To start a successful business, students need to understand the steps necessary to achieve their desired profits. While Managerial textbooks teach each step independently, we demonstrate how these steps are integrated. We present a Multi-Disciplinary Case-Method approach to teaching Cost-Volume-Profit (CVP) Analysis. Finally, students prepare a Flexible Budget demonstrating the importance of distinguishing between activity and revenue/spending variances.
INTRODUCTION
"We first present an alternative, more comprehensive teaching approach, for Cost-Volume-Profit (CVP) analysis from the commonly used approach which simply teaches students how to use a series of equations to solve various questions related to CVP analysis, in which unit selling price, total fixed costs, and unit variable costs are assumed to remain constant (Garrison et al., 2010; Choo and Tan, 2010). We use a multi-disciplinary approach in the context of a realistic case-analysis. We believe this approach offers useful insights and provides a useful learning tool for students pursuing an advanced Master's Degree." (Machuga, 2012). This case requires students to: (a) make assumptions about cost behavior in a dynamic and interactive way, and (b) research a variety of marketing issues for the proposed business that simulates a real life business situation, and (c) use the information from their CVP analysis for planning purposes, applying what they typically learn when they read about budgeting, and (d) compare the results of their business venture using the Income Statement prepared based on their planned level of sales volume to the results that should have occurred based on the actual level of sales volume, as well as the actual results we provide in the case. This allows students to see how budgets are used to develop goals, as well as to determine if actual results were achieved. This paper's approach emphasizes the importance of CVP analysis and how it ties directly into planning and control processes management must take in order to start a potentially successful business. More importantly, we show students the importance of these key practical yet very relevant management-accounting tools, all done in one integrative setting instead of teaching those concepts separately.
A very important concept for students to understand is whether they have accomplished profit goals they set in their CVP analysis. In other words, they need to understand how to take their assumptions from the first part of the case and use them to develop the necessary budgets in order to finally prepare a projected Income Statement. Budgets force management to plan for the future as does CVP analysis. In addition, preparing a number of budgets allows students to understand that in order accomplish their profit goal they must also prepare budgets to coordinate activities throughout the company. This case will allow students to understand how budgets can help them coordinate activities throughout the entire company by integrating material purchases' plans, and labor use, etc. Even more importantly, students will learn the importance of budgets and their use for evaluation and control purposes. Because the actual level of activity will most likely differ from the planned level of activity, we also require the students to prepare a Flexible budget. The Flexible budget allows them to understand the reason planned results differ from actual results in terms of activity variances versus revenues and spending variances (Horngren et al., 2012).
DEVELOPMENT OF THE CASE
"The case assumes students will open a milkshake shack on the beach of a resort on the "big Island" of Hawaii. I have studied existing restaurants, read industry reports, and have done some research on expected minimum costs to be incurred in operating the business. A unique feature of my milkshakes is that I will serve them with flavored straws that match the flavor of the chosen milkshakes by customers. My research embeds the following assumptions:" (see Machuga, 2012)
Sales prices of milkshakes ($7.00 for small, and $10.00 for large)
DIRECT MATERIAL INGREDIENTS
Small (8 oz. size)
Large (12 oz. size)
Whole Milk ($15 for a 5 gallon=640 oz.)
(need 2 oz. of milk)
(need 3 oz. of milk)
Cream ($20 for 1 gallon=128 oz.)
(need 2 oz. of cream)
(need 3 oz. of cream)
Sugar ($10 for a 15 lb. bag=30 cups)
(need ½ cup of sugar)
(need ¾ cup of sugar)
Premium Vanilla Ice Cream ($24 for 600 oz.)
(need 6 oz. of ice cream)
(need 9 oz. of ice cream)
Flavorings
.25 per shake
.40 per shake
Flavored specialty straws
.75 per straw
.75 per straw
Cups (500 8 oz. cups @ a cost of $200)
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Cups (500 12 oz. cups @ a cost of $250)
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Fixed costs:
• Shack rental: $500 a month
• Cleaning and other miscellaneous supplies: $100 a month
• Equipment: Industrial Milk Shake Maker: $72 per machine x 10 machines=$720
• Equipment: Industrial Refrigerator/freezer: $480
• Countertops: $1,200
• Tables and benches for customers to sit outside: $108 per bench-set x 10=$1,080
• Annual insurance: $600 a year
• Sign: use your marketing knowledge to think of a good name= $100
• Advertising expenses: $5,000 a month
• Accounting and bookkeeping costs: $500 a month
• Owner's salary: $96,000 a year
• Dues and membership fees: $2,000 a year.
• Licenses and permit fees: $600 a year.
• Maintenance services: $400 a month.
• Office supplies: $300 a month.
Employees:
• Two part-time employees: each receiving a monthly salary of $800 (including benefits).
Total Start-up Costs = $20,247 for which students are assumed to take out a non-owner loan for the first months expenses and cost of long-term assets, which consist of the following amounts:
($500+$100+$720+$480+$1,200+$1,080+$50+$100+$5,000+$500+$8,000+$167+$50+$400+$300+1,600=$20,247).
A self-amortizing loan is assumed to be obtained from a bank, and carries an annual interest rate of 6% payable over 2 years with monthly payments (each monthly payment consists of both principal and interest). The loan amortization schedule is include in the appendix of this case study (first months interest expense is $101.24).
Other costs:
10% of gross sales must be given to resort where shack will be located on its premises.
Owner's capital will be used to cover direct materials' costs.
