Advanced Topics in Management Accounting & Control
Case Study I (“Winbald”)

Abstract: The following Case Study is targeting Budgeting problems of a Profit Centre (Winbald) within a large publicly listed company. Winbald was just acquired and before that, was privately owned. It is June 2013, and Anne Wright, general Manager of Winbald, is worried about her companies’ substantial underperformance against budget. She needs to understand what has happened, and what might be the best courses of action. The Case Study gives several information on the sales and costs budgeting process as well as the final budget of the company. Furthermore, the Case Study requires an evaluation of the budgeting process as well as a final suggestion (based on two possible courses of action) to the management.

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Contents

Questions & possible solutions to the Case (A) Sales Budget (B) Costs Budget (C) Overall Solution

Appendix (Analysis of the Case – notes to solve problems of the Case Study) A I.I Background Information to the Case
A I.II Examining the Sales Budget Process
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A I.II Examining the Costs Budget Process (link to the Case Study itself)
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Questions & possible solutions to the Case

(A) Sales Budget
What do you think of the way the sales budget for 2013 was established? What are the strengths and weaknesses of the process?
Referring to 2.1., 2.4. and 2.5. of the Case Study: The sales budget was fed with figures of two separate sources. This is an effective way of getting a greater insight on the range and the accuracy of predictions and estimated figures. However, in the final budget the figures of only one source were followed up and the predictions of the other source were completely ignored. Following the common understanding of the budgeting process, the sales budget should be the outcome of elaborate information gathering and discussions among several sources (Marketing Department & Field Sales Force).
Referring to 2.2. & 2.3. of the Case Study: Both sources of information, the marketing department as well as the Field Sales Force, used valid methods to estimate the sales of the year 2013. Together they have a wide insight on possible growth rates and valuable market and customer knowledge.
The strengths of the used process is the survey of sales forecasts of two (independent) sources. However, the weakness of the sales budgeting follows up on the above showed problem. The process should involve further negotiations between the both sources of information, to ensure a higher quality of prediction.
Furthermore, the present case study does not give any insight on pricing or the link between production planning and sales. It needs to be ensured to evaluate the pricing of goods on a regular basis to reach the maximum of possible sold goods. Moreover, the case study does not give any information about the link between production planning and sales planning. It is an essential issue if the number of planed goods to be sold can be produced within the planning horizon. The Case Study does not give any information about any products which are already produced in stock. This is an important information for the production planning of a company.

(B) Costs Budget
What do you think of the way the costs budgets for 2013 were established? What are the strengths and weaknesses of the process?
Referring to 3.1 of the Case Study: The fact that the costs budgets were mainly prepared by the two divisional managers of Winbald leads to assets and drawbacks. It can be assumed that both managers have a good quality of information and a greater insight on costs then the general manager of Winbald itself. However, this decentralized structure can also lead to an overestimation of costs. If the individual performance measurement of the managers is depending on the difference between actual and budgeting figures – managers will have an incentive to overestimate the costs of their division since goals will be more easily achievable.
Referring to 3.2. of the Case Study: The prediction of the costs for materials, which is mainly depending on the costs of aluminium, was done by the average costs of material from the previous year. This assumes that the costs of aluminium in 2012 will also be suitable for the costs of this resource in 2013. However it can be assumed that the prices of 2012 are only partially (or not at all) suitable for revealing future developments of the prices for aluminium. Other methods, (e.g. financial data, such as the prices for aluminium on the future market) should be considered to predict future developments.
Furthermore the average ratio of materials to sales was used to forecast the amount of materials needed in 2013. This assumes that the distribution of materials of 2012 will be reached again within the planning horizon. Since there are new products in line (as noted in the Case Study), it is doubtful that this will be suitable. Detailed research needs to be done on a possibly changing ratio, resulting from the production of new products.
There are many quantitative methods for the forecasting of costs. It can be distinguished between analytical and synthetic methods. However, before choosing a method, the trade-off between accuracy and effort needs to be assessed closely.
Referring to 3.3. of the Case Study: The way the direct labour costs were calculated seems suitable for the costs budgeting process. However, it needs to be evaluated if the capacity of workers is sufficient for the planned increase on production (considering the labour law) following out of the higher budgeted sales. If the capacity of production is exceeded, it is doubtful that the costs of labour will increase proportionally to the amount produced. Depending on several issues (e.g. on the local labour law), stepped fixed costs can incur and finally lead to a non-proportional rise of labour costs.
Referring to 3.4. of the Case Study: The consideration of inflation as well as the increases of efficiency within the production is a good step towards a high quality budget. However, the case gives information about a false information (of the rate of efficiency increase) which was spread within the management of Winbald. This indicates an incentive system for managers which is misleading in the budgeting process. The incentive system should be inspected and adopted to the needs of the budgeting process.
Referring to 3.5 of the Case Study: The allocation of corporate overhead costs for marketing, administration and engineering should be evaluated. The costs are all apportioned based on the level of expected sales. Further research on the allocation of those costs can lead to a better allocation of the overhead costs and prevent negative effects on the company. If figures result from allocation bases that fail to capture cause-and-effect relationships, managers may make decisions that conflict with maximising long-run company goals.

