206542492 whiz calculator company

Whiz Calculator Company

Michele Granata 4th

year Euro BBA Student ID: 09409688

Whiz Calculator Company (case 4-4)

Case Overview

How to control selling costs in a sales branch?

Whiz Calculator Company is considering a new methodology for planning and controlling selling

costs. The old method was unsatisfactory according to new president Bernard Riesman.

Old method of planning and controlling selling cost:

1) Selling expenses budgeted with a “fixed” budgeting approach. Each October, the accounting

department, sent to selling departments an accurate record of their actual department expenses for

the previous year and the current year- to-date.

2) Considering this record, the estimates for the succeeding year‟s sales and their own judgment, the

department heads, drew up estimates of the expenses for their departments.

3) Following this, these estimates were sent to the sales manager, who verified them and cleared up

any doubtful items by correspondence.

4) After approval by the sales executive, the branch costs estimates were submitted to the marketing

manager, who was in charge of all promotion, selling and warehousing activities.

5) The marketing manager discussed these figures with the managers concerned, and she combined

the estimates of all departments into a selling expense budget.

6) Finally, the budget was submitted to the budget committee for approval. These budgeted figures

were divided into 12 parts and compared to each month`s actual results.


New Budget Method proposed by Mr Riesman:

Flexible Budgeting.

Setting selling cost on a fixed and variable basis.

Fixed costs to be those incurred at the minimum sales volume.

Setting the variable expense standard using linear regression.

Variable costs to be expressed as an amount per sales dollar.

Activity driver: sales value.

Questions

Question 1

Determine whether each item of expense is (a) variable with sales volume, (b) partly variable

with sales volume, (c) variable with some other factors, or (d) not related to output volume at

all.

There is more than one possible answer for most of the items.

Manager‟s salary: (d) not related to output volume at all.

Office salaries: (b) partly variable with sales volume and/or (c) variable with some other factors.

Variable element might be due to a bonus based on sales or variability based on overtime.

The fixed element of the office salaries is just a small percentage of the total (139$, just 11.5% of

the flexible budget). The assumption is that this fixed part relates to a sales level of zero. However,

sales never go down to that level. It is probable that the company always operates within a fairly

narrow range of sales. For instance, if the minimum sales value in this range is 250,000$, the „fixed

part‟ would effectively be 139+0.0041*250,000= 1,164; which is 96.28% of the budget figure.

Sales force compensation: (a) completely variable with sales volume for two reasons:


The variable factor is a round number, 5 cents per dollar sales (0.005).

The budget is exactly the same as the actual cost.

Travel expense: (b) partly related to sales volume or (c) variable with some other factors.

Issue of time lag, travel expenses in this month could generate a sale in the following months.

Stationery, office supply: (b) partly variable with sales volume or (c) variable with some other

factors, because of seasonality. Perhaps, they could decide to have a start of term sale and start

preparing posters, flyers.....

Postage: (b) partly variable with sales volume or (c) variable with some other factors.

Light and heat: (c) variable with some other factors. It principally varies with the time of year.

The variances are due to the calculation of budget figures in a given month, dividing the total for

the year by twelve. It does not consider that, there is a higher usage of these factors in some periods

of the year.

Subscription and dues: (b) partly variable with sales volume and/or (c) variable with some other

factors. It depends on the nature of the subscriptions and dues.

Donations: (b) partly variable with sales volume and/or (c) variable with some other factors. If

the profit of the company goes down they could decide to trim donation expenses. On the other

hand, in the case of a disaster they might decide to donate a consistent amount of money.

It is highly likely to also have a fixed element.

Advertising Expense:

(b) Partly variable with sales volume. Causality issue: is a higher sales level which leads to

increasing advertising expenses or vice-versa?

(c) Variable with some other factors.

Social Security taxes: (b) partly variable with sales volume and/or (c) variable with some other

factors.


Same logic that applies to salaries and sale force compensation, as presumably the company pays

tax on these expense items.

Rental: (d) purely fixed. The actual is the same as the budget. They know how much the annual

rental is going to be and just divide it by twelve.

Depreciation: (d) not related to output volume at all.

Accounting figure, depends on the assumption that they adopt in the underlying depreciation

method.

Problem: possibility of dysfunctional behaviour. Is it appropriate to use an arbitrary accounting

figure in the calculation of the budget used to incentivise staff?

Other branch expense: (b) partly variable with sales volume and/or (c) variable with some other

factors.

It is not clear what is included.

Question 2

What bearing do your conclusions in question 1 have on the type of budgeting system that is

most appropriate?

