https://docs.google.com/document/d/1Uzo-gPmM5LJdaIbjQI6YmGN4fe7Z_7mTyYxo5PIaoLk/edit
Water Play, Inc. is ready to launch the sale of the underwater vehicle, Shark Scout, developed by the company’s engineers; this is a new product and has no competitors at this point. The accountants have been asked to do financial planning for the first year of operation. The information used in the planning has been developed by marketing, engineering, production operations, procurement, human resources, accounting and managers in several other functional areas of the company. The key information is the forecast of product and period costs based on an estimate of 72,000 units to be produced and sold.
The first part of the analysis begins with classifying the company’s costs as product or period, direct or indirect, and variable or fixed; selling and administrative fixed costs are then further identified as discretionary or committed fixed costs. Next is the preparation of a contribution format income statement so that cost-volume-profit analysis can be completed. Cost-volume-profit analysis will look at the company’s cost structure, its break-even point, margin of safety and operating leverage; this will allow the company’s management to evaluate the company’s ability to generate profits, assess how quickly profits will increase or decrease with changes in sales, and the level of risk presented by its cost structure.
The second part of the report is based on analyzing a master budget under two demand patterns. The first set of budgets will be based upon a constant demand assumption of 18,000 units per quarter and the budgets will be shown on a quarterly basis and in total for the year. The second set of budgets will be based on a seasonal demand pattern that predicts sales of 15,000 vehicles in quarter one, 25,000 in quarter two, 20,000 in quarter three, and 12,000 in quarter four. The two sets of budgets will then be compared to identify similarities and differences in the predicted cash budgets, income statements and balance sheets.
Finally, halfway through the first year, variance analysis for the four product costs will be prepared and analyzed. Then, based on actual information for the first two quarters and forecasted information for quarters three and four, a revised cash budget, income statement and balance sheet will be prepared to assess the profitability as a result of having actual information for the first two quarters of the first year of operations.
Cost Classifications and Cost-Volume-Profit Analysis
The starting point in preparing a cost-volume-profit analysis is to classify the company’s forecasted costs found on the bill of materials, labor routing, manufacturing overhead and selling and administrative expense schedules found in the appendix (appendices A-1 through A-4).
The bill of materials, (appendix A-1) identifies the component parts used in manufacturing the Shark Scout and the labor routing schedule (appendix A-2) identifies all the labor activities needed to assemble the vehicles. The costs on both these schedules are direct, product costs that have a variable cost behavior. Direct costs are those that can be directly traced and measured in each vehicle produced; for example, each vehicle uses two base pads as the first components in the vehicle’s assembly. Product costs are those that are incurred in the manufacture of the vehicles; product costs are all materials, labor and manufacturing overhead incurred to produce the vehicles. Variable costs are those that remain constant on a per-unit basis but increase or decrease in total proportionately as the volume of production increases or decreases.
Manufacturing Overhead Schedule Cost Classifications (Appendix 3):
Selling and General Administrative Expense Schedule Cost Classifications (Appendix 4):
Discuss which of the “fixed” costs could potentially be discretionary fixed costs:
Marketing/Advertising, Research and Development cannot be considered discretionary for the first year of operations. These costs should not be cut even for a short time during the inaugural year.
-WE NEED TO WRITE 2 PARAGRAPHS ON THE INFORMATION ABOVE!
Flexible Expenses
Discretionary spending pays for costs that can be cut or greatly reduced in the short without compromising the business. Fixed costs will not decrease with a decrease in unit production so cuts would need to be made by management. In Appendix A-4, Water Play, Inc’s. Selling and general administrative expenses budget, advertising expenses, research & development, fringe benefits, sales office supplies, executive salaries, executive fringe benefits, office supplies, and clerical fringe benefits are all possible discretionary costs.
Certain costs will cost the company in the longer term from being competitive, but a short-term cut can greatly reduce its cash burn. These expenses are Advertising at $85 million, research and development at 25$ million. In total, this represents approximately 20% of the selling and general administrative expenses budget.