(C) What should Anne (as a General Manager of Winbald) do?

The Case Study gives possible courses of action as a reaction to the underperformance against budget. Action 6.2 would save EUR 100,000 by eliminating an advertising campaign. Action 6.3 would eliminate EUR 60,000 by postponing the hiring of two new engineers. Following both actions could therefore eliminate EUR 160,000 of costs for the remaining year and contribute positively to the budgeted goals. However, both actions have negative effects on the company. To give effective solutions, the reasons for the underperformance against budget needs to be evaluated.
Before deciding on further actions it needs to be excluded that external reasons, like seasonal or economical fluctuations, lead to a distorted view on the deviating performance against budget. External effects, like the ones mentioned above, could not or only hardly be tackled by the general manager of Winbald and would need further investigations on pricing or marketing of the company.
To understand the current situation of Winbald, the underperformance against budget needs to be analysed in detail. Computing the deviation of the actual and budgeted figures shows, that not only the lower sales contribute to the variation in the operating profit. A small saving on direct costs contributes positively to the operating profit. However, it can also be shown, that an unproportioned higher burden of overhead costs contributes highly negative on the operating profit (Table 2). Assuming that the overhead costs of the year have not risen and will be the same as budgeted in the year 2013 this leads to a defusing of the current underperformance. As shown in Table 3 the negative deviation of the operating profit decreases down to 8% (instead of currently 19% deviation against budget).

| | Budgeted | % of Sales | Actual | % of Sales | % deviation to budget | Sales | | 6060 | | 5340 | | -11,88% | | Labour | 480 | 7,92% | 426 | 7,98% | | | Material | 2112 | 34,85% | 1779 | 33,31% | | | Overhead | 966 | 15,94% | 861 | 16,12% | | Direct Costs | | 3558 | 58,71% | 3066 | 57,42% | -13,83% | Contr. Margin | 2502 | | 2274 | | | | | | | | | | Overheads: | Marketing | 300 | | 348 | | 10,36% | | Admin. | 162 | | 168 | | | | Enginee. | 378 | | 411 | | | | | | | | | | Operating Profit | 1662 | | 1347 | | -19% |
Table 2: Comparison of actual and budget performance for the four months to 30th April 2013

