Colin Drury, Management and Cost Accounting – Boston CreameryBoston Creamery Professor John Shank, The Amos Tuck School of Business Administration Dartmouth College This case is reprinted from Cases in Cost Management, Shank, J. K. 1996, South Western Publishing Company. The case was prepared by Professor John Shank from an earlier version he wrote at Harvard Business School with the assistance of William J. Rauwerdink, Research Assistant. This case deals with the design and use of formal "profit planning and control" systems. It was originally set in an ice cream company in 1973, a few years before the advent of "designer ice cream". Frank Roberts, Vice-president for Sales and Marketing of the Ice Cream Division of Boston Creamery, was pleased when he saw the final earnings statement for the division for 2000 (see Exhibit 1). He knew that it had been a good year for ice cream, but he hadn't expected the results to be quite this good. Only the year before the company had installed a new financial planning and control system. This was the first year that figures comparing budgeted and actual results were available. Jim Peterson, president of the division, had asked Frank to make a short presentation at the next management meeting commenting on the major reasons for the favorable operating income variance of $71,700. Peterson asked him to draft his presentation in the next few days so that the two of them could go over it before the meeting. Peterson said he wanted to illustrate to the management group how an analysis of the profit variance could highlight those areas needing corrective attention as well as those deserving a pat on the back. THE PROFIT PLAN FOR 2000 Following the four-step approach outlined in the Appendix, the management group of the Ice Cream Division prepared a profit plan for 2000. Based on an anticipated overall ice cream market of about 11,440,000 litres in their marketing area and a market share of 50%, forecasted overall litre sales were 5,720,329 for 2000. Actually, this forecast was the same as the latest estimate of 1999 actual litre sales. Since the 2000 budget was being done in October of 1999, final figures for 1999 were not yet available. The latest revised estimate of actual litre volume for 1999 was thus used. Rather than trying to get too sophisticated on the first attempt at budgeting, Mr. Peterson had decided just to go with 1999's estimated volume as 2000's goal or forecast. He felt that there was plenty of time in later years to refine the system by bringing in more formal sales forecasting techniques and concepts. This same general approach was also followed for variable product standard costs and for fixed costs. Budgeted costs for 2000 were just expected 1999 results, adjusted for a few items which were clearly out of line in 1999. Original Profit Plan for 2000 Standard Contribution Margin/litre Vanilla Chocolate Walnut Buttercrunch Cherry Swirl Strawberry Pecan Chip Total $.4329 .4535 .5713 .4771 .5153 .4683 .5359 $.4530 Forecasted litre Sales 2,409,854 2,009,061 48,883 262,185 204,774 628,560 157,012 5,720,329 Forecasted Standard Contribution Margin $1,043,200 911,100 28,000 125,000 105,500 294,400 84,100 $2,591,300 This only shows up if we adjust the budget to the actual volume level: Carton Allowance Forecast Volume Carton Budget Actual Volume Actual Carton Expense Variance (Based on Forecast Volume) Variance (Based on Actual Volume) = $.591.Colin Drury.000 litres.900 Total $6. Management and Cost Accounting – Boston Creamery Breakdown of Budgeted Total Expenses Variable Costs Manufacturing Delivery Advertising Selling Administrative Total Recap Sales Variable Cost of Sales Contribution Margin Fixed Costs Income from Operations $9.900 703.000 litres for the year as opposed to the budgeted figure of about 11.400 $5.219. an increase of about 248.300 553. The fixed costs in the revised profit plan are the same as in the original plan.800 448.200 --$6.600 Fixed Costs $612.600 553. thereby eliminating all cost variances due strictly to the difference between planned volume and actual volume For costs which are highly volume dependent. If we actually sell only 8.900 6. Market research data indicated that the total ice cream market in their marketing area was 12.800 448.000 litres but use $350 worth of cartons.