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 Favourabl Flexible Budget Variance (E - I)

Actual Units sold Retail and catalog (174,965 units Internet (105,429 units Wholesale (45,162 units Total revenue

Master (Static) Budget

Flexible Budget

3,25,556

3,25,556 -

85,73,285 1,16,62,000 30,88,715 Unfavorable 85,73,285 44,28,018 0 44,28,018 Favourable 44,28,018 14,45,184 13,44,000 1,01,184 Favourable 14,45,184 1,44,46,487 1,30,06,000 14,40,487 Favourable 1,44,46,487

Variable production costs: Direct materials Acrylic pile fabric 10-mm acrylic eyes 45-mm plastic joints Polyester fiber filling Woven label Designer Box Accessories Total direct materials Direct labor Variable overhead Total variable production costs Variable selling expenses Total variable expenses Contribution margin Fixed costs: Manufacturing overhead Selling expenses Administrative expenses Total fixed costs Operating income 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 Unfavorable 271302.0926 19,237 Unfavorable 123711.28 50,002 Unfavorable 227889.2 85,456 Unfavorable 424850.58 2,422 Unfavorable 16277.8 2,288 Unfavorable 78133.44 32,413 Unfavorable 39066.72 2,14,916 Unfavorable 1181231.113 -14,880 1,926 18,113 26,005 144 -8,645 26,946 49,609 Favourable Unfavorable Unfavorable Unfavorable Unfavorable Favourable Unfavorable Unfavorable

9,80,305 Unfavorable 3125337.6 5,42,967 Unfavorable 6,79,361 Unfavorable 1216537.661 5,09,127 Unfavorable 18,74,582 Unfavorable 5523106.373 11,01,704 Unfavorable 6,41,314 Unfavorable 1416494.156 4,43,100 Unfavorable

25,15,896 Unfavorable 6939600.529 15,44,803 Unfavorable 10,75,409 Unfavorable 75,06,886 -15,44,803 Unfavorable

6,58,897 50,23,192 11,23,739 68,05,828 -8,43,745

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

3,023 Favourable 769614.384 -1,10,717 Favourable 5,60,192 Unfavorable 44,63,000 5,60,192 Unfavourable -261 Favourable 261 Favourable 11,24,000 -5,56,908 Unfavorable 6356614.384 4,49,214 Unavourable 11,50,272 -19,94,017 Favourable

7,88,572 -16,32,317 Unfavorable

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

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 e & E Fe
 

Pr e

Acrylic pile fabric 10-mm acrylic eyes 45-mm plastic joints Polyester fibre filling Woven label Designer Box Accessories To re er
!  

Direct labour 3668305 3125337.6 r e o er e 1725665 1216537.661 F: Favorable, U: Unfavorable

 # " 



re

er

256422 271302.0926 125637 123711.28 246002 227889.2 450856 424850.58 16422 16277.8 69488 78133.44 66013 39066.72 1230840 1181231.113

276850 125637.12 271183.22 499039.25 16422.35 75804.96 39066.72 1304003.62

20428 0.12 25181.22 48183.25 0.35 6316.96 -26946.28 73163.62

-5547.9074 -1925.84 F -43294.02 F -74188.67 -144.55 F 2328.48 U 0 F -122772.5074

3591976 -76329 U -466638.4 1398176.658 -327488.342 U -181638.9972

Pr e r e

         

e y

e y e

Similarly, the sales analysis has been given below. These calculations have been done assuming that the internet sales would have been included:
S e
5 1 762 40)1$1 3 1& $ &)& %$(' & %$

S e M r e

3,25,556

2,80,000

45,556

3,25,556

3,25,556

Retail and catalog (174,965 units) Internet (105,429 units) Wholesale (45,162 units) To re e
2( B %$1

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

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

0 ($ ) $ 8 9) & %$

M S

er

er e e

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

0 ($ ) $ 8 A2% 8 & %$

Fe

e e

4 9 ) A & % $& 5 1 7 62 3 5 1 7 62 %@)9 %

4 9 ) A & %$ & %$ 21 0 '3 5 1 76 2 %@)9 %

Fe

e e e

0 ($ ) $ 8 5 1 762 1& $

S e o e r e 45,556

%$ 21 0' 6 % & &1 ) (

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 Budget Price 35.00 0.19 0.14 1.45 0.05 0.24 0.12 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 Bonus @20% 232388.83

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

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

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. Rita S ith (Marketing)
C

Actual 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

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

Therefore, Rita receives a bonus of $23,898.10

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 E iciency Variances Production e iciency 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%
DD DD

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

U U U U U F

-466638 U -181639 U -76329 U -327488 U 3023 F -1171844 U 0

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

QUANTITATIVE ANALYSIS
Marketing Manager
 48% of Flexible Budget Variance (Unfavorable) => Variable Selling Expense ($443,100) +

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

-Special Internet Sales Price Discount Unfavorable Sales Mix Variance ($675,596) Purchasing Manager
 50% of Flexible Budget Variance (Unfavorable)  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 Manager
 Formulation of standard costs invalid

-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 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 Usage 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 spending 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
Advantages 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. Disadvantages 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.

Role of budget 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. Budget variances should not be the only parameter for performance evaluatio n

Suggestions for improving 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)))

1) The Berkshire Toy Company

o o

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

2) Marketing
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) Purchasing
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

5) Management
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