We’ve got a budget crisis! Instead of a profit of $47,000, we’re looking at a loss of over $86,000. If we continue to incur losses like this, we won’t be able to buy the new equipment that everyone’s been screaming for.

In January, Molly Kitka, manager and senior stylist of New Wave Hair Salon (NWHS), located in Portland Oregon, was expressing her concern about the results of the previous year’s operations, which she had just received. Thinking that perhaps her salon was not alone in having problems of this sort, she decided to analyze the reasons for the poor performance and present her findings and some recommended solutions at the annual retreat of the salon’s holding company, New Wave Enterprises (NWE). The retreat was scheduled to take place in one week.

BACKGROUND

NWE owned several salons throughout Oregon and Washington. Its strategy was focused on the increasing need of the professional community for stylish hair cuts. NWE provided some central services to its salons, such as information systems support and financial analysis, and conducted training programs for stylists and assistants. NWE salons distinguished themselves by a strict “no tipping” philosophy. To compensate for this, NWE had developed a compensation policy, described below, in which stylists could earn annual bonuses.

NWHS had been established three years ago, and NWE had appointed Ms. Kitka as manager one year later. Under her leadership, the salon had grown. Last year, there were 4 stylists and 2 assistants. Based on increased demand for services, the budget for this year had called for 7 stylists and 3 assistants. Ms. Kitka commented on the staffing:

The assistants help the stylists by doing things like washing a client’s hair, removing curlers, and sweeping the floors. Their role is to make the stylists as productive as possible. I had thought that a 2:1 ratio made . . .

Assignment

1. What kind of responsibility center is NWHS? What kind of responsibility center is a stylist is in NWHS? How do you know?
2. Are these responsibility centers well-designed? Why or why not?
3. What information does the flexible budget (Exhibit 3) convey to Ms. Kitka? Please be specific, identifying both what the $71,700 profit means, and how Ms. Kitka might use it in her decision making.
4. Exhibit 4 shows a contribution margin volume variance for Children’s Cuts totaling $39,000, and a revenue price variance for Children’s Cuts of $30,000. How were these amounts computed?
5. At the end of the case, Ms. Kitka says that the stylists have told her that they have saved the salon $22,500 from budget. Exhibit 4 shows that $18,000 of this amount is from Children’s Cuts. The $18,000 comprises a $30,000 positive productivity and usage variance, and a $12,000 negative wage and price variance. How were these latter two amounts computed?
6. Assuming there were sufficient cash on hand to pay the bonuses, should Ms. Kitka pay the stylists the bonuses they say they have earned? Why or why not?
7. What recommendations should Ms. Kitka make at the retreat about the design of NWE’s management control system and about an individual salon’s management control system?