For item of type (a), (b) and (c) the new budgeting system is preferable since it allows for:

Separation of fixed and variable factors.

Adjustment of the variable portion of budget allowance to correspond to the actual sales value.

However, for item (c), the cause of variation should not be sales value.

In addition, another distinction is relevant:

Engineered costs: vary directly with sales volume (e.g. manufacturing expenses).

Discretionary costs: result of branch manager‟s decision.


Many of the sales costs are discretionary (e.g. donation, promotion...). Thus, the new quantitative

budgeting method based on the linear regression may not be appropriate. Moreover, accounting

information is not sufficient for control purpose for discretionary costs. They should be integrated

with a system of informal control.

Question 3

Should the proposed sales expense budgeting system be adopted?

A) Fixed Budget Method

The new President believed there were two limitations to this approach.

There was no possibility to ascertain the plausibility of the estimates made by department heads.

Selling conditions fluctuated over time after the budget had been adopted. Nevertheless, there

was no way to consider these changes in the budget for the year once it was established.

Other weaknesses;

The sales branch manager estimated future costs based on past spending. Past costs are

problematic in predicting the future; just relying on past costs is not sufficient.

Potential problems in relying on past costs:

Inflation

Market Conditions

New products and competitors in the marketplace (changes in the competitive

environment. For example, mobile phones entered this market as substitutes to calculators a few

years ago.)


Total budget for the year divided by twelve: problem of seasonality. This is a calculator business,

and thus, it experiences a sales peak at the beginning of the year when the schools and colleges

start.

Potential conflict of interest between accountants and sales people. In the cases of unfavourable

variances, the sales manager could use the pitfalls in the budgeting system as an excuse. This

problem is, to a certain extent, also related to the difference in the average personality between

accountants and sales employees (see sentence at the end of the case).

Strengths of the fixed budget method;

Acknowledgment that optimum expense levels and performance cannot be determined precisely.

Reliance on action-accountability control to provide an indication of allowed expenses.

B) Flexible Budget Method

Problems of the flexible budget method;

Mr Riesman had been vice president of manufacturing. In fact, the methodology that he

proposed is more typical in manufacturing expense control and may not be the best solution for

selling costs. This is the reason behind the final statement of the sales executive in the case study,

where he asserts that the implementation of the new method is not appropriate for the sales

department.

Is it appropriate to use a quantitative approach when many costs are discretionary?

The hypotheses related to the fixed portion are largely arbitrary.

Variable portion expressed as a certain amount per sales dollar:

Does not consider selling difficulties, economies of scale for large orders, or consumer

behaviour.

The underlying assumption is that selling costs are driven by sales value.


Not all selling expenses are variable with sales, and some are only partly variable with

sales.

Linear regression technique to set the variable expense standard. The regression is

formed around equations which showed how this variable had fluctuated with sales volume in

the past and modified arbitrarily by the controller on the basis of his judgement.

Sales manager has an incentive to increase sales value. The higher the sales value, the

higher the budget for the various cost items (Revenue Centre Approach). Is that beneficial for the

business? It does not give a clear signal for revenue-expense trade-off. It gives an incentive to

increase sales but not necessarily profit.

Solution: Profit centre approach. The budget is not set based on the sales value, but on the profit

generated by those sales. It allows for a trade-off between incremental selling expenses and their

contribution.

Strengths of the flexible budget method

Convenient because readily available and easy to understand.

It allows for an adjustment of the variable portion so as to correspond to the actual sales that

occurred in a month.

More accurate if the range of the sales figures presents a high degree of variability, which is

highly probable in a business characterized by seasonality.

Final Remarks

Both methods present pros and cons and neither is perfect. However, I believe the new method

(flexible budgeting) should be adopted. It enables the separation between fixed and variable

components of the expenses and thus is more apt to adapt to fluctuations in actual volume of sales.

This is particularly relevant in the calculator business which is characterized by seasonality.


Moreover, the controller is aware of the pitfalls of the new method, and he plans to make

improvements in subsequent years:

Defining a more accurate measurement of the causes of variation.

Setting the rates of variation using the time-study technique.

Finally, the total difference between actual and budgeted figures is lower with the new system than

under the old one. This is potentially a sign that the flexible budget provides a more accurate and

valuable description of reality.

Question 4

Other suggestions regarding sales expense reporting

Given the discretionary nature of the sales costs, it is fundamental to partner the formal (accounting)

control system analysed with a system of informal controls;

Meetings to discuss changes in the competitive environment.

Analyses of the variances on a case by case basis.

Teamwork, collaboration and communication between sales and the accounting department in

establishing the sales budget.

206542492 whiz calculator company

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