Winnbrook Day Care Center was located in Newtown, Indiana, and was owned by a local corporation that wished to provide child care services to its employees. Until 2007, the corporation's policy had been that Winnbrook should operate on approximately a breakeven basis: that is, the corporation did not intend to use its own funds to finance the operation, nor did it expect its employees to pay more than the center's full cost for day care services. Winnbrook was one of seven day care centers in Newtown that had its own building. Many smaller centers were located in church basements or private homes. In 2007, Winnbrook's enrollment was 50 children, all of whom were pre-school. They attended for the full day, while their parents were at work, and took part in various activities. The center provided them with lunch.
Winnbrook operated in a two-story building located on a large lot. The corporation owned both the building and the lot. The building was old and needed repair. According to a recent inspection by the city fire marshal, it was in violation of the fire code because, among other things, the second floor did not have two outside exits, not all the exit doors opened outward, smoke detectors and emergency lighting were missing, stairwells were not enclosed, and materials used in ceiling and walls were substandard. The city's Department of Child Services had indicated that it would revoke Winnbrook's license unless it either renovated the building or constructed a new one.
A local contractor, estimating the necessary repairs to the building would cost roughly $ 100,000, had recommended that Winnbrook construct a new building on the same lot. The cost would be $ 80,000, assuming that the parents would do much of the interior finishing on a volunteer basis. The $ 80,000 figure included demolition and removal of the old building after construction of the new one (the lot was large enough to accommodate this approach). Following construction, Winnbrook's capacity would be 70 children.
Based on Ms. Johnson's recommendation, the corporation's CFO had decided to construct a new building, but she had indicated to Ms. Johnson that, beginning in 2008, the center should earn a return of about 10% on the cost of the building and land. The land had been purchased ten years earlier, along with the old building. The total cost was $ 60,000 of which the land represented about one-third. Ms. Johnson had agreed, and construction began in January, 2007. The building was scheduled for occupancy in January, 2008 and had an economic life of twenty years.
FINANCIAL DATA
Most Winnbrook children were in low-income families. In most cases, the corporation employed both parents. In 2006 and 2007, the center charged $ 35 per week, the lowest rates of any of the seven centers, where rates were as high as $ 50 per week. Centers at the top of the scale attracted children from higher-income families. Most centers, including Winnbrook, operated at capacity.
For tax purposes, Winnbrook's accounting system was separate from the corporation's. Ms. Johnson had prepared an income statement for 2006. From bank