Barrington Products. Inc. – Case Solution

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Barrington Products. Inc. Case Answers

Summary

Barrington products is a manufacturing company with five divisions- cotton textiles, Knitted goods, woolen goods, artificial fiber products, and artificial leather. Each division is headed by Division general managers who is also the deputy president of Barrington products. It is mentioned that each division maintains accounting records, submit a balance sheet and income statement to main headquarters once in every month. The case notes that corporate staff are not directly involved in the division activities but only help when need be to coordinate division activities such as preparing an estimate of annual sales.

Each division has a management control system where individual division forecast sales, then an estimate of sales is prepared by corporate staff and the division general manager reviews the estimates and makes necessary changes. After approval by the division general managers, the summary of the estimates is forwarded to the president of Barrington products for the final approval. The last stage of the approval process is that the budgets from all divisions are integrated into a profit budget and presented to the company’s board of directors for final and last approval and it becomes a basis of for evaluating each division’s performance and paying out bonuses for the first time.

Key problem(s)

Barrington products is a multiple product company with a management control system that is not properly operating. The top management is concerned about the huge variances seen in its budget. Some divisions are showing favorable and unfavorable variances and even though there are some favorable variances, but the work done in the divisions is not satisfactory.

It is stated that the management control system was recently introduced, and the controller of Barrington products had thought that the system would work well for the divisions products because it had worked well for the industrial products.

The monthly report reveals that sales volume revenues were not budgeted well or inaccurate and it shows huge revenue variances, the president notes that either sales volume had gone up or down than the budget. Another problem is that the costs are varied which is unusual and there is a need to explain the reason for the variances. Again, the artificial leather division has revealed some problems even though it is showing a favorable sales volume variance compared to other divisions but it generally performing poorly. Generally, there are lots of issues to be resolved by Barrington products management.

Analysis of the variances

Profit variance-Unfavorable

The decrease in profit in the profit to be accounted for is ($54,000) unfavorable which arise from the difference between the budgeted and the actual profits and reduces profit. These difference between the budgeted and the actual profits can be explained in terms of; sales price variance, sales volume variance and costs variance. The division general manager of the cotton textile can explain the explain the unfavorable profit variance. The manager might have sold lower total number of units than the budgeted or the less profitable products were sold than what was anticipated in the budget. Some of the other reasons was may be due to decrease in demand for the products or increase competition in the market. The manager can also explain why the materials purchased were too expensive or there was no discount offered due to small order sizes.

Sales volume variances-Unfavorable

This is the difference between the flexible budget amount for the clothes and the amount for the clothes reflected in the master budget for the month of April. From the flexible budget variance, the sales volume variance for the month of April ($65,000) which is unfavorable. This means that the standard profit of the cotton textiles division is lower than the amount budgeted. This might be attributed to low quantity of items were sold than the budgeted quantity or the demand for the more profitable products became lower than expected. It might also be because of decrease in the production of high profit margin products due to shortage of raw materials or labor. The division also might have failed to set proper goal for the month, the division set inappropriate selling price for the clothes and the marketing and promotion programs were not effective.

Raw materials variance

This is the difference between the actual direct materials cost and the total standard direct materials cost for the month. Unfavorable-The raw materials usage variance for the month of April is ($3,000) which means that the actual quantity of materials used were more than the budgeted quantity. The manager in charge can explain why the workers used too much materials to make the fabrics or were the materials of low quality that caused the fabrics to be rejected or did the workers waste materials in making fabrics? Barrington products top management need to understand this kind of information to come up with a solution.

Favorable- the materials price variance for the month of April is $4,000 meaning that the actual price of buying materials was lower than the budgeted amount. This might have been due to discounts received that were not expected when the budget was prepared. Was there a positive change in the standard of materials?

Direct Labor variance

It results from the total direct labor cost for the period being different from the total standard direct labor cost. There was a positive variance in direct labor $10,000 and this can be explained in terms of rate of labor or efficiency of labor. Factors which might have led to favorable variance are; use of higher nix of skilled workers, use of high quality materials which resulted in less time spent working with fabric waste, the division might have purchased more efficient machines and employee training program improved the efficient use of time.

Variable overhead variance

This is the difference between the total variable cost incurred during the month of April and the total variable cost in the flexible budget. The variable overhead reflected a favorable variance $5,000 which can be explained in terms of overhead expenditure and overhead efficiency. The division general manager can explain the reasons for this variance for example may be there was better control of costs, or the output might have differed from the budgeted.

Advertising and promotion variance-Unfavorable

The advertising and promotion variance for the month of April is ($16,000) which means that the actual cost was more than the budgeted cost. The division general manager can explain the reasons for the variances in terms of; intense advertising and promotion to bring back declining sales volume. Maybe the manager chose the wrong advertising medium hence spending a lot of money and hurting the business.

