Ferguson Foundry Limited

Topics: Variable cost, Costs, Fixed cost Pages: 6 (1347 words) Published: March 23, 2013
Case: Ferguson Foundry Limited (FFL)


Date: March 10 2013
To: Mark Ferguson, President
From: Carl Holitzner
Re: FFL’s Lower-Than-Budgeted Profit for the Fiscal Year Ended May 31 2010

The major issue is determining why Ferguson Foundry Limited’s (FFL) actual profit was $367,600 lower than budgeted, despite selling 2,000 more wood stoves (12,000 instead of 10,000 units). This will be explained using Variance Analysis to demonstrate the underlying reasons why the company failed to meet its president’s expectations. FFL profit for 2010 was below budget due to many factors both production and marketing related.

From a production perspective, there were 3 major areas of concern all of which were unfavorable with respect to Variance Analysis (As shown in Exhibit 3):

1. Direct Labor
2. Variable Overhead
3. Fixed Cost

The $139,200 unfavorable Direct Labor Variance can be attributed to many reasons however it is most likely linked to the management team. Due to the early retirement of the sales manager, the production manager being hospitalized and the accountant quitting, it can be understood that inefficiencies were bound to arise. Without proper management, labor reduced overall productivity of the company, as these workers took 121,200 hours to produce 12,00 stoves rather than the standard 120,000 hours that it should have taken. This reduced Net Income by $18,000 (Labor Yield Variance calculation).

Secondly, the problem arising from Direct Labor also transcends to the Variable Overhead, as it is used as its cost driver. As a result, the $69,600 unfavorable Variable Overhead Variance can also be attributed to the more hours undertaken to produce the 12,000 stoves. With the lack of an inefficient management team, overhead could have accumulated through inefficient use and/or the budget could have not even accurately portrayed current rates for overhead items.

The third problem with regards to the production perspective concerns the increase in fixed costs. In particular, the fixed manufacturing cost increased by $30,000 over budgeted costs, which in turn resulted in a reduction of net income by the same amount. This could have resulted due to several reasons such as additional machinery being required to handle the increased sales volume. However at this point it is unclear given the information provided and so further investigation must be conducted in an effort to better budget for future fixed costs.

From a marketing perspective, there were also 3 major areas of concern all of which were unfavorable with respect to Variance Analysis:

1. Price
2. Fixed Cost
3. Sales Mix

In analyzing the price changes, although it was beneficial to increase the sell price of the Basic Wood Stove ($300 to $325), this income benefit was significantly outweighed by the reduction in sell price of the Deluxe Wood Stove ($800 to $700). In the end, the price changes of both products resulted in a $300,000 reduction in profit (Sales Price Variance).

Another reason for FFL’s lower than budgeted profit, although obvious and minor, had to do with the increase in selling and administration cost. As can be seen in Exhibit 3 by the Fixed Selling & Administration Budget Variance, an increase in the fixed costs reduced net profit by $7,000.

The third problem area, concerning the marketing perspective, involved the difference in sales mix from actual to budget. FFL actually sold more Basic Wood Stoves and fewer Deluxe Wood Stoves than budgeted. Unfortunately, the Deluxe Wood Stove possessed a higher standard contribution margin per unit than the Basic ($210 to $80). Therefore the difference in the mix of sales caused FFL’s net profit to be reduced by $234,000 (Sales Mix Variance). Ultimately, more market research must be conducted to better understand consumer wants and needs and thus be able to efficiently budget company products...
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