Ferguson Foundry Limited

————————————————- Case: Ferguson Foundry Limited (FFL) EXECUTIVE SUMMARY Date: March 10 2013 To: Mark Ferguson, President From: Carl Holitzner Re: FFL’s Lower-Than-Budgeted Profit for the Fiscal Year Ended May 31 2010 The major issue is determining why Ferguson Foundry Limited’s (FFL) actual profit was $367,600 lower than budgeted, despite selling 2,000 more wood stoves (12,000 instead of 10,000 units). This will be explained using Variance Analysis to demonstrate the underlying reasons why the company failed to meet its president’s expectations.FFL profit for 2010 was below budget due to many factors both production and marketing related. From a production perspective, there were 3 major areas of concern all of which were unfavorable with respect to Variance Analysis (As shown in Exhibit 3): 1. Direct Labor 2. Variable Overhead 3. Fixed Cost The $139,2 00 unfavorable Direct Labor Variance can be attributed to many reasons however it is most likely linked to the management team. Due to the early retirement of the sales manager, the production manager being hospitalized and the accountant quitting, it can be understood that inefficiencies were bound to arise.Without proper management, labor reduced overall productivity of the company, as these workers took 121,200 hours to produce 12,00 stoves rather than the standard 120,000 hours that it should have taken. This reduced Net Income by $18,000 (Labor Yield Variance calculation). Secondly, the problem arising from Direct Labor also transcends to the Variable Overhead, as it is used as its cost driver. As a result, the $69,600 unfavorable Variable Overhead Variance can also be attributed to the more hours undertaken to produce the 12,000 stoves.With the lack of an inefficient management team, overhead could have accumulated through inefficient use and/or the budget could have not even accurately portrayed current rates for overhead items. The third problem with regards to the production perspective concerns the increase in fixed costs. In particular, the fixed manufacturing cost increased by $30,000 over budgeted costs, which in turn resulted in a reduction of net income by the same amount. This could have resulted due to several reasons such as additional machinery being required to handle the increased sales volume.However at this point it is unclear given the information provided and so further investigation must be conducted in an effort to better budget for future fixed costs. From a marketing perspective, there were also 3 major areas of concern all of which were unfavorable with respect to Variance Analysis: 1. Price 2. Fixed Cost 3. Sales Mix In analyzing the price changes, although it was beneficial to increase the sell price of the Basic Wood Stove ($300 to $325), this income benefit was significantly outweighed by the reduction in sell price of the Del uxe Wood Stove ($800 to $700).In the end, the price changes of both products resulted in a $300,000 reduction in profit (Sales Price Variance). Another reason for FFL’s lower than budgeted profit, although obvious and minor, had to do with the increase in selling and administration cost. As can be seen in Exhibit 3 by the Fixed Selling & Administration Budget Variance, an increase in the fixed costs reduced net profit by $7,000. The third problem area, concerning the marketing perspective, involved the difference in sales mix from actual to budget.FFL actually sold more Basic Wood Stoves and fewer Deluxe Wood Stoves than budgeted. Unfortunately, the Deluxe Wood Stove possessed a higher standard contribution margin per unit than the Basic ($210 to $80). Therefore the difference in the mix of sales caused FFL’s net profit to be reduced by $234,000 (Sales Mix Variance). Ultimately, more market research must be conducted to better understand consumer wants and needs and th us be able to efficiently budget company products accordingly to reach profitability goals. APPENDIX EXHIBIT 1| | BASIC (Actual)| BASIC (Std. | DELUXE (Actual)| DELUXE (Std. )| Selling Price| $325| $300| $700| $800| Variable Costs:| Direct Materials| $67. 