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Issues in Accounting Education
Vol
...
2
May 2000

Budgeting and Performance Evaluation
at the Berkshire Toy Company
Dean Crawford and Eleanor G
...
As a purely mechanical
problem, the case asks for calculations of various price, efficiency, spending,
and volume variances from a set of budgets and actual results
...
After the variances have been computed, the next step
is to develop plausible conjectures about their likely causes
...
The company has
an incentive plan, based on the budget variances, that needs to be analyzed and
critiqued
...

The corporation manufactures and
sells many different kinds of products,
including luggage, music synthesizers,
breakfast cereals, peanut butter, and
children’s toys
...

It is late July 1998 and McKinley
has just received the preliminary income statement for her division for the
year ended June 30, 1998 (see Table
1)
...
McKinley looks at the bottom
line, a loss approaching a million dollars, then picks up the phone to call you
...
You
worked with McKinley when her company was acquired by Quality Products,

and now she has called you for advice
...
“But we made great
strides this year
...
The essential facts relating to production and sales have been retained
...
Thus, if any names used in this
case are those of actual firms or individuals,
then it is purely coincidental
...
Henry
are both Associate Professors at SUNY
at Oswego
...
Stout, and
associate editor, Jeffrey Cohen, two anonymous reviewers, and the students of the
Graduate School of Business Administration
at the University of Michigan and the College of Business Administration at the University of Toledo are gratefully acknowledged
...


Crawford and Henry

ever
...
There must be a
way to make this business work and
turn a profit, too
...
Could
you do an analysis of the budget
variances?”

BACKGROUND

The Berkshire Toy Company was
founded by Franklin Berkshire, Janet
McKinley’s father, in 1974
...
His first creation, a teddy bear
that he presented to Janet on her seventh birthday, occupies a place of
honor at Berkshire Toy Company’s
headquarters
...
He
modified the machine to mass produce
stuffed animals, and the Berkshire Toy
Company was born
...
By 1986, annual
sales exceeded a million dollars for the
first time
...
She
had started out with the company in the
mail room as a part-time summer employee
...
She was named
Assistant to the President in 1988 after
receiving her M
...
A
...
Janet
McKinley became CEO of the company
on July 1, 1993 when her father retired
...
2 million
...

The Berkshire Toy Company produces the Berkshire Bear, a fifteen-inch
teddy bear enjoyed by children and
adult toy collectors around the world
...
The bears are fully jointed,
constructed of washable acrylic pile fabric, and stuffed with a polyester fiber
filling
...
Thus, the product can be personalized for numerous occasions
...
In communicating with customers, the company
refers to its repair center as the “bear
hospital
...

The Berkshire Toy Company’s 241
employees are organized into three
departments: purchasing, production,
and marketing
...
The
department is responsible for acquiring and maintaining the supply of production materials
...
This method of merging two companies is quite different from a
“hostile takeover,” which is initiated by the
acquiring company over the objections of the
target’s incumbent management
...
The marketing department is
headed by Rita Smith
...
The remaining
three employees are McKinley, her secretary, and her secretary’s assistant
...
The
press-cutter machine applies 23,000
pounds per square inch of pressure to
a tray of pattern stainless steel dies3
that are stamped into the fabric
...
The fabric is
measured at this time for length and
width and inspected for fabric flaws,
tears, and soiled areas
...
Shortages in length or
width may require a different cutting
set-up and increase fabric waste
...
The press-cutter machine cuts 14 layered bolts at a time,
enough for 588 units
...

The fabric is also inspected for
trueness of color
...
Thus,
fabric dye lots are important for matching shades of brown
...
Off-color fabric must be
scrapped or returned to the supplier
...
Berkshire obtains the most economical price
for specified colors by timing its fabric
orders with the production runs of its
suppliers
...


Issues in Accounting Education

In the next stage of production, operators of industrial sewing machines
construct the six parts of the finished
unit: two arms, two legs, the head, and
the torso
...
Sewing is the most labor-intensive phase of the production process
...

