PPM 4-3

1. MOBI CO

Mobi Co produces microphones for mobile phones and operates a standard costing system. Before production commenced, the standard labour time per batch for its latest microphone was estimated to be 200 hours. The standard labour cost per hour is $12 and resource allocation and cost data were therefore initially prepared on this basis.

Production of the microphone started in July and the number of batches assembled and sold each month was as follows:

Month                                    No of batches assembled and sold

July                                                                       1

August                                                                 1

September                                                          2

October                                                               4

November                                                           8

The first batch took 200 hours to make, as anticipated, but, during the first four months of production, a learning effect of 88% was observed, although this finished at the end of October. The learning formula is shown on the formula sheet and at the 88% learning rate the value of b is –0.1844245.

Mobi Co uses ‘cost plus’ pricing to establish selling prices for all its products. Sales of its new microphone in the first five months have been disappointing. The sales manager has blamed the production department for getting the labour cost so wrong, as this, in turn, caused the price to be too high. The production manager has disclaimed all responsibility, saying that, ‘as usual, the managing director prepared the budgets alone and didn’t consult me and, had he bothered to do so, I would have told him that a learning curve was expected.’

Required:

A. Calculate the actual total monthly labour costs for producing the microphones for each of the five months from July to November.

B. Discuss the implications of the learning effect coming to an end for Mobi Co, with regard to costing, budgeting and production.

C. Discuss the potential advantages and disadvantages of involving senior staff at Mobi Co in the budget-setting process, rather than the managing director simply imposing budgets on them.

2. SCEW CO

Scew Co is a multinational consumer goods company. Traditionally, the company has used a fixed annual budgeting process in which it sets quarterly sales revenue targets for each of its product lines. Historically, however, if a product line fails to reach its sales revenue target in any of the first three quarters, the company’s sales director (SD) and finance director (FD) simply go back and reduce the sales revenue targets for the quarter just ended, to make it look like the target was reached. They then increase the target for the final quarter to include any shortfall in sales from earlier quarters.

During the last financial year ended 31 August 20X6, this practice meant that managers had to heavily discount many of their product lines in the final quarter in order to boost sales volumes and meet the increased targets. Even with the discounts, however, they still did not quite reach the targets. On the basis of the sales targets set at the beginning of that year, the company had also invested $6m in a new production line in January 20X6. However, to date, this new production line still has not been used. As a result of both these factors, Scew Co saw a dramatic fall in return on investment from 16% to 8% in the year.

Consequently, the managing director (MD), the FD and the SD have all been dismissed. Two key members of the accounts department are also on sick leave due to stress and are not expected to return for some weeks. A new MD, who is inexperienced in this industry, has been appointed and is in the process of recruiting a new SD and a new FD. He has said:

‘These mistakes could have been largely avoided if the company had been using rolling budgets, instead of manipulating fixed budgets. From now on, we will be using rolling budgets, updating our budgets on a quarterly basis, with immediate effect.’

The original fixed budget for the year ended 31 August 20X7, for which the first quarter (Q1) has just ended, is shown below:

The budget was based on the following assumptions:

(1) Sales volumes would grow by a fixed compound percentage each quarter.

(2) Gross profit margin would remain stable each quarter.

(3) Distribution costs would remain a fixed percentage of revenue each quarter.

(4) Administration costs would be fixed each quarter.

The actual results for the first quarter (Q1) have just been produced and are as follows:

Actual results                                                                       Q1

$000

Revenue                                                                            14,096

Cost of sales                                                                     (8,740)

––––––

Gross profit                                                                       5,356

Distribution costs                                                             (705)

Administration costs                                                      (2,020)

––––––

Operating profit                                                               2,631

––––––

The new MD believes that the difference between the actual and the budgeted sales figures for Q1 is a result of incorrect forecasting of prices, however, he is confident that the four assumptions the fixed budget was based on were correct and that the rolling budget should still be prepared using these assumptions.

Required:

A. Prepare Scew Co’s rolling budget for the next four quarters.

B. Discuss the problems which have occurred at Scew Co due to the previous budgeting process and the improvements which might now be seen through the use of realistic rolling budgets.

C. Discuss the problems which may be encountered when Scew Co tries to implement the new budgeting system.

3. ZBB

Some commentators argue that: ‘With continuing pressure to control costs and maintain efficiency, the time has come for all public sector organisations to embrace zero-based budgeting. There is no longer a place for incremental budgeting in any organisation, particularly public sector ones, where zero-based budgeting is far more suitable anyway.’

Required:

A. Discuss the particular difficulties encountered when budgeting in public sector organisations compared with budgeting in private sector organisations, drawing comparisons between the two types of organisations.

