Budgeting and Performance Evaluation at the Berkshire Toy Company Essay

Executive SummaryIn 1974, Berkshire Toy Company (BTC) was founded by Franklin Berkshire, Ja clams McKinleys farther. Ja lolly was soon became the chief operating officer of the company when her father retires on 1993. After two years, BTC was acquired by Quality Products Corporation, a manufacturer of different crossings, for a common stock of $23.2 million.The preliminary instruction of divisional operating income for the year ended June 30, 1998 presented the actual values generated together with the higher-up (static) budget and master budget divisions for the period. The company obtained higher Total tax than their budget but it turned out to an Operating Loss near a million dollars. This paper aims to study the budgets from actual results, and to compute the budget variances and to hit the books its causes. After that, the company instruction execution will be evaluated to recommend alternative solutions for improvement.IntroductionAs a division of Quality Products Corpor ation, Berkshire Toy Company produces the Berkshire Bear, a fifteen-inch teddy jump which are fully jointed, washable, and dressed in various accessories. It is sold to customers like children and adult collectors with unconditional lifetime guarantee. The company is organized into lead de divorcements purchasing (managed by David Hall), production (managed by Bill Willford) and marketing (managed by Rita Smith).An incentive compensation plan was implemented in 1997, intended to enhance the involution and team ca-ca of the managers. It provides bonuses for eachdepartment heads in the following conditions Purchasing 20% of net materials set variance, assuming aureate Marketing 10% of excess variance of net revenue, assuming favourable mathematical product 3% of net variance in material, labour, variant smash-up, labour rate variance, and the variable and fixed overhead disbursal, assuming favourable variances.Statement of the ProblemObtaining a loss approaching a million doll ars despite the increase in gross revenue. Substantial unfavourable variances resulting from production department effect of the incentive compensation plan to the performance of each departmentsDiscussion real(a)MasterBudget var.Units sold325,556.00280,000.0045,556.00Total revenue14,446,487.0013,006,000.001,440,487.00 (U)Total variable expenses8,484,4045,968,5082515,896 (U)Contribution margin5,962,0837,037,4921,075,409 (U)Total fixed costs6,805,8286,248,920556,908 (U)Operating income-843,745788,5721632,317 (U)Table 1. Preliminary Statement of Divisional Operating Income for the Year Ended June 30, 1998The following push aside be derived from the tableRevenue were 11% higher than the master budgetVariable expenses were $2,515,896 higher than the master budget Fixed costs were $556,908 higher than the master budgetActual(1)Master (Static) Budget(2) supple Master Budget(3)Sales Mix variance(1-3)Sales standard variance(3-2)Units sold325,556.00280,000325,556.00045,556.00 (F)Retail & catalog8,573,285.0011, 662,000.0013, 559,407.404,986,122.40 (U)1,897,407.40 (F)Internet4,428,018.00004,428,018.00 (F)0Wholesale1,445,184.001,344,000.001,562,668.80117,484.80 (U)218,668.80 (F)Total revenue14,446,487.0013,006,000.0015,122,076.20675,589.20 (U)2,116, 067.20 (F)Table 2. Sales Analysis ScheduleSales sight quantity variance indicates an increase in profit by $2,116,067.20 if the budgeted sales mix is maintained for the actual sales volume of 325,556. However, there is an unfavourable variance of $675,589.20 because the actual sales mix was not in accordance with the budgeted sales mix.If we would check the sales volume variance, sales volume quantity variance plus sales mix variance is equal to favourable $1,440,487.00, which is the variance in table 1.Production costsActualMaster Static BudgetFlexible BudgetMaster Budget VarianceFlexible varianceTotal use up Materials1,230,840.001,015,924.001,181,214.83214,916.00 (U)49,625.17 (U)Direct Labour3,668,305.002,688,000.003,1 25,337.60980,305.00 (U)542,967.40 (U)Variable Production overhead1,725,665.001,046,304.001,216,537.66679,361.00 (U)509,127.34 (U)Fixed Manufacturing overhead658,897661,920769,614.383023 (F)-110,717.38 (F)Table 3. Schedule of Production VariancesDirect Material varianceThe budgeted price is higher than the actual resulting to a favourable material price variance. This is cod to the price discounts of 7 to 10 percent of the three main inputs of the product namely acrylic pile fabric, plastic joints, and polyester fiber filling which contributed to some savings.However, the actual quantity used in production is greater than the standard quantity allowed per unit that results to unfavourable material usage variance. This whitethornbe because of substandard quality of materials used that more than materials are look ated to produce one unit of product. In addition, there was an incident of thunderstorm that ruined the uninsured materials wherein the company doesnt able to date from l arge amount of fiber filling.Another mover that would affect the direct material usage variance is the lifetime guarantee that the company offers which include the bear hospital since repairs or replacements of teddy bear are free. Also, defects whitethorn be a factor for the material variances which are only traced after the production process.Direct Labour varianceThe actual issue forth of hours used and the actual wage rate of BTC are higher than the standard rate allowed for the actual