Deck 6: Budgets and Budgeting

Question 1

Rogers Petersen and Cabots are two of the five largest investment banks in the united States. Last year there was a major scandal at Cabots involving manipulation of some auctions for government bonds. A number of senior partners at Cabots were charged with price fixing in the government bond market. The ensuing investigation led four of the eight managing directors (the highest-ranking officials at Cabots) to resign. A new senior managing director was brought in from outside to run the firm. This individual recruited three outside managing directors to replace the ones who resigned. There was then a thorough housecleaning. In the following six months, 15 additional partners and over 40 senior managers left Cabots and were replaced, usually with people from outside the firm.
Rogers Petersen has had no such scandal, and almost all of its senior executives have been with the firm for all of their careers.
Required:
a. Describe zero-based budgeting.
b. Which firm, Rogers Petersen or Cabots, is most likely to be using ZBB Why

Answer 1

Budget
It is an estimate that is made by a company in order to make projections for a definite period. This may be made for a quarter half year or may cover complete year. This is considered as a base to compare the actual performance.
a.Zero Based Budgeting is one of the methods of budgeting in which all expenses get justified for every new period. In this budgets are prepared with the zero base level and are built around what is required for the budgeted period in spite of the fact that the figures are higher or lower than the previous one.
b.Decision management is separated from the decision control in all kinds of budgeting systems. Managers, recommending the next year's budget, are not given the authority to approve the rights relating to the decisions. Rights relating to the decision monitoring, possessed by managers, shall too have the knowledge to implement the ratification rights.
There is no doubt that zero based budgeting is quite costly as compared to the incremental budgeting, in regard to operating the same, but at the same time, it is quite useful as it transfers much precise knowledge in regard to each line of item involving the budget.
The organizations experiencing high turnover in regards to the people about decision monitoring rights, in that case, the benefits attained by zero based budgeting are much higher as compared to the firms with stable management.
Mostly, managers are promoted vertically in an organization. As managers have their roots from lower level positions, they have the specific knowledge in regard to their subordinates' budgets. This concludes that zero based budgeting is lower in an organization having a minute turnover of senior management position.
Hence, because high external turnover in Cabots, zero based budgeting is more to be used in Cabots as compared to Rogers Petersen.

Question 2

Adrian Power manufactures small power supplies for car stereos. The company uses flexible budgeting techniques to deal with the seasonal and cyclical nature of the business. The accounting department provided the accompanying data on budgeted manufacturing costs for the month of January:
ADRIAN POWER
Planned Level of Production for January
Required:
a. Prepare a report comparing the actual operating results with the flexible budget at actual production.
b. Write a short memo analyzing the report prepared in (a). What likely managerial implications do you draw from this report What are the numbers telling you

Answer 2

The given case deals with a firm A.Power which deals in manufacturing small power supplies to car stereos and given the nature of its entity is following flexible style of Budgeting.We are required to analyze actual results, management performance for month of January of A.Power based on facts available to us.
WN-1: Calculation of Variable cost per unit based on budgeted details.
[a]
Flexible budget is a budget, in which the changes due to uncontrollable factors like volume changes are not considered.Variance report is a report that analyses the differences among the budgeted figures and actual figures and reports it to the management.
Variance report based on Flexible budget with the actual results is given below.
Here the Flexible budget is prepared by preparing the budget for 15400u (keeping fixed costs constant and variable cost per unit constant), based on the spirit of Flexible style of Budgeting. It could be used to prepare further such cases.
[b]
1. We need to prepare a memo analyzing the operating results for the given period.2. Remember to keep your memo short and as informative as possible.
3. The following could be used as a sample for preparing your memo.
To: Finance Director
From: Analyst, Finance Department
Date: 28/05/2020
Subject: Analysis on Operating results for January
There is a significant decrease in direct material cost accompanied with significant increase in other costs. The major increase in cost is labor cost.
The saving in direct material cost may be due to change in supplier.
This might have long term implications, both if the quality is superior or inferior positively or negatively.
The increase in labor cost might be a result of overall hike in labor costs in industry.
The management needs to improve in its cost management, while keeping entity's objective at the center of budget making.

Question 3

James, Inc., a large mail-order catalog firm, is thinking of expanding into Canada. The Buffalo district office would manage the expansion and must decide how much to spend on the advertising campaign. The expansion project will be either successful (S) or unsuccessful (U). The probability of success depends on the amount spent on the advertising campaign. If the project is successful, the gross profit (before advertising) is $1.4 million. If the project is unsuccessful, the gross profit (before advertising) is $100,000. The accompanying table lists how the probability of success varies with the amount of spending on the Canadian venture.
James, Inc., is a publicly traded firm and its senior managers and shareholders wish to maximize expected net cash flows from this venture. The Buffalo manager receives a bonus of 10 percent of the net profit (gross profit less advertising).
The bonus is paid only if the firm has gross profit net of advertising. If gross profit less advertising is negative, no bonus is paid. The manager wants to maximize her bonus and has private knowledge of how the probability of success varies with advertising.
Required:
a. What advertising level would senior managers choose if they had access to the Buffalo manager's specialized knowledge
b. What advertising level will the Buffalo manager select, knowing that senior managers do not have the specialized knowledge of the payoffs
c. If the advertising levels in (a) and (b) differ, explain why.

Answer 3

This problem is designed to illustrate that differences in risk sharing between agent and principal will cause the agent to take actions which maximize the agent's utility but not the principal's utility. In particular, since the agent does not share proportionally in the losses, the agent more readily accepts projects where losses are more likely as long as they also promise greater gains.
a. The following table derives the firm profit-maximizing level of spending on the campaign. As can be seen from the table, the firm will want the Buffalo manager to spend $10,000 on the campaign, which will yield expected net profit of $315,000 (net of the manager's expected bonus).
b. Based on the following set of calculations, the manager will choose to spend more on the project than profit-maximizing shareholders. The manager will seek to spend $145,000 on the project thereby reducing the expected profits of the firm from $315,000 to $295,610.
c. For increases in advertising, the manager's bonus falls for both success and unsuccessful outcomes. However, the expected bonus rises because more weight is being placed on the successful payoff which is worth a lot more than the unsuccessful outcome. Therefore, even though the bonus falls for successful and unsuccessful outcomes as advertising is increased, the expected bonus rises.
The two levels in parts a and b above differ because the manager views risk differently than the firm. In particular, the manager's bonus is bounded from below at zero. Therefore, if the manager spends a lot on marketing but is unsuccessful, the manager's bonus does not fall below $0. The manager is gambling with the shareholders' money, not the manager's bonus. This result does not depend on the manager being risk averse. Both the owner and manager value dollars.