Possible solutions

1. Timing of variance recognition- division general managers should be able to identify variances at an early stage. Recognition of variances will help them to be aware of deviations from expected performance and exercise maximum control. For example, a direct material price variance can be identified either at the time of purchase or the time the materials are issued to production. Understanding of the price variance at point of purchase allows the division to take proper actions preventing the continuation of an unfavorable price variance or attaining the most benefit from favorable price variance.
2. Rewarding the division general managers based on the accuracy of sales and forecasting. Compensating each manager according to how much his or her actual sales exceed the budgeted sales of the other division manager. It is mentioned that the evaluation would have been used as a basis of rewarding bonus to the managers. If the idea had been introduced earlier, then each division manager would have been careful in ensuring that there are no large unfavorable variances in the budget. However, the managers who have self-interest might reward themselves bonuses even when their performance is not satisfactory.
3. Rewriting the budget- regardless of whether the variances are favorable or unfavorable rewriting it can be an important step to undertake when dealing with budget losses. For example, if the sales volume has gone down in the market, rewrite the budget to compensate for the lower sales. It is also important to investigate on why the variances were favorable to find ways to make them more favorable in future and continue with this trend in future. The process of identifying and rewriting each variance can be time-consuming.

Best solution

The plausible solution here to deal with the variances is to rewrite the budgets variance both the favorable and unfavorable. In this way it is easier to identify the extend of the losses and act to prevent them from being a trend and rewriting areas of favorable variances can help management to come up with strategies to them permanent favorable variances.

1. Investor looking for a company with after tax-return of at least 15%

There is not enough information to determine the return on investment for the Barrington products. We are unable to determine the average operating assets such as cash, inventory, accounts receivable and fixed assets (usually provide in the balance sheet) used by Barrington to conduct its business operations. Assuming the net operating income is equal to the net profit after tax then the return on investment would be; Net operating income divided by the total assets. So, unless we are provided with the missing information we cannot determine either average operating assets or the turnover which will help in calculating the return on investment and therefore a basis for the decision on whether to invest in Barrington products to gain an after-tax return of at least 15%.

2. Barrington products incorporation is a profit center

Each Barrington products incorporation division is a profit center because its aim is to generate profits/revenues and incurs costs such as variable and the fixed costs to produce the desired revenue. Each of the 5 divisions is headed by the division general manager who is responsible for the revenues generated and costs incurred in the division. The division general manager is also accountable for aligning the division goals directly with the top management (president) goals to make the company profitable. The responsibility center design is a good one because it clearly defines the superiors and subordinates and their duties. The reports clearly define which division general manager is responsible for performance and for investigating the variances in the budget. For example, it is mentioned that Artificial leather division general manager has been performing poorly and shows favorable variance. Another good thing about the design is that each division generates profits directly from its activities. It is stated that cotton textiles division produce fabric and sells them directly to manufacturers. With this design it possible to control budget because each division is evaluated based on deducting actual costs from the budgeted costs, therefore offering more budgetary control.

3. Reasons for the variances in performances of DGM’s

From the profit performance budget report for the cotton textiles division for example; the total direct materials variance reports a favorable variance of $1,000 but it is shown that the materials price variance was $4000, and the materials usage was unfavorable variance of ($3000). This may mean that the division general manager authorized the purchase of materials that seem like a good deal but were of low quality resulting in waste during production. The report shows unfavorable direct materials usage variance, but it was offset by favorable direct material price variance. This may have lead a division general manager to report a favorable total materials variance and may be thought that profits were not affected. In this case variances should be used as a guide for investigation of both the favorable and unfavorable variance and take corrective actions. The additional information required to assess the performance of cotton textile division is the performance budget reports from the other four divisions showing the breakdown of the variances because it doesn’t necessarily mean someone is doing a bad or good job without doing the variance analysis of each division. Again, it does not necessarily mean that if a profit center division is performing well or earning more profits than the other then the overall profits of the company is optimized. So, knowing the performance in terms of profits, contribution margins of each division will be helpful in identifying areas that need corrective actions.

4. Changes that should be made to the current management control system

Barrington products incorporation should introduce financial and non-financial measures such as quality and customer satisfaction to their management control system. From the report, most of the variances are due to the quality of materials used which might have caused unfavorable results or the sales volume variance cam about due to customer demanding less items may be due to quality.

Setting performance targets- targets should be specified for every performance dimension that is measured. This will ensure that each division general manager and other employees are aware of what Barrington Products want from them, so individuals will act their best way possible and assess their performance.

Conclusion

Variances analysis help managers to focus their attention on areas that are not operating as expected and giving less attention to areas operating as expected. By identifying the areas that have deviated most from the expectations, variances enable managers to focus their efforts on the most critical areas that need correction or improvement. Variance analysis is also used in performance evaluation based on management control system and to motivate mangers to improve on their competitive performance, enhances their profit consciousness and contribute in many ways to making decision-making process more effective.