Other costs are related to employee’s pay, benefits, and supplies used in offices. In total these costs would add up to 97.2$ million. Decreases in these costs could lead to a loss of qualified staff as fringe benefits being cut would disincentivize them to work for the company. Office supply costs being cut could lead to less efficiency in office work as the supplies would decrease as they were used up. These cuts would be very unpopular with employees but could save a large amount of cash as it represents approximately 18% of the Selling and General Administrative Expenses budget.
Executive pay could be fully cut if need be to save in the short term. This has been done by other companies in order to avoid layoffs and cutting benefits of lower level employees. This can lead to the loss of experienced management but can demonstrate management’s commitment to the company’s and employees’ success. The executive salary expense is 60% million and is approximately 11% of the Selling and General Administrative Expenses budget
Finally, wage expenses can be reduced with either pay cuts or layoffs. Cutting costs this way will lead to less staff and can compromise the company’s ability to handle a large influx of orders as well as often include severance or unemployment insurance costs. While salaries cannot be cut completely they can be reduced significantly in times of need and allow the business to still function. In total these costs are 37$ million and are approximately 6.8% of the Selling and General Administrative Expenses budget.
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Discretionary fixed costs are those that can be cut in the short-term without disrupting operations; if you cut the pay of managers who have employment contracts, they will be leaving for greener pastures
The other piece of discretionary fixed costs is that they are set by management decision for the period to spend at certain levels
Salaries, benefits, supplies, etc. those are based on contracts, agreements, and planned level of operations and are not discretionary fixed costs
Identifying which costs are be committed or discretionary fixed costs:
Water Play’s committed fixed costs include executive salaries, employee benefits, and materials used for manufacturing its products for the consumer.
Water Play’s discretionary fixed costs include advertising expenses, research and development, and changes in specific technology.
Administrative or discretionary administrative expenses:
Water Play’s administrative expenses include office supplies and clerical staff benefits.
Water Play’s discretionary administrative expenses include fringe benefits to keep employee retention which changes short-term and long-term salaries.
Taylor is going to change this into a format setting. Wrote down some notes that will fit within the paragraph above to answer her answer posted on the right hand side.
Contribution Format Income Statement and Cost Structure
As seen in appendix A-7, a contribution format income statement based upon the 72,000 projected sales units for the year has been prepared showing the contribution format income statement in total dollars for 72,000 units sold, per unit through contribution margin, and as a percentage through contribution margin. The contribution margin is the amount remaining from sales after all variable expenses have been deducted. Fixed costs are deducted from contribution margin to compute net operating income. Examining Water Play, Inc.’s contribution format income statement demonstrates how the cost structure impacts the profitability of the company with regard to sales volume. The starting point of cost-volume-profit analysis is determining the cost structure which is computed by dividing variable costs by total costs and fixed costs by total costs; the cost structure for Water Play is 68.4% variable costs and 31.6% fixed costs identifying that the company has low fixed costs in its cost structure. All the following calculations are provided in Appendix A-7.
Break-even Point
The break-even point in sales dollars is computed by dividing total fixed costs by the contribution margin ratio or percentage which is $1,413.5 million and the break-even point in units is computed by dividing total fixed costs by the contribution margin per unit which is 47,116 Given that the forecasted sales volume is 72,000 units Water Play, Inc. is well-positioned to not only cover its costs but also to achieve substantial profitability in the first year of operations. Since the budget is not based on any actual information, having a significant cushion should volume not materialize as planned reduces financial risk for Water Play.
Operating Leverage and Margin of Safety
The operating leverage for the company is 2.89 as shown in Appendix A-7. This leverage ratio identifies the sensitivity of net earnings to changes in sales and is affected by the cost structure. The operating leverage can be raised or lowered by changes in the proportion of fixed costs. Increasing fixed costs in relation to variable costs would increase the operating leverage ratio. Since the operating leverage is fairly low, a decline in sales below what is budgeted would cause earnings to decline 2.89% for each 1.0% decline in sales. As a startup company, Water Play’s budget is not based on prior historical information and it is more likely that actual sales will come in below budget due to startup issues and inability to effectively reach the target market. This lower ratio is beneficial and reduces the risk of generating a loss during the first year of operation.