Question 4

LaserFlo
Marti Meyers, vice president of marketing for LaserFlo, was concerned as she reviewed the costs for the AP2000 laser printer she was planning to launch next month. The AP2000 is a new commercial printer that LaserFlo designed for medium-sized direct mail businesses. The basic system price was set at $74,500; the unit manufacturing cost of the AP2000 is $46,295, and selling and administrative cost is budgeted at 33 percent of the selling price. The maintenance price she planned to announce was $85 per hour of LaserFlo technician time. While the $74,500 base price is competitive, $85 per hour is a bit higher than the industry average of $82 per hour. However, Meyers believed she could live with the $85 price. She is concerned because she has just received a memo from the Field Service organization stating that it was increasing its projected hourly charge for service from $35.05 to $38.25.
The $85 price Meyers was prepared to charge for service was based on last year's $35.05 service cost. She thought that using last year's cost was conservative since Field Service had been downsizing and she expected the cost to go down, not up. The $35.05 cost still did not yield the 60 percent margin on service that was the standard for other LaserFlo printers, but Meyers had difficulty justifying a higher maintenance price given the competition. With a service cost of $38.25, Meyers knows she cannot raise the price to the customer enough to cover the higher costs without significantly reducing sales. Given the higher cost of the LaserFlo field technicians and the prices charged for maintenance by the competition, she will not be able to make the profit target in her plan.
Background
LaserFlo manufactures, sells, and services its printers throughout the United States using direct sales and service forces. It has been in business for 22 years and is the largest of three manufacturers of high-speed laser printers for direct mailers in the United States. LaserFlo maintains its market leadership by innovating new technology. Direct mail marketing firms produce customized letters of solicitation for bank credit cards, real estate offers, life insurance, colleges and universities, and magazine giveaway contests. Personalized letters are printed on high-speed printers attached to computers that have the mailing information. The printers print either the entire letter or the address and salutation ("Dear Mrs. Jeremy McConnell") on preprinted forms. Direct mail firms have computer systems to manage their address lists and mailings, and LaserFlo printers are attached to the client's computer system.
Direct mail laser printers process very high volumes; a single printer commonly addresses 75,000 letters a day. Hence, LaserFlo printers for direct mail marketers differ from general-purpose high-speed printers. In particular, they have specialized paper transfer mechanisms to handle the often custom, heavy paper; varying paper sizes; and high-speed paper flows. With such high paper flow rates, these printers require regular adjustments to prevent paper jams and misalignments. LaserFlo's nationwide field service organization of about 500 employees maintains these printers.
The standard LaserFlo sales contract contains two parts: the purchase price of the equipment and a maintenance contract for the equipment. All LaserFlo printers are maintained by LaserFlo field service personnel, and the maintenance contract specifies the price per hour charged for routine and unscheduled maintenance. Most of LaserFlo's profits come from printer maintenance. Printers have about a 5 to 10 percent markup over manufacturing and selling cost, but the markup on maintenance has historically averaged about 60 percent.
LaserFlo printers have a substantial amount of built-in intelligence to control the printing and for self-diagnostics. Each printer has its own microcomputer with memory to hold the data to be printed. These internal microcomputers also keep track of printing statistics and can alert the operator to impending problems (low toner, paper alignment problems, form breaks). When customers change their operating system or computer, this often necessitates a LaserFlo service call to ensure that the new system is compatible with the printer. The standard service contract calls for normal maintenance after a fixed number of impressions (pages); for example, the AP2000 requires service after every 500,000 pages are printed. Its microcomputer is programmed to call LaserFlo's central computer to schedule maintenance whenever the machine has produced 375,000 pages since the last servicing.
LaserFlo organization
LaserFlo is organized into engineering, manufacturing, marketing, field service, and administration divisions. Engineering designs the new printers and provides consulting services to marketing and field service regarding system installation and maintenance. Engineering is evaluated as a cost center. Manufacturing produces the printers, which are assembled from purchased parts and subassemblies. LaserFlo's comparative advantage is quality control and design. Manufacturing also provides parts for field service maintenance. Manufacturing is treated as a cost center and evaluated based on meeting cost targets and delivery schedules. Manufacturing's unit cost is charged to marketing for each printer sold.
Marketing, a profit center, is responsible for designing the marketing campaigns, pricing the printers, and managing the field sales staff. LaserFlo sells six different printers; each has a separate marketing program manager. The six marketing program managers report to Marti Meyers, vice president of marketing, who also manages field sales.
Field sales is organized around four regional managers responsible for the sales offices in their region. Each of the 27 sales offices has a direct sales force that contacts potential customers and sells the six programs. Salespeople receive a salary and a commission depending on the printer and options sold. The salesperson continues to receive commissions from ongoing revenues paid by the account for service. Since ongoing maintenance forms a significant amount of a printer's total profit, the salesperson has an incentive to keep the customer with LaserFlo.
Field service contains the technical people who install and maintain the printers. Headed by Phil Hansen, vice president of field service, field service usually shares office space with field sales in the cities where they operate. Field service is a cost center, and its direct and indirect costs are charged to programs when the printers are serviced. The price charged is based on the budgeted rate set at the beginning of the year. Any difference between the actual amount charged to the programs and the total cost incurred by the field service group is charged to a corporate overhead account, not to the marketing programs.
Administration manages human resources, finance, accounting, and field office leases. It handles customer billing and collections, payroll, and negotiating office space for the field sales and field service people. Administration is evaluated as a cost center. While local office space is managed by administration, the cost of the office space is allocated to the field sales and service groups and included in their budgets and monthly operating statements.
Service contracts
Each LaserFlo printer sold requires a service contract. The AP2000's service contract calls for normal maintenance every 500,000 pages at a price of $0.51 per 1,000 pages. Normal maintenance requires three hours. The typical AP2000 prints 12 million pages per year. Besides normal maintenance (sometimes called preventive maintenance ), unscheduled maintenance occurs due to improper operator setups, paper jams, system upgrades, and harsh usage of the equipment. Past statistical studies have shown that each normal maintenance hour generates 0.50 unscheduled maintenance hours. Unscheduled maintenance is billed to the customer at the service contract rate of $85 per hour.
When maintenance is performed on a particular machine, the service revenues less field service costs are credited to the marketing manager for that program. All the programs' actual service profits are compared with the plan; they form part of Meyers's performance evaluation. The field salesperson receives a commission based on the total service revenue generated by the account. In evaluating each new printer program, LaserFlo uses the following procedure. Profits from service are expected to create an annuity that will last for five years at 18 percent interest. To evaluate a proposed new printer, the one-year maintenance profits are multiplied by 3.127 to reflect the present value of the future service profits each printer is expected to generate over its life (about five years).
Parts
Any parts used during service are charged directly to the customer and do not flow through field service budgets or operating statements. LaserFlo purchases most of the printers' parts from outside suppliers, and the customer pays only a token markup. Marketing does not receive any revenue, nor is it charged any costs when customers use parts in the service process. The reason for not charging customers a larger markup on parts stems from an antitrust case filed against LaserFlo and other printer companies six years ago. A third-party service company, Servwell, sued the printer manufacturers for restraint of trade, claiming they prevented Servwell from maintaining the printers by only selling replacement parts at very high prices. To prevent other such claims, LaserFlo sells parts at a small markup over costs. Yet Servwell and other third-party service firms have never been able to penetrate LaserFlo's service markets because laser printing technology changes rapidly, and an outside company cannot keep a work force trained to fix the latest products. Besides, each printer usually has at least two engineering modifications each year to fix problems or upgrade the printer or its microcomputer hardware and/or software. An outside service company cannot learn of these changes and provide the same level of service as LaserFlo.
Recent changes in field service
LaserFlo field service had two types of technicians: Tech1 and Tech2. Both were trained to repair electromechanical problems, but Tech2s had more training in electronics and computers to work on the latest, most sophisticated printers.
Field service had been trying to reduce the size of the service force the last few years through voluntary retirements and attrition. As the printers became more sophisticated, they became more reliable. The newer systems had self-diagnosing software that allowed a service technician to call up a customer's printer and run a diagnostic program. Often the problem was solved over the phone line by having a LaserFlo technician make the repair in the software. If a mechanical problem was detected, the technician dispatched a repair person (often a Tech1) with the right part. Also, past customers replaced their older printers with newer ones that required less maintenance. The result was excess capacity in the field staff.
The voluntary retirements over the past few years did not produce the reductions necessary to eliminate the excess capacity. In 2010, field service went through a very large involuntary reduction of its workforce. Through attrition, early retirements, and terminations, LaserFlo reduced the number of technicians by 75, down to 500 budgeted for 2011. The company simultaneously improved the skill level of its remaining field force substantially.
AP2000 sales plan for 2011
Marti Meyers's 2011 sales plan for the AP2000 calls for 120 placements this year and a program profit projection of about $2.5 million based on capitalizing the service income using the 3.127 annuity factor. If she were to raise the service price much above $0.51 per 1,000 pages, LaserFlo would lose sales, which are already ambitious. She called Phil Hansen and raised her concerns with him.
"Phil," she began, "explain to me how you downsized your field personnel, cut some office locations, consolidated inventories, and reduced other fixed costs, yet the price I'm being charged for service increased from $35.05 per hour to $38.25. I thought the whole purpose of the field service reorganization was to streamline and make us more cost competitive. You know that our service costs were out of line with our competitors'. We were planning to charge $85 an hour for the AP2000 service contract. Even at $85 per hour, I would be violating the corporate policy of maintaining a 60 percent markup on service. If I were to follow the 60 percent rule, I would have to charge $87.63 per hour if you had kept your cost to me at $35.05. But with your cost of $38.25 and my price at $85, the margin falls to 55 percent. I already had to get special permission to lower the margin to 59 percent with $35.05."
Hansen replied, "Well, there are a number of issues that you've just raised. Let me respond to a few over the phone now and suggest we meet to discuss this more fully next week when I'm back in the office. In the meantime, I'll send you our projected budget for next year that derived the $38.25 rate. Regarding the key question as to how our hourly rate could go up after downsizing, it's really quite simple. We had a lot of idle time being built into the numbers. People just pretended to be busy. Had we not downsized, the hourly charge would have gone up even more than it did. For example, on the AP2000 that you mentioned, we would have used 3.25 hours per normal servicing had we kept our labor force mix of Tech1s and 2s the same as in 2010. Had we not downsized, our fixed costs in 2011 would have remained the same as they were in 2010, and our variable costs for Tech1s and 2s would have increased to the 2011 amounts because of wage increases and inflation. Let me get you our numbers so you can see for yourself how much progress we've been making."
That afternoon, Meyers received a fax from Hansen's office (see Table 1). In trying to decide how to proceed, Meyers would like you to address the following questions:
a. Calculate the projected five-year profits of an AP2000 using first the $35.05 and then the $38.25 service cost.
T ABLE 1 Field Service Projected Hourly Rate for 2011

