1. Discuss budgetary areas that raise concern in the budget planning.
The master budget made by Competition Bikes Inc. is quite sound however there are certain issues that have come forward from the budget. The issues have been briefly described below. One of the prime concerns is the timing of the budget. They have not been divided quarterly although cycling is a weather dependent sport and is affected by seasonal fluctuations. By separating the budget quarterly will allow us to have a better idea of the peak and the off-peak seasons and will allow the company to make more informed decisions. This may also allow the company to maintain an inventory level consistent with the expected demand and sales of their products.
Apart from this, the sales projections are also not reflective of the current trends of the firm. In the year 8 they faced a 15% decline from the sales in year 7. However, in year 9 the projected sales are based on the expectation that the sales will rise. The trend of declining sales is expected to continue for the next three years. Which means it may continue until year 11. Therefore, the decline in sales should also have been reflected in the budgeted statements created by Competition Bikes Inc.
2. Evaluate the flexible budget and its variances.
a. Recommend corrective actions for areas of concern based on a variance analysis.
In the flexible budget we see an unfavourable variance for the net sales. This is because the actual output sold is lower than the units expected by 110 units. Direct materials, Direct Labour, Variable Manufacturing Overhead and the variable selling expenses is favourable, however, it was favourable since actual units sold was lower than forecasted. So, it reality is does not reflect any role of the management in reducing the costs.
Although the advertising and transportation costs were made for 3510 units, the actual costs for 3400 units surpassed by the predicted costs leading to an unfavourable transportation costs. The management should be concerned about this, because although the transportation budget was allocated for 3510 units, it did not even suffice to transport 3400 units in reality. The research and development costs tends to have been favourable, however, this may mean that the company is cutting down on its research and development initiatives which may hurt the competitiveness of the firm in the long-run. Continuous changes and new product developments have always been an advantage for Competition Bikes Inc.; therefore cutting down on these costs is not a good choice.
Dividing the financial statements according to quarters is also a good option. It will help Competition Bikes, Inc to have more insights into the individual peak and off-peak seasons and to plan accordingly. This will also allow them to manage their inventory levels more efficiently according to the demand fluctuations. Competition bikes also have issues with the transportation costs and operating profit, both of which are unfavourable. The change of the actual and forecasted units sold is not proportional to the change in the actual and forecasted operating profit. The incentive plans had also been omitted from the previous assumptions.
The advertising expenses are also unfavourable, which means that although the company invested $2,838 more in advertising, they have failed to make enough sales in return. The research and development cost is favourable by $3,577, however, the investment in research and development should have been more. As the sales are expected to decline over the next three years; they should try to invest more in research and development. By doing so they may be able to come up with more innovative products and therefore increase their sales. Apart from this, the research and development is considered under fixed costs, however, it has fluctuated and it should have been included as a part of variable costs.
b. Discuss how the concept of management by exception could be applied to the variances.
As we know, the concept of management by exception means that the management should only focus its attention to areas where there is a significant difference between the actual and forecasted results. This allows them to centre the necessary attention to the key aspects of a business only. By doing so the management is better able to develop effective strategies for the business.
In the case of Competition Bikes, they should focus on the levels of transportation costs which were supposed to be lower, since they have sold 110 units than initially apprehended. But this was clearly not the case and the transportation costs have somehow been more. An investigation into this issue is highly recommended. They may come up with more convenient ways to reduce their transportation costs.
In order to have a deeper analysis of the underlying problems, the managers should consider finding out the individual materials price variance, Labour efficiency variance and the manufacturing overhead variances. These are crucial components in finding out any underlying operational discrepancies.
Competition Bikes should also consider making individual budgets for materials, labour, variable costs, sales revenue and overhead expenses on a quarterly basis. They do have these budgets; however, they have been created for the entire year and not quarterly. Dividing the budgets quarterly will help them in considering the seasonal fluctuations associated with the demand of their bikes.
The transportation costs increase is rather questionable. Although the price for transporting is fixed at $30/unit it has still increased. This indicates some discrepancies in the forecasted budget created by Competition Bikes and should be reviewed. According to the rate of $30/unit, the transportation costs for 3400 units should have been $102,000 and not $107,569. As per the cost of $107,569 around 3500 units should have been sold, but it is not the case. Further investigation is required concerning the transportation costs.
The management by exception should also check the forecasted and the actual operating profit from the sales of 3400 units. The profit from the sales of 3510 units was forecasted to be $79,962 whereas the operating profit from the actual sales of 3400 units was a mere $34,142 with an unfavourable variance of $45,820. A difference of 110 units cannot claim a profit of $45,820 in profits. Therefore, the management should be rather concerned about their forecasting techniques. Although the sales are expected to follow a downward trend, which was evident from the 15% dip in sales in year 8 compared to year 7, the sales have been forecasted to have increased in year 9, which is not appropriate. The research and development should be considered as part of the variable expenses and not fixed costs as it has changed according the number of units sold. This will also affect the contribution margin and further decrease it. Apart from these the direct material, direct labour, variable manufacturing overhead and variable selling expenses are all variable. Therefore, although the variance is quite high management does not need to bother about them as it appears that the company had maintained them well.
1. Garrison, Noreen and Brewer. (2009). Managerial Accounting, United States. McGraw-Hill Irwin.