The margin of safety in dollars is computed by deducting break-even sales dollars from total budgeted sales; the margin of safety percentage is computed by dividing the margin of safety in dollars by total budgeted sales. Appendix A-7 shows the margin of safety is $746.5 million and 34.6% as a percentage. The margin of safety shows the amount budgeted sales can decline before the company begins to generate a loss. Based on projected or budgeted sales, the company can sustain a sales decline of slightly over one-third before the company begins to generate a loss.
Many startup companies experience problems with budgeting and their sales for the first few years of operation; while the company has no competitors at this point, the vehicle is a discretionary, luxury consumer product that can be detrimentally affected by the strength of the economy when the product is launched.
The break-even point, margin of safety and operating leverage ratio are affected by the cost structure of the company. The lower fixed costs in the structure lead to a lower break-even point and operating leverage ratio but a higher margin of safety. All these present less operational risk should actual sales be lower than planned sales which is positive for a startup company introducing a new discretionary, luxury consumer product.
Going forward, management should carefully monitor actual sales since no prior information was available in developing the budgets. It is also important to monitor the level of costs incurred and to remember to not consider any of the fixed selling and general administrative expenses as discretionary as the advertising and research and development costs are critical to the successful launch of Water Play.
However, it is noticed that profits are more likely considering these facts; no competition and the new technological advancements being used. A margin of safety which is 34.6% would represent a decrease in sales of 24,884 units before the company reaches the break-even point. Considering all this if management thinks that this is a possibility then they are in danger of being unprofitable. The likelihood of this happening is based on how well the company has predicted the sales and costs they have budgeted for. Some ways this could be done include doing more market research to ensure the demand is understood, adding focus groups to give input on the product, customer surveys, and looking at similar products. Assessing overall economic conditions is important as people tend to buy luxury goods when the economy is growing and unemployment is low.
If an economic slowdown seems likely then management needs to be prepared for a possible lack of demand for their product. These slowdowns are difficult to foresee and can be acute and unpredictable like with the COVID-19 pandemic. Management should look to keep a strong balance sheet to be able to weather any short-term headwinds that may disturb the demand for a luxury product.
To reflect Water Play’s situation as a start-up, it can be seen that the company is pushing hard to enter a market where there is no competition. By combining the latest cutting-edge technology from company engineers. Along with technological advances Water Play plans to add artificial intelligence to help with laborious tasks and to ensure safety, all while saving money. Water Play also runs accurate and appropriate financial statements through its financial reporters, this will see the company continue to thrive and blossom against aquatic innovation. Add that to the fact that Water Play is committed to sustainability/efficiency meaning that green energy is being used. The company wants to do its part to eliminate greenhouse gasses and help against climate change.
Constant and Seasonal Demand Budgets
Two sets of budgets have been developed under a constant quarterly demand assumption and then under a seasonal quarterly demand assumption. The following compares and contrasts the quarterly and annual information identifying key numbers from the budgets in appendices B-2 through B-11 for constant demand and appendices C-2 through C-11 for seasonal demand. The starting point of the master budget is the sales budget which impacts all the subsequent schedules and budgeted financial statements. The critical numbers on the sales budgets are sales units, sales dollars and cash collections which are summarized in tables.
Sales Budgets
Sales volume under constant demand is 18,000 units per quarter for a total of 72,000 units for the year; seasonal demand volume is the same for the year but varies by quarter with the higher volumes in quarters two and three as shown in table 1 below.
Sales in Units
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Annual Total
Constant Demand
18,000
18,000
18,000
18,000
72,000
Seasonal Demand
15,000
25,000
20,000
12,000
72,000
Table 1: See appendices B-2 and C-2
Since the selling price per unit is the same under both budgets, the volume drives the revenue up or down as shown in table 2 below; annual sales are the same under both demand patterns at $2,160.0 million. Quarterly sales are the same amount under constant demand but differ with volume under seasonal demand; again the highest revenue is generated in quarters two and three under seasonal demand.
Sales Dollars
(in millions)
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Annual Total
Constant Demand
$540.0
$540.0
$540.0
$540.0
$2,160.0
Seasonal Demand
$450.0
$750.0
$600.0
$360.0
$2,160.0
Table 2: See appendices B-2 and C-2
Cash collections in quarter one are lower than the other quarters under both sales patterns due to having no beginning accounts receivable balance at the start of year one. Under constant demand, quarterly collections for the remaining three quarters are the same; however, under seasonal demand, cash collections are higher in quarters two and three due to higher sales.
