Question

Regarding the variances, what kind of explanations or observation can I make?

The new incentive compensation plan was adopted. Under this plan, each three department heads are rewarded based on the performance of his or her responsibility center. Performance is measures against the company’s master budget and standard cost system. The plan was the result of several meetings with Janet McKinley who is employed by the Quality Products Corporation and Vice President in charge of BTC’s division of quality products and her managers. The managers argued and bargained for a plan that rewarded the managers fairly for individual contribution and achievements. McKinley’s plan was intended to promote participation and teamwork and the manages accepted the new preprogram enthusiastically. The plan provides for the followings:

David Hall, the purchasing manager, will receive a bonus equal to 20% of the net materials price if the variance is favorable

Rita Smith, the production manager, will receive a bonus equal to 10% of the excess, if any of the actual net revenues (revenues minus both variable and fixed selling expenses) over master budget net revenues.

Bill Wilford, the production manager, will receive a bonus equal to 3% of the net of several variances: the efficiency (usage or quality) variances for materials, labor, and variable overhead; the labor rate variance; and the variance and fixed overhead spending variances. He will receive no bonus if his net variance is unfavorable.

Statement of Operating Income for the Year Ended June 30, 1998
		Actual	Master Budget	Master Budget Variance	F/ U	Flexible Budget	Flexible Budget Variance	F/ U
Units sold		325,556	280,000	45,556	F	325,556
Retail and catalog in units	174,965	8,573,285	11,662,000	3,088,715	U	8,573,285
Internet	105,429	4,428,018	-	(4,428,018)	F	4,428,018
Wholesale	45,162	1,445,184	1,344,000	(101,184)	F	1,445,184
Total units	325,556
Total Revenue		14,446,487	13,006,000	(1,440,487)	F	14,446,487
Variable Production Costs
Direct Materials
Acrylic pile fabric		256,422	233,324	(23,098)	U	$271,302	(14,880)	F
10-mm acrylic eye		125,637	106,400	(19,237)	U	$123,711	1,926	U
45-mm plastic joints		246,002	196,000	(50,002)	U	$227,889	18,113	U
polyester fiber filling		450,856	365,400	(85,456)	U	$424,851	26,005	U
woven label		16,422	14,000	(2,422)	U	$16,278	144	U
designer box		69,488	67,200	(2,288)	U	$78,133	(8,645)	F
accessories		66,013	33,600	(32,413)	U	$39,067	26,946	U
Total Direct Labor Materials		1,230,840	1,015,924	(214,916)	U	$          1,181,231	49,609	U
Direct labor		3,668,305	2,688,000	(980,305)	U	3,125,338	542,967	U
variable overhead		1,725,665	1,046,304	(679,361)	U	1,216,538	509,127	U
Total variable production costs		6,624,810	4,750,228	(1,874,582)	U	5,523,091	1,101,719	U
Variable Selling expenses		1,859,594	1,218,280	(641,314)		1,416,494	443,100	U
Total variable expenses		8,484,404	5,968,508	(7,266,124)	U	6,939,585	1,544,819	U
Contribution Margin		5,962,083	7,037,492	7,037,492	U	7,506,902	(1,544,819)	U
Fixed costs
manufacturing overhead		658,897	661,920	3,023	F	769,614	(110,717)	F
selling expenses		5,023,192	4,463,000	(560,192)	U	4,463,000	560,192	U
administrative expenses		1,123,739	1,124,000	261	F	1,124,000	(261)	F
total fixed costs		6,805,828	6,248,920	(556,908)	U	6,356,614	449,214	U
Operating Income		(843,745)	788,572	7,594,400	U	1,150,272	(1,994,017)	F

