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LLJ Satellites: Variance Analysis and Budgeting
Jack Childs is nervous about his company's future performance. The Childs family own
40% of the shares of LLJ Satellites, and generally has control over the direction of the company.
In fact, Jack is cu
ently the CFO and is also a member of the Board of Directors. However,
outside shareholders are becoming increasingly anxious due to poor operating results from the
past few years.
You have been hired by Jack into the controller’s office to provide some fresh
perspectives about operations at LLJ Satellites. For your first assignment, Jack asks you to
eview the financial information from the last fiscal year and to help create a budgeted plan for
the next fiscal year. To help you complete this assignment, Jack has provided you with various
financial data relating to the previous fiscal year as well as a
ief synopsis of the firm’s business
model.
LLJ Satellites – Company Overview
LLJ Satellites makes two types of specialized transistors for satellite communication
eception: an advanced and a basic device. At the beginning of each fiscal year, the company
creates a projected income statement for planning purposes. Below is the budgeted income
statement for the past fiscal year and standard cost information used to create the budget.
Cu
ently, the company uses a plant-wide predetermined manufacturing overhead rate to
apply manufacturing overhead to its products. Manufacturing overhead includes indirect
manufacturing costs such as plant utilities, factory depreciation, plant maintenance, and
production supervisor’s salaries. Basically, manufacturing overhead costs include all factory-
elated costs that are not direct materials or direct labor. These costs are generally estimated
using a predetermined manufacturing overhead rate based on a chosen cost driver. Budgeted
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manufacturing overhead is typically calculated using the following formula: Budgeted MOH =
Pre-Determined MOH Rate * Budgeted Cost Driver Amount. LLJ Satellites has chosen Machine
Hours for its cost driver to calculate budgeted manufacturing overhead. For example, the
$14,250,000 of Budgeted MOH in Table 1 for the Advanced Units = $9.50 per machine hour *
300,000 projected advanced units * 5 projected machine hours per advanced unit (information
taken from Tables 1 and 2).
Table 1: Budgeted Income Statement for Previous Fiscal Year
Revenues – Advanced (Projected Sales = 300,000 units) $52,500,000
COGS - Advanced
Direct Materials $17,700,000
Direct Labor $16,800,000
Budgeted MOH $14,250,000
Gross Margin - Advanced $3,750,000
Revenues – Basic (Projected Sales = 350,000 units) $47,250,000
COGS - Basic
Direct Materials $11,725,000
Direct Labor $19,600,000
Budgeted MOH $9,975,000
Gross Margin - Basic $5,950,000
Total Gross Margin $9,700,000
Selling Costs
Commissions (2 percent of revenues) $1,995,000
Salaries $450,000
Fixed Administrative Costs $1,650,000
Interest $520,000
Pre-Tax Income $5,085,000
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The company employs a just-in-time inventory system for all of its inventory types (raw
materials, work-in-process, and finished goods inventory). Because LLJ Satellites supplies major
satellite companies, the company can accurately predict production needs in advance. Thus, the
company ca
ies little or no balances in any inventory account. For example, the raw materials
manager only buys silicon and plastic when it will be immediately used in production and no real
inventory of materials is kept on hand. You can assume all beginning and ending inventory
alances are zero for this case.
Table 2: Standard Cost Card for Previous Fiscal Year
Advanced Device Basic Device
Direct Materials
Ounces of Plastic per Unit XXXXXXXXXX
Cost per Ounce of Plastic $2.50 $2.50
Ounces of Silicon per Unit XXXXXXXXXX
Cost per Ounce of Silicon $22.00 $22.00
Direct Labor
DL Hours per Unit (Electrical Components XXXXXXXXXX
DL Hours per Unit (Assembly XXXXXXXXXX
Total DL Hours per Unit XXXXXXXXXX
Cost per DL Hour $14.00 $14.00
Manufacturing Overhead (machine hours is the chosen cost driver)
Machine Hours per Unit (Electrical Components XXXXXXXXXX
Machine Hours per Unit (Assembly XXXXXXXXXX
Total Machine Hours per Unit XXXXXXXXXX
Pre-Determined MOH Rate per Machine Hour $9.50 $9.50
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As seen in the standard cost card (Table 2), all production units go through two
production departments: Electrical Components (where the electrical components in each
eceiver are produced) and Assembly (where the receivers are assembled). Jack asks that you
organize your analyses based on these two departments rather than product line. In other words,
you may wish to evaluate the two productions departments separately to better understand what
is happening with LLJ’s production processes.
