Question: Scion Corp. manufactures earth-moving equipment.
Scion Corp. manufactures earth-moving equipment. Department A303 produces a number of small metal parts for the equipment, including specialized screw products, rods, frame fittings, and some engine parts. Scion uses flexible budgeting. The budget for each line item is based on an estimate of the
TABLE 1 Part Number UAV 672
budgeting Standards per 100 Parts per Batch
Raw materials…………………………………….. $26.72
Direct labor, salaried ………………………..2.5 hours
Direct labor, hourly ………………………….3.2 hours
Machine hours …………………………………6.3 hours
fixed costs and variable costs per unit of volume for that item. The volume measure chosen for each line item is the one with the greatest cause-and-effect relation to the item. For example, the volume measure for utilities is machine hours, whereas the volume measure for supervision is direct labor hours of hourly employees.
At the beginning of the year, the plant is given an annual production quota consisting of the number of each piece of earth-moving equipment to produce. These equipment quotas are exploded into the total number of parts each department must produce, using data about what parts are required for each unit of equipment. Each department has a detailed set of standards, developed over a number of years that translate each part produced into the number of machine hours, direct labor hours, raw materials, and so on. Table 1 summarizes the operating results of department A303—specifically, the budgeted cost per batch of 100 parts for part number UAV 672.
Given the production quotas and the detailed set of quantities of each input required to produce a particular part, Department A303’s financial budget for the year can be developed. At the end of the year, the actual number of each type of part produced times the budgeting standards for each part can be used to calculate the flexible budget for that line item in the budget. That is, given the actual list of parts produced in Department A303, the flexible budget in Table 2 reports how much should have been spent on each line item. Price fluctuations in raw materials are not charged to the production managers. If low-quality materials are purchased and cause the production departments to incur higher costs, these variances are not charged to the production departments.
The manager of Department A303 does not have any say over which parts to produce. The manager’s major responsibilities include delivering the required number of good parts at the specified time while meeting or bettering the cost targets. The two most important components of the manager’s compensation and bonus depend on meeting delivery schedules and the favorable cost variances from the flexible budget.
Senior management of the plant is debating the process used each year to update the various budgeting standards. Productivity increases for labor would cause the amount of direct labor per part to fall over time. One updating scheme would be to take the budgeting standards from last year (e.g., Table 1) and reduce each part’s direct labor standard by an average productivity improvement factor estimated by senior plant management to apply across all departments in the plant. The productivity improvement factor is a single plant wide number. For example, if the average productivity factor is forecast to be 5 percent, then for part UAV 672 the budgeting standard for “Direct labor, salaried†becomes 2.375 hours (95 percent of 2.5 hours). This is termed “adjusting the budget.â€
An alternative scheme, called “adjusting the actual,†takes the actual number of direct labor hours used for each part and applies the productivity improvement factor. For example, suppose part UAV 672 used an average of 2.6 hours of salaried direct labor last year for all batches of the part manufactured. The budgeting standard for “Direct labor, salaried†for next year then becomes 2.47 hours (95 percent of 2.6 hours).
Under both schemes, last year’s actual numbers and last year’s budgeted numbers are known before this year’s budget is set.
Required:
Discuss the advantages and disadvantages of the two alternative schemes (adjusting the budget versus adjusting the actual).
Transcribed Image Text:
TABLE 2 Scion Corporation Machining Department A303 Operating Results for Last Year Favorable Actual Last Year Budget (Unfavorable) Variance Last Year Volume Measures 265,000 152,000 Machine hours 238,654 146,400 Direct labor hours Parts machined 33,565,268 35,759,000 Departmental Financial Performance $ 8,150,000 $ 8,326,875 1,546,729 Raw materials Direct labor, salaried Direct labor, hourly Supervision $(176,875) 96,271 (90,623) 8,403 1,643,000 1,375,000 460,000 325,000 285,000 82,000 53,000 210,000 1,465,623 451,597 Maintenance 315,864 9,136 5,220 Engineering 279,780 69,539 85,750 188,500 Utilities Training Factory overhead 12,461 (32,750) 21,500 Total operating expenses $12,730,257 $12,583,000 $(147,257) "Budget reflects expected fixed costs plus variable costs per unit volume times actual volume.
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