50| $70. 00| $171. 00| $190. 00| Direct Labor| $104. 00| $90. 00| $248. 00| $240. 00| Overhead| $52. 00| $45. 00| $124. 00| $120. 00| Sell & Admin| $15. 00| $15. 00| $40. 00| $40. 00| Total Variable Costs| $238. 50| $220. 00| $583. 00| $590. 00| Contribution Margin| $86. 50| $80. 00| $117. 00| $210. 00| CONTRIBUTION MARGINS TABLE| Illustration of some calculations involved: *Using the Actual Results Table Provided in Exhibit AActual Unit Selling (Basic) = Sales Revenue ? Sales Volume (units) = $2,340,000 / 7,200 units = $325 Unit Direct Materials (Basic) = Direct Materials Cost ? Sales Volume (units) = $486,000 / 7,200 units = $67. 50 *Using the Unit Cost Standards Table Provided in Exhibit B Std. Unit Direct Labor (Basic) = DL Std . Qty. Per Unit x DL Std. Rate Per Hr. = 6 hrs. x $15. 00 per hr. = $90 APPENDIX EXHIBIT 2| For the Year Ended May 31 2010| | ACTUAL| FLEX-BUDGET VARIANCE| FLEX BUDGET| SALES-VOLUME VARIANCE| STATIC BUDGET| TOTAL VARIANCE| Quantity (units)| 12,000| | 12,000| | 10,000| |Sales Revenue| $5,700,000| ($300,000)| $6,000,000| $250,000| $5,750,000| ($50,000)| Variable Costs| $4,515,600| ($99,600)| $4,416,000| ($181,000)| $4,235,000| ($280,600)| CM| $1,184,400| ($399,600)| $1,584,000| $69,000| $1,515,000| ($330,600)| Fixed Costs| $919,500| ($37,000)| $882,500| | $882,500| ($37,000)| Net Income| $264,900| ($436,600)| $701,500| $69,000| $632,500| ($367,600)| FLEXIBLE BUDGET REPORT| GIVEN CALCULATED FILL IN THE BLANK VARIANCES: ($) = UNFAVORABLE & $ = FAVORABLE Illustration of some calculations involved for Flex Budget: Flex Sales Revenue = Std.Sell Price Per Unit x Actual Sales volume (units) Basic Wood Stove = $300 x 7,200 units = $2,160,000 Deluxe Wood Stove = $800 x 4,800 units = $3,840,000 Total Flex Sales Revenue = $6,000,000 Flex Variable Costs = Std. Variable Price Per Unit x Actual Sales Volume (units) Basic Wood Stove = $220 x 7,200 = $1,548,000 Deluxe Wood Stove = $590 x 4,800 = $2,832,000 Total Flex Variable Costs = $4,416,000 Flex Fixed Costs = Static Fixed Costs APPENDIX EXHIBIT 3| | FLEX BUDGET VARIANCE| SALES VOLUME VARIANCE| SALES VARIANCES| | | | Sales Price| | $300,000 U| -| Sales Mix| | -| $234,000 U|Sales Quantity| | -| $303,000 F| Sales Volume | | -| $69,000 F| TOTAL SALES VARIANCE| | $300,000 U| $69,000 F| | | | | VARIABLE COST VARIANCES| | | | Direct Materials| | $109,000 F| -| Direct Labor| | $139,200 U| -| Overhead| | $69,600 U| -| Selling & Admin| | $0| -| TOTAL VARIABLE COST VARIANCE| | $399,600 U| -| | | | | TOTAL CM VARIANCE| | $399,600 U| -| | | | | FIXED COST VARIANCES| | | | Mfg. Budget| | $30,000 U| -| Sell & Admin Budget| | $7,000 U| -| TOTAL FIXED COST VARIANCE| | $37,000 U| -| | | | | TOTAL VARIANCE| | $436,600 U| $69,000 F| | | | | VA RIANCES TABLE| U = UnfavorableF = Favorable APPENDIX Illustration of some calculations involved in creating Exhibit 3: SALES VARIANCE Section Sales Price Variance = Actual Units sold x (Actual Sell Price – Budgeted) Basic Wood Stove = 7,200 x ($325-$300) = $180,000 F Deluxe Wood Stove = 4,800 x ($700-$800) = $480,000 U Total Sales Price Variance = $300,000 U Sales Mix Variance = (Actual Sales Mix % – Budgeted) x Actual total units sold x Budgeted CM per unit Basic Wood Stove = [(7,200/12,000)-(4,500/10,000)] x 12,000 x $80 = $144,000 F Deluxe Wood Stove = [(4,800/12,000)-(5,500/10,000)] x 12,000 x $210 = $378,000 UTotal Sales Mix Variance = $234,000 U Sales Quantity Variance = (Actual total units sold – Budgeted) x Budgeted Sales Mix % x Budgeted CM per unit Basic Wood Stove = (12,000-10,000) x (4,500/10,000) x $80 = $72,000 F Deluxe Wood Stove = (12,000=10,000) x (5,500/10,000) x $210 = $231,000 F Total Sales Quantity Variance = $303,000 F Sales Volume Variance = (Actual Sales Volume – Budgeted) x Budgeted Cm per unit Basic Wood Stove = (7,200-4,500) x $80 = $216,000 F Deluxe Wood Stove = (4,800-5,500) x $210 = $147,000 U Total Sales Volume Variance = $69,000 F Ferguson Foundry Limited ————————————————- Case: Ferguson Foundry Limited (FFL) EXECUTIVE SUMMARY