In the next step, two optical-grade,
acrylic eyes are attached to the head
with plastic rivets
...
If
the rivet posts are too long, the eyes
will stand out from the head, giving a
nonstandard appearance
...
Acrylic eyes
are purchased from vendors in “dark
brown,” but the exact shade may vary
from supplier to supplier
...
At that point, defective
eyes are discarded and replaced with
ones that meet specifications
...

3

4

5

6

Dies are heavy-duty, three-dimensional patterns used to cut the fabric into parts for the
bear
...

Fabric is shipped from the manufacturer
wrapped around a cylindrical core or “bolt
...

Appliqués are descriptive or ornamental features made from contrasting materials that
are applied to the outside surface of the bear
...
Another example is an identifying patch applied to pockets of uniforms bearing the employer’s name and logo
...
The stuffing machine is
not patented
...
Bags of filling are loaded into
the machine hopper and mechanically
fluffed to the proper loft
...
The machine operator judges
whether the part has been filled correctly
...
Inferior
grade fiber filling is less expensive but
can cause clumping and clogging in the
hopper
...

Next, the arms, legs, and head are
attached to the torso using three-part,
snap-on, hard plastic disc joints
...
The plastic joints are designed to be foolproof in production and
dependable for the life of the product
...
Occasionally,
after initial joint insertion, the parts
do not fit together properly and they
must be removed and replaced
...
More polyester filling is
stuffed into the torso and the back seam
is hand-stitched, using essentially the
same “shoelace” procedure practiced by
surgeons
...

The production process is a continuous source of airborne polyester and
acrylic fibers that must be controlled,
both to protect the health and safety of

287

the employees and to safeguard the
production equipment
...
First, an air filtration system
works constantly to remove dust and
fibers from the factory
...

Finally, regular cleaning and maintenance of the sewing, cutting, and stuffing machines is performed to prevent
the fibers from building up
...
Machine
oil and static electricity attract pile
fabric lint
...
The Berkshire Bear
workmanship is guaranteed for life
...

All production employees are paid
a regular wage for a 40-hour work
week
...
The
cost of fringe benefits and employer
taxes, such as social security, health
insurance, and vacation time, adds
20
...
The
employees’ regular wages are charged
to direct labor
...

Marketing
Marketing of the product takes
place at the retail level via catalogue
sales and in the company’s retail store
7

Fiber filling is a loose material
...
The filling is loaded manually into a metal bin or “hopper
...
The proper mixture of air and filling is the “loft
...
Retail
Internet sales are a new addition to
the overall marketing effort
...
The product
can be delivered by two-to-five-day
ground service, next-day air, or holiday express
...

Berkshire promises same or next-day
shipment
...

When the company receives a
customer’s order, an employee takes a
bear of the requested color and dresses
it according to the customer’s wishes
...
The designer box
contributes to the product image
...
The box is also important to toy collectors who expect to pay
or receive a price premium in the secondary market for items that are in
“mint-in-box” condition
...

The unit cost of the box decreases with
the size of the order that the company
places with the manufacturer
...
In July 1997, the purchasing
manager placed an order for enough
boxes to cover budgeted sales in the
coming year
...
Commissions of 3 percent
are paid on retail store sales and sales
to wholesale buyers
...
The companyowned retail outlets have proved unprofitable, so all of them, except for the

Issues in Accounting Education

factory store, have been closed in previous years
...

“Did inventory change much?” you
ask
...
Our peak selling time is from Christmas to Mother’s
Day, so we don’t have much on hand at
the June 30 year-end
...
” You jot down a note to ignore
changes in raw materials and finished
goods inventories and to assume that
production volume equals sales volume
...
Perhaps it was a factor in what happened
this year
...

Under this plan, each of the three department heads is rewarded based on
the performance of his or her responsibility center
...
The plan
was the result of several meetings with
McKinley and her managers who argued and bargained for a plan that rewarded the managers fairly for individual contributions and achievements
...
The plan provides for the following:
•

David Hall, the purchasing manager, will receive a bonus equal to
20 percent of the net materials

Crawford and Henry

•

•

289

price variance, assuming the net
variance is favorable
...