$350 = $50F = $320 .000 litres over budget. actual sales for the year totaled over 5.800 516.888.$350 = $30U .300 1.000 litres.000 litres A revised profit plan for the year at the actual volume level is shown below.574. The variance is clearly unfavorable by $30 ($350-$320).04 per litre = 10.180.720.000 litres = $350 = $400 . the budget allowance for cartons is $400.900 $645. it is misleading to say that there is a favorable variance of $50 ($350-$400).000 litres = $400 = 8.000 litres. it is not necessary to adjust the budget for these items for volume differences.900. however.968. variances should be based on a budget which reflects the volume of operations actually attained.000 $1. If we forecast volume of 10. Assume. The original budget for fixed-cost items is still appropriate.200 368.440.945. The variable costs. have been adjusted to reflect the actual volume level of 5.628. $1. for example.000 litres instead of the forecasted volume of 5.945.000 $8.945.500.968.04 per litre. In fact.628.100 187.500 ACTUAL RESULTS FOR 2000 By the spring of 2000 it had become clear that sales volume for 2000 was going to be higher than forecast.300 -368. Since the level of fixed costs is independent of volume anyway. that cartons are budgeted at $.600 2. 700F 12.936.458.300 2.4329 .300 6.5713 .800 516.800 578.4771 . The detailed expense breakdowns for the other departments have been excluded for purposes of this case.200 $6.000 1.725.882.300 $9.400 28.000F $99.Colin Drury.018.5359 $.000 $8.300 -368.366 Standard Contribution Margin $1.000F 58.000 $. He showed Jim the following schedule: Favorable Variance Due to Sales: Volume Price a Actual litre Sales 2.645.800 88.124 268.000U 54.709.839 261.240 747.200 915.700F Unfavorable Variance Due to Operations: Manufacturing Delivery Advertising Selling Administration .100 $117.100 $2.000 $1.945.000U 6.377 5.4539 Fixed Costs $612.945.000U $129.900 $763. Three days after Jim Peterson asked Frank Roberts to pull together a presentation for the management committee analyzing the profit variance for 2000. Frank came into Jim's office to review his first draft.525 50.4683 .212 2.800 448. The figures for the month of December have been excluded for the purposes of this case.900 Total $6.600 128.709. Exhibit 2 is the detailed expense breakdown for the manufacturing department.000F 29.113.600 349.900 760.300 134.700 --$6. Management and Cost Accounting – Boston Creamery Revised Profit Plan for 2000 (Budgeted Profit at Actual Volume) Standard Contribution Margin/litre Vanilla Chocolate Walnut Buttercrunch Cherry Swirl Strawberry Pecan Chip Total Breakdown of Budgeted Total Expenses Variable Costs Manufacturing Delivery Advertising Selling Administrative Total Recap Sales Variable Cost of Sales Contribution Margin Fixed Costs Income from Operations ANALYSIS OF THE 2000 PROFIT VARIANCE Exhibit 1 is the earnings statement for the division for the year.049 164.5153 .968.800 448.000F 10.936.064.700 368.500 578.100 244.4535 . Finally. Frank thought to himself.645. Vice President for Manufacturing and Operations. would you make in the variance analysis schedule proposed by Frank Roberts? Can the suggestions offered by Jim Peterson be incorporated without making the schedule "too technical"? example. For 3. What do you see as the main weakness in this approach to management? What is your overall assessment of this "management tool". As Frank Roberts returned to his office. Frank said that he planned to give each member of the management committee a copy of this schedule and then to comment briefly on each of the items. and that rules out John Vance. Armed with this document and his common sense. Management and Cost Accounting – Boston Creamery Net Variance . if he needed some help in the mechanics of breaking out these different variances. The next day Frank Roberts learned that his counterpart. Organizationally. he said. he wondered how to best treat the price variances. how much of the total was due to price differences versus quantity differences? Since the division was a pure "price taker" for commodities like milk and sugar. and the part actually attributable to overall volume changes.700F This price variance is the difference between actual sales value of the litres actually sold and the standard sales value ($9. The approach to "profit planning and control" described in the case is still very common today. Parker felt it was Marketing's responsibility to set prices so as to recover all commodity cost increases.