Kite, Inc.: budget-variance analysis (Case Study)

Go Fly a Kite
Kite, Inc. manufactures and sells kites. They sell their kites to retailers throughout the United States. They have three products. One product, which is appropriately named "Childs Play", is intended for kids and other beginner kite flyers. Another product, which is named "The Challenger" is intended for semi-experienced kite flyers. A third product, which is named "The Pro" is intended for experienced or competition kite flyers.
Kite, Inc. has been in business for 25 years and is family owned and operated. There are a total of 30 employees. The owners name is Dave N. Port. Kite, Inc. has a fiscal calendar which begins January 1 and ends December 31.
On the pages following, and in the related Microsoft Excel file, you will find financial data pertaining to fiscal years 2007, 2008 and 2009.
Requirement #1: Prepare a Multi-Year Income Statement for Years 2007, 2008 and 2009. Stated differently, prepare a side-by-side Income Statement for these three years. This should be done using the "Managerial Accounting Format".
The company has never used a formal budget planning process. However, as the business has grown the company leaders have had a more difficult time keeping all the employees focused on the same goals. Furthermore, it has become quite a challenge to predict the financial performance.
You are the Controller. You suggest to the owner that he should consider employing a formalized budget process for fiscal year 2010.
Requirement #2: Write a memo to the owner explaining what a formalized budget process is, what kind of reports it produces, and what some of the advantages and disadvantages may be.
Requirement #3: Using the data provided on the following pages, and in the related Microsoft Excel file, please complete a comprehensive Master Budget. The Master Budget Package should include all the following supporting budgets:
• Sales Budget
• Production Budget (assume units of sales equals the units of production)
• Marketing Cost Budget
• Administrative Cost Budget
• Master Budget Profit Plan for 2010
• Updated Multi-Year Incomes Statement (i.e. this time add 2010 to the previous three years you did in requirement #1)
As a guide for format use the examples from the exhibits in your text, chapter 9.
To complete the 2010 Master Budget you will need to make some of your own assumptions along the way. For example, what will sales be in 2010? Sales are a function of volume, mix and price. You get to decide what assumptions to use for 2010. You will have to assign volume and prices as you see fit. You will need to defend your reasoning. Be creative and reasonable. There is not any right or wrong answers when it comes to making assumptions for the future. However, keep in mind, in the real world you have to be able to defend your logic. The same holds true here. As you read the case you will notice that in some cases the 2010 projections are given. For example, the Purchasing Manager has already calculated the direct material costs for 2010. However, anywhere the 2010 projection is not given you will have to define the assumption.
When your budget schedules are complete, please prepare a professional "Reporting Package" inclusive of your budget reports. The reporting package should include an executive summary consisting of the assumptions you made, the rationale for those decisions, and the consequences to the numbers and ultimately what the Master Budget predicts for business in 2010. Assume that inventory issues are neutral. That is, you don't have make adjustment for inventory changes. Therefore, the units you intend to sell equates to the units you need to produce.
Sales Data

Additional information:
A new competitor has surfaced. They are from outside the United States and they are touting lower cost products. The quality of their product is inferior to yours, but the prices they offer are lowers as well. As of yet, the competitor has not gained much on your market share. However, the possibility is out there that some of your bigger customers may give them a chance. From what you have heard the competitor's products are 20% lower costs than yours.
Kite, Inc. currently enjoys a 30% market share. Past experience has shown that the customers seem to value price and quality evenly.

Cost Data - Manufacturing Costs / Variable

Cost Data - Manufacturing Costs / Fixed

According to Plant Manager, and Purchasing Manger a Direct Material cost reduction is planned for 2010. All direct materials will realize a 2.5% reduction from 2009 values.
According to Human Resources, you should assume a 2.0% increase for all labor and wages.
You schedule a meeting the Plant Manager to discuss the 2010 projections for variable and fixed manufacturing overhead. Use your judgment to forecast the 2010 values.
Marketing Cost Data

Other Facts:
• Historically travel expenses have been 1% of sales. However, Kite Inc. is considering more travel. They believe that they may have to have more face-to-face interaction with top customers in order to keep them from trying the lower cost competing product. You have to make an assumption as to how much travel to budget.
• The Sales Salaries for the year 2009 equaled $65,000. HR suggests that a 2.0% increase should be planned for all exempt employees as well.
• Determine what your advertising budget should be for 2010
Administrative Cost Data

• 2010 Salaries should be 2.0% higher than 2009
• For office supplies, utilities admin., and rent administrative make assumptions for 2010
• All Administrative Costs are assumed to be fixed by year.

Requirement #4: Assume that the first month of 2010 is completed. Assume the actual units sold and produced were as follows:
Product Jan. 10
Childs Play 4,933
The Challenger 8,216
The Pro 6,336
Total 19,485

Complete the Flexible Budget Variances and Sales Volume Variances. Assume that the 2010 Master Budget you prepared will be equally distributed by month. For example, to get your static monthly budget values for Month 1 take 1/12th of the 2010 annual.

Requirement #5: Compute the Break-even points and the Margin of Safety for the following:
• 2009
• 2010 (based on Static Budget)

Requirement #6: There is a staff meeting and in the meeting the owner asks what would happen to profit if the company eliminated the "Childs Play" product and focused exclusively on the "The Challenger" and "The Pro".
Using Differential Analysis, with the use of a spreadsheet determine the answer for the owner. Make assumptions on your own relative to what if any might change regarding fixed costs.

Requirement #7: At a different staff meeting the owner mentions that he is considering buying a competitor. He explains that the cost would be $1,050,000. He states that his accounting firm has determined that the purchase would generate additional cash by year as follows:
• Year 1: $100K
• Year 2: $150K
• Year 3: $200K
• Year 4: $250K
• Year 5: $250K
• Year 6: 250K
If the interest rate to use for NPV is 10%, will you accept this project?
If the interest rate to use for NPV is 6%, will you accept this project?