Exercise 1

The Trouser Factory started its operations on January 1, 2012. The company is still small but has high expectations regarding its sales growth. Currently there is one tailor’s workshop. None of the tailors has a permanent employment contract, all work on a “stand-by basis”, in other words their working hours are flexible. The Trouser Factory manufactures design jeans that are sold to upscale shops. After a few weeks of operations the Trouser Factory assesses that the demand for designer jeans is high in the segment of young people (age 10 – 20 years) and not in the segment of young adults (age 20 – 30 years) and middle aged people (age 30 – 40 years) as originally expected.

The recently hired controller of the Trouser Factory has the task to prepare a budget for the first quarter of the calendar year 2012. The general manager has passed the following information on to the controller:

Budget information for the period January – March 2012

During the budget preparation process the controller made several assumptions. All sales will be made on account; thereof 30 percent will be collected in the month in which the product has been sold and the remainder will be collected in the month following the sale.

The Trouser Factory pays all purchases in cash except jeans fabric. Each purchase of jeans fabric will be split into 60 percent on account and 40 percent cash payment. 20 percent of the purchases on account will be paid in the month in which goods have been purchased and 80 percent in the month following the purchase. The Trouser Factory desires to maintain a minimum ending inventory of jeans fabric that is equal to 30 percent of the volume required to manufacture next month’s budgeted sales. At the end of each month there is no inventory of finished goods (jeans). As of January 1, 2012 the beginning balance of accounts receivable, accounts payable, raw materials (jeans fabric) and finished goods (jeans) has been € 0.00.

Question 1

Edmonds et al. (2011) describes four advantages of having a budget process in place. Please choose two advantages and explain them briefly.

Question 2

The controller of the Trouser Factory has prepared the pro forma (budgeted) balance sheet as of January 31, 2012. What is the ending balance for January for accounts receivable, raw material inventory ( jeans fabric) and accounts payable?

At the beginning of February 2012 the controller collects actual information related to the month of January as summarized below:

Question 3A

See the table with information over the month of January above. Please assist the controller and prepare an income statement for the month of January 2012, using the below format. It is not necessary to calculate an income tax charge.

Question 3B

The above income statement shows variances. Please explain the variances in detail – using the split into usage and price (rate) variances. For each variance indicate whether it is favorable or unfavorable.

Question 4

What are the results of your variance analysis and what are your conclusions? Please write a short report of your findings. This report should explain a least three likely reasons for the occurrence of the variances. Please use the information that is supplied in the section related to the Trouser Factory.

One of the purposes of a detailed analysis of variances for the Trouser Factory is that it wants to evaluate the performance of the various managers involved. However, this is only possible if the managers can influence these variances; otherwise it would not be fair. Therefore, the Trouser Factory is contemplating if it should organize the company in so-called 'Responsibility Centers'.

Question 5

Explain which responsibility center would be most appropriate for the production department, which is responsible for the production of Jeans. Make sure you explain your answer carefully.

Exercise 2

Kugelstein BV manufactures laptops as well as other products. The estimated annual production and sales volume of laptops is worldwide 80,000 units. The laptop screens are currently purchased from a supplier at € 65.00 per unit.

Kugelstein BV has decided to discontinue the manufacturing of one product as of March 1, 2013. This business decision frees up production capacity on one machine called M10. Kugelstein BV considers using this capacity to manufacture laptop screens instead of purchasing them. The in-sourcing of the laptop screen manufacturing would not require any additional investments. Machine M10 has been exclusively used for the manufacturing of the product to be discontinued. The only possible alternative use of M10 is to manufacture laptop screens.

M10 has been purchased for € 3,000,000.00 on March 1, 2009. The current market price for a machine with comparable specifications is still the same. This type of machine has an estimated useful life of 5 years, no salvage value at the end of its useful life and the straight-line method is used to calculate the depreciation amount. As of March 1, 2013 the expected sales price for M10 is € 300,000.00.

The variable cost related to M10 is € 100.00 per hour and the production capacity per hour is 20 laptop screens. Assuming that Kugelstein BV would start to manufacture laptop screens as of March 1, 2013, it would incur the following cost per laptop screen:

Kugelstein BV allocates all fixed cost to individual products based on the estimated annual production volume.

Question 1

What does Edmonds et al. (2011) consider to be relevant information related to revenues and costs?

Question 2

Please indicate for Kugelstein BV whether the above described revenues and costs are relevant or not regarding the decision of making or buying laptop screens. Please explain your choices.

Question 3

Please determine whether it is advantageous for Kugelstein BV to manufacture laptop screens on M10. Support your answer with appropriate computations.

Question 4

Please discuss three qualitative factors that Kugelstein BV may consider as beneficial to make laptop screens in-house.