b. Why did the field service hourly cost increase? What caused the hourly rate to go from $35.05 to $38.25?
c. Did the reorganization of field service reduce the cost of servicing the AP2000? Calculate what the total annual service cost of the AP2000 would have been had the reorganization not occurred.
d. Identify the various options Meyers has for dealing with the service cost increase and analyze them.
e. Why does LaserFlo make more money on servicing printers than selling them? Does such a policy make sense?

Question 5

Panarude Airfreight is an international air freight hauler with more than 45 jet aircraft operating in the United States and the Pacific Rim. The firm is headquartered in Melbourne, Australia, and is organized into five geographic areas: Australia, Japan, Taiwan, Korea, and the United States. Supporting these areas are several centralized corporate function services (cost centers): human resources, data processing, fleet acquisition and maintenance, and telecommunications. Each responsibility center has a budget, negotiated at the beginning of the year with the vice president of finance. Funds unspent at the end of the year do not carry over to the next fiscal year. The firm is on a January-to-December fiscal year.
After reviewing the month-to-month variances, Panarude senior management became concerned about the increased spending occurring in the last three months of each fiscal year. In particular, in the first nine months of the year, expenditure accounts typically show favorable variances (actual spending is less than budget), but in the last three months, unfavorable variances are the norm. In an attempt to smooth out these spending patterns, each responsibility center is reviewed at the end of each calendar quarter and any unspent funds can be deleted from the budget for the remainder of the year. The accompanying table shows the budget and actual spending in the telecommunications department for the first quarter of this year.
PANARUDE AIRFREIGHT Telecommunications Department: First Quarter Budget and Actual Spending (Australian Dollars)
At the end of the first quarter, telecommunications' total annual budget for this year can be reduced by $7,000, the total budget underrun in the first quarter. In addition, the remaining nine monthly budgets for telecommunications are reduced by $778 (or $7,000 9). If, at the end of
the second quarter, telecommunications' budget shows an unfavorable variance of, say, $8,000 (after the original budget is reduced for the first-quarter underrun), management of telecommunications is held responsible for the entire $8,000 unfavorable variance. The first-quarter underrun is not restored. If the second-quarter budget variance is also favorable, the remaining six monthly budgets are each reduced further by one-sixth of the second-quarter favorable budget variance.
Required:
a. What behavior would this budgeting scheme engender in the responsibility center managers
b. Compare the advantages and disadvantages of the previous budget regime, where any end- of-year budget surpluses do not carry over to the next fiscal year, with the system of quarterly budget adjustments just described.

Question 6

In March, a devastating ice storm struck Monroe County, New York, causing millions of dollars of damage. Mathews Peat (M P), a large horticultural nursery, was hit hard. As a result of the storm, $653,000 of additional labor and maintenance costs were incurred to clean up the nursery, remove and replace damaged plants, repair fencing, and replace glass broken when nearby tree limbs fell on some of the greenhouses.
Mathews Peat is a wholly owned subsidiary of Agro Inc., an international agricultural conglomerate. The manager of Mathews Peat, R. Dye, is reviewing the operating performance of the subsidiary for the year. Here are the results for the year as compared with budget:

After thinking about how to present the performance of M P for the year, Dye decides to break out the costs of the ice storm from the individual items affected by it and report the storm separately. The total cost of the ice storm, $653,000, consists of additional labor costs of $320,000, additional materials of $220,000, and additional occupancy costs of $113,000. These amounts are net of the insurance payments received due to the storm. The alternative performance statement follows:

Required:
a. Put yourself in Dye's position and write a short, concise cover memo for the second operating statement summarizing the essential points you want to communicate to your superiors.
b. Critically evaluate the differences between the two performance reports as presented.

Question 7

Veriplex manufactures process control equipment. This 100-year-old German company has recently acquired another firm that has a design for a new proprietary process control system. A key component of the new system to be manufactured by Veriplex is called the VTrap, a new line of precision air-flow gauges.
Veriplex uses tight financial budgets linked to annual bonuses to control its manufacturing departments. Each manufacturing department is a cost center. The VTrap gauge is being manufactured in Veriplex's gauge department, which also manufactures an existing line of gauges. The gauge department's budget for the current year consists of two parts: €6.60 million for manufacturing the existing line of gauges and €0.92 million to develop and manufacture VTrap.
The gauge department is responsible for introducing VTrap, which has been in development in the gauge department since the beginning of the year. The new gauge will be manufactured using much of the same equipment and personnel as the existing gauges. VTrap is an integral part of the proprietary process control system that Veriplex hopes will give it a sustainable competitive advantage. Senior management is heavily committed to this strategy. Senior engineering staff members are always in the gauge department working with the manufacturing personnel to modify and refine both the gauges' design and the production processes to produce them. (Note: Engineering department costs are not assigned to the gauge department.)
By the end of the fiscal year, the gauge department had spent €1.30 million on the VTrap program and €6.39 million on existing gauge production. Both the new and existing gauge lines achieved their target production quotas and quality goals for the year.
Required:
a. Prepare a financial statement for the gauge department that details its financial performance for the fiscal year just completed.
b. Upon further investigation of previous new product introductions, you discover the same patterns in other departments between new and existing products and their budgets and actual costs. What are some possible reasons why the pattern in the gauge department is not an isolated occurrence but has occurred with other new product introductions and is likely to occur with future new product introductions

Question 8

a. What is the difference between budget lapsing and line-item budgets
b. What types of organizations would you expect to use budget lapsing
c. What types of organizations would you expect to use line-item budgets

Question 9

Madigan produces a single high-speed modem. The following table summarizes the current month's budget for Madigan's modem production:

Actual production and sales for the month were 3,900 units. Total production costs were $1,114,800, of which $631,800 were variable costs.
Required:
a. Prepare an end-of-month variance report for the production department using the beginning-of-month static budget.
b. Prepare an end-of-month variance report for the production department using the beginning-of-month flexible budget.
c. Write a short memo evaluating the performance of the production manager based on the variance report in (a).
d. Write a short memo evaluating the performance of the production manager based on the variance report in (b).
e. Which variance report-the one in (a) or (b)-best reflects the performance of the production manager Why

Question 10

Question 11

Webb Drye (WD) is a New York City law firm with over 200 attorneys. WD has a sophisticated set of information technologies-including intranets and extranets, e-mail servers, the firm's accounting, payroll, and client billing software, and document management systems-that allows WD attorneys and their expert witnesses access to millions of pages of scanned documents that often accompany large class action lawsuits. Bev Piccaretto was hired at the beginning of last year to manage WD's IT department. She and her staff maintain these various systems, but they also act as an internal consulting group to WD's professional staff. They help the staff connect to and use the various IT systems and troubleshoot problems the staff may encounter.
The IT department is a cost center. Piccaretto receives an annual operating budget and believes she is accountable for not exceeding the budget while simultaneously providing high- quality IT services to WD. Piccaretto reports to Marge Malone, WD's chief operating officer. Malone is responsible for IT, accounting, marketing, human resources, and finance functions for Webb Drye. She reports directly to WD's managing partner, who is the firm's chief executive officer.
The fiscal year has just ended. The following table contains IT's annual budget, actual amounts spent, and variances from the budget.