Jack is concerned because actual year-end income fell short of projected income for the
third straight year (see actual income for the previous fiscal year in Table 3). He notes that the
company changed its pricing and selling strategy very early in the fiscal year (after the budget
was set) in an attempt to jumpstart sales in the recessionary economy. The company also decided
to purchase silicon from a new supplier that offered a lower price. Last year, the company
eliminated one sales position, saving on the salary of this salesperson. However, after extended
labor negotiations, LLJ Satellites increased the wage rate of the factory employees to $15 per
hour at the beginning of the fourth quarter. The firm also eliminated an employee training
program that represented a $145,000 savings in administration costs. Unfortunately, the
company had an unexpected cash shortage in September. Thus, the firm needed a costly
emergency short-term loan that significantly increased the interest costs for LLJ Satellites. Jack
wants assistance understanding other reasons why the company fell short of budgeted
projections.
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Table 3: Actual Income Statement for Previous Fiscal Year
Revenues – Advanced (Actual Sales = 350,000 units) $59,500,000
COGS - Advanced
Direct Materialsa $20,580,000
Direct Labo
$19,950,000
Actual MOHc $18,725,000
Gross Margin - Advanced $245,000
Revenues – Basic (Actual Sales = 200,000 units) $29,000,000
COGS - Basic
Direct Materialsa $6,769,000
Direct Labo
$11,685,000
Actual MOHc $6,700,000
Gross Margin - Basic $3,846,000
Total Gross Margin $4,091,000
Selling Costs
Commissions (2 percent of revenues) $1,770,000
Salaries $425,000
Fixed Administrative Costs $1,505,000
Interest $630,000
Pre-Tax Income (Loss) ($239,000)
a – Direct materials costs consist of 2,100,000 ounces of plastic for the advanced units and
1,820,000 ounces of plastic for the basic; plus 735,000 ounces of silicon for the
advanced units and 110,000 for the basic units. The average price paid was $2.45 per
ounce for plastic and $21.00 per ounce for silicon.
– Actual direct labors totaled 750,000 hours in the Electrical Components department and
1,470,000 hours in the Assembly department for the fiscal year.
c – Actual machine hours totaled 1,350,000 hours in the Electrical Components department
and 1,192,500 hours in the Assembly department for the fiscal year.
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Looking Forward – Planning for the Next Fiscal Year
On the advice of outside shareholders, Jack has agreed to change its product pricing
strategy. Specifically, the firm is planning on charging $180 for an advanced unit and $140 for a
asic unit. Due to a projected improvement in the overall economy, the sales teams believes they
can sell 360,000 units of the advanced device and 300,000 units of the basic device at those
prices. Sales in this industry are cyclical and the company expects 50 percent of the total sales to
occur in the fourth quarter. For simplicity, assume the remaining 50 percent of annuals sales are
uniform throughout the first three quarters of the year.
Based on the variance analysis, some changes may be needed in the standard costs used
for budgeting and planning purposes. However, unless variance results suggest otherwise, all of
the standard usages (e.g., ounces of plastic or silicon per unit, machine hours per unit, and direct
labor hours per unit) will remain the same as last year for the upcoming fiscal year. The company
has no plans that will substantively change the manufacturing process to increase the standard
efficiency in using these resources. However, each year LLJ Satellites updates its standard direct
materials costs (e.g., cost of silicon/plastic per ounce) to better match cu
ent prices. Jack also
wants advice if LLJ Satellites should continue to purchase silicon from the new supplier or go
ack to the old supplier. Also, as a result of the labor negotiations with factory workers, the
average hourly pay rate is expected to remain at $15.00 per direct labor hour.
A recent accounting hire at LLJ Satellites has analyzed the manufacturing overhead costs
at the company. Specifically, she examined past manufacturing overhead costs in each of the two
production departments and regressed these costs on various potential cost drivers. Jack is unsure
how to best use this data. Results from this analysis are in the table below.
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Table 4: Regression Analysis of Factory MOH Costs on Potential Cost Drivers
Annual Electrical Components Department MOH Costs***
Cost Driver Regression Results (for cost driver) R2
Machine Hours (Electrical Components) Y = 2,800, XXXXXXXXXXX) 0.83
Direct Labor Hours (Electrical Components) Y = 5,250, XXXXXXXXXXX) 0.55
Annual Assembly Department MOH Costs***
Cost Driver Regression Results (for cost