INTRODUCTION

BERKSHIRE TOY COMPANY

The Berkshire Toy Company was founded by Janet McKinley s father, Franklin Berkshire, in 1974. The company started out small but with Berkshire s reputation for quality made the company grow fast. Janet joined the company as a part-time summer employee. After her post-graduation in Business Administration, Janet was named the Assistant to the President in 1988. The company went public in 1991 on Janet s recommendation. Janet succeeded her father as the next CEO, on his retirement in 1993. Later, in 1995, BTC was acquired by the Quality Products Corporation, a corporation that sells and manufactures different kinds of products, for $23.2 million. Janet was allowed to stay on as Vice President of BTC, as per the terms of acquisition. The BTC is widely known for its Berkshire Bear, a fifteen-inch stuffed teddy bear that is fully jointed and washable. The company prides on the handcrafted features of the bear and proclaims it to be the only teddy bear made in America. The bear is completely customizable and has a wide range of accessories. The product is sold largely through Retail and mail order and wholesale. However, internet sales are in operation since November 1997. The BTC has 241 employees, spanned into 3 departments, viz. Purchasing (led by David Hall, 11 employees), Production (175 employees managed by Bill Wilford) and Marketing (52 employees led by Rita Smith). The other three employees are Janet, her secretary and her secretary s assistant. The Berkshire Toy Company is currently facing an accounting problem. A new incentive compensation plan was adopted in 1997, under which the three heads of department will be awarded performance-based bonuses. Armed with the income statements, and schedules of standard and actual direct production costs, Janet needs to find out why the company is making loss of about $1 million, even though the sales are at their peak.

ANALYSIS OF VARIANCES
The table below shows the calculation of variances:
Preliminary Statement of Divisional Operating Incomefor the Year Ended June 30, 1998 Master Budget Variance (F - E) 2,80,000 45,556 Fa ou ab e

Actual Units sold

Master (Static) Budget

Flexible Budget 3,25,556 -

Flexible Budget Variance (E - I)

3,25,556

Variable production costs: 2,56,422 1,25,637 2,46,002 4,50,856 16,422 69,488 66,013 12,30,840 36,68,305 17,25,665 66,24,810 18,59,594 84,84,404 59,62,083 2,33,324 1,06,400 1,96,000 3,65,400 14,000 67,200 33,600 10,15,924 26,88,000 10,46,304 47,50,228 12,18,280 59,68,508 70,37,492 23,098 Unfa 19,237 Unfa 50,002 Unfa 85,456 Unfa 2,422 Unfa 2,288 Unfa 32,413 Unfa 2,14,916 Unfa o o o o o o o o ab e 271302.0926 ab e 123711.28 ab e 227889.2 ab e 424850.58 ab e 16277.8 ab e 78133.44 ab e 39066.72 ab e 1181231.113

There are two aspects to be considered here. A Master Budget Variance is calculated based on the Master (static) budget, i.e. the one which shows the expected earnings and spending with the actual earnings and spending. On the other hand, internet sales were started in the current year. This complicates things as the forecast was based on calculations that did not include the internet sales. Thus, two different flexible budgets can be calculated to observe what would have been the

Operating income

-8,43,745

7,88,572 -16,32,317 Unfa o ab e

11,50,272 -19,94,017 Fa ou ab e

6,58,897 50,23,192 11,23,739 68,05,828

6,61,920 44,63,000 11,24,000 62,48,920

3,023 Fa ou ab e 769614.384 -1,10,717 Fa ou ab e 5,60,192 Unfa o ab e 44,63,000 5,60,192 Unfa ou ab e 261 Fa ou ab e 11,24,000 -261 Fa ou ab e -5,56,908 Unfa o ab e 6356614.384 4,49,214 Una ou ab e

Fixed costs: anufa tu ng o e head Se ng e pen e d n t at e e pen e Total fixed costs

  