Answers Exercise 1

Answer question 1

The four advantages are:

• Planning: A budget formalizes the planning process and documents the plan in writing. It facilitates the communication of objectives, both to managers and their superiors.

• Coordination: The budgeting process forces coordination among departments to promote decisions in the best interests of the company as a whole.

• Performance Measurement: Budgets are specific, quantitative representations of management’s objectives. Comparing actual results to budget expectations provides a way to evaluate performance.

• Corrective Action: Budgeting provides advance notice of potential shortages, bottlenecks, or other weaknesses in operating plans; thereby enabling the management to intervene on a timely basis and to implement corrective actions.

•  

Answer question 2

Accounts receivable:

Ending balance= beginning balance + sales on account – payments of sales on account Ending balance= 0 + 120*95 – 120 *95*0.3= 0 + 11,400 – 3,420 = Є 7,980

Inventory jeans fabric:

Quantity of jeans fabric required in the month of February = 240 jeans pants * 1.2 meters per jeans pants = 288 meter

Ending inventory = 0.3 * 288 meter * Є 15 per meter = Є 1,296

Accounts payable:

Ending balance= beginning balance + purchases on account – payments of purchases on account

Ending balance= 0 + 0.6 * (120 * 1.20 * 15 + 1,296) – 0.2 * 0.6 (120* 1.20 *15 + 1,296)= 0 + 2,073.60 – 414,72

= Є 1,658.88

Anwer Question 3A

Answer Question 3B

Answer Question 4

The largest variance is caused by revenues. The sales price was € 10.00 lower than budgeted and resulted in an unfavourable variance of € 1,400.00. An explanation may be that the originally targeted customer segment of young adults and middle aged people did not buy the product. Instead young people purchased the designer jeans. This group is younger and may not be able to spend as much money to buy trendy products as people in the other two segments. This may have led the managers of the upscale shops to the decision to lower the sales price for the designer jeans. This analysis leads to two questions: Why didn’t the originally targeted segment group buy the product? Should future sales activities be directed towards the sales segment of young people?

The variance related to material costs is also unfavourable. The cost of jeans fabric is slightly higher than expected. The variance got caused by a higher purchase price. An explanation for the higher purchase price may be that volume discounts could not be negotiated as expected. The higher purchase price for jeans fabric is partly made up by a more efficient usage.

The variance of € 255.50 related to the tailor’s labour cost is favourable. Although the hourly rate was € .50 higher than budgeted, a favourable usage variance made up for it. The usage variance is most likely related to the fact that the tailors worked more efficiently than was expected. Perhaps it got assumed during the budget preparation that the tailors need to be trained on the job which was not the case.

The unfavourable variance of € 200.00 fixed overhead costs has to be further investigated; there is currently no indication available of what causes it.

The income shows an unfavourable variance of € 1,442.50. Although the variance is negative, the Trouser Factory is still profitable. It is the first month of business and the above variance analysis may help to optimize the operations and increase future profitability.

Answer Question 5

A responsibility center is an organizational unit that controls identifiable items; it may be divided into three categories:

1. A cost center incurs expenses but generates no revenues

2. A profit center incurs expenses and also generates revenues.

3. An investment center incurs expenses, generates revenues and the manager is responsible for the invested capital.

The production department only incurs cost for the jeans fabric and the tailor’s workshop. A unit that only incurs cost is called cost center, therefore it should be called the “production cost center”. The other two categories are not appropriate because there are not only costs included but also other items (revenues, invested capital). Revenues are not incurred in the production department and the invested capital is not relevant either.

Answers Exercise 2

Answer Question 1

Costs and revenues are reviewed whether they are relevant or in other words avoidable related to a certain business decision. Two characteristics of relevant information are (1) that it differs among the alternatives and (2) is future oriented.

Answer Question 2

Answer Question 3

Relevant cost for both alternatives as basis for a decision:

In-house manufacturing is favourable.

Answer Question 4

In-house manufacturing may have the following qualitative advantages:

• There is no risk that Kugelstein BV will be faced with a sudden price increase of the laptop screens.

• Kugelstein BV will not be dependent on the product quality that the supplier delivers.

• Kugelstein BV will not suffer from possibly delayed deliveries of a supplier

Answer Question 5

The number of available machine hours is the bottleneck. The maximum sales volume is: 1,000 units x 4 hrs + 1,000 units x 3 hrs + 200 units x 5 hrs + 200 units x 4 hrs = 8,800 machine hours. The maximum of available machine hours is 5,000 hours.

The production plan will be determined based on the highest contribution margin per machine hour.

In the first place it would be favourable to manufacture and sell as much as possible from product B. The remaining capacity should be used to manufacture first product A, then D and thereafter C.

The remaining capacity will be first allocated to product A. 2,000 hrs : 4= 500 units of product A