B. Explain the terms ‘incremental budgeting’ and ‘zero-based budgeting’.

C. State the main stages involved in preparing zero-based budgets.

D. Discuss the view that ‘there is no longer a place for incremental budgeting in any organisation, particularly public sector ones,’ highlighting any drawbacks of zero-based budgeting that need to be considered.

4. BROWN CO

Brown Co provides skilled labour to the building trade. They have recently been asked by a builder to bid for a kitchen fitting contract for a new development of 600 identical apartments. Brown Co has not worked for this builder before. Cost information for the new contract is as follows:

Labour for the contract is available. Brown Co expects that the first kitchen will take 24 man-hours to fit but thereafter the time taken will be subject to a 95% learning rate. After 200 kitchens are fitted the learning rate will stop and the time taken for the 200th kitchen will be the time taken for all the remaining kitchens. Labour costs $15 per hour.

Overheads are absorbed on a labour hour basis. Brown Co has collected overhead information for the last four months and this is shown below:

Hours worked                           Overhead cost $

Month 1                                    9,300                                         115,000

Month 2                                    9,200                                         113,600

Month 3                                    9,400                                         116,000

Month 4                                    9,600                                         116,800

Brown Co normally works around 120,000 labour hours in a year.

Brown Co uses the high low method to analyse overheads.

The learning curve equation is y = ax^b, where b = log r/log 2 = –0.074

Required:

A. Describe FIVE factors, other than the cost of labour and overheads mentioned above, that Brown Co should take into consideration in calculating its bid.

B. Calculate the total cost including all overheads for Brown Co that it can use as a basis of the bid for the new apartment contract.

C. If the second kitchen alone is expected to take 21.6 man-hours to fit demonstrate how the learning rate of 95% has been calculated.

5. DH CO

DH Co manufactures security cards that restrict access to government-owned buildings around the world.

The standard cost for the plastic that goes into making a card is $4 per kg and each card uses 40 g of plastic after an allowance for waste. In November 100,000 cards were produced and sold by DH Co and this was well above the budgeted sales of 60,000 cards.

The actual cost of the plastic was $5.25 per kg and the production manager (who is responsible for all buying and production issues) was asked to explain the increase. They said ‘World oil price increases pushed up plastic prices by 20% compared to our budget and I also decided to use a different supplier who promised better quality and increased reliability for a slightly higher price. I know we have overspent but not all the increase in plastic prices is my fault. The actual usage of plastic per card was 35 g per card and again the production manager had an explanation. They said, ‘The world-wide standard size for security cards increased by 5% due to a change in the card reader technology; however, our new supplier provided much better quality of plastic, and this helped to cut down on the waste.’

DH Co operates a just-in-time (JIT) system and hence carries very little inventory.

Required:

A. Discuss the behavioural problems that can arise from using standard costs and ways to prevent them.

B. Analyse the above total variances into component parts for planning and operational variances in as much detail as the information allows.

C. Assess the performance of the production manager.

6. GRILL CO

Grill Co owns a number of restaurants. It is a well-established company, and its restaurants have gained a favourable reputation for the quality of their meals.

Grill Co’s restaurants are all set in rural locations, where there is limited competition, and this enabled them to develop a loyal customer base. Restaurants design their own menus and décor to fit with the requirements of their local market.

Grill Co has been consistently profitable, however as is the case across the restaurant industry, profit margins are quite low and there is still a constant need for Grill Co to monitor costs.

One of Grill Co’s restaurants is located in the small town of Caprew. Caprew has recently been the location for the filming of a popular television series and visitor numbers to the town have increased significantly as a result. Grill Co’s restaurant in Caprew has noticed a similar increase in customer numbers.

At the start of the current month a new restaurant opened in Caprew. The manager of Grill Co’s restaurant in Caprew has expressed concerns about the impact this new competitor will have on their ability to achieve profit targets for the rest of the year.

Budgets for all of Grill Co’s restaurants are prepared by the head office. At the start of each year, restaurant managers are given an annual budget, which is split into months. At the end of each month, the manager receives a statement comparing actual monthly performance against budget.

The statement for the Caprew restaurant for the most recent completed month is as follows:

Notes:

• Rent, rates and other overheads are apportioned to its restaurants by Grill Co’s head office, based on a fixed annual charge.
• All other budgeted costs are treated as variable costs, based on the expected number of customers.

Grill Co currently adopts an incremental approach to budgeting, with the annual budget figures for each year being based on the previous year’s figures. However, a new finance director has recently joined the company, and he has questioned whether this is suitable for all Grill Co’s restaurants.