Annual cash collections are higher under seasonal demand than constant demand; this is caused by cumulative sales being 6,000 units higher under seasonal demand by the end of quarter three which leads to $40.5 million higher collections by the end of the year as shown in table 3 below. Since bad debts expense is $10.8 million under both sales budgets, ending accounts receivable is higher under constant demand by the same $40.5 million. The timing difference of when sales occur affects the cash collections for the year but eventually that higher receivable balance under constant demand will be collected. Water Play diligently monitored its cash collections throughout the quarters. The company’s timely documentation of profits enabled more operational efficiency and annual growth.
Cash Collections
(in millions)
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Annual Total
Constant Demand
$361.8
$537.3
$537.3
$537.3
$1,973.7
Seasonal Demand
$301.5
$648.8
$645.8
$436.2
$2,032.2
Table 3: See appendices B-2 and C-2
Production Budget
The total units produced under constant demand are 18,000 units per quarter for a total of 72,000 units for the year; seasonal demand total unit production is the same for the year but varies by quarter with higher production volumes in the second and third quarters as shown in table 4 below. The varying quarterly production under seasonal demand is a direct result of sales volume and the changing quantity of beginning and ending finished goods. The production budget provides the data needed for the next three budget schedules which calculates the product costs for material, labor and overhead. Next, the direct material budget schedules are analyzed.
Total Units Produced
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Annual Total
Constant Demand
18,000
18,000
18,000
18,000
72,000
Seasonal Demand
16,000
24,500
19,200
12,300
72,000
Table 4: See appendices B-3 and C-3
Direct Material Budgets
The direct material purchases in total for the year are the same at $540.0 million under both constant and seasonal demand as shown in table 5 below. Under constant demand, the quarterly amounts are the same at $135.0 million since production volume and inventory levels do not vary. However, under seasonal demand, the highest purchases occur in quarters two and three which corresponds to the higher production which drives purchases.
Materials Budget
(in millions)
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Annual Total
Constant Demand
$135.0
$135.0
$135.0
$135.0
$540.0
Seasonal Demand
$126.4
$179.8
$138.8
$95.0
$540.0
Table 5: See appendices B-4 and C-4
Cash disbursements for quarter one are lower under both constant and seasonal demand since there was no beginning accounts payable balance as this is the first quarter of operations. The next three quarters under constant demand are constant at $135.0 million for a total of $490.1 million disbursed. Under seasonal demand, the disbursements vary by quarter and for the year in total equals $504.8 million; this accounts for $14.7 million more in cash disbursements under seasonal demand which leads to a lower accounts payable balance at year’s end.
Cash Disbursements
(In millions)
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Annual Total
Constant Demand
$85.1
$135.0
$135.0
$135.0
$490.1
Seasonal Demand
$79.6
$160.0
$154.0
$111.2
$504.8
Table 6: See appendices B-4 and C-4
Direct Labor Budgets
Total direct labor for the year is the same under both demand schedules at $208.0 million; under constant demand, the quarterly amount is the same but under seasonal demand it varies with the higher labor costs in quarters two and three corresponding to production.
Direct Labor Budget
(in millions)
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Yearly
Constant Demand
$52.0
$52.0
$52.00
$52.0
$208.0
Seasonal Demand
$46.2
$70.8
$55.5
$35.5
$208.0
Table 7 : See appendices B-5 and C-5
Manufacturing Overhead Budgets
The total manufacturing overhead cost under both budget assumptions is shown below in Table 8. Manufacturing overhead is the third product cost and unlike direct material and labor which are variable in behavior, manufacturing overhead is a mixed cost since some costs are variable and others are fixed. That necessitates splitting this budget into variable and fixed costs; under constant demand, the variable overhead is the same each quarter but under seasonal demand, the variable overhead varies with the volume of labor hours so is higher in quarters two and three when more units are produced. However, fixed costs do not flex or change with changes in volume of production or direct labor hours so those costs are simply spread equally over each quarter under both constant and seasonal demand. So the only difference in quarterly overhead is caused by the variable overhead costs spread over more or less direct labor hours. The annual cost is the same at $566.4 million under both budgets.