Date: March 10 2013 To: Mark Ferguson, President From: Carl Holitzner Re: FFL’s Lower-Than-Budgeted Profit for the Fiscal Year Ended May 31 2010 The major issue is determining why Ferguson Foundry Limited’s (FFL) actual profit was $367,600 lower than budgeted, despite selling 2,000 more wood stoves (12,000 instead of 10,000 units). This will be explained using Variance Analysis to demonstrate the underlying reasons why the company failed to meet its president’s expectations.FFL profit for 2010 was below budget due to many factors both production and marketing related. From a production perspective, there were 3 major areas of concern all of which were unfavorable with respect to Variance Analysis (As shown in Exhibit 3): 1. Direct Labor 2. Variable Overhead 3. Fixed Cost The $139,2 00 unfavorable Direct Labor Variance can be attributed to many reasons however it is most likely linked to the management team. Due to the early retirement of the sales manager, the production manager being hospitalized and the accountant quitting, it can be understood that inefficiencies were bound to arise.Without proper management, labor reduced overall productivity of the company, as these workers took 121,200 hours to produce 12,00 stoves rather than the standard 120,000 hours that it should have taken. This reduced Net Income by $18,000 (Labor Yield Variance calculation). Secondly, the problem arising from Direct Labor also transcends to the Variable Overhead, as it is used as its cost driver. As a result, the $69,600 unfavorable Variable Overhead Variance can also be attributed to the more hours undertaken to produce the 12,000 stoves.With the lack of an inefficient management team, overhead could have accumulated through inefficient use and/or the budget could have not even accurately portrayed current rates for overhead items. The third problem with regards to the production perspective concerns the increase in fixed costs. In particular, the fixed manufacturing cost increased by $30,000 over budgeted costs, which in turn resulted in a reduction of net income by the same amount. This could have resulted due to several reasons such as additional machinery being required to handle the increased sales volume.However at this point it is unclear given the information provided and so further investigation must be conducted in an effort to better budget for future fixed costs. From a marketing perspective, there were also 3 major areas of concern all of which were unfavorable with respect to Variance Analysis: 1. Price 2. Fixed Cost 3. Sales Mix In analyzing the price changes, although it was beneficial to increase the sell price of the Basic Wood Stove ($300 to $325), this income benefit was significantly outweighed by the reduction in sell price of the Del uxe Wood Stove ($800 to $700).In the end, the price changes of both products resulted in a $300,000 reduction in profit (Sales Price Variance). Another reason for FFL’s lower than budgeted profit, although obvious and minor, had to do with the increase in selling and administration cost. As can be seen in Exhibit 3 by the Fixed Selling & Administration Budget Variance, an increase in the fixed costs reduced net profit by $7,000. The third problem area, concerning the marketing perspective, involved the difference in sales mix from actual to budget.FFL actually sold more Basic Wood Stoves and fewer Deluxe Wood Stoves than budgeted. Unfortunately, the Deluxe Wood Stove possessed a higher standard contribution margin per unit than the Basic ($210 to $80). Therefore the difference in the mix of sales caused FFL’s net profit to be reduced by $234,000 (Sales Mix Variance). Ultimately, more market research must be conducted to better understand consumer wants and needs and th us be able to efficiently budget company products accordingly to reach profitability goals. APPENDIX EXHIBIT 1| | BASIC (Actual)| BASIC (Std. | DELUXE (Actual)| DELUXE (Std. )| Selling Price| $325| $300| $700| $800| Variable Costs:| Direct Materials| $67. 50| $70. 00| $171. 00| $190. 00| Direct Labor| $104. 