The new finance director has also suggested that the company should adopt a more participative approach to budgeting.

Required:

A. i) Prepare a flexed budget for the Caprew restaurant.

ii) With reference to your answer from part (i), explain the main weaknesses in the current monthly budget statements issued to the restaurants as a basis for managing performance.

B. Discuss whether an incremental approach to budgeting is appropriate for Grill Co.

C. Define a participative approach to budgeting and explain the potential advantages and disadvantages of introducing this approach at Grill Co.

7. CAKES AND BAKES

Cakes and Bakes (CB) makes cakes, which are sold directly to the public. The new production manager (a celebrity chef) has argued that the business should use only organic ingredients in its cake production. Organic ingredients are more expensive but should produce a product with an improved flavour and give health benefits for the customers. It was hoped that this would stimulate demand and enable an immediate price increase for the cakes.

CB operates a responsibility-based standard costing system which allocates variances to specific individuals. The individual managers are paid a bonus only when net favourable variances are allocated to them.

The new organic cake production approach was adopted at the start of March 20X9, following a decision by the new production manager. No change was made at that time to the standard costs card. The variance reports for February and March are shown below (Fav = Favourable and Adv = Adverse).

 The production manager is upset that they seem to have lost all hope of a bonus under the new system. The sales manager thinks the new organic cakes are excellent and is very pleased with the progress made.

CB operates a JIT inventory system and holds virtually no inventory.

Required:

A. Assess the performance of the production manager and the sales manager and indicate whether the current bonus scheme is fair to those concerned.

In April 20X9 the following data applied:

Standard cost card for one cake (not adjusted for the organic ingredient change)

The budget for production and sales in April was 50,000 cakes. Actual production and sales was 60,000 cakes in the month, during which the following occurred:

All cakes produced must weigh 0.36 kg, as this is what is advertised.

B. Calculate the material price, mix and yield variances for April. You are not required to make any comment on the performance of the managers.

With the benefit of hindsight, the management of CB realizes that a more realistic standard cost for current conditions would be $0.40 per cake. The planned standard cost is unrealistically low.

C. Calculate the total cost planning and operational variances for April. Briefly comment on each variance.

8. BB LTD

BB Ltd manufactures and markets a range of electronic office equipment. The company currently has a turnover of $40 million per annum. The company has a functional structure and currently operates an incremental budgeting system. The company has a budget committee that is comprised entirely of members of the senior management team. No other personnel are involved in the budget-setting process.

Each member of the senior management team has enjoyed an annual bonus of between 10% and 20% of their annual salary for each of the past five years. The annual bonuses are calculated by comparing the actual costs attributed to a particular function with budgeted costs for that function during the twelve-month period ended 31 December in each year.

A new Finance Director, who previously held a senior management position in a ‘not for profit’ health organisation, has recently been appointed. Whilst employed by the health service organisation, the new Finance Director had been the manager responsible for the implementation of a zero-based budgeting system which proved highly successful.

Required:

A. Identify and discuss the factors to be considered when implementing a system of zero-based budgeting within BB Ltd. Include, as part of your discussion, a definition of the existing incremental budgeting system and a zero-based budgeting system.

B. Identify and discuss the behavioural problems that the management of BB Ltd might encounter in implementing a system of zero-based budgeting, recommending how best to address such problems in order that they are overcome.

C. Explain how the implementation of a zero-based budgeting system in BB Ltd may differ from the implementation of such a system in a ‘not for profit’ health organisation.

9. OLIVE

Olive is a restaurant that is only open in the evenings, on six days of the week. It has eight restaurant and kitchen staff, each paid a wage of $8 per hour on the basis of hours actually worked. It also has a restaurant manager and a head chef, each of whom is paid a monthly salary of $4,300. Olive’s budget and actual figures for the month of May was as follows:

 The budget above is based on the following assumptions:

• The restaurant is only open six days a week and there are four weeks in a month. The average number of orders each day is 50 and demand is evenly spread across all the days in the month.
• The restaurant offers two meals: Meal A, which costs $35 per meal and Meal B, which costs $45 per meal. In addition to this, irrespective of which meal the customer orders, the average customer consumes four drinks each at $2.50 per drink. Therefore, the average spend per customer is either $45 or $55 including drinks, depending on the type of meal selected. The May budget is based on 50% of customers ordering Meal A and 50% of customers ordering Meal B.
• Food costs represent 12.5% of revenue from food sales.
• Drink costs represent 20% of revenue from drinks sales.
• When the number of orders per day does not exceed 50, each member of hourly paid staff is required to work exactly six hours per day. For every incremental increase of five in the average number of orders per day, each member of staff has to work 0.5 hours of overtime for which they are paid at the increased rate of $12 per hour. You should assume that all costs for hourly paid staff are treated wholly as variable costs.
• Energy costs are deemed to be related to the total number of hours worked by each of the hourly paid staff, and are absorbed at the rate of $2.94 per hour worked by each of the eight staff.