$9. Indicate the corrective actions you would recommend for 2001. he thought. Jim Peterson said he thought the schedule was okay as far as it went. but that it just didn't highlight things in a manner which indicated what corrective actions should be taken in 2001 or indicated the real causes for the favorable overall variance. from a contemporary perspective? . Besides. 2. for example? He suggested that Frank try to break down the sales volume variance into the part attributable to sales mix. if any. What changes.Favorable a $71. he considered Jim Peterson's suggestion of getting John Vance involved in revising the variance report.300 . he suggested that Frank call on John Vance. ASSIGNMENT QUESTIONS 1. the document shown here as the Appendix. Roberts and Parker were the only two vice presidents in the division. in the following day's mail.300). Delivery and Administration to Parker. A telephone call to John Vance asking about any written materials dealing with mix variances and volume variances produced. He also suggested breaking down the unfavorable manufacturing variance to indicate what main corrective actions are called for in 2001. Frank couldn't imagine a quicker way to put people to sleep than to throw one of Vance's number-filled six-page memos at them. Can you speculate about how John Parker might structure the variance analysis report.657. For example. Many people still consider this approach to be "bread and butter" management theory. you don't have to be a CPA to focus on the key variance areas from a general management viewpoint. Also indicate those areas which deserve commendation for 2000 performance. Jim Peterson specifically wants a nontechnical presentation. had seen the draft variance report and was very unhappy about it. 4. Marketing and Advertising reported to Roberts and Manufacturing. the corporate controller. Frank did not want to consult John Vance unless it was absolutely necessary because he thought Vance always went overboard on the technical aspects of any accounting problem. Parker had apparently told Jim Peterson that he felt Roberts was "playing games" with the numbers to make himself look good at Parker's expense. Which elements were uncontrollable. the part attributable to market share shifts. Frank Roberts dug in again to the task of preparing a nontechnical breakdown of the profit variance for the year. based on the profit variance analysis.Colin Drury. Vance said to see Exhibit A for the variance analysis breakdown. John Parker. Sales. Cartonizing and Freezing** Labor .940.300 599.000 25.800 567.100 607.900 57. a Year-to-Date Actual $9.725.800 251.800 448.900 29.000 41.648.900 23.657.882.300 6. Schedules A-3 through A-6 have not been included in this case.800 32.200 41.100 566.000 $6.000 35.000 40.000 3.900 760.900 **The primary reason for the increase in labor for cartonizing and freezing and decrease in delivery cost was a change during the year to a new daily truck loading system: .800 578. 2000 Month Actual Flexible Budget Sales-Net Manufacturing Cost (Schedule A-2a) Delivery (Schedule A-3)** Advertising (Schedule A-4) Selling (Schedule A-5) Administrative (Schedule A-6) Total Expenses Income from Operations Variance Analysis in Exhibit 3.000 $612. * See Exhibit 3.000 $652.000 $8.200 28.824.725.000 $6.800 Note Flexible Budget $9.06 per litre sold to a "budget" of 6% of Sales.500 31.000 30.200 $717.200 81.900* 706.113.900 $390.700 $6.172.700 362. Management and Cost Accounting – Boston Creamery EXHIBIT 1 ICE CREAM DIVISION Earnings Statement December 31.000 $8.Colin Drury.700 235.200 $763.800 438.679.800 -982.824.In 2000 the company changed from an advertising "budget" of $.100 EXHIBIT 2 ICE CREAM DIVISION Schedule A-2 Manufacturing Cost of Goods Sold December 31.200 $3.800 $6.700 368. Note .800 46.400 946.500 -596.645.Other Repairs Depreciation Electricity and Water Spoilage Subtotal Total Year-to-Date Actual Flexible Budget $3.000 31. 