Rita Smith, the marketing manager, will receive a bonus equal to
10 percent of the excess, if any, of
actual net revenues (revenues minus both variable and fixed selling
expenses) over master budget net
revenues
...
Wilford receives no bonus if his net variance is
unfavorable
...

“Smith had a terrific year this year
...
She says one
of the principal factors was the new
Internet sales policy she instituted and
the advertising campaign to support it
...
”
The Berkshire Toy Company began
selling over the Internet in November
1997
...
All radio advertisements are tagged with a reference to
the web site that, in turn, provides visual support for the radio advertising

and an opportunity for customers to
order online
...
Because the
discounted Internet price ($42
...
00), McKinley approved
the price change
...
The
Christmas and Valentine’s Day sales
featured the Berkshire Bear in special
seasonal costumes
...
The greatest success was the Mother’s Day campaign
...
”
The 15-inch bears produced by
the Berkshire Toy Company are identical except for their color and their
accessories
...
The average historical cost
of accessories has been a very small
part of the total cost of the bear, and
the standard cost of accessories is
computed as an average
...


The master (static) budget for the year ended June 30, 1998 was prepared before the
Internet program and price change were adopted
...
00 =
42,000 units × $32
...
Thus, the budgeted average selling price was $46
...

Actual sales for the year were as follows:
Retail and catalog
174,965 units × $49
...
00 =
4,428,018
Wholesale
45,162 units × $32
...
“He
managed to get some substantial
price discounts on acrylic pile fabric,
plastic joints, and polyester fiber filling
...
” Berkshire Toy
Company’s schedule of standard
manufacturing costs is reproduced in
Table 2
...

“So,” McKinley continues, “at least
on the surface, it looks like marketing
and purchasing had a good year, but
production is another story
...
Headquarters sent him here from
Hercules (the luggage division) to learn
the ropes after Jack Johnson left
...
”
“During Bill’s first week on the
job, we had a freak thunderstorm and
the storm drain backed up, ruining a
large amount of fiber filling
...
Since then, I have
gotten plenty of feedback from Bill
who has been struggling to keep up
with production
...
The plant has been operating at
near to maximum capacity of 350,000
units
...
Some of
them quit and had to be replaced at

higher-than-standard wage rates
...
He’s been vehement about stock-outs of some of the
imported accessories
...
But he tries to be fair and responsible
...
This is a small
place and I hear almost everything
that goes on
...
“I have the
1997–98 income statement (prior to
bonus calculations), the breakdown of
budgeted and actual revenues, and
schedules of standard and actual direct
production costs
...
After that, I’ll get back to you as soon as
I can
...
These
are shown in Tables 4 and 5
...
02381 bolts
2 eyes
5 joints
0
...

1 label
1 box
various

Input
Price

Standard
Cost
Per Unit

$35
...
19/eye
$0
...
45/lb
...
05/each
$0
...
8333
0
...
7000
1
...
0500

...
1200
3
...
50 hours
0
...
30 hours
0
...
20 hours

$8
...
6000

1
...
1140/DLH

3
...
9651

Fixed manufacturing overhead

1
...
9700/DLH

2
...
3291

a
b

c

d

One bolt of fabric is 10 yards long by 72 inches wide
...

The cost of accessories varies from 7 cents per unit for a bow tie to 45 cents per unit for fisherman’s
gear
...

Less than 0
...
Therefore, hours spent in the cutting
operation are not separately recorded
...

Variable and fixed overhead are allocated to production on the basis of standard direct labor hours
allowed
...
Maximum practical
capacity is 350,000 units of production attainable in consideration of planned maintenance and
scheduled down time for holidays
...


292

Issues in Accounting Education

TABLE 3
Berkshire Toy Company
A Division of Quality Products Corporation
Schedule of Actual Manufacturing Costs
for the Year Ended June 30, 1998

Direct materials
Acrylic pile fabric
10-mm acrylic eyes
45-mm plastic joints
Polyester fiber filling
Woven label
Designer box
Accessories
Total direct materials
Direct labor
Sewing
Stuffing and cutting
Assembly
Dressing and packaging
Total direct labor

Quantity
Used

Input
Price

Total
Cost

7,910 bolts
661,248 eyes
1,937,023 joints
344,165 lbs
...
4174/bolt
$0
...
1270/joint
$1
...

