated administrative costs				4000	5250	-1,250	-31%
Equipment depreciation				1250	1250	0	0%
				21,625	28,845	-7,220	-33%

  

Answer 1

Based on given data Flexible budget prepares based on seggregation of fixed and variable costs

Particulars                                                              Budgeted                Actual             %variance

1.Client nighs                                                             9500                     12000                   -26%

2.Pounds of loundry processed                                  125000                  155000                  -24%

          Total                   134500 167000

3.Costs:

VARIABLE COST:     

.laundry                                                                          (9000)              ( 12385)                -38%

.Supplies                                                                        (1125)              (1785)                    -59%

.Water and water heating                                                  (1750)             (2350)                    -34%

Contribution                                                                    122625             150480

.

FIXED COST :   

Equipment depreciation (1250)     (1250)                      0%

Maintenance                                                                 (1375)                  (2075)                    -51%

Supervisor's salary                                                         (3125)                  (3750)                    -20%

Allocated administrative cost                                          (4000)                  (5250)                    -31%

Net profit                                                                       112875               138155

Note:1 based on calculations as above budgeted profit is lower than actual profit bacause lower budgeted proceeds estimation and lower cost estimation,

Estimation of a budget based on previous budgets analysis it gives effective budget that is flexible budget with seggregation of fixed cost and variable cost analysis.