Evaluating Profit and Investment Center Performance P 3. Bobbie Howell, the mana

Question

Evaluating Profit and Investment Center Performance

P 3. Bobbie Howell, the managing partner of the law fi rm Howell, Bagan, and Clark, L LP,

makes asset acquisition and disposal decisions for the fi rm. As managing partner, she

supervises the partners in charge of the fi rm’s th ree branch offices. Those partners have

the authority to make employee com-

pensation decisions. The partners’ compensation depends on the profitability of their

branch office. Victoria Smith manages the City Branch, which has the following master

budget and actual results for the year:

Master Budget

Actual

Results

Billed hours

5,000

4,900

Revenue

$250,000

$254,800

Controllable variable costs

Direct labor

120,000

137,200

Variable overhead

40,000

34,300

Contribution margin

$90,000

$83,300

Controllable fixed costs

Rent

30,000

30,000

Other administrative expenses

45,000

42,000

Branch operating income

15,000

11,300

Required

1. Assume that the City Branch is a profit center. Prepare a performance report that

includes a f lexible budget. Determine the variances between actual results, the f lexible

budget, and the master budget.

2. Evaluate Victoria Smith’s performance as manager of the City Branch.

3. Assume that the branch managers are assigned responsibility for capital expenditures

and that the branches are thus investment centers. City Branch is expected to generate a

desired ROI of at least 30 percent on average invested assets of $40,000.

a. Compute the branch’s return on investment and residual income.

b. Manager Insight:Using the ROI and residual income, evaluate Victoria Smith’s

performance as branch manager.

Explanation / Answer

1) A performance report that includes a flexible budget: The variances between actual results, the flexible budget, and the master budget :

2. Victoria Smith’s performance as manager of the City Branch has not been good because the actual results shows reduction in the Operating Income as compared to Master Budget and the Flexible budget. The Manager is unable to control the Direct Labor cost.

3. If the branch is also a Investment centre and branch is expected to generate a desired ROI of at least 30 percent on average invested assets of $40,000, then

(a) the branch’s return on investment= 11300/40000 = 28.25. Expect return = $12000 and residual income=$(700)

(b)Victoria Smith’s as branch manager has failed to maintain the expected return of 30% on the invested assets of $40000 and desired return has been fallen short by $700.

Income Statement line items Per unit $ Master Budget $ Flexible Budget $ Actual Results $ Master Budget Variance $ Flexible Budget Variance $ (A) (B) (C) (A - C) (B - C) Billed hours 5000 4900 4900 Revenue 50 250000 245000 254800 4800 9800 Less: Variable Costs: Direct Labor 24 120000 117600 137200 (17200) (19600) Variable Overhead 8 40000 39200 34300 5700 4900 Contribution Margin 18 90000 88200 83300 (6700) (4900) Less: Fixed Costs Rent 30000 30000 30000 0 0 Other Admin. Expenses 45000 45000 42000 3000 3000 Operating Income 15000 13200 11300 (3700) (1900)

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