Manufacturing overhead contains depreciation which is a non-cash expense. The total manufacturing overhead cost of $566.4 million which includes depreciation is used to calculate the standard product cost for each unit; however, the quarterly and annual depreciation is deducted from the total manufacturing overhead so the cash disbursements can be computed for the cash budget. The total annual cash disbursement is the same under both budgets at $545.0 million.
Total Manufacturing Overhead
(in millions)
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Yearly
Constant Demand
$141.6
$141.6
$141.6
$141.6
$566.4
Seasonal Demand
$132.0
$172.7
$147.4
$114.3
$566.4
Table 8: See appendices B-6 and C-6
Finished Goods Inventory Schedules
Finished goods inventory under constant demand is 300 units higher than under seasonal demand which leads to end-of-year inventory on the balance sheet under constant demand to be $32.9 million while under seasonal demand it is $27.4 million. Also calculated on this schedule is the cost of goods sold which is the same for the year under both demand patterns at $1,314.4 million since the same volume of units is sold under both budgets; this amount will be deducted on the income statement.
Selling and Administrative Expense Budgets
Selling and administrative expenses are also mixed costs unrelated to the production process; therefore, the costs on this budget are split into variable and fixed costs. Variable costs by quarter are affected by the volume of units sold; therefore, under constant demand, quarterly costs are constant, but under seasonal demand, they vary with sales volume. The fixed costs do not flex with sales volume but are simply allocated equally to each quarter under both demand patterns. As shown in Table 9 below, while total selling and administrative expenses differ by quarter under the two demand patterns, the total annual cost is the same at $536.6 million. This total is deducted as a period cost below the gross margin on the income statement.
As in the case of manufacturing overhead, depreciation is included in the total cost and must be deducted to calculate the cash paid for selling and administrative expenses, which is used on the cash budget.
Throughout the four quarters, Water Play experienced stable total selling and administrative expense constant demand patterns. During quarter two, a significant increase in expenses incurred from seasonal marketing/advertising activities or administrative costs. With seasonal demand comes the ups and downs of positive inflow and outflow. Balancing profitability maximizes the company’s efforts to continue to grow and mature.
Total Selling and Administrative Expenses
(in millions)
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Annual Total
Constant Demand
$134.1
$134.1
$134.1
$134.1
$536.6
Seasonal Demand
$126.9
$150.9
$138.9
$119.7
$536.6
Table 9: See appendices B-7 and C-7
Cash Budget
The cash budget for the company is made up of four categories. Those are cash receipts, cash disbursements, cash excess or deficiency, and financing. The cash budgets are constructed quarter by quarter and each quarter’s ending balance becomes the beginning balance for the next quarter. Water Play desires to maintain a minimum balance of $25.0 million to start each quarter and will borrow money that will be repaid at year’s end if needed to meet that minimum balance.
At the beginning of Water Play’s first year of operation, the company has the same beginning cash balance and also had no accounts payables or receivables in quarter one under both assumptions. Seasonal demand has lower cash collections in quarter one which causes a larger amount of borrowing to occur in quarter one as opposed to constant demand where the cash collections in quarter one were higher. The borrowing under both budgets eliminates the deficit as well as covers the quarterly interest on the long-term loan; it also assures that the ending cash balances of $25.0 million is met under both budgets. The larger borrowing causes a larger amount of short-term interest to be due at the end of the year under seasonal demand than under constant demand; this interest will affect the income statements. Seasonal demand sales volume causes more cumulative sales to occur in the first three quarters which causes higher cash collections and leads to a higher ending cash balance at the end of the year than for constant demand as shown in table 10 below. The next section will discuss the budgeted income statement compared under constant and seasonal demand.
Budgeted Income Statement
When taking a look at sales and revenue it is noticeable that it was generated from the seasonal and constant demand categories. The amount of $19.6 million dollars accrued by Water Play is categorized as interest expense. This is due to the fact there is still a remaining balance of $25 million dollars, from the requirement brought by the first quarters’ seasonal demand. A ramification of our interest expense is that it lowers Water Plays’ income under the seasonal demand category.