Malone expresses her concern that the IT department had substantial deviations from the original budgeted amounts for software licenses and salaries, and that Piccaretto should have informed Malone of these actions before they were implemented. Piccaretto argues that since total spending within the IT department was in line with the total budget of $1,657,000 she managed her budget well. Furthermore, Piccaretto points out that she had to buy more sophisticated antivirus software to protect the firm from hacker attacks and that, in paying for these software upgrades, she did not replace a staff person who left in the fourth quarter of the year. Malone counters that this open position adversely affected a large lawsuit because the attorneys working on the case had trouble downloading the scanned documents in the document management system that IT is responsible for maintaining.
Required:
Write a short memo analyzing the disagreement between Malone and Piccaretto. What issues underlie the disagreement Who is right and who is wrong What corrective actions (if any) do you recommend

Question 12

Two years ago Federal Insurance was charged with making misleading marketing claims about the way it was selling its insurance products. In response to these allegations and subsequent investigations, Federal's board of directors fired the chief executive officer (CEO), the chief financial officer (CFO), and the senior vice presidents of marketing and underwriting. They replaced these managers last year with other managers from within the insurance industry, but from firms other than Federal.
A similar insurance firm, Northeast, is about the same size as Federal, operates in the same states, and writes the same lines of insurance (home, auto, life). Both firms prepare detailed annual budgets.
Which of the two firms, Federal or Northeast, is more likely to use zero-based budgeting and why

Question 13

Spa Ariana promotes itself as an upscale spa offering a variety of treatments, including massages, facials, and manicures, performed in a luxurious setting by qualified therapists. The owners of Spa Ariana invested close to $450,000 of their own money three years ago in building and decorating the interior of their new spa (six treatment rooms, relaxation rooms, showers, and waiting area). Located on the main street in a ski resort, the spa has a five-year renewable lease from the building owner. The owners hire a manager to run the spa.
The average one-hour treatment is priced at $100. Ariana has the following cost structure:
Assume that all treatments have the same variable cost structure depicted in the table.
Required:
a. Calculate the number of treatments Spa Ariana must perform each month in order to break even.
b. In April, the owners of Ariana expect to perform 550 treatments. Prepare a budget for April assuming 550 treatments are given.
c. In April Spa Ariana performs 530 treatments and incurs the following actual costs. Prepare a performance report for April comparing actual performance to the static budget in part (b) based on 550 treatments.
Actual Operating Results for April
d. Prepare a performance report for April comparing actual performance to a flexible budget based on the actual number of treatments performed in April of 530.
e. Which of the two performance reports you prepared in parts (c) and (d) best reflect the true performance of the Spa Ariana in April Explain your reasoning.
f. Do the break-even calculation you performed in part (a) and the budgeted and actual profits computed in parts (a) - (d) accurately capture the true economics of the Ariana Spa Explain why or why not.

Question 14

Golf World is a 1,000-room luxury resort with swimming pools, tennis courts, three golf courses, and many other resort amenities.
The head golf course superintendent, Sandy Green, is responsible for all golf course maintenance and conditioning. Green also has the final say as to whether a particular course is open or closed due to weather conditions and whether players can rent motorized riding golf carts for use on a particular course. If the course is very wet, the golf carts will damage the turf, which Green's maintenance crew will have to repair. Since she is out on the courses every morning supervising the maintenance crews, she knows the condition of the courses.
Wiley Grimes is in charge of the golf cart rentals. His crew maintains the golf cart fleet of over 200 cars, cleans them, puts oil and gas in them, and repairs minor damage. He also is responsible for leasing the carts from the manufacturer, including the terms of the lease, the number of carts to lease, and the choice of cart vendor. When guests arrive at the golf course to play, they pay greens fees to play and a cart fee if they wish to use a cart. If they do not wish to rent a cart, they pay only the greens fee and walk the course.
Grimes and Green manage separate profit centers. The golf cart profit center's revenue is composed of the fees collected from the carts. The golf course profit center's revenue is from the greens fees collected. When the results from April were reviewed, golf cart operating profits were only 49 percent of budget. Wiley argued that the poor results were due to the unusually heavy rains in April. He complained that there were several days when, though only a few areas of the course were wet, the entire course was closed to carts because the grounds crew was too busy to rope off these areas.
To better analyze the performance of the golf cart profit center, the controller's office recently implemented a flexible budget based on the number of cart rentals:

Required:
a. Evaluate the performance of the golf cart profit center for the month of April.
b. What are the advantages and disadvantages of the controller's new budgeting system
c. What additional recommendations would you make regarding the operations of Golf World

Question 15

Picture Maker is a freestanding photo kiosk consumers use to download their digital photos and make prints. Shashi Sharma has a small business that leases several Picture Makers from the manufacturer for $120 per month per kiosk, and she places them in high-traffic retail locations. Customers pay $0.18 per print. (The kiosk only makes six- by eight-inch prints.) Sharma has one kiosk located in the Sanchez Drug Store, for which Sharma pays Sanchez $80 per month rent. Sharma checks each of her kiosks every few days, refilling the photographic paper and chemicals, and collects the money. Sharma hires a service company that cleans the machine, replaces any worn or defective parts, and resets the kiosk's settings to ensure the kiosk continues to provide high-quality prints. This maintenance is performed monthly and is independent of the number of prints made during the month. The average cost of the service runs about $90 per month, but it can vary depending on the extent of repairs and parts required to maintain the equipment.
Paper and chemicals are variable costs, and maintenance, equipment lease, and store rent are fixed costs. If the kiosk is malfunctioning and the print quality deteriorates, Sanchez refunds the customer's money and then gets his money back from Sharma when she comes by to check the paper and chemical supplies. These occasional refunds cause her variable costs perprint for paper and chemicals to vary over time.
The following table reports the results from operating the kiosk at the Sanchez Drug Store last month. Budget variances are computed as the difference between actual and budgeted amounts. An unfavorable variance (U) exists when actual revenues fall short of budget or when actual expenses exceed the budget. Last month, the kiosk had a net loss of $23, which was $87 more than budgeted.
Sanchez Drug Store Kiosk Last Month
Required:
a. Prepare a schedule that shows the budget Sharma used in calculating the variances in the preceding report.
b. How many good prints were made last month at the Sanchez Drug Store kiosk
c. Prepare a flexible budget for the Sanchez Drug Store kiosk based on a volume of 2,000 prints.

Question 16

Bay View Country Club is considering imposing a minimum spending plan on its members. Each member would prepay $50 of restaurant charges at the beginning of each month in addition to the normal dues. At the end of the month, a member who has restaurant charges in excess of $50 is billed the difference. A member who spends less than $50 in any month loses whatever he or she doesn't spend. (Note: Only members or their guests can eat at the club. The club's restaurant is not open to the general public.)
In explaining why the minimum is being proposed, the treasurer gave the following reasons:
The food operation is losing more money than budgeted. We have always budgeted to lose about $50,000 in the restaurant. But this year, the projected loss is $150,000. The problem is the revenue side of the budget. Revenues are down about 20 percent from budget, while costs are on target. If the members are unwilling to support the restaurant by eating here, then they have to pay for the unbudgeted deficit of $100,000 with either higher dues, a special assessment, or a minimum spending plan.
About one-third of the members spend in excess of $50 per month at the restaurant, but two- thirds spend less than $50 per month. It is not fair that one-third of the members are supporting the other two-thirds.
Knowing how much the members will be eating at the club each month will help tremendously in our budgeting and planning process. It will cut down on food waste because we will know how much revenue we will be generating and can plan accordingly.
Required:
Critically evaluate the costs and benefits of the proposed minimum spending plan. What consequences are likely to result