Contribution margin

10,75,409 Unfa o ab e

75,06,886 -15,44,803 Unfa o ab e

Total variable expenses

25,15,896 Unfa o ab e 6939600.529 15,44,803 Unfa o ab e

Variable selling expenses

6,41,314 Unfa o ab e 1416494.156

4,43,100 Unfa o ab e

e t abo a ab e o e head Total variable production costs

9,80,305 Unfa o ab e 3125337.6 5,42,967 Unfa o ab e 6,79,361 Unfa o ab e 1216537.661 5,09,127 Unfa o ab e 18,74,582 Unfa o ab e 5523106.373 11,01,704 Unfa o ab e

-14,880 1,926 18,113 26,005 144 -8,645 26,946 49,609

Fa ou ab e Unfa o ab e Unfa o ab e Unfa o ab e Unfa o ab e Fa ou ab e Unfa o ab e Unfa o ab e

Direct materials p e fab a e e 10p a t jo nt 45o e t e f be f ng o en abe e gne Bo e o e Total direct materials


Reta and ata og 174,965 un t Inte net 105,429 un t ho e a e 45,162 un t Total revenue

       

 

85,73,285 1,16,62,000 30,88,715 Unfa o ab e 85,73,285 44,28,018 0 44,28,018 Fa ou ab e 44,28,018 14,45,184 13,44,000 1,01,184 Fa ou ab e 14,45,184 1,44,46,487 1,30,06,000 14,40,487 Fa ou ab e 1,44,46,487

difference in the various factors, if the expected budget had predicted the same number of sales or if the prediction had included the internet sales with the actual number of sales. The price and efficiency variances have been calculated below: Pr c & ff c nc Var anc c ua npu , xb andard Bud Pr c s 276850 125637.12 271183.22 499039.25 16422.35 75804.96 39066.72 1304003.62
"    &#  ' " " !     " % #  #$  

Direct labour 3668305 3125337.6 Var ab rh ad 1725665 1216537.661 F: Favorable, : nfavorable

0 0   2 # 3 

3591976 -76329 1398176.658 -327488.342

Acrylic pile fabric 256422 271302.0926 10-mm acrylic eyes 125637 123711.28 45-mm plastic joints 246002 227889.2 Polyester fibre filling 450856 424850.58 Woven label 16422 16277.8 Designer Box 69488 78133.44 Accessories 66013 39066.72 a d r c a r a s 1230840 1181231.113
#   " ) "   #

#  

r c

a ras 20428 0.12 25181.22 48183.25 0.35 6316.96 -26946.28 73163.62 F F F F -5547.9074 -1925.84 -43294.02 -74188.67 -144.55 2328.48 0 -122772.5074 -466638.4 -181638.9972

c ua

  

Pr c Var anc
 

ff c nc Var anc

" ! " "  ( 2 " 1

Similarly, the sales analysis has been given below. These calculations have been done assuming that the internet sales would have been included:
Sa s na s s c ua
D C C C C 8 74 6 54

Units s ld

3,25,556

2,80,000

45,556

3,25,556

3,25,556

Retail and catalog (174,965 units) nternet (105,429 units)

E

85,73,285 44,28,018 14,45,184 1,44,46,487

1,16,62,000 0 13,44,000 1,30,06,000

30,88,715 44,28,018 1,01,184 14,40,487

85,73,285 44,28,018 14,45,184 1,44,46,487

13559407.4 0 1562668.8 15122076.2

Wholesale (45,162 units) Total revenue

as r Static Bud t
B 5C

Master Bud et Variance

Flexible Bud et (Actual sales mix

Flexible Bud et (Bud et sales mix

59

Sales Mix Variance 0

Sales V lume Variance 45,556

A @

9 6 D

-49,86,122 44,28,018 -1,17,485 -6,75,589

18,97,407 0 2,18,669 21,16,076

INCENTIVE PLAN
DAVID HALL (Purchase)