Required:

A. Prepare a flexed budget for the month of May, assuming that the standard mix of customers remains the same as budgeted.

B. After preparation of the flexed budget, you are informed that the following variances have arisen in relation to total food and drink sales:

Sales mix contribution variance                           $1,014 Adverse

Sales quantity contribution variance                  $11,700 Favourable

BRIEFLY describe the sales mix contribution variance and the sales quantity contribution variance. Identify why each of them has arisen in Olive’s case.

C. Olive’s owner told the restaurant manager to run a half-price drinks promotion at Olive for the month of May on all drinks. Actual results showed that customers ordered an average of six drinks each instead of the usual four but, because of the promotion, they only paid half of the usual cost for each drink. You have calculated the sales margin price variance for drink sales alone and found it to be a worrying $11,700 adverse. The restaurant manager is worried and concerned that this makes their performance for drink sales look very bad.

Briefly discuss TWO other variances that could be calculated for drinks sales or food sales in order to ensure that the assessment of the restaurant manager’s performance is fair.

These should be variances that COULD be calculated from the information provided above although no further calculations are required here.

10. FURNICO

Furnico manufactures and sells executive leather chairs. They are considering a new design of massaging chair to launch into the competitive market in which they operate.

They have carried out an investigation in the market and using a target costing system have targeted a competitive selling price of $120 for the chair. Furnico wants a margin on selling price of 20% (ignoring any overheads).

The frame and massage mechanism will be bought in for $51 per chair and Furnico will upholster it in leather and assemble it ready for despatch.

Leather costs $10 per metre and two metres are needed for a complete chair although 20% of all leather is wasted in the upholstery process.

The upholstery and assembly process will be subject to a learning effect as the workers get used to the new design. Furnico estimates that the first chair will take two hours to prepare but this will be subject to a learning rate (LR) of 95%. The learning improvement will stop once 128 chairs have been made and the time for the 128th chair will be the time for all subsequent chairs. The cost of labour is $15 per hour.

The learning formula is shown on the formula sheet and at the 95% learning rate the value of b is –0.074000581.

Required:

A. Calculate the average cost for the first 128 chairs made and identify any cost gap that may be present at that stage.

B. Assuming that a cost gap for the chair exists suggest four ways in which it could be closed.

C. The production manager denies any claims that a cost gap exists and has stated that the cost of the 128th chair will be low enough to yield the required margin.

C. Calculate the cost of the 128th chair made and state whether the target cost is being achieved on the 128th chair.

11. CANDY CO

Candy Co makes high quality, hand-made chocolate truffles which it sells to a local retailer. All chocolates are made in batches of 16, to fit the standard boxes supplied by the retailer. The standard cost of labour for each batch is $6.00 and the standard labour time for each batch is half an hour. In November, Candy Co had budgeted production of 24,000 batches; actual production was only 20,500 batches. 12,000 labour hours were used to complete the work and there was no idle time. All workers were paid for their actual hours worked. The actual total labour cost for November was $136,800. The production manager at Candy Co has no input into the budgeting process.

At the end of October, the managing director decided to hold a meeting and offer staff the choice of either accepting a 5% pay cut or facing a certain number of redundancies. All staff subsequently agreed to accept the 5% pay cut with immediate effect.

At the same time, the retailer requested that the truffles be made slightly softer. This change was implemented immediately and made the chocolates more difficult to shape. When recipe changes such as these are made, it takes time before the workers become used to working with the new ingredient mix, making the process 20% slower for at least the first month of the new operation.

The standard costing system is only updated once a year, in June, and no changes are ever made to the system outside of this.

Required:

A. Calculate the total labour rate and total labour efficiency variances for November, based on the standard cost provided above.

B. Analyse the total labour rate and total labour efficiency variances into component parts for planning and operational variances in as much detail as the information allows.

C. Assess the performance of the production manager for the month of November.

12. ALGA CO

Alga Co a medium sized company, produces a single product in its one overseas factory. For control purposes, a standard costing system was recently introduced.

The standards set for the month of May were as follows:

Production and sales                                               16,000 units

Selling price (per unit)                                             $140

Materials:

Material 003                                                             6 kilos per unit at $12.25 per kilo

Material GL60                                                           3 kilos per unit at $3.20 per kilo

Labour                                                                        4.5 hours per unit at $8.40 per hour

Overheads (all fixed)                                               $86,400 per month.