Question 17

City Hospital is a city government-owned and -operated hospital providing basic health care to low- income people. Most of the hospital's revenues are from federal, state, county, and city governments. Some patients covered by private insurance are also admitted, but most of the patients are covered by government assistance programs (Medicare and Medicaid).
Maxine Jones is the director of nursing for the 40-bed pediatrics unit at City Hospital. She is responsible for recruiting nurses, scheduling when they work (days, evenings, weekends), and preparing the nursing budget for the pediatrics unit. A variety of different nursing skills is needed to staff the unit: There are nursing aides, nurse practitioners, registered nurses, nursing supervisors, and clinical nurses. Each type of nurse provides different patient care services (care and feeding, drawing blood samples, giving injections, changing dressings, supervising, etc.). Not all types of nurses can provide all services, and each type of nurse has a different wage rate. Minimum nurse staffing levels per patient must be maintained. If the minimums are violated, new patients cannot be admitted.
Over 45 full-time nurses are required to staff the pediatrics unit. The number of each type of nurse is set in the budget (8 nurses aides, 12 nurse practitioners, 14 registered nurses, etc.). To change the mix of nurse types or their wage rates during the year requires time-consuming approval from the nursing administration, the hospital administration, and finally the city council. The director can change the staffing mix and pay scales in the next budget year by submitting a budget with the revised staffing levels and wage rates and having the budget approved through a lengthy review process that ultimately requires the city council's agreement.
In selecting where to work, nurses evaluate working conditions, pay, and amenities, as all employees do. A key working condition for nurses is flexibility in choosing their schedule. Because of the shortage of nurses in the community, all hospitals have become competitive in terms of work schedules and hours. Some private hospitals allow nurses to schedule when they want to work and how many hours a week they are willing to work. City Hospital often finds its nurses being hired away by private hospitals. If a nurse practitioner is hired away, Jones must replace her or him with another nurse practitioner. The private hospitals do not have such a constraint. If a nurse practitioner position is open, a private hospital will temporarily move a registered nurse with a higher level of skills into the position until a nurse practitioner can be found.
Required:
a. What type of specialized knowledge does Maxine Jones acquire in preparing the nursing schedule for the upcoming month
b. What are some of the consequences of the constraints Jones must operate under
c. Explain why City Hospital does not allow Jones as much freedom in her staffing decisions as her counterparts in private hospitals.

Question 18

The coating department of a parts manufacturing department coats various parts with an antirust, zinc- based material. The parts to be processed are loaded into baskets; the baskets are passed through a coating machine that dips the parts into the zinc solution. The machine then heats the parts to ensure that the coating bonds properly. All parts being coated are assigned a cost for the coating department based on the number of hours the parts spend in the coating machine. Prior to the beginning of the year, cost categories are accumulated by department (including the coating department). These cost categories are classified as either fixed or variable and then a flexible budget for the department is constructed. Given an estimate of machine hours for the next year, the coating department's projected cost per machine hour is computed.
Here are data for the last three operating years. Expected coating machine hours for 2012 arre 16,000 hours.
Required:
a. Estimate the coating department's flexible budget for 2012. Explicitly state and justify the assumptions used in deriving your estimates.
b. Calculate the coating department's cost per machine hour for 2012.

Question 19

Madden International is a large ($7 billion sales), successful international pharmaceuticals firm operating in 23 countries with 15 autonomous subsidiaries. The corporate office consists of five vice presidents who oversee the operations of the subsidiaries. These five vice presidents report to two executive vice presidents, who in turn report to the president of the firm.
The 15 subsidiaries specialize by pharmaceutical type and in some cases by country. The pace of innovation in this industry is very fast. In addition, each country has its own elaborate regulatory environment that controls new drug introduction, pricing, and distribution. Each market has its own peculiarities concerning hospital drug purchases. It is an understatement to say that Madden International operates in a very complex world that changes daily.
The corporate office requires each subsidiary to maintain an elaborate, detailed budget and control system. The following points summarize the budget and control system in each subsidiary:
• Every three months the subsidiaries must reconcile actual performance to budget and write detailed reports to the corporate office explaining variances and corrective actions to be taken.
• The corporate vice president assigned to the subsidiary makes quarterly visits for three days of meetings that involve extensive reviews of the budgets and operating results. These meetings involve all the senior managers in the subsidiary.
• Subsidiary senior managers are not compensated or rewarded for meeting budget targets. Rather, they are evaluated on their ability to develop new markets, solve short-run problems, add value to their organization and to Madden International, and manage and motivate their subordinates. These performance evaluation criteria are quite subjective. But the corporate vice presidents have a great deal of in-depth personal contact with each of the senior people in their subsidiaries and are able to arrive at suitable performance evaluations.
• Preparing for these meetings with the corporate vice president and developing the budgets requires the involvement of all the senior managers in the subsidiary. One manager remarked, "I'd hate to see how much more money we could be making if we didn't have to spend so much time in budget and financial review meetings."
It turns out that Madden International is not unique in the amount of senior management time spent on budgeting and financial reviews. A survey of large, publicly traded U.S. firms supports the Madden system. Researchers found that innovative firms in complex environments characterized by high uncertainty and change used much more elaborate formal financial control (budgeting) systems than did firms in more stable, mature industries. Innovative firms seem to employ more financial controls than less-innovative firms.
Required:
a. List the strengths and weaknesses of the budgeting and control system at Madden International.
b. Why might you expect firms like Madden International to rely so heavily on formal financial control systems

Question 20

Robin Jensen, manager of market planning for Viral Products of the IDP Pharmaceutical Co., is responsible for advertising a class of products. She has designed a three-year marketing plan to increase the market share of her product class. Her plan involves a major increase in magazine advertising. She has met with an advertising agency that has designed a three-year ad campaign involving 12 separate ads that build on a common theme. Each ad will run in three consecutive monthly medi285cal magazines and then be followed by the next ad in the sequence. Up to five medical journals will carry the ad campaign. Direct mail campaigns and direct sales promotional material will be designed to follow the theme of the ad currently appearing. The accompanying table summarizes the cost of the campaign:

The firm's normal policy is to budget each year as a separate entity without carrying forward unspent monies. Jensen is requesting that, instead of just approving the budget for next year (Year 1 above), the firm approve and budget the entire three-year project. This would allow her to move forward with her campaign and give her the freedom to apply any unspent funds in one year to the next year or to use them in another part of the campaign. She argues that the ad campaign is an integrated project stretching over three years and should be either approved or rejected in its entirety.
Required:
Critically evaluate Jensen's request and make a recommendation as to whether a three-year budget should be approved per her proposal. (Assume that the advertising campaign is expected to be a profitable project.)

Question 21

Republic Insurance has a direct sales force that sells life insurance policies. All salespeople at the beginning of the year forecast the number of policies they expect to sell that year. At the end of the year, they are evaluated based on how many policies they actually sell. The compensation scheme is based on the following formula:
Total compensation = $20,000 + $100B + $20(S - B) if S B
$20,000 + $100B - $400(B - S) if S B
where
B = Budgeted number of policies reported by the manager S = Actual number of policies sold
Required:
a. Suppose a particular salesperson expects to sell 100 policies. This salesperson is considering reporting budgeted policies of 90, 99, 100, 101, 102, and 110. What level of budgeted policy sales should this person report at the beginning of the year
b. Critically analyze the Republic Insurance compensation scheme.