00| $90. 00| $248. 00| $240. 00| Overhead| $52. 00| $45. 00| $124. 00| $120. 00| Sell & Admin| $15. 00| $15. 00| $40. 00| $40. 00| Total Variable Costs| $238. 50| $220. 00| $583. 00| $590. 00| Contribution Margin| $86. 50| $80. 00| $117. 00| $210. 00| CONTRIBUTION MARGINS TABLE| Illustration of some calculations involved: *Using the Actual Results Table Provided in Exhibit AActual Unit Selling (Basic) = Sales Revenue ? Sales Volume (units) = $2,340,000 / 7,200 units = $325 Unit Direct Materials (Basic) = Direct Materials Cost ? Sales Volume (units) = $486,000 / 7,200 units = $67. 50 *Using the Unit Cost Standards Table Provided in Exhibit B Std. Unit Direct Labor (Basic) = DL Std . Qty. Per Unit x DL Std. Rate Per Hr. = 6 hrs. x $15. 00 per hr. = $90 APPENDIX EXHIBIT 2| For the Year Ended May 31 2010| | ACTUAL| FLEX-BUDGET VARIANCE| FLEX BUDGET| SALES-VOLUME VARIANCE| STATIC BUDGET| TOTAL VARIANCE| Quantity (units)| 12,000| | 12,000| | 10,000| |Sales Revenue| $5,700,000| ($300,000)| $6,000,000| $250,000| $5,750,000| ($50,000)| Variable Costs| $4,515,600| ($99,600)| $4,416,000| ($181,000)| $4,235,000| ($280,600)| CM| $1,184,400| ($399,600)| $1,584,000| $69,000| $1,515,000| ($330,600)| Fixed Costs| $919,500| ($37,000)| $882,500| | $882,500| ($37,000)| Net Income| $264,900| ($436,600)| $701,500| $69,000| $632,500| ($367,600)| FLEXIBLE BUDGET REPORT| GIVEN CALCULATED FILL IN THE BLANK VARIANCES: ($) = UNFAVORABLE & $ = FAVORABLE Illustration of some calculations involved for Flex Budget: Flex Sales Revenue = Std.Sell Price Per Unit x Actual Sales volume (units) Basic Wood Stove = $300 x 7,200 units = $2,160,000 Deluxe Wood Stove = $800 x 4,800 units = $3,840,000 Total Flex Sales Revenue = $6,000,000 Flex Variable Costs = Std. Variable Price Per Unit x Actual Sales Volume (units) Basic Wood Stove = $220 x 7,200 = $1,548,000 Deluxe Wood Stove = $590 x 4,800 = $2,832,000 Total Flex Variable Costs = $4,416,000 Flex Fixed Costs = Static Fixed Costs APPENDIX EXHIBIT 3| | FLEX BUDGET VARIANCE| SALES VOLUME VARIANCE| SALES VARIANCES| | | | Sales Price| | $300,000 U| -| Sales Mix| | -| $234,000 U|Sales Quantity| | -| $303,000 F| Sales Volume | | -| $69,000 F| TOTAL SALES VARIANCE| | $300,000 U| $69,000 F| | | | | VARIABLE COST VARIANCES| | | | Direct Materials| | $109,000 F| -| Direct Labor| | $139,200 U| -| Overhead| | $69,600 U| -| Selling & Admin| | $0| -| TOTAL VARIABLE COST VARIANCE| | $399,600 U| -| | | | | TOTAL CM VARIANCE| | $399,600 U| -| | | | | FIXED COST VARIANCES| | | | Mfg. Budget| | $30,000 U| -| Sell & Admin Budget| | $7,000 U| -| TOTAL FIXED COST VARIANCE| | $37,000 U| -| | | | | TOTAL VARIANCE| | $436,600 U| $69,000 F| | | | | VA RIANCES TABLE| U = UnfavorableF = Favorable APPENDIX Illustration of some calculations involved in creating Exhibit 3: SALES VARIANCE Section Sales Price Variance = Actual Units sold x (Actual Sell Price – Budgeted) Basic Wood Stove = 7,200 x ($325-$300) = $180,000 F Deluxe Wood Stove = 4,800 x ($700-$800) = $480,000 U Total Sales Price Variance = $300,000 U Sales Mix Variance = (Actual Sales Mix % – Budgeted) x Actual total units sold x Budgeted CM per unit Basic Wood Stove = [(7,200/12,000)-(4,500/10,000)] x 12,000 x $80 = $144,000 F Deluxe Wood Stove = [(4,800/12,000)-(5,500/10,000)] x 12,000 x $210 = $378,000 UTotal Sales Mix Variance = $234,000 U Sales Quantity Variance = (Actual total units sold – Budgeted) x Budgeted Sales Mix % x Budgeted CM per unit Basic Wood Stove = (12,000-10,000) x (4,500/10,000) x $80 = $72,000 F Deluxe Wood Stove = (12,000=10,000) x (5,500/10,000) x $210 = $231,000 F Total Sales Quantity Variance = $303,000 F Sales Volume Variance = (Actual Sales Volume – Budgeted) x Budgeted Cm per unit Basic Wood Stove = (7,200-4,500) x $80 = $216,000 F Deluxe Wood Stove = (4,800-5,500) x $210 = $147,000 U Total Sales Volume Variance = $69,000 F Ferguson Foundry Limited CASE ANALYSIS: FERGUSON FOUNDRY LIMITED (FFL) EXECUTIVE SUMMARY Introduction After reviewing the financial statements for the fiscal year ended May 31, 2010, Mark Ferguson, President