$0
...
2200 each
various

$ 256,422
125,637
246,002
450,856
16,422
69,488
66,013a
1,230,840

$8
...
0850/hour

423,970
1,301,695b

189,211 hours
104,117 hours
121,054 hours
34,615 hours
448,997 hours

Overtime premium
103,787 hours
Other variable manufacturing overhead
Fixed manufacturing overhead

a
b

658,897
$7,283,707

The actual input price for accessories is derived by dividing the actual cost of $66,013 by units sold
(325,556), yielding an average accessories cost of $0
...

The actual input price for variable overhead is obtained by dividing the total variable overhead
($1,301,695 + $423,970) by actual direct labor hours worked, yielding a price or rate of $3
...


Crawford and Henry

293

TABLE 4
Berkshire Toy Company
A Division of Quality Products Corporation
Schedule of Actual Manufacturing Overhead Expenditures
for the Years Ended June 30, 1994 through 1998
1998
325,556

1997
271,971

1996
252,114

1995
227,546

1994
201,763

Variable overhead:
Payroll taxes and fringes
Overtime premiums
Cleaning supplies
Maintenance labor
Maintenance supplies
Miscellaneous
Total

$ 840,963
423,970
4,993
415,224
27,373
13,142
$1,725,665

$524,846
24,665
6,842
256,883
15,944
11,244
$840,424

$467,967
2,136
6,119
232,798
12,851
9,921
$731,792

$413,937
1,874
5,485
244,037
15,917
8,906
$690,156

$356,150
1,965
4,996
216,142
14,323
7,794
$601,370

Fixed overhead:
Utilities
Depreciation—machinery
Depreciation—building
Insurance
Property taxes
Supervisory salaries
Total

$ 121,417
28,500
88,750
62,976
70,101
287,153
$ 658,897

$119,786
28,500
88,750
61,716
70,101
274,538
$643,391

$117,243
28,500
88,750
57,211
68,243
275,198
$635,145

$116,554
28,500
88,750
55,544
68,243
269,018
$626,609

$113,229
28,500
88,750
54,988
66,114
254,469
$606,050

Units produced

TABLE 5
Berkshire Toy Company
A Division of Quality Products Corporation
Schedule of Actual Selling Expenses
for the Years Ended June 30, 1998 and 1997
1998

1997

Units sold:
Variable expenses:
Packing and shipping
Commissions
Catalogs, brochures, and samples
Total

325,556

271,971

$1,580,089
129,080
150,425
$1,859,594

$1,015,913
216,116
65,658
$1,297,687

Fixed expenses:
Salaries
Advertising and promotion
Total

$2,734,868
2,288,324
$5,023,192

$2,345,121
2,086,021
$4,431,142

294

flexible budget8 for the Berkshire
Toy Company for the year ended
June 30, 1998
...

Compare the flexible and master
(static) budgets and prepare a
schedule showing the sales volume variance
...
Subdivide the flexible budget variances into the appropriate
price (rate or spending) and efficiency (usage or quantity) variances for materials, labor, and
variable overhead
...
Compute the bonuses earned in
fiscal 1998, if any, by David Hall
of the purchasing department,
Rita Smith of the marketing department, and Bill Wilford of the
production department
...
a
...
Using the information provided, formulate some likely explanations
for the observed variances
...
Comment on the advantages and
disadvantages of the incentive
compensation plan as it applies to
department heads
...


8

modifications to the incentive
plan would you recommend? Why?
(Optional) Suppose that Berkshire Toy Company adopts a
balanced scorecard (BSC) to measure its performance
...
(1999, 13–18)
...
For Internet sales, use
a “revised” budget price of $42
...
Multiply these quantities by
the respective budgeted sales prices
...
A comparison between the master (static)
budget and the flexible budget prepared on the
basis of the budgeted mix is the “sales volume
variance
...
The net of the sales mix
variance and the sales volume variance equals
the “sales activity variance

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