Question 22

Potter-Bowen (PB) manufactures and sells postage meters throughout the world. Postage meters print the necessary postage on envelopes, eliminating the need to affix stamps. The meter keeps track of the postage, the user takes the meter's counter to a post office and pays money, and the post office initializes the meter to print postage totaling that amount. The firm offers about 30 different postage systems, ranging from small manual systems (costing a few hundred dollars) to large automated ones (costing up to $75,000).
PB is organized into Research and Development, Manufacturing, and Marketing. Marketing is further subdivided into four sectors: North America, South America, Europe, and Asia. The North American marketing sector has a sales force organized into 32 regions with approximately 75 to 200 salespeople per region.
The budgeting process begins with the chief financial officer (CFO) and the vice president of marketing jointly projecting the total sales for the next year. Their staffs look at trends of the various PB models and project total unit sales by model within each marketing sector. Price increases are forecast and dollar sales per model are calculated. The North American sector is then given a target number of units and a target revenue by model for the year. The manager of the North American sector, Helen Neumann, and her staff then allocate the division's target units and target revenue by region.
The target unit sales for each model per region are derived by taking the region's historical percentage sales for that machine times North America's target for that model. For example, model 6103 has North American target unit sales of 18,500 for next year. The Utah region last year sold 4.1 percent of all model 6103s sold in North America. Therefore, Utah's target of 6103s for next year is 758 units (4.1% X 18,500). The average sales price of the 6103 is set at $11,000. Thus, Utah's revenue budget for 6103s is $8,338,000. Given the total forecasted unit sales, average selling prices, and historical sales of each model in all regions, each region is assigned a unit target and revenue budget by model. The region's total revenue budget is the sum of the individual models' revenue targets.
Each salesperson in the region is given a unit and revenue target by model using a similar procedure. If Gary Lindenmeyer (a salesperson in Utah) sold 6 percent of Utah's 6103s last year, his unit sales target of 6103s next year is 45 units (6% X 758). His total revenue target for 6103s is $495,000 (or 45 X $11,000). Totaling all the models gives each salesperson's total revenue budget. Salespeople are paid a fixed salary plus a bonus. The bonus is calculated based on the following table:
Required:
Critically evaluate PB's sales budgeting system and sales force compensation system. Describe any potential dysfunctional behaviors that PB's systems are likely to generate.

Question 23

Old Rosebud is a Kentucky horse farm that specializes in boarding thoroughbred breeding mares and their foals. Customers bring their breeding mares to Old Rosebud for delivery of their foals and after-birth care of the mare and foal. Recent changes in the tax laws brought about a substantial

decline in thoroughbred breeding. As a result, profits declined in the thoroughbred boarding industry.
Old Rosebud prepared a master budget for the current year by splitting costs into variable costs and fixed costs. The budget was prepared before the extent of the downturn was fully recognized. Table 1 above compares actual with budget for the current year.
Required:
Prepare an analysis of the operating performance of Old Rosebud Farms. Supporting tables or calculations should be clearly labeled.

Question 24

Artisans Shirtcraft
Background
Artisans Shirtcraft manufactures and sells hand-painted shirts of original design. The company was founded in 1992 by three sisters: Cathy, Linda, and Valerie Montgomery. Shirtcraft started out as a means of financing a hobby; profits from shirt sales were used to pay the cost of supplies. However, word of the sisters' appealing products spread quickly, eventually creating strong and widespread demand for Shirtcraft shirts. By 1996, the year of Shirtcraft's incorporation, the company no longer relied on selling at the occasional crafts fair. It now earned almost all of its revenues through sales to upscale boutiques and department stores. Shirtcraft had grown into a legitimate business, but the hobby mentality remained. The company retained a simple approach that had served it well: Buy quality materials when available at a bargain price and produce them into shirts. At this time, the sisters had a ready market for whatever they could produce.
In 1997, the sisters loosely organized Shirtcraft into three functional areas, each based around a talent at which one of them excelled. Cathy would hunt high and low for the best prices, Linda would oversee the painting of the original designs, and Valerie would sell the shirts and deal with the general annoyances of business administration. No separate departmental financial records were kept.
Demand for Shirtcraft shirts continued to grow. To finance additional production, the company had become increasingly dependent upon debt. By the beginning of the 2000s, bankers had become an integral part of life at Shirtcraft. The sisters were devoting themselves primarily to executive administration, leaving most day-to-day operations to hired managers.
By the end of 2002, more than 75 employees were on the payroll. However, some of Shirtcraft's creditors began to get cold feet. Given the sluggish economy, some felt that continued investment in a company such as Shirtcraft would be foolish. In light of the scrutiny under which their industry presently operated, the bankers wondered about the prudence of increased and continued commitment to a company that was virtually devoid of financial controls. The bankers were particularly concerned by Shirtcraft's continuing reliance on the bargain purchase strategy. They thought the company would inevitably vacillate between periods of incurring excessive inventory holding costs for overpurchased materials and periods of lost sales due to underpurchasing. If Shirtcraft wanted the banks to commit long term to a rapidly growing credit line, the sisters would have to demonstrate their willingness to establish organizational structures and controls such as those found in larger companies.
Plan
In April 2003, a plan was established. Three functional areas were organized: purchasing, production, and sales and administration. Purchasing and production would be cost centers, each monitored by comparisons of actual costs to budgeted costs. Compensation for key personnel of the cost centers would be tied to the results of this comparison. The sisters would officially be employees of the sales and administrative department, which would hold final responsibility for all executive and corporate decisions. Key employees of sales and administration would be judged and compensated based on overall firm profitability.
For the 12 months beginning in September 2003, the sisters expected to sell 192,000 shirts at an average price of $23 per shirt. Expenses for the sales and administrative department are estimated at $750,000 for the year. Interest expenses for the period are estimated at $550,000. Incentive pay to the various departments is expected to amount to $75,000 per functional area. Under the plan, all expenses are charged to the individual department that incurs them, except for interest expenses, taxes, and incentive pay. These are treated as corporate profit and loss items. Taxes are expected to be 40 percent of corporate pretax income.
After considerable negotiations between the sisters and the purchasing manager, it was agreed that direct materials costs should average about $7 per shirt if purchases are made based on production department demand. Although this approach results in higher direct materials costs than a bargain purchase strategy, the demand-based purchase strategy is cheaper when opportunity costs such as inventory holding costs and contribution margin forgone due to lost sales are considered. Salaries and other overhead for the purchasing department are expected to amount to $150,000 for the year.
Discussions with the production manager led to estimates that production will use fixed overhead costing $240,000. Production's variable overhead consists wholly of direct labor. An average of 1/2 hour of direct labor, at a cost of $6 per hour, is needed for each shirt.
Previously, financial records were kept only on a corporate level. Under the new plan, cost records, both budgeted and actual, will be kept for each department. Of Shirtcraft's sales, 40 percent are expected to occur during September, October, November, and December. Sales are divided equally between months within each group of months. All costs that do not vary with shirt production are divided equally throughout the year. All monthly purchasing and production are based on that month's orders and are assumed to be completely sold during that month. Only negligible inventory is held.
Required:
a. Considering only costs, prepare budgeted annual and monthly financial statements for purchasing and production. (Assume that production is not responsible for any costs already assigned to purchasing.) Prepare an annual budgeted income statement for Artisans Shirtcraft for the period September 2003 through August 2004. Annual costs for income statement purposes consist of the following:
Cost of goods sold
Administrative expenses
Interest
Taxes
All salaries and overhead for purchasing and production are treated as product costs and assigned to individual units. Therefore, these costs should be included in Shirtcraft's annual income statement under cost of goods sold.
b. In general terms, consider the changes in Shirtcraft due to growth. How is the company different from an organizational standpoint What role do budgeting and cost centers have in attempting to meet the challenges presented by this growth

Question 25

The purchasing department at Feder buys all of its raw materials, supplies, and parts. This department is a cost center. It uses a flexible budget based on the number of different items purchased each month to forecast spending and as a control mechanism.
At the beginning of February, the purchasing department expected to purchase 8,200 different items. Given this expected number of purchased items, purchasing calculated its flexible budget for February to be $1,076,400. In reviewing actual spending in February, the purchasing department was over its flexible budget by $41,400 (unfavorable) when calculated using the actual number of items purchased. Actual spending in February was $1,175,000, and the department purchased 9,300 units.
Budgeted fixed cost and budgeted variable cost per item purchased remained the same in the flexible budgets calculated at the beginning and end of February.
Required:
Calculate the fixed cost and the variable cost per item purchased used in the purchasing department's flexible budget in February.