| | Budgeted | % of Sales | Actual | % of Sales | % deviation to budget | Sales | | 6060 | | 5340 | | -11,88% | | Labour | 480 | 7,92% | 426 | 7,98% | | | | Material | 2112 | 34,85% | 1779 | 33,31% | | | Overhead | 966 | 15,94% | 861 | 16,12% | | Direct Costs | | 3558 | 58,71% | 3066 | 57,42% | -13,83% | Contr. Margin | 2502 | | 2274 | | | | | | | | | | Overheads: | Marketing | 300 | | 264,36 | | -11,88% | | Admin. | 162 | | 142,7544 | | | | Enginee. | 378 | | 333,0936 | | | | | | | | | | Operating Profit | 1662 | | 1533,792 | | -8% |
Table 3: Comparison of actual and budget performance for the four months to 30th April 2013 under usage of the same proportional shortage on overhead costs then the sales. For further insight on the situation, I computed several possible scenarios of costs and sales developments throughout the year. It got clear that Winbald is even running short on sales compared to the initial budget, which was set up by the general manager of Winbald at first. Therefore it can be assumed, that the deviation in operating profit is not a cause of the high budgeted goals which were set by the management of the company. In fact, a shortage on sales as well high overhead costs leads to the underperformance of the budget.
Taking all this information in account, neither of the shown possible courses of action should be taken into consideration. Eliminating EUR 100,000 of advertising costs seems not to lead to a better situation in the end of the year. Winbald is short on sales and, referring to the details of the Case Study, the adverts are important and very helping for the number of sales. Postponing the hiring of two engineers would save further EUR 60,000, and help reaching budgeting goals by the end of the year. However, referring to the case, the engineers could contribute highly to the performance of the sales and costs side of Winbald. A postponing of this effect leads to a loss in present value of this investment in human capital. Hiring the engineers as planned promises a better performance in the upcoming years and could add its part to achieving budgeted goals in the upcoming year 2014.
From the general manager of Winbald perspective, at least the postponing of the hiring of two engineers could contribute positively to budgeted goals of 2013 and help on the short run. Considering the situation of Winbald (and Get Movin! S.a.r.l.) in total, it seems more expedient and effective to follow neither one of the options and focus on further sales and development.

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Appendix (Analysis of the Case – notes to solve problems of the Case Study)
The following notes have the objective to get a more structured view on the problems of the Case Study and helped me to understand the processes used by the company. The notes are not covering all information given by the Case Study and only show an incomplete set of information which were used to find possible solutions.

A I.I Background information to the case
The following chart aims to summarize the information provided from the Case Study and give a quick inside of the organizational structure of the company. Winbald was privately owned till last year and got acquired by Get Movin! S.a.r.l (GM). Winbald is now treated as an autonomous unit (as a profit centre for reporting purposes).

Table 1: Organization Chart of Get Movin! S.a.r.l.

A I.II Examining the Sales Budget process

Facts: * Profit plan for 2013 was prepared from the beginning of October 2012 * Forecast Data collected by two sources: (1) Marketing Department, (2) Field Sales Force (for control reasons)
Background information about the forecasts of both sources: (1) Marketing Department (MD) Sales Forecast (by product line):
Normal growth
+ sales resulting from industry growth of existing customers
+ increased sales from new products
+ sales resulting from further market penetration with existing products
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= Sales Forecast 2013

(2) Field Sales Force Forecast (SF) (by product line): Sales Forecast 2013 = number of orders* x value of orders*
*Based on industry and customer knowledge

(3) Sales figures, historic and forecast for the two division

| | City Bikes | Off-Road Bikes | Total | actual | 2011 | 5 | 4,2 | 9,2 | actual | 2012 | 6 | 6,3 | 12,3 | | | | | | Forecast MD | 2013 | 9 | 7,4 | 16,4 | Forecast SF | | 7,5 | 7 | 14,5 | | | | | | Used in Budget | 2013 | 9 | 7,4 | 16,4 |

The forecasts of the marketing department (MD) was followed. Reason (as shown in the case study) was the better knowledge of potential future developments in the City Bikes division.
The projected mEUR 3 increase in City Bikes sales result from the forecast of (a) mEUR 0,6 from increased sales of existing products to existing customers (b) mEUR 1,5 from increased market penetration with existing products (c) mEUR 0,9 from sales of new products

A I.III Examining the Cost Budget process

All information on the costs budgeting process are well structured within the Case Study. I did not make the effort to note them additionally in the Appendix of this paper.