2000 Actual Month Flexible Budget Variable Costs Dairy Ingredients Milk Price Variance Sugar Sugar Price Variance Flavoring (Including Fruit and Nuts) Cartons Plastic Wrap Additives Supplies Miscellaneous Subtotal Fixed Costs Labor .000 81. Schedule A-2 is reproduced as Exhibit 2.100 $425.300 6.000 3. This substitutes lower cost factory labor for higher cost driver labor for loading the trucks and also frees up some driver time each day for more customer contact and point of sales merchandising.400 763. Sugar is an example of a pure variable cost. based on tomorrow's sales orders. In both cases of fixed cost. Each change in volume will automatically bring a change in the sugar cost. Variable marketing cost per unit is based on the allowable rate (for example. Depreciation charges for plant would be an example of a relatively extreme fixed cost. based on today's sales orders. After: Carton handling workers sort daily production each day onto pallets grouped by delivery truck. The Financial Planning and Control System for the Ice Cream Division The beginning point in making a profit plan is separating cost into fixed and variable categories. Very large increases in volume can usually be realized before this type of cost is pressured to change.700F 46. the change in cost level is not automatic. will vary if significant changes in volume occur. but they. too. It is this dilemma that management is constantly facing: to withstand the pressure to increase or be ready to decrease when the situation demands it. pressure will be felt to increase or decrease this expense. Costs that are not pure variable are classified as fixed. it is dictated by volume. require a management judgment and decision to increase or decrease the spending.000U $71.100 117. There will be varying degrees of sensitivity to volume changes among these costs. Pure variable costs require an additional amount with each increase in volume. It would be a mistake to set a standard variable cost for items like route salesmen's salaries or depreciation. on the other hand. EXHIBIT 3 Analysis of Variance from Forecasted Operating Income Month (1) Actual Income from Operations (2) Budgeted Income at Forecasted Volume (3) Budgeted Income at Actual Volume Variance Due to Sales Volume and Mix [(3) minus (2)] Variance Due to Operations [(1) minus (3)] Total Variance [(1) minus (2)] Year to Date $717. Advertising is the only cost element not fitting the explanation of a variable cost given in the first paragraph. ranging from a point just short of pure variable to an extremely fixed type of expense which has no relationship to volume. based on past performance. Route salesmen's salaries would be an example of a fixed cost that is fairly sensitive to volume. Fixed costs. The reason for differentiating between fixed and variable so emphatically is because variable cost spending requires no decision. The manager has little control over this type of cost other than to avoid waste. because they must constantly be evaluated for better and more efficient methods of doing the task. As volume changes. but management must make the decision.100 645. only the yield can be controlled. each route sales delivery driver loads the truck from inventory. Management and Cost Accounting – Boston Creamery Before: Every morning. before leaving the plant. but not pure variable.06 per litre for advertising). The accountant can easily determine the variable manufacturing cost per unit for any given product or package by using current prices and yields.700F APPENDIX This description of the financial planning and control system is taken from a company operating manual. a decision from management is required to increase or decrease the cost. Drivers spend up to 2 hours each day loading the truck before they can begin their sales route. Advertising costs are set by management decision rather than being an "automatic" cost .Colin Drury. $. 