REQUIREMENTS OF THE FIRST PART OF THE CASE - which you already completed however I have given you the correct answer below:
ANSWERS TO THE FIRST PART OF THE CASE: Presented below is one possible answer to this case using only information provided in the case with the following assumptions:
1) the milkshake's sales-mix will be 60% large and 40% small,
2) the suggested sales prices are used to be competitive with other vendors, and
3) the milkshake makers, tables and benches are assumed to last for 3 years, but the refrigerator/freezer and counter tops are assumed to last for 10 years and the sign is assumed to last only one year.
Since this is a simulation exercise, the case allows students to see how the break-even sales volume changes depending upon different assumptions about product sales-mix, sale prices, depreciable lives of long-term assets as well as variable costs, and allows them to add other necessary fixed costs to the cost structure of the business conditional on their own unique business strategy. Consequently, their answers may vary.
1) You will need to sell 3,135 milkshakes/month to break even = ($16,840.61/5.372) 1,254 (3,135*40%) will be small and 1,881 (3,135*60%) will be large.
Variable Cost Income Statement: using 40% (small) and 60% (large) sales-mix in determining the break-even sales volume (no salary allowance for owner):
REQUIREMENTS OF THE SECOND PART OF THE CASE
The second part of this case is intended to demonstrate the importance of using a BUDGET process to plan, direct and control the organization..
• Using assumptions you made in the first part of the case regarding, sales price per unit, variable costs per unit and total fixed costs, as well as the information about sales volume presented below, prepare the following budgets for the first quarter:
• Sales budget
• Production budget
• Direct materials budget for JUST THE MILK - to save time I filled in the other raw material budgets necessary to make milk shakes
• Manufacturing Overhead budget
• Operating budget
• Using the information from the budgets you prepared above, prepare a projected Income Statement for the first month.
The Sales Budget must be prepared first as it affects all the other budgets. In order to prepare the sales budget an estimate of the expected number of units to be sold and the expected sales price needs to be determined. To prepare the sales budget we used the following assumptions. Statistics for tourism in Hawaii are available from the www.hawaiitourismauthority.org and the Department of Business, Economic Development and Tourism of the State of Hawaii ( Hawaii.gov/debdt ).
• Number of visitors to the island from January 2007 to May 2007 were 125,000, 125,000, 150,000, 125,000 and 125,000, respectively. (For simplicity, we assume each visitor, on average, purchases one milk shake. (Students can get more elaborate and research the average number of days visitors stay and the average number of couples, versus families with kids).
• The sales mix and the sales price will be consistent with the first part of the case at 40% small and 60% large with the sales price set at the competitors price of $10 for large and $7 for small (less the resort fee of 10%).
The next budget to be prepared is the Production budget, where the number of milk shakes needed to be produced (based on the sales budget) are determined. This will equal:
Number of milk shakes expected to be sold
+ safety stock (ending finished goods inventory) in case demand is higher than predicted
Total milk shakes needed
Less: Beginning finished goods inventory (which is zero at the start of business)
Milk shakes needed to be produced
To prepare the production budget we used the following assumptions:
• 10% of next months expected milk shake sales is desired to be left in ending inventory as a safety cushion.
• Remember, beginning inventory is last months ending inventory.
A DIRECT MATERIALS budget will need to be produced for each ingredient used to make the milk shakes. The direct materials budget for whole milk was prepared using the following assumptions:
• 10% of next months expected milk needs are desired to be left in ending inventory as a safety cushion.
• Remember, beginning inventory is last months ending inventory.
• Cost of whole milk was determined to be $0.02344 per ounce
Milk Purchases Budget - 1st quarter
DIRECT MATERIALS BUDGET - CREAM.
The direct materials budget for cream was prepared using the following assumptions:
• 10% of next months expected cream needs are desired to be left in ending inventory as a safety cushion.
• Remember, beginning inventory is last months ending inventory.
• Cost of cream was determined to be $0.15625 per ounce
DIRECT MATERIALS BUDGET - SUGAR.
The direct materials budget for sugar was prepared using the following assumptions:
• 10% of next months expected sugar needs are desired to be left in ending inventory as a safety cushion.
• Remember, beginning inventory is last months ending inventory.
• Cost of sugar was determined to be $0.33333 per cup.
DIRECT MATERIALS BUDGET - ICE CREAM.
The direct materials budget for ice cream was prepared using the following assumptions:
• 10% of next months expected ice cream needs are desired to be left in ending inventory as a safety cushion.
• Remember, beginning inventory is last months ending inventory.
• Cost of ice cream was determined to be $0.04 per ounce.
DIRECT MATERIALS BUDGET - FLAVORINGS.
The direct materials budget for flavorings was prepared using the following assumptions:
• 10% of next months expected flavoring needs are desired to be left in ending inventory as a safety cushion.
• Remember, beginning inventory is last months ending inventory.
• Cost of flavorings was $ 0.40 for a large shake and $ 0 .25 for a small shake.
DIRECT MATERIALS BUDGET - STRAWS.
The direct materials budget for straws was prepared using the following assumptions:
• 10% of next months expected straw needs are desired to be left in ending inventory as a safety cushion.
• Remember, beginning inventory is last months ending inventory.
• Cost per straw is $ 0.75.
MANUFACTURING OVERHEAD BUDGET
First, we need to determine whether each manufacturing overhead expense is variable or fixed. It has been determined that all the manufacturing overhead costs are fixed, although salary of part-time workers and utilities can be variable or mixed expenses as well.
OPERATING BUDGET
First we need to determine whether each operating budget expense is variable or fixed. It has been determined that all the operating costs are fixed.