For David Hall, the bonus will be equal to 20 percent of the net materials price variance, assuming the net variance is favorable. Quantity Master Bud et Price
F

Direct Materials Acrylic pile fabric (bolts) 10-mm acrylic eyes (eyes) 45-mm plastic joints (joints) Polyester fibre filling (lbs) Woven label (labels) Designer box (boxes) Accessories Total Bonus

Actual Price 0.00 0.00 0.00 0.00 0.00 0.00 0.00

Purchase Variance 276850.00 0.00 271183.22 499039.25 0.00 75804.96 39066.72 1161944.15

7,910 6,61,248 19,37,023 3,44,165 3,28,447 3,15,854 3,25,556

35.00 0.19 0.14 1.45 0.05 0.24 0.12

@20%

232388.83

Thus, he will be awarded a bonus of $232,388.83

RITA SMITH (Marketing)

Rita, the marketing manager, receives a bonus of 10 percent of the excess, if any, of actual net revenues over master budget net revenues.
H

Rita Smith (Marketin

Less

Total revenue Variable Selling Expenses Fixed Selling Expenses Net revenues Excess of Net revenues Bonus @ 10%

1,44,46,487 18,59,594 50,23,192 75,63,701 2,38,981 23898.10

Therefore, Rita receives a bonus of $23,898.10

Actual

Master Bud et 1,30,06,000 12,18,280 44,63,000 73,24,720

BILL WILLFORD (Production)

Bill Wilford, the production manager, will receive a bonus equal to 3 percent of the net of several variances: - The efficiency (usage or quantity) variances for materials, labor, and variable overhead - The labor rate variance -The variable and fixed overhead spending variances Efficiency Variances Production efficiency variances Acrylic pile fabric 10-mm acrylic eyes 45-mm plastic joints Polyester fiber filling Woven label Designer Box Accessories Direct labor Variable overhead Direct Labour wage Variable Overhead Spending Fixed overhead spending Total Bonus @ 3%
I

Since Bill s net of variances is negative, he will receive no bonus.

-1171844

-76329 -327488 3023 F

-466638 -181639

P P P P P

-5548 -1926 -43294 -74189 -145 2328 F 0

QUANTITATIVE ANALYSIS
Marketin Mana er
 48% of Flexible Budget Variance ( nfavorable) => Variable Selling Expense ($443,100) +
R Q Q

Fixed Selling (560,192)

 Increase in Sales Volume

-Favorable Sales Volume Variance ($2,116,083) -Decrease in total commission Shift to online space. -Decline in the retail and catalog sales; Increase in the internet sales;
 Aggressive Marketing Efforts
S

-Special Internet Sales Price Discount ($675,596) Purchasin Mana er

 50% of Flexible Budget Variance ( nfavorable)
U T T

nfavorable Sales Mix Variance

 Favorable price variances for fabric, plastic joints and fiber filling

-Purchase of inferior materials

 # of bears sold, 1998 325, 556

-# of designer boxes 315, 854 -Different substandard or no packaging for 9,702 units Product Image
 Unfavorable Price Variance for Accessories

-Unexpected temporary or permanent price increase -Cost of Rush orders or special orders of imported items -Shift from historical mix of accessories to more expensive accessories Production Mana er
 Formulation of standard costs invalid
V

-Production close to capacity, 1998 -Beyond range of determined production standards

 Unfavorable production variances - $1,177, 890

-Unfavorable Direct Labor Efficiency Variance - $466, 638 -Unfavorable Direct Materials Efficiency Variance - $122772 -Unfavorable Direct Labor wage rate Variance - $76, 329
W Y X

Overall Analysis

Direct material price variance was favorable This could have been because the materials were purchased at a discount(This could have an impact on the quality also) Direct Material Usa e variance was unfavorable One of the reason could be the quality of direct materials The loss due to thunderstorm also has some effect.

Direct labor price variance was unfavorable Could be because of overtime the employees had to put up.