06 . advertising is like route salesmen's expense.025 1. by product and package type. Examples of two different packages for one product are shown below.40 . as well as to the number of Fridays and Mondays.16 .50 .10 1. therefore. As already pointed out. STEP 1 VANILLA ICE CREAM Regular 1-litre Item Dairy Ingredients Sugar Flavor Production Warehouse Transportation Total Manufacturing Advertising Delivery Total Marketing Packaging Total Variable Selling Price Marginal Contribution per litre Paper Container $.12 .16 1. the accountant can do this by using current prices and yields for material costs and current allowance rates for marketing costs.53 . has transformed advertising into an expense which is treated as variable for profit planning purposes.79 . management has decided that the allowance for advertising expense is equal to $.25 1. because all plans drive from the anticipated level of sales activity.06 .325 .Colin Drury.02 .04 . Other factors that should be considered are: 1 2 3 4 General economic conditions of the marketing area Weather Anticipated promotions Competition .06 per litre for the actual number of litres sold. this amount is subtracted from the selling price to arrive at a standard marginal contribution per unit.08 .15 .96 .675 2. Following is an example of the four-step approach to one-year profit planning.10 . however. After the total unit variable cost has been developed. by product and package size.15 . This management decision. In this sense. Management and Cost Accounting – Boston Creamery item like sugar or packaging.34 Premium 1-litre Plastic Container $. For our company.725 Step 2 is perhaps the most critical in making a profit plan.10 .10 . as these are two of the heaviest days and will make a difference in the sales forecast.04 .10 .06 . Consideration should be given to the number of days in a given period. The first step in planning is to develop a unit standard cost for each element of variable cost. Much thought should be given in forecasting a realistic sales level and product mix. 920 3.000 $12.668 10.000 128.000 50.000 $152.280 3.000 225.Colin Drury.440.668 668 $32. and so on.667 $2.000 Step 3 involves setting fixed-cost budgets based on management's judgment as to the need.668 3.348 $21. we arrive at a total marginal contribution by month.000 10. After Step 4 has been performed.000 $5.000 $12.000 5. Because this system is based on a one-year time frame.612 $7.000 225.000 20.167 1.700.000 60.000 2.332 $20.000 10.326 $62.000 December Total Step 4 is the profit plan itself.000 $7.000 December 100.663 1. STEP 3 BUDGET FOR FIXED EXPENSES January Manufacturing Expense Labor Equipment repair Depreciation Taxes Total Delivery Expenses Salaries .332 6.000 5. Insurance and taxes are budgeted.000 8.000 1.000 120.000 495.004 $10.940. Paper 1 litre.663 $32.652 652 $31.000 40.000 120. Management and Cost Accounting – Boston Creamery STEP 2 VANILLA ICE CREAM SALES FORECAST IN LITRES January 1 litre. Plastic 2 litres.956 $120.Driver Helpers Supplies Total Administrative Expense Salaries Insurance Taxes Depreciation Total Selling Expense Repairs Gasoline Salaries Total $2.200.000 600.667 5.000 20.667 1. It is here that good planning makes for a profitable operation. manufacturing labor is considered to be a fixed cost. The number of routes needed for both winter and summer volume is planned.663 5.000 $248.667 833 $9.163 1. The level of manufacturing payroll is set.334 $5. Subtracting the fixed .General Salaries . The level of the manufacturing work force is not really variable until a time frame longer than one year is adopted.000 $384.652 10.000 $112. Premium Total 100.000 $10.348 6.652 3.000 495.000 50. By combining our marginal contribution developed in Step 1 with our sales forecast from Step 2.000 60. Paper 1 litre.663 837 $9.000 40.000 Total 1.000 128.268 $88. it may be necessary to return to Step 3 and make adjustments to some of the costs that are discretionary in nature.000 10.000 80.000 5. in light of the sales forecast. 000 90. The impact of each of these two factors is also shown in Exhibit A: EXHIBIT A JANUARY Actual litre Sales 1 litre.000 $195. Paper 1 litre.000 Standard Contribution Per litre $.044.612 32. Looking back at our sales forecast (Step 2) we see that 495.000 384.600 28.3957 January litres 100. Paper 1 litre.305 . we have an operating profit by month.000 112.500 $.000 $195. 2 and/or 3. Paper 1 litre.258 $248.750 195.350.000 120.000 $189.725 $.625 87.Colin Drury.000 50. 