Budgeted Balance sheet
Comparing Water Play, Inc’s balance sheets under constant and seasonal demand scenarios, differences in current assets and accounts payable show differences in the strategies. Under seasonal demand (Appendix C-11), total current assets are $400.3 million, with lower accounts receivable at $117.0 million, reflecting the lower sales during the first and fourth quarter. Conversely, constant demand (Appendix B-11) shows higher total current assets at $425.3 million, and a higher accounts receivable at $175.5 million, this is a result of the constant flow from sales and receivables.
The analysis highlights the differences in accounts payable as seasonal demand reports accounts payable at $35.2 million, while constant demand records $50.0 million. Water Play should expect to have an increase in inventory levels at the beginning of next year because the company is buying and selling more than usual due to its production activities.
Furthermore, the difference in retained earnings is due to the adjustment of contributed capital to the balance sheet, because of the differing beginning inventory levels. This adjustment reflects the varying demand patterns, and to accurately reflect its financial position in both scenarios.
The difference in retained earnings is due to the difference in net income caused by interest expense
Contributed capital did not change from the beginning balance sheets to the ending balance sheets under either demand assumption
Overall Water Play, Inc. would benefit from having a seasonal demand in its earlier infancy as a company in America, as it is consumers discretionary market, and later on adopt a constant demand for international as it allows for better planning expenses, meeting financial goals, and more predictable cash flow, just a simpler process for bigger things.
Note: Never begin a section with a table; always have an introductory sentence or paragraph with the table following. Every table should have a heading and tables with large dollar amounts as in the paragraph should have amounts rounded to the nearest 1/10 of a million so there should be a notation below the heading that the amounts are in millions. The column headings are centered over each column but the amounts below them are right justified/aligned. The labels in the first column should be left justified. Every table should be identified by a number and reference the appendix or appendices where the information comes from below the table.
You can simply copy and paste the table format provided here into your report and then simply copy and paste it for the entire part 2 of the report. You would just change the numbers, headings, and references.
Variance Analysis and Revised Budgets
Variance analysis and revised budgets guide strategic adjustment and ultimately fosters continuous improvement within a company’s financial management. Operational inefficiencies, unforeseen circumstances, and market changes all have a large impact on variance analysis and revised budgets because future planning and allocating various levels of capital will vary from time to time. Different variance tables are listed below with accurate data.
Direct Material Price Variances
Over the span of two quarters, Water Play has analyzed seat assembly, engine blocks, and diving suits. With this, we look at the cost fluctuations that have occurred across the diverse product lines. A favorable variance in one component rather than another will offset different variances. However, each component has an equal level of percentage throughout both quarters, ensuring efficiency and the proper allocation of resources for different components.
Quarter 1
Quarter 2
Seat Assembly
7.0% F
7.0% F
Engine Block
4.0% U
4.0% U
Diving Bell Suit
2.0% U
2.0% U
Table 10: See Appendices E-1, E-2, and E-3
Direct Material Quantity Variances
Water Play’s seat assembly, engine blocks, and diving suits offer insight to the company’s production efficiency and resource use. Understanding the quantity variances from quarter one to two comes from being favorable or unfavorable. Unfavorable variance is the overuse or underuse of resources, which could lead to increasing costs or production delays.
Quarter 1
Quarter 2
Seat Assembly
7.4% U
1.4% U
Engine Block
8.1% U
2.2% U
Diving Bell Suit
7.7% U
1.9% U
Table 11: See Appendices E-1, E-2, and E-3
Direct Labor Rate and Efficiency Variances
Direct labor rate and efficiency variances gives Water Play an understanding of its overall cost management and workforce productivity. The percentages below give a sense of the direction the company’s variances are shifting towards and how improved employee productivity is crucial for profitability and competitiveness within this industry.