Direct labor efficiency variance was unfavorable The material procured could have been of low quality since they were bought for discounts Deviation from standard production plans Plant was operating at near to maximum capacity, people were tired Machine /equipment was not in proper working condition

Variable overhead spendin variance was unfavorable because Extra maintenance was required. Frequent breakdowns of machines Overtime premium expenses of labors increased

Variable overhead efficiency variance was unfavorable Maintenance labor increased due to breakdown and extra maintenance required on machinery Overtime labor hours increased

QUALITATIVE ANALYSIS
a c g

Advanta es of incentive compensation plan -

The incentive plan motivated the manager to work hard and departments to work efficiently. Basically was intended towards promoting participation and teamwork.

Disadvanta es of the incentive compensation plan -

Only the manager and not the team were getting the incentive so not motivation for other employees.

Rita was rewarded for increase in net revenue and not on profit. Bill s team faced overtime situations on few occasions. Instead of promoting more participation the 3 departments were working in silos. There is no clear reasoning on how Rita sets the price for the Internet discounts and established the budgets. This causes unfavourable mix variance.
e d

Role of bud et in performance evaluation -

It helps determining the manager s performance. It should help the firm attain more profits. It should promote good interaction among employees basically for a better and efficient running of the firm.

ff

Budget variances should not be the only parameter for performance evaluatio n
f

Su estions for improvin the compensation plan -

All the managers incentives should be based on the increase in the profits and not on revenues If possible distribute profits to all employees on profit sharing basis instead of just the managers. Stock options will provide motivation for managers to increase the market value of the company More interaction and open communication between departments will bring more profits.

BALANCE SCORECARD
BTC s Balance Scorecards should be aligned to support the corporate strategy, both for the short and long terms. Incentives should be assigned to the degree as the different measures contribute to the corporate goals. Managers shall respond to incentive, thus supporting corporate goals. A Balanced Scorecard typically includes measures in each of four areas: Financial, Customer, Internal Business Processes, and Learning and Growth. Some organizations add other dimension to support their strategy, or replace one of the four perspectives with one that uniquely reflects their mission and strategy. The actions of management are not static but, rather, are dynamic over time. A round of performance improvement (usually every year at the time budgets are being developed) may result in an increase in the goals that have been established by the manager and their supervisor. Each time the assessment approaches or exceeds the goal, the goal is increased until performance is at a level at which further improvements may not be desired. The management group of a corporation will develop plans for the year, those plans are revised through time, incentives are allocated and measures are taken to draw new plans for future years. The Balance Score card allows managers to keep their score and their measures clear, so that decisions are made towards a goal that is congruent with the corporate goal. Outcome measures are results. Driving measures are incremental in nature. In the case of BTC the identified areas are: Corporate (BTC)
y y y y

Marketing Purchasing Production, and Management

The proposed set of Balanced Scorecard for BTC is presented below:

Group-Scorecard-Measure-(((Outcome-Performance Driver-Initiatives)))

2) Marketin
o

High market share in the stuffed toys domain- % market share and cost to attain a new customer

o o o

Brand Recognition- % people that relate teddy bear to TCB Reduction in selling expenses- Difference in selling expense over previous yr Successful introduction of new product variations and distribution channels No of new designs introduced and break even time; reduction in delivery costs

3) Purchasin
o

Reduction in raw material cost while maintaining quality- No of times raw material was rejected

Minimizing shortages of raw materials- No of back orders placed

4) Production
o o o

Minimize production cycle time-Production cycle time Minimize defects- No of warranty claims/returns, service failure index Timeliness-Average waiting time for a customer
q

5) Mana ement
o

Maintaining proper information coverage- No of processes having adequate information on cost, quality and cycle time

Returns on data-Savings due to maintaining database or running reports

The Berkshire Toy Company

o o

Customer Satisfaction- No of complaints Employee Satisfaction- Involvement, productivity and retention