production. Since most part of the production of bear is assiduity-intensive, the company may spend a penny set a low standard for the number of hours required to produce a unit. Additional secure steps and inspection of the fabric color may have contributed to the actual force hours used.Moreover, shortages of length in the cutting stage may require redundant cutting set-ups which increase production time. Considering the production of the company, they have operated near to maximum capaci ty that the people are tired and some of them quit and had to be replaced at higher-than-standard wage rates that may lead to higher cost when unskilled manoeuvreers are employed.Variable OverheadDue to the effect of the increased in labor requirements, the company also incurred increased payroll taxes and fringes. Employees need to have overtime to meet the actual demanded product volume which is higher than the budgeted that consequently increase the overtime premiums paid by BTC.Since the company has been using the same machine since it was established, frequent breakdowns occurred that maintenance work have contributed to the increase in the variable expenses. This includes the maintenance labor andsupplies needed.Fixed OverheadThe increase in utilities expense was related to the overtime of employees in the production as the demand of teddy bear boost.Incentive blueprintDavid HallWith the favourable net materials price variance of $295,144.00, David Hall the Purchasing Manag er will have a bonus of $59,028.72.Rita Smith, Marketing ManagerSince the Actual Net Revenue is a loss, the marketing manager will not have bonus even if she manage to increase the company sales.Bill Wilford, Production ManagerDirect LabourVariable OverheadFixed OverheadDirect Material Efficiency Variance$ 122,790 (U)Direct Labor Efficiency Variance466,638.40 (U)Direct Labor rate Variance76,329.00 (U)Variable Overhead spending variance327,488.34 (U)Variable Overhead Efficiency Variance181,639.00 (U)Fixed Overhead spending variance(3,023.00) (F)Total Variance1,171,862 (U)BonusZeroAdvantages and Disadvantages of Incentive Compensation PlanAdvantagesDisadvantagesThe incentive plan will motivate department headsMarketing surgical incision focuses on less profitable distribution mix. Increase the morale of employees as their efforts will be rewarded Production Departmentuses low quality materialsforced to work overtimePerformance of the company will attract positive resultsPurchasing Dep artment bought discounted materials which may sacrifice the quality of production.ConclusionThough the company may have increased their number of sales for the current period, they still have incurred losses due to the unfavourable variances that have resulted from their production. Substantial increase in the number of bears sold is noted for the years performance. It can be assumed of a good performance of the marketing department. However, loss still occurred.The figures of sales may post a good performance conversely the current sales might give the lowest possible sales due to wrong sales mix. The marketing department has focused too much on the Internet Sales whereas it gives a lower contribution than the Retail Sales.Variances in the production of the product are due to the wrong focused of the department head because of the new incentive compensation program. Favourable direct material price variance occurred due to lower prices and discounts on the materials purchased. Howe ver, unfavourable material usage variance have occurred probably due to substandard materials were used to the production.Direct labour on the hand, have resulted to unfavourable variances on both efficiency and rate. Focused of the manager may be on the efficiency of labour due to the incentive program which gives the need to hire more skilled workers. This resulted to unfavourable labour rate variance. However, due to substandard materials were used the workers may have needed additional time to work on the teddy bears which still resulted to unfavourable variance.The incentive program may have good intentions but this lead the department heads on the wrong charge and have resulted to unfavourable variances. Other factors that may have affected the variances are the spoilage due to the thunderstorms that have occurred. Machine maintenance is another factor especially in the overhead variances where frequent breakdowns happened.Alternative solutions obtainFirst solution that we re commend is the revision of the incentive compensation plan. The objective of the plan is good and should be maintained however some computation for the said bonus should be changed. Computation of Bonus for the Marketing Manager could be retained as net revenue is a good measure not only in the performance of the marketing department but as well as the performance of the company.Computation for the Purchasing Manager should have also ciphered the Material Usage Variance as quality of the materials purchased in also a key factor in their production. Bonus for the production manager may have been a good computation as it may have covered different factors to pass judgment the performance of the department.On the other hand, some overhead expenses should be observed by the companyas it continuously increase overtime. They may need to consider purchasing new machine as maintenance cost has been a big part of their cost. A new machine may also turn the issue of frequent overtime of em ployees and the increasing maintenance supplies expenses.