Quarter 1
Quarter 2
Direct Labor Rate Variance
10.8% F
5.2% F
Direct Labor Efficiency Variance
8.0% U
4.5% U
Table 12: See Appendix E-4
Variable Overhead Rate and Efficiency Variances
Since Water Play Inc., is a new company that lacks proper historical data, it cannot accurately estimate the overhead costs, which has underestimated costs involved. To continue on, the new company with their new product lacks experience in the production, meaning that the first years of producing the product will not be efficient. Variable overhead efficiency will improve with direct labor efficiency, giving reason to why they share the same percentages of 8% unfavorable in quarter 1 and 4.5% unfavorable in quarter 2. With time both the Variable overhead rate and efficiency variances will improve.
Quarter 1
Quarter 2
Variable Overhead Rate
4.3% U
2.0% U
Variable Overhead Efficiency Variances
8.0% U
4.5% U
Table 13: See appendix E-5
Fixed Overhead Budget and Volume Variances
The favorable 17.6% in the overhead budget, in quarter one signifies that the actual quantity was lower than budgeted, whereas quarter two with its Unfavorable 14.3% indicates that the actual quantity was more than budgeted. Unfavorable volume variances in both quarters indicate that production levels fell short of Water Play’s expectations, but the increase from unfavorable 66.7% in quarter 1 to 11.1% in quarter 2, is a result of increase in demand, if the increase in demand continues we can see a closer alignment of actual production volume with the standard cost.
Quarter 1
Quarter 2
Fixed Overhead Budget
17.6% F
14.3% U
Fixed Overhead Volume Variances
66.7% U
11.1% U
Table 14: See appendix E-6
Revised Budget Schedules and Financial Statements
Water Play Inc.’s revised year-one budget schedules and financial statements are based on quarters one and two data. What would be discussed is the multiple changes in the cash budget, income statement, and balance sheet.
Comparison of Income Statements
The revised income statement when compared to the original income statement has decreases in profit due to the same factor in the cash budget section. That factor is a drop in the number of units sold. To go into further detail of the aftermath the decrease in sales resulted in a decline of 48.7% in net income on the new income statement. The other factors that caused that decline of 48.7% are located at the halfway mark of the revised income statement. This factor is caused by the result of there being a decrease in revenue and the production cost of the product by Water Play Inc. decreasing. Due to this, there is a negative rate of change for the gross margin. Because the gross margin has a large decline in a shorter amount of time than the sales of the product by Water Play Inc. Another cause of that 48.7% negative impact on the income statement is caused by the operating cost, the selling and administrative cost, and the debt present at that moment not decreasing by much. The last cause of the 48.7% negative impact on the income statement is due to a factor that was discussed in the comparison of the cash budgets section. Which is Water Play Inc. having to take on more debt and the rising interest that was associated with it and not expected/not planned for. Basically, this information indicates that Water Play Inc. is not on target to meet its set goal for its net income for the first year due to decreasing sales in the first and second quarters.
Comparison of Cash Budgets
The change in the cash budget for Water Play Inc. results from decreased unit sales in the first two quarters. To go into further detail the decrease in sales has caused a decrease in the ending cash balance of 67.2% at the end of year one. What also caused that decrease of 67.2% in the ending cash balance is that the decrease in sales for the product forced Water Play Inc. to borrow 82.8% more than expected to maintain the minimum ending cash balance requirements. This borrowing increase has gained more cost due to having large amounts of interest as a larger amount was borrowed. This resulted in a total accruing cost increase of 96.5% this year. These three factors affect the revised budget and cause a noticeable change when compared to the original cash budget.
Comparison of Balance Sheet
According to the revised balance sheet, total assets had dropped by 27.6% comparing the original balance sheet to the revised balance sheet. All noncurrent assets were unchanged although cash accounts declined 72.7% being the majority of the reason why total assets fell. Total liabilities increased 8% because the accounts payable increased by $14.8 million. Stockholders equity declined by 30.3% due to retained earnings falling short because of a lack of net income. As Water Play Inc. moves forward it seems to be headed into the right direction, but it’s important to monitor production and sales goals moving on.
You need to add two tables to the report for variable overhead rate (spending) variance and efficiency variance and then one for fixed overhead budget variance and volume variance. Use the direct labor rate and efficiency variances model for those two sets of variances. The analysis of the variances should focus on the specific causes (read the background documents in Canvas and watch the video in Connect) and whether the variances have improved or worsened from quarter one to quarter two. It is important that you focus on the variance “percentage” rather than dollar amounts as you can have a variance decrease as a percentage but increase as a dollar amount from one quarter to the next as a result of the change in volume produced. You will number the tables for part three by picking up with the last table numbered in part two.