of Ferguson Foundry Limited’s (FFL), was disappointed with the results. Operating Income was $367,600 below expectation, despite having sold 2,000 wood stove units greater than budgeted. To determine which areas FFL’s actual performance was better or worse than expected, a variance analysis will be conducted.However, it is important to note that variance analysis alone can only emphasize areas that need improvement, and not determine the reason for these discrepancies. A further investigation is warranted once determining the issues outlined through variance analysis. Analysis – Qualitative and Quantitative There are many areas within FFL’s production which have been proven to be unfavourable, and where immediate improvement is necessary. Of particular concern is the variable overhead, where an unfavorable variance of $180,600 was discovered (Appendix F).Within this variance, the variable overhead costs, both manufacturing and non-manufacturing of the Deluxe model are what seem to be causing inefficiencies. The Deluxe model accounts for $157,200 of the $180,600U mentioned above. Other Key Areas of Concern Outlined Through Variance Analysis: * Appendix I: Although the selling price of the basic model increased by $25, a $100 reduction in the selling price of the Deluxe model counterbalanced this increase, and negatively affected income. Appendix E: The difference between the budgeted and actual sales mix had an adverse effect on revenues. The Deluxe model had a greater CM/unit of 210, and was budgeted at 55% of the sales mix, however, it only ended up accounting for 40% of the actual sales mix. * Appendix H: The market share of FFL resulted in being less than expected (10% to 9%), in a market which was larger than expected/budgeted (133,333 to 100,000 uni ts). Recommendation and Implementation We recommend a proper rectification of the issues with regards to FFL’s unfavourable variances.Firstly, is it of utmost importance to have all the necessary components of management (i. e. supervisors, directors, and managers) on the job and ready to manage. Once FFL has the personnel to solve these significant issues, the following must be corrected, in order: Direct labor inefficiencies and high overhead costs, most importantly. Then, they can â€Å"fine tune† and solve higher than usual selling and administrative expenses and high fixed overhead costs. Further instructions with regards to solving these issues are outlined in Appendix K.However, if FFL is not capable of reorganising the company by itself, external help is necessary to implement specific changes that will improve FFL’s bottom line. REFERENCES Bhimani, Alnoor et al. Management and Cost Accounting. Pearson Education Limited, 2012. Print. APPENDIX A DIRECT MA TERIAL VARIANCES Note: F = Favorable and U = Unfavorable APPENDIX B DIRECT MATERIAL VARIANCES CONTINUED *540,000 + 912,000 = 1,452,000 *315,000 + 1,045,000 = 1,360,000 Note: F = Favorable and U = Unfavorable APPENDIX C DIRECT LABOR VARIANCESNote: F = Favorable and U = Unfavorable APPENDIX D DIRECT LABOR VARIANCES CONTINUED Note: F = Favorable and U = Unfavorable APPENDIX E SALES VARIANCES 7200/12000 = 0. 6 4500/10000 = 0. 45 Note: F = Favorable and U = Unfavorable APPENDIX F VARIABLE OVERHEAD VARIANCE *Variable Selling & Administrative Expenses are labeled as Non-Manufacturing in this table. Total Variable Overhead for Basic and Deluxe = 27,000U + 18,000F = 9,000U Note: F = Favorable and U = Unfavorable APPENDIX G FIXED OVERHEAD VARIANCE *750,000 ? 115,000 = 6. 217 Note: F = Favorable and U = Unfavorable APPENDIX H MARKET VARIANCES Note: F = Favorable and U = Unfavorable APPENDIX I VARIANCE OVERVIEW Note: F = Favorable and U = Unfavorable Note: F = Favorable and U = Unfavorable APPE NDIX J ANALYSIS OF THE UNFAVORABLE VARIANCES Note: F = Favorable and U = Unfavorable Note: $421,300 represents the sum of all unfavorable variances that have brought down the company’s annual earnings. Note: F = Favorable and U = Unfavorable APPENDIX K RECOMMENDATIONS: REDUCING THE TOTAL UNFAVOURABLE VARIANCE