We’ve got a crisis on our hands. We had budgeted a profit of just over $132,000, and we’ve lost over $144,000. It seems as though everything has gone wrong somehow.
Alex Yianna, Administrator of El Conejo Auto Clinic, was greatly concerned that the results of the year’s operations were considerably worse than budgeted. One reason for this problem was that competition had forced the company to lower its price for one of its most significant jobs, but there appeared to be some other reasons as well. Mr. Yianna decided to analyze these reasons in preparation for his upcoming meeting with the clinic’s supervisors.
El Conejo Auto Clinic had been formed over five years ago. Initially its only line of business was muffler replacements. As the quality of original equipment mufflers improved, and as Mr. Yianna realized that its customers were interested in more than just muffler replacements, the company expanded its product lines. Currently, the company offered four services (or “jobs,” as they frequently were called): muffler replacement, minor tune-up, major tune-up, and lube and oil change. The principal distinction between a minor and major tune-up was that with a minor tune-up the mechanics did not replace the spark plugs. Hence a minor tune-up required less time and fewer supplies than a major tune-up.
A distinctive feature of the clinic was its use of mechanic assistants. Since much of the work traditionally done by mechanics did not require the skill of a trained mechanic, Mr. Yianna realized that he could offer lower prices to his customers by having mechanics only perform those tasks that required their specialized skills. The remaining tasks were done by lower-skilled, and hence lower wage, mechanic assistants.
Another distinctive feature of the clinic was its testing function. Mr. Yianna had purchased some highly sophisticated equipment that allowed him to test the work of every job to make sure that there were no defects. The equipment that tested muffler replacement, for example, assessed the quality of the seals between the muffler and tailpipes to make sure that they would not rupture after only a few hundred miles of driving. Similarly, other equipment tested the timing of an engine following a tuneup.
Exhibit 1 contains the budgeted number of jobs, by type, the budgeted price per job, and the budgeted variable expenses per job, classified into four “inputs:” mechanics, mechanic assistants, supplies, and testing. It also shows the total revenue and variable expenses for each job type, and contribution of each job type to fixed expenses. As it shows, the fixed expenses were then deducted from the total contribution to give a total budgeted profit of $132,500 for the period.
- Be sure you understand how Exhibits 2 and 3 were prepared. Do you agree with Ms. Marco’s analyses so far?
- Besides changes in the number of jobs and the selling price per job, what are the other reasons why actual results might have diverged from budget?
- Calculate the variance associated with each of the reasons you gave in Question 2*. How, if at all, might this information be used by Mr. Yianna in managing the clinic? How might it be used by the clinic’s supervisors? By the clinic’s sales manager?
- What information concerning jobs, costs, and revenues would you suggest that Mr. Yianna, the supervisors, and the sales manager see on a regular basis? Why?
- Try to set up a spreadsheet to calculate the variances. Make sure you get the signs (+/-) correct.