Case Study: Accounting for Decision Making Shelter

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SAMPLE EXCERPT:

[. . .] This percentage provides the base for calculating the proportionate break even.

*The assumption is that all costs are fixed and no costs are variable for the production of computer hours capable of generating revenue. The only variable costs would be power to operate the servers and computers, but it is doubtful that they would be shut down during off hours, though they may have a "sleep" function, and any adjustments to worker hours, but since we don't have a base from which to calculate these figures, the results would be speculative, at best. Regardless, the variable costs are likely to be very small -- $5 to $25 per hour -- and can reasonably be omitted from gross estimates.

Estimated Average Revenue

82000

42%

105600

54%

186,933

95%

10370

5%

197,303

Total

Intracompany

Commercial

FC =

57423

73829

Units

Var Cost

0

0

UP=

Q=

92

82000

105600

Impact on Operations

Assumption A

By increasing the commercial price of computer service hours to $1,000, generating an estimated reduction in demand of approximately 30%, the company would experience a loss of revenue in the amount of $39,600 over Q2. The estimated figure for April alone would be a loss of revenue of approximately $13,200. Calculations are shown in the Addendum.

Assumption B

Reducing the commercial price of computer service hours to $600, all other things remaining the same, would reduce revenue to $171,570 for the month of April. However, if the demand picked up by 30% as estimated, then the revenue for April should approach $195,330. Calculations are shown in the Addendum.

Assumption C

All other things being equal, an increase in demand by 30% should result in monthly revenue of approximately $195,330. If the average fixed expenses figure is $136,720, as calculated from Q1, then the net profit is $58,610. This figure is well above any reasonable anticipated expenditure for sales promotion costs. Calculations are shown in the Addendum.

Assumption D

Reducing by 20% the number of hours that commercial computer service is available would reduce revenue to $176,850 for the month of April. Calculations are shown in the Addendum.

Suggestions for Changes

"Corporate services" is used as a catch-all category for work provided by Prestige Telephone Company employees for Prestige Data Systems. While it is reasonable for the costs of the corporate services to be based on some percentage of the full-time equivalents (FTE) of the personnel doing the work, these percentages should show up explicitly in association with an identified role. For example, the percentage of time that payroll personnel expend to calculate and pay wages and benefits to the Prestige Data Systems employees should be a line item in the budget, and should also be listed under Wages and Salaries on the quarterly statement. Ostensibly, the statement could retain the line item "Corporate services," but the line item should be moved to the appropriate activity.

As explained in the section on Available Service Hours, the accounting for revenue hours should be adjusted to separate the hours set aside for computer maintenance and servicing.

Body Glove

Purposes of Budgeting System

The budget was used during the year primarily to monitor production performance, and to detect early "red flags" of potential problem areas. Management compared budget-to-actual for each month and on a year-to-date basis. Budget monitoring occurred monthly, and discrepancies could be reflected on the performance ratings of department heads if reasonable factors -- circumstances beyond the control of the department heads causing budget overruns -- could not be ascertained.

Key Events in Budgeting Process

The body suit production process entails two manufacturing cycles corresponding with preparation of the spring line and the fall line. Because of their denser and more expensive fabric, body suits in the fall line consumed more labor. However, production continued for both lines throughout the year. A three-phase order cycle consists of the following stages: 1) pre-book, 2) build, and 3) deliver. Pre-book takes place during October and November for the fall line, and May/June for the spring line. Estimates of upcoming orders were formed during the pre-book period when salespeople visited retail stores to show samples of the new styles in the seasonal line-up. Volume discounts and waived freight charges were granted to retailers who ordered during the pre-book period. From this initial period of ordering and estimating orders, the stock was built in readiness for production. The build period takes place in November/December for the fall line and in June/July for the spring line. The target time period for having the fall in the retail stores and outlets was August/September, and the target time period for the spring line was February/March. The delivery period for the fall lines runs January through June and the delivery period for the spring line runs September through December.

Absence of Budget

The managers had developed an intimate feel for their projected expenses. In 1991, the company was just a few years short of being in business for 43 years. Assuming reasonable stability in managerial employment at the small company, years of practice appear to have cultivated a market feel for the business that resulted in substantive accuracy. The company budget was treated like a household budget -- approximations were fairly easy because product changes happened incrementally. Flexibility was an important dynamic and certainly production was not hampered by budget restrictions. However, issues with supply and demand, particularly attempts to maintain a low inventory of stock, did result in a loss to the company in 1990 of $1 million dollars.