Question 26

Adrian and Pells (AP) is an advertising agency that uses flexible budgeting for both planning and control. One of its clients, Troika Toys, asked AP to prepare an ad campaign for a new toy. AP's contract with Troika calls for paying AP $120 per design hour for between 150 and 200 hours.
AP has a staff of ad campaign designers who prepare the ad campaigns. Customers are billed only for the time designers work on their project. Partner time is not billed directly to the customer. As part of the planning process, Sue Bent, partner-in-charge of the Troika account, prepared the following flexible budget. "Authorized Design Hours" is the estimated range of time AP expects the job to require and what the client agrees to authorize.

AP's executive committee reviewed Bent's budget and approved it and the Troika contract. After some preliminary work, Troika liked the ideas so much it expanded the authorized time range to be between 175 and 250 hours.
Bent and her design team finished the Troika project. Two hundred and twenty design hours were logged and billed to Troika at the contract price ($120 per hour). Upon completion of the Troika campaign, the following revenues and costs had been accumulated:

AP's accounting manager keeps track of actual costs incurred by AP on each account. AP employs a staff of designers. Their average salary is $45 per hour. New designers earn less than the average; those with more experience earn more. The actual design labor costs charged to each project are the actual hours times the designer's actual hourly cost. Artwork consists of both in-house and out-of-house artists who draw up the art for the ads designed by the designers. Office and occupancy costs consist of a charge per designer hour to cover rent, photocopying, and phones, plus actual long-distance calls, faxes, and overnight delivery services.
Required:
Prepare a table that reports on Sue Bent's performance on the Troika Toys account and write a short memo to the executive committee that summarizes her performance on this project.

Question 27

Using the data in Table 6-1 (on page 241), how much did it cost the members of Bay View Country Club to operate the club for September 2008

Question 28

Access.Com produces and sells software to libraries and schools to block access to Web sites deemed inappropriate by the customer. In addition, the software also tracks and reports on Web sites visited and advises the customer of other Web sites the customer might choose to block. Access.Com's software sells for between $15,000 and $20,000.
Three account managers (V J. Singh, A. C. Chen, and P. J. Martinez) sell the software and are paid a fixed salary plus a percentage of all sales in excess of targeted (budgeted) sales. Vice President of Marketing S. B. Ro sets the budgeted sales amount for each account manager. The following table reports actual and budgeted sales for the three account managers for the past five years.
Required:
a. Based on the data in the table, describe the process used by Ro to set sales quotas for each account manager.
b. Discuss the pros and cons of Access.Com's budgeting process for setting account managers' sales targets.

Question 29

The sales department of a cellular phone company pays its salespeople $1,500 per month plus 25 percent of each new subscriber's first month's billings. A new subscriber's first-month bill averages $80. Salespeople work 160 hours a month (four weeks at 40 hours per week). If salespeople work more than 160 hours per month, they receive $12 per hour for hours in excess of 160.
Sales leads for the sales department are generated in a variety of ways-direct mailings to potential customers who then call to speak to a salesperson, lists of prospective customers purchased from outside marketing firms, and so forth. The manager of the sales department reviews potential leads and assigns them to particular salespeople who contact them. The manager of the sales department is expected to oversee the time spent by each salesperson per assigned lead and to approve overtime requests to work beyond the 40 hours per week. Each new customer added requires on average 2 hours of salesperson time to make the sale.
Last month, the sales department was budgeted for eight full-time salespeople. However, because of a new ad campaign, an additional salesperson was hired and overtime was approved, bringing actual hours worked up to 1,580. The department added 725 new customers.
Required:
a. Prepare a performance report comparing actual performance to budgeted performance using a static budget based on eight salespeople and no budgeted overtime.
b. Prepare a performance report comparing actual performance to budgeted performance using a flexible budget based on nine salespeople selling 725 new accounts.
c. Discuss when you would expect to see the report prepared in (a) used and when you would expect to see the report in (b) used.

Question 30

Eastern University Catalog
Eastern University publishes and distributes over 100,000 copies of its Official Bulletin on Undergraduate Studies to prospective students, high school guidance counselors, faculty and staff of the university, and other interested parties. This 250-page catalog with four-color pictures is one of the primary marketing devices for the university's undergraduate programs. High school seniors expressing interest in attending the university receive the Bulletin along with other information about the university. It lists the various programs of studies, course offerings, and requirements. Each year it is revised and reprinted as courses and programs change, and the photographs are updated to improve it as a recruiting tool. The annual cost of preparing and printing the Bulletin is about $1 million, which includes the cost of photographers, nonuniversity graphic designers, typesetting, and printing but excludes the cost of university employees who rewrite the text, proofread the galleys, and manage the entire process.
The responsibility of preparing the catalog is shared by the admissions office and public relations. The admissions office coordinates collection of the basic data on course and program changes. Many of these are not known until May, after the various faculties have met and approved academic program and course changes. These changes are edited and the overall content of the publication is determined based on the admissions office's experience with high school applicants. Admissions then sends a draft copy of the brochure to public relations. Public relations is responsible for the overall image and publicity of the university and for ensuring that the university publications present a consistent image. Public relations, using outside graphic designers, marketing specialists, typesetters, and printers its staffers have come to know, takes the changes and produces an attractive, high-quality brochure. Admissions reports to the dean of the undergraduate college, who reports to the president. Public relations reports to the vice president of external affairs, who reports to the president. The admissions office affects the cost of the brochure in terms of the quantity of text to be included and how many Bulletins must be ordered to satisfy its distribution plan. Public relations affects the cost by using more color photographs, more expensive paper and cover materials, and elaborate layouts. Both admissions and public relations raise the cost by not meeting timely production schedules. If copy is returned late or the design is not completed on time, additional charges are incurred by typesetters and printers who work overtime to meet the publication schedule. It is critically important to the admissions process that the Bulletin be available for distribution in September to high school seniors beginning their college search process.
Admissions and public relations are both cost centers. They have been arguing over whether the cost of the Bulletin should be in the admissions office budget or the public relations department budget.
Required:
a. Discuss the advantages and disadvantages of placing the budget for the Bulletin in the public relations versus the admissions office budget.
b. What are some other ways of handling the Bulletin 's budget
c. Based on your analysis, what recommendation would you make

Question 31

Videx is the premier firm in the security systems industry. Martha Rameriz is an account manager at Videx responsible for selling residential systems. She is compensated based on beating a predetermined sales budget. The last seven years' sales budgets and actual sales data follow. Videx sets its sales budgets centrally in a top-down fashion.
Required:
a. Martha Rameriz sells $908,000 in year 7. What budget will she be assigned for year 8
b. Suppose Rameriz sells $900,000 of systems in year 7. What budget will she be assigned in year 8

Question 32

Wielson Company employs flexible budgeting techniques to evaluate the performance of several of its activities. The selling expense flexible budgets for three representative monthly activity levels are shown here.

The following assumptions were used to develop the selling expense flexible budgets:
• The average size of Wielson's sales force during the year was planned to be 75 people.
• Salespeople are paid a monthly salary plus commissions on gross dollar sales.
• Travel costs are best characterized as step-variable costs. The fixed portion is related to the number of salespeople, while the variable portion fluctuates with gross dollar sales.
A sales force of 80 people generated a total of 4,300 orders resulting in a sales volume of 420,000 units during November. Gross dollar sales amounted to $10.9 million. Selling expenses incurred for November were as follows:

Required:
Prepare a selling expense report for November that Wielson Company can use to evaluate its control
over selling expenses. The report should have a line for each selling expense item showing the appropriate budgeted amount, the actual selling expense, and the monthly dollar variation.

Question 33

I've given a good deal of thought to this issue of how companies... go about negotiating objectives with their different business units. The typical process in such cases is that once the parent negotiates a budget with a unit, the budget then becomes the basis for the bonus. And they are also typically structured such that the bonus kicks in when, say, 80 percent of the budgeted performance is achieved; and the maximum bonus is earned when management reaches, say, 120 percent of the budgeted level. There is thus virtually no downside and very limited upside.
Now, because the budget is negotiated between management and headquarters, there is a circularity about the whole process that makes the resulting standards almost meaningless. Because the budget is intended to reflect what management thinks it can accomplish-presumably without extraordinary effort and major changes in the status quo-the adoption of the budget as a standard is unlikely to motivate exceptional performance, especially since the upside is so limited. Instead it is likely to produce cautious budgets and mediocre performance So, because of the perverse incentives built into the budgeting process itself, I think it's important for a company to break the connection between the budget and planning process on the one hand and the bonus systems on the other hand. The bonuses should be based upon absolute performance standards that are not subject to negotiation.
Required:
Critically evaluate this quotation.

