Competition Bikes Task 2

Competition Bikes, Inc.
Task 2
A budget is a plan expressed quantitatively in detail. This detailed plan spells out how the company will acquire resources as well as how the resources will be allocated for a specific time. The budget is used for projecting future income and expenses. The purpose of a budget is the assist the company in providing a methodology in determining what direction to go, to improve efficiency, delegate responsibility and provide a means of controlling the finances of the company. In some cases, managers use budgets to determine how to set targets and standards for employees.
This report will provide an assessment of Competition Bikes Inc.’s budget. By examining the Budget Schedules and Proformas, the areas of concern
will be revealed.
First, the sales budget must be addressed. Any time a company overestimates a portion of the budget, the actual income projected is less or the actual expenses that were budgeted are less. In some cases, both problems can occur. For year 9, Competition Bikes, Inc., expects to sell 3510 units which is 110 more than the previous year; however, the sales for year end 8 were down by 15% due to the current economic situation. Recovering from a decline of 15% in sales brought on by a decline in the economy is not impossible; however, to project sales to be 3.2% more than the previous year is an aggressive sales approach and not warranted at this time.
Second, advertising is an area of concern. The budget for advertising is too low. In a time of economic downtown, the goal should be to encourage other customers to make purchases. This one area that should be increased so that the company can maintain or increase its market share. Additionally, increasing the budget for advertising will let competitors know that Competition Bikes, Inc. is a stable company and solidify its position with its current and future customers.
Finally, the Budgeted Income Statement, reflects $1,340,038 for selling, general, and administrative expenses under the operating expenses category. The selling, general, and administrative expenses consist of all the selling expenses (advertising, website creation and maintenance, sales commissions, distribution network support, and transportation out), and general and admin expenses (administrative salaries, executive compensation, employment taxes, utilities, payroll services-non manufacturing, research and development, depreciation expense and other general and admin expenses. This expense category is too high. During Competitive Bikes, Inc., most prosperous year, year 7, the operating expenses were $1,322,075. Given the economic downturn, areas that do not generate sales in the operating expenses should not be increased.
A flexible budget is a tool used by most companies to control overhead costs. A flexible overhead budget is a detailed plan for controlling overhead costs that is valid in the firm’s relevant range of activity. (Hilton, 2008)
First, there is a large unfavorable variance for revenue. The net sales are down by $130,065 for the activity variance and the revenue and spending variance is down by $20,538 for year 9. This is due to the budget being built around the units expected to be sold of 3510.
Second, for the variable costs, the categories under the variable cost were favorable under the activity variance because sales were down. When sales are down, it is favorable for the company to keep the categories under variable costs such as direct materials, direct labor, manufacturing overhead, variable selling expenses, advertising expenses and transportation out down. Additionally, the revenue and spending variances for direct material are favorable, as well as the price variance. Unfortunately, the efficiency variance is up by $100,000 and therefore unfavorable. Which means that CBI used more materials than budgeted for the amount of bikes built. One way to correct this problem is make sure purchasing is ordering quality materials. Additionally, make sure workers are trained as well as supervised. Overall, the total variable costs category is as follows:
• The overall activity variance is favorable. The activity variance is favorable because the level of activity budgeted for in the planning budget was more than the actual level of activity used in the flexible budget.
• The overall revenue and spending variances is favorable.
The revenue and spending variances are favorable because revenue was higher than expected for the amount of bikes produced and the cost was lower than expected.
• The overall price variance was favorable because the favorability of the price of direct materials outweighed the fact that the price variance of the direct labor costs, manufacturing overhead costs, advertising expenses and transportation out costs were unfavorable. To correct the unfavorable categories of the overall price variance, CBI would need to hire more efficient workers, purchase higher-quality materials, find more efficient ways of advertising and find other means of transporting a finished product.
• The overall efficiency variance was unfavorable. This is largely due to the large amount of direct materials used inefficiently. Although the direct labor and advertising costs were favorable; it was not enough to counter the difference between the amount that was budgeted and the actual amount used for direct materials. In order to correct the overall efficiency variance, CBI can purchase high-quality materials which would result in fewer defective products and more efficient use of
time.
Third, the contribution margin was unfavorable for the activity variance. This means that the profitability of the product was not favorable. This largely due to shortage in sales. However, the revenue and spending variances for the contribution margin were favorable. This due to the direct materials cost being favorable which offset the other categories which were unfavorable-direct labor, manufacturing overhead, advertising expenses, advertising expenses and transportation out. As a result, the overall contribution margin was favorable.
Finally, the total general and admin expenses were favorable. This is due to the executive compensation being down by $2000, employment taxes being down by $77, utilities being down by $1,777, research and development being down by $2,397 and other utilities being down by $500. All of the previous categories outweighed the unfavorable categories-administrative salaries and other general and admin expenses.
Overall based on the flexible budget, the operating income for the company is unfavorable. This stems from the shortage in number of units produced verses the number of units which should have been produced. Although the number units produced was down, the overall revenue/spending variances for the operating income are favorable.
Management by exception is a methodology used to present only significant changes in the budget to management. This method is used for management to focus on specific issues. While management is focusing attention and time on critical variances; the staff can focus on the day to day operations of the company. A standard should be set to determine what is considered a significant change in the budget. The set standard will be used to determine what changes will be addressed by management.
First, in regards to the unfavorable efficiency variance of $100,000 in direct materials. Management can hone in on my why the variance is unfavorable and how to eradicate the problem. Management can adjust the production process or adjust purchases to adhere the standards they have set.
Second, the unfavorable revenue and spending variances of $100,000 for direct labor.
Management must determine why, direct labor has a large variance. Management should evaluate the training the skilled workers. Additionally, management should determine if enough skilled workers have been hired to alleviate possible excess overtime. Other times there are unforeseen problems.
Third, the unfavorable, price variance of $150,000 for direct labor should be evaluated by management. Management must decide what has happened to cause CBI to incur more direct labor cost in regards to price variance. Management can look at the newly hired employees. If the supervisors are hiring highly skilled works; higher pay is required. Therefore, the price variance for direct labor would become unfavorable.
Fourth, the unfavorable revenue and spending variances and unfavorable price variances for manufacturing overhead. The unfavorable variance of $26,426 for revenue and spending and the $24,000 unfavorable price variance was due to the company spending more than the expected amount for the actual amount of output. These are area management should be made aware of so they can pinpoint areas that need
correction.
Fifth, the unfavorable efficiency variance of $53,580 for total variable cost must be addressed by management. Management will need to determine core issues for the company that is triggering the unfavorable variances for efficiency when it comes to total variable cost.
Finally, the unfavorable contribution margin and operating income. This is driven by the initial issue. The company budgeted for a goal and did not meet the goal. Management must drill down and determine why the goal was possibly set so high. If the goal was not set high, then why did the company not meet the goal. Unfavorable net sales of $130,065 for activity variance is due to the company’s actual sales not meeting budgeted sales.
Overall, a standard must be set to determine which items management will review. From there management will determine the corrective measures.