The approach to forecasting changed with the new management team, such that, the information from the pre-book phase -- which generally contributed 50% to 60% of the total sales for a season -- was factored along with historical data. The result was that more inventory was built prior to receiving actual order, inventory turned faster, and sales increased by up to 45% one season. The forecasts permitted management to develop a Materials Requirement Plan (MRP) and to forecast the orders of neoprene from Japan, the company's preferred supplier.

Recommended Changes

It is difficult to know what to recommend regarding changes to the budget as the case does not provide an actual sample budget. An income statement is given, but it seems to lack the sort of activity divisions that make reading an income statement simpler. The company has continued to expand its product mix (Body Glove 2011, Dive 'n' Surf 2011) and appears to be maintaining a healthy market share, but so has O'Neill's (O'Neill 2011). A different approach to the budgeting process and framework for this company might be to segregate the spring and fall lines. The company can identify the revenue derived from each seasonal production, but they may not have the budget sufficiently fine-tuned to provide more detailed supplier and inventory costs ("Job-Order Costing" 2011).

Changes to Accommodate Growth

As the company grows, it makes sense to be able to track object costs to different product lines. The technology associated with the production of the body suits changes over time. It would be helpful to ascertain if costs were increasing only for specific product lines and to determine if fluctuations in revenue were a result of increases or decreases in sales of any particular product line.

References

Arsham, H. (2011). Break-Even Analysis and Accounting. [Web] Retrieved http://home.ubalt.edu/ntsbarsh/Business-stat/otherapplets/BreakEven.htm

Averkamp, H. (2011). Accounting Tools [Web]. Retrieved http://www.accountingtools.com/questions-and-answers/what-is-a-cost-object.html

Averkamp, H. (2011). Accounting Coach. [Web]. Retrieved http://www.accountingcoach.com/online-accounting-course/11Xpg01.html

Averkamp, H. (2011). Accounting Coach. [Web]. Retrieved http://www.accountingcoach.com/online-accounting-course/01Xpg03.html#break-even-point-profits

Body Glove Art Box [Web]. Retrieved http://bodygloveartbox.blogspot.com/2009/06/body-glove-introduces-dive-n-surf.html

Dive 'n' Surf [Web]. Retrieved http://divensurf.com/familystory.html

Job Order Costing. (2011). Middle City. [Web]. Retrieved http://www.middlecity.com/ch17.shtml

Martin, J.R. (2010). Traditional two stage cost allocation approach, Managing and Accounting Web. Retrieved http://maaw.info/Chapter6.htm#Allocating%20Service%20Department%20Costs

O'Neill [Web]. Retrieved http://www.oneill.com/

Shelter Partnership. [Web]. Retrieved http://www.shelterpartnership.org/

This document below is for you to use to compare my calculations with another source. I don't intend for you to use it in your References section.

Prestige Telephone Company (2004) [Course Notes ] AIM 4343 Retrieved

http://docs.google.com/viewer?a=v&q=cache:8mLK7amCBPsJ:www.utdallas.edu/~nataraj/bvitnotes/prestige-4343-additional%2520notes.doc+prestige+telephone+company&hl=en&gl=us&pid=bl&srcid=ADGEESi8FtXm5B7NuuW18v2J8OH2UZNzEcX4JW56bO6N8BfJo45r8tU2cdQoMD5inmsAvvmLUpSJmc2PZipagRT9Bb8amI0HIl11VnuG01UoIaQ0JGe5a9s4qRDER9TQ6__hOULAGkwy&sig=AHIEtbTUwxshUvDi_5CWduM7fG8M1h3Yzw&pli=1

ACCOUNTING FOR DECISION MAKING

Question 3.

Assumption A.

Jan

Feb

Mar

Adjusted Demand

86.1

94.5

96.6

Difference (Loss) in Commercial Income

12300

13500

13800

39600

Intracompany rate = $400/hr

82400

72400

89200

Commercial rate = $800/hr

98400

86100

108000

94500

110400

96600

180800

180400

199600

Other Revenue

12685

31110

REV*

190,041

177,741

189584

176084

212285

198485

197,303

Assumption B.

$600/hr

> 30% demand

82000

82000

79200

102960

161200

184,960

10370

10370

171570

195,330

Assumption C.

> 30% demand

82000

102960

184,960

10370

195,330

136,720

58,610

Assumption D.

>20% capacity [END OF PREVIEW]

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