Question 34

New York Fashions owns 87 women's clothing stores in shopping malls. Corporate headquarters of New York Fashions uses flexible budgets to control the operations of each of the stores. The following table presents the August flexible budget for the New York Fashions store located in the Crystal Lakes Mall:
Variable costs are based on a percentage of revenues.
Required:
a. Revenues for August were $80,000. Calculate budgeted profits for August.
b. Actual results for August are summarized in the following table:
Prepare a report for the New York Fashions-Crystal Lakes Mall store for the month of August comparing actual results to the budget.
c. Analyze the performance of the Crystal Lakes Mall store in August.
d. How does a flexible budget change the incentives of managers held responsible for meeting the flexible budget as compared to the incentives created by meeting a static (fixed) budget

Question 35

Magee Inc. pays its sales manager a bonus of $10,000 if the manager meets the sales quota. The sales manager can exert either high effort or low effort. The additional disutility of the manager in exerting high effort relative to low effort to meet the sales quota is $1,500. Management can set a tight quota that is extremely difficult to achieve even with a great deal of effort, a loose quota that is achieved easily, or a medium-tight quota. The probability of achieving the sales figure under each quota is summarized in the accompanying table.
Probability of Achieving Quota
The sales manager can either achieve the sales quota or not. Because each quota affects the total number of units sold and thus the gross margin earned by the firm, the following table outlines the gross margin earned by the firm when each quota is reached and is not reached.
Gross Margin of Achieving Quota
Should management set a loose, medium-tight, or tight quota

Question 36

Scion Corp.
Scion Corp. manufactures earth-moving equipment. Department A303 produces a number of small metal parts for the equipment, including specialized screw products, rods, frame fittings, and some engine parts. Scion uses flexible budgeting. The budget for each line item is based on an estimate of the fixed costs and variable costs per unit of volume for that item. The volume measure chosen for each line item is the one with the greatest cause-and-effect relation to the item. For example, the volume measure for utilities is machine hours, whereas the volume measure for supervision is direct labor hours of hourly employees.
At the beginning of the year, the plant is given an annual production quota consisting of the number of each piece of earth-moving equipment to produce. These equipment quotas are exploded into the total number of parts each department must produce, using data about what parts are required for each unit of equipment. Each department has a detailed set of standards, developed over a number of years, that translate each part produced into the number of machine hours, direct labor hours, raw materials, and so on. Table 1 summarizes the operating results of department A303-specifically, the budgeted cost per batch of 100 parts for part number UAV 672.
Given the production quotas and the detailed set of quantities of each input required to produce a particular part, Department A303's financial budget for the year can be developed. At the end of the year, the actual number of each type of part produced times the budgeting standards for each part can be used to calculate the flexible budget for that line item in the budget. That is, given the actual list of parts produced in Department A303, the flexible budget in Table 2 reports how much should have been spent on each line item. Price fluctuations in raw materials are not charged to the production managers. If low-quality materials are purchased and cause the production departments to incur higher costs, these variances are not charged to the production departments.
The manager of Department A303 does not have any say over which parts to produce. The manager's major responsibilities include delivering the required number of good parts at the specified time while meeting or bettering the cost targets. The two most important components of the manager's compensation and bonus depend on meeting delivery schedules and the favorable cost variances from the flexible budget.
Senior management of the plant is debating the process used each year to update the various budgeting standards. Productivity increases for labor would cause the amount of direct labor per part to fall over time. One updating scheme would be to take the budgeting standards from last year (e.g., Table 1) and reduce each part's direct labor standard by an average productivity improvement factor estimated by senior plant management to apply across all departments in the plant. The productivity improvement factor is a single plantwide number. For example, if the average productivity factor is forecast to be 5 percent, then for part UAV 672 the budgeting standard for "Direct labor, salaried" becomes 2.375 hours (95 percent of 2.5 hours). This is termed "adjusting the budget."
T ABLE 1 Part Number UAV 672 Budgeting Standards per 100 Parts per Batch

T ABLE 2 Scion Corporation Machining Department A303 Operating Results for Last Year

An alternative scheme, called "adjusting the actual," takes the actual number of direct labor hours used for each part and applies the productivity improvement factor. For example, suppose part UAV 672 used an average of 2.6 hours of salaried direct labor last year for all batches of the part manufactured. The budgeting standard for "Direct labor, salaried" for next year then becomes 2.47 hours (95 percent of 2.6 hours).
Under both schemes, last year's actual numbers and last year's budgeted numbers are known before this year's budget is set.
Required:
Discuss the advantages and disadvantages of the two alternative schemes (adjusting the budget versus adjusting the actual).

Question 37

You are working in the office of the vice president of administration at International Telecon (IT) as a senior financial planner. IT is a Fortune 500 firm with sales approaching $1 billion. IT provides long-distance satellite communications around the world. Deregulation of telecommunications in Europe has intensified worldwide competition and has increased pressures inside IT to reduce costs so it can lower prices without cutting profit margins.
IT is divided into several profit and cost centers. Each profit center is further organized as a series of cost centers. Each profit and cost center submits a budget to IT's vice president of administration and then is held responsible for meeting that budget. The VP of administration described IT's financial control, budgeting, and reporting system as "pretty much a standard, state-of-the-art approach where we hold our people accountable for producing what they forecast."
Your boss has assigned you the task of analyzing firmwide supplies expenditures, with the goal of reducing waste and lowering expenditures. Supplies include all consumables ranging from pencils and paper to electronic subcomponents and parts costing less than $1,000. Long-lived assets that cost under $1,000 (or the equivalent dollar amount in the domestic currency for foreign purchases) are not capitalized (and then depreciated) but are categorized as supplies and written off as expenses in the month purchased.
You first gather the last 36 months of operating data for both supplies and payroll for the entire firm. The payroll data help you benchmark the supplies data. You divide each month's payroll and supplies amount by revenues in that month to control for volume and seasonal fluctuations.The accompanying graph plots the two data series.
Payroll fluctuates from 35 to 48 percent of sales, and supplies fluctuate from 13 to 34 percent of sales. The graph contains the last three fiscal years of supplies and payroll, divided by the vertical lines. For financial and budgeting purposes, IT is on a calendar (January-December) fiscal year.

Besides focusing on consolidated firmwide spending, you prepare disaggregated graphs like the one shown, but at the cost and profit center levels. The general patterns observed in the consolidated graphs are repeated in general in the disaggregated graphs.
Required:
a. Analyze the time-series behavior of supplies expenditures for IT. What is the likely reason for the observed patterns in supplies
b. Given your analysis in (a), what corrective action might you consider proposing What are its costs and benefits

Question 38

The local sales manager of Kink Sales receives a fixed salary plus a bonus based on sales. Only the local sales manager knows the probability distribution over possible sales levels for the next year in her sales district, which is as follows:

The manager's bonus is $100 for every unit above the budgeted sales figure she forecasts at the beginning of the year, with the bonus being nonnegative. That is,
Bonus = $100 X (Actual sales - Budgeted sales), Bonus 0 (1)
Senior management is considering changing the bonus scheme to the following:
Bonus = $100 X Actual sales - $20 X | Budgeted sales - Actual sales | (2)
In this scheme, the local manager would receive $100 per unit sold but be penalized $20 for every unit sold that differs from budget. (Note: The symbol |... | denotes absolute value.)
If senior management changes the bonus, it will adjust the fixed component of salary to offset any gain or loss in the expected level of total compensation.
Required:
a. Graph the two bonus schemes.
b. Using the first bonus scheme, what budgeted sales figure will the local manager report
c. Using the proposed bonus scheme, what budgeted sales figure will the local manager report
d. Which method do you prefer Why