495.125 less standard contribution than the 495. Management and Cost Accounting – Boston Creamery cost budgeted in Step 3. unfavorable. When we apply our marginal contribution per unit for each product and package. we will take the month of January and assume the level of sales activity for the month to be 520.617 $121.500 Once the plan is completed and the year begins.340 .500 1.3649 Total Standard Contribution $30. U.125U $.3957 Actual 520.000 litres have produced $6.000 715. The $6.3649 90.000 litres) Variance Planned litres Contribution Average Std. as shown below. we find that the 520. Paper 1 litre.000 $2.000 495.0308U .340 .725 $. Premium Total Marginal Contribution Fixed Cost (See Step 3) Manufacturing Expense Delivery Expense Administrative Expense Selling Expense Total Fixed Operating Profit $20. a new evaluation should be made for Steps 1.000 $ $34.000 15. STEP 4 THE PROFIT PLAN Standard Marginal Contribution 1 litre.000 $1.667 $74. Premium Total Forecasted Standard Contribution (at 495. It is thus due to differences in volume and to differences in average mix. If this profit figure is not sufficient.000 litres had been forecasted.250 59. profit variance is calculated monthly as a "management control" tool.875 6. the mix has been unfavorable. So even though there has been a nice increase in sales volume.000 $896.875 Total Year $408. To illustrate the control system.000 litres. Plastic 2 litres. favorable.000 520.265 .000 95.305 . Plastic 2 litres.925 65.000 152.125 U Difference 25. Contribution F.000 183.265 .000 245.000F $6.125 represents the difference between standard profit contribution at forecasted volume and standard profit contribution at actual volume.334 12.000 litres would have produced at the forecasted mix.454.750 $.975 64.250 $189.000 225.004 9.875 $. 125U. A sheet is issued for each department.332 Taxes $20. The totals for each department are carried forward to an earnings statement. as shown: EXHIBIT C EARNINGS STATEMENT January Month Actual $867. Management and Cost Accounting – Boston Creamery Variance Due to Volume 25.612 Subtotal .065 6.537 Total Actual Year-to-Date Flexible Budget Since the level of fixed costs is independent of volume anyway.225 Production 11.350 Warehouse 69.000 Sugar 55. it is not necessary to adjust the budget for these items for volume differences. thereby eliminating cost variances due strictly to the difference between planned and actual volume.537 Manufacturing Cost of Goods Sold 52.000 Dairy Ingredients 78. The original budget for fixed-cost items is still appropriate. EXHIBIT B MANUFACTURING COST January Month Actual $312. We have assumed all other department's actual and budget are in line.514 $571.668 3.0308U X 520.290 38. so the only operating variance is the one for manufacturing.3957 = $9.332 $21.304 56.922 7.025 Flavorings 37. there is an unfavorable operating variance of $22.Fixed $570.300 4.Variable 7.300 11.287 52. In our example.Colin Drury.744 82.287 Flexible Budget $299. Exhibit C.925 Subtotal .668 Depreciation 3.332 Equipment Repair 6.750 ($570.365 $593. You should note that the budget for variable cost items has been adjusted to reflect actual volume.280 Labor 3.804 Flexible Budget $867.804 Delivery Expense Actual Year-to-Date Flexible Budget . so the person responsible for a particular area of the business can see the items that are in line and those that need attention.000 litresF X $.892F Total variance = $6.325 Transportation $549.770 70.750 $593.287). results in an overall variance from the original plan of $28.125U Variance Due to Mix $.750 Total Ice Cream Sales $570. added to the sales volume and mix variance of $6.537-$593.875U.017U Exhibit B shows a typical departmental budget sheet for the month of January comparing actual costs with budget.000 litres = $16. This variance. 92.133 = 22.115.075 Packaging Expense 12.258 .383 = 28.383 . Management and Cost Accounting – Boston Creamery 31.258 (2) 115.367 $92.133 (3) 115.875U .Colin Drury.334 $775.200 76.383 (1) 121.617 Total Expense $115.334 Administrative Expense $752.258 = 6.121.133 Operating Profit Variance Recap Actual Profit before Taxes Original Profit Plan Revised Profit Plan.667 Selling Expense 9.125U 92.200 Advertising Expense 76.383 31.750U 121.133 . Based on Actual Volume Variance Due to Volume and Mix (3-2) Variance Due to Operations (1-3) Total Variance (1-2) = = = 92.667 9.075 12.