The comparison of the revised cash budget, income statement and balance sheet provided in part three (appendices D-10, D-11 and D-12) to the original constant demand cash budget schedules from part two (appendices B-9, B-10 and B-11) should be analyzed for changes between what was originally projected and what the revised budgets show (remember the revised budgets reflect actual data for the first two quarters and budgeted data for the third and fourth quarters). The best way to approach comparison of these schedules/financial statements is to compute the rate of change (horizontal percentages) between the original budget and the revised budget. So for sales revenue the horizontal rate of change is a decrease of 12.5% ($2,160.0 minus $1,890.0 which is $270.0 million then divided by $2,160.0 which equals 12.5%; since the original budget is larger than the revised budget, the revision projects a decline in sales of 12.5%).
For those who are working on pt3, pt1, “ prepare a variance report explaining the potential causes of these variances. Explain potential causes of the variances in light of the fact that this is a start-up company that has no experience manufacturing the Shark Scout vehicle”-
WaterPlayPart3-1.doc,
Water play Inc.
For Year Ended Dec. 20XX
Cost-volume-profit analysis
Predicted Units sold 72,000
Price per un $ 30,000.00
PER UNIT TOTAL Full Total Percentage
Revenue $ 2,160,000,000 100%
Variable Cost:
Direct Material $ 7,500 $ 540,000,000.00 25%
Direct Labor $ 2,889 $ 208,008,000.00 10%
MO Variable $ 4,792 $ 345,000,240.00 16%
Selling expense variable $ 2,400 $ 172,800,000.00 8%
Variable expenses $ 17,581 $ 1,265,808,240 58.6%
Contribution margin $ 12,419 $ 894,191,760 41.4%
Fixed Cost:
MO fixed $ 3,075 $ 221,400,000.00
Selling fixed $ 3,000 $ 215,987,500.00
Fixed administrative expense $ 2,052 $ 147,762,500.00
Fixed expense $ 8,127 $ 585,150,000
Profit $ 4,292
Net Income $ 309,041,760
Units to Break Even 47,116
Dollars to Break Even $1,413,482,048
Margin of safety $ 746,517,952
Degreee of operating leverage 2.89
Table of Predicted Costs and Revenues
Units Fixed Revenue Total Expense Net Income
Q1 $ 18,000 $ 585,150,000 $ 540,000,000 $ 901,602,060 $ (361,602,060)
Q2 $ 36,000 $ 585,150,000 $ 1,080,000,000 $ 1,218,054,120 $ (138,054,120)
Q3 $ 54,000 $ 585,150,000 $ 1,620,000,000 $ 1,534,506,180 $ 85,493,820
Q4 $ 72,000 $ 585,150,000 $ 2,160,000,000 $ 1,850,958,240 $ 309,041,760
Table of Predicted Costs and Revenues
Units Fixed Revenue Total Expense Net Income
Q1 $ 18,000 $ 585,150,000 $ 540,000,000 $ 901,602,060 $ (361,602,060)
Q2 $ 36,000 $ 585,150,000 $ 1,080,000,000 $ 1,218,054,120 $ (138,054,120)
Q3 $ 54,000 $ 585,150,000 $ 1,620,000,000 $ 1,534,506,180 $ 85,493,820
Q4 $ 72,000 $ 585,150,000 $ 2,160,000,000 $ 1,850,958,240 $ 309,041,760
Units Revenue Fixed Total Expense Net Income
Q1 15,000 $ 450,000,000.00 $ 585,150,000.00 $ 848,860,050.00 $(398,860,050.00)
Q2 40,000 $ 1,200,000,000.00 $ 585,150,000.00 $1,288,376,800.00 $ (88,376,800.00)
Q3 60,000 $ 1,800,000,000.00 $ 585,150,000.00 $1,639,990,200.00 $160,009,800.00
Q4 72,000 $ 2,160,000,000.00 $ 585,150,000.00 $1,850,958,240.00 $309,041,760.00