Price and Efficiency Variance Actual Costs Price Variance   Actual input, standard Prices Efficiency Variance   Flexible Budget Direct Materials Acrylic pile fabric             256,422             20,428 F $276,850 ($5,548) U $271,302 10-mm acrylic eye             125,637                   -   $125,637 ($1,926) U $123,711 45-mm plastic joints $246,002             25,181 F $271,183 ($43,294) U $227,889 polyester fiber filling             450,856             48,183 F $499,039 ($74,188) U $424,851 woven label               16,422                   -                 16,422 ($145) U $16,278 designer box               69,488              6,317 F $75,805 $2,328 F $78,133 accessories               66,013           (26,946) U $41,346 $0 $39,067 Total Direct materials        1,230,840           73,164 F $1,306,283 ($122,772) U $1,181,232 Direct Labor           3,668,305 ($76,329) U $3,591,976 ($466,638) U $3,125,338 Variable Overhead 1,725,665 ($327,488) U $1,398,177 ($181,639) U $1,216,538 Total Variable Cost        6,624,811        (330,654) U         6,296,435          (771,049) U        5,523,107
Sales Units Actual Master Budget Master Budget Variance Flexible Budget (Actual Sales Mix) Flexible Budget Variance (Budget Sales Mix) Sales Mix Variance Sales Volume Variance Unit Sold 325,556 280,000 45,556 325,556 325,556 0 45,556 Retail and Catalog 174,965 8,573,285     11,662,000    3,088,715 8,573,285 13,559,574 -4,986,289 1,897,407 Internet 105,429 4,428,018                   -   (4,428,018) 4,428,018 0 4,428,018 0 Wholesale 45,162 1,445,184       1,344,000     (101,184) 1,445,184 1,562,656 -117,472 218,669 Total revenue 14,446,487 13,006,000 -1,440,487 14,446,487 15,122,230 -675,743 2,116,076

Answer 1

Observation & Explanation for the variances:

1. Apparently it would appear that the Performance of Sales is excellent, as the Total units sold is much higher the budgeted and hence a favourable variance of 45,556 units.

However, when looked closely, the product “Internet” was not even included in Master budget, which means that budget was incorrect and hence, the total favourable variance (of units sold) is questionable.

Assuming that , budgeted quantity of “Internet” even equals the actual quantity sold, then, the budged total units sold would be 17,434,018 (13006000+4428018).In that case, the total unit sold would be unfavourable.

2. Operating income budgeted was $788572, whereas Actual was a loss (-843745$). This is Unfavourable (but shown as favourable which is incorrect0

Let us now analyse the bonus plan based on the given data:

1

Purchase Manager

Bonus:

20% of the net material price Variance (if fav)

Net material price variance:

Actual quantity (Standard price-Actual price)

73164

(F), as given

Eligible for bonus

Bonus amount

14633

(20% of 73164)

2

Production Mgr (Rita Smith)

Bonus :

10% of the excess of (net actual revenue over master budget net revenues). Net rev = Rev - var & fix selling exp

Actual

Budget

Revenue (actual)

14,446,487

13,006,000

Less: Variable selling exp

-1,859,594

-1,218,280

Less: Fixed selling expense

-5,023,192

-4,463,000

Net Revenue

7,563,701

7,324,720

Excess over budget revenue

238,981

(7563701-7324720)

Bonus :

23,898

(10% of 238981)

Though, based on the master budget data, Rita Smith is eligible for bonus, actually she should not be given until, budget figure is revised

to include sales of the product "internet", as explained earlier

3

Production Mgr (Bill Wilford)

Bonus :

Bonus of 3% of net of (efficiency or usage variance for Materials, Labour and variable Overheads;

the labour rate variance and the variable & fixed overhead spending variances. ) Only if net variance is fav.

Efficiency var of Materials

-122772

(Unfav)

labour efficency variance

-466638

(Unfav)

var overheads-eff variance

-181639

(Unfav)

Labour rate variance

-76329

(Unfav)

Var OH spending variance

-679,361

(Unfav)

(cost as per master budget Vs Actual expenditure)

Fixed OH spending variance

-556,908

(Unfav)

($6248920-$6805828)

Net variance (sum of above)

-2083647

(Unfav)

As the net variance is unfavourable, Mr. Bill is not eligible for any bonus.