(They are not absorbed into the product costs)

The actual data for the month of May is as follows:

Produced 15,400 units which were sold at $138.25 each.

Materials: Used 98,560 kilos of material 003 at a total cost of $1,256,640 and used 42,350 kilos of material GL60 at a total cost of $132,979.

Labour: Paid an actual rate of $8.65 per hour to the labour force. The total amount paid out, amounted to $612,766.

Overheads (all fixed): $96,840.

Required:

A. Prepare a standard costing profit statement, and a profit statement based on actual figures for the month of May.

B. Prepare a statement of the variances which reconciles the actual with the standard profit or loss figure. (Mix and yield variances are not required.)

C. Explain briefly the possible reasons for inter-relationships between material variances and labour variances.

D. State TWO possible causes of an adverse labour rate variance.

13. CUBE CO

Cube Co operates an absorption costing system and sells three types of product – Commodity 1, Commodity 2 and Commodity 3. Like other competitors operating in the same market, Cube Co is struggling to maintain revenues and profits in face of the economic recession which has engulfed the country over the last two years. Sales prices fluctuate in the market in which Cube Co operates. Consequently, at the beginning of each quarter, a market specialist, who works on a consultancy basis for Cube Co, sets a budgeted sales price for each product for the quarter, based on their expectations of the market. This then becomes the ‘standard selling price’ for the quarter. The sales department itself is run by the company’s sales manager, who negotiates the actual sales prices with customers. The following budgeted figures are available for the quarter ended 31 May 20X3.

Cube Co uses absorption costing. Fixed production overheads are absorbed on the basis of direct machine hours and the budgeted cost of these for the quarter ended 31 May 20X3 was $174,400. Commodities 1, 2 and 3 use 0.2 hours, 0.6 hours and 0.8 hours of machine time respectively.

The following data shows the actual sales prices and volumes achieved for each product by Cube Co for the quarter ended 31 May 20X3 and the average market prices per unit.

 The following variances have already been correctly calculated for Commodities 1 and 2:

Sales price operational variances

Commodity 1: $35,760 Adverse

Commodity 2: $25,840 Favourable

Sales price planning variances

Commodity 1: $65,560 Favourable

Commodity 2: $56,240 Adverse

Required:

A. Calculate, for Commodity 3 only, the sales price operational variance and the sales price planning variance.

B. Using the data provided for Commodities 1, 2 and 3, calculate the total sales mix variance and the total sales quantity variance.

C. Briefly discuss the performance of the business and, in particular, that of the sales manager for the quarter ended 31 May 20X3.

14. SOAP STORIES

Soap Stories makes environmentally friendly soap using three basic ingredients. The standard cost card for one batch of soap for the month of September was as follows:

Material                                      Kilograms                                Price per kilogram ($)

Lye                                                    0.25                                                    10

Coconut oil                                       0.6                                                      4

Shea butter                                      0.5                                                      3

The budget for production and sales in September was 120,000 batches. Actual production and sales were 136,000 batches. The actual ingredients used were as follows:

Material                                 Kilograms

Lye                                             34,080

Coconut oil                               83,232

Shea butter                              64,200

Required:

A. Calculate the total material mix variance and the total material yield variance for September.

B. In October the materials mix and yield variances were as follows:

Mix: $6,000 adverse

Yield: $10,000 favourable

The production manager is pleased with the results overall, stating:

‘At the beginning of September, I made some changes to the mix of ingredients used for the soaps. As I expected, the mix variance is adverse in both months because we haven’t yet updated our standard cost card but, in both months, the favourable yield variance more than makes up for this. Overall, I think we can be satisfied that the changes made to the product mix are producing good results and now we are able to produce more batches and meet the growing demand for our product.’

The sales manager, however, holds a different view and says:

‘I’m not happy with this change in the ingredients mix. I’ve had to explain to the board why the sales volume variance for October was $22,000 adverse. I’ve tried to explain that the quality of the soap has declined slightly and some of my customers have realised this and simply aren’t happy, but no-one seems to be listening. Some customers are even demanding that the price of the soap be reduced and threatening to go elsewhere if the problem isn’t sorted out.’

i) Briefly explain what the adverse materials mix and favourable materials yield variances indicate about production at Soap Stories in October.

Note: You are NOT required to discuss revision of standards or operational and planning variances.

ii) Discuss whether the sales manager could be justified in claiming that the change in the materials mix has caused an adverse sales volume variance in October.

C. Critically discuss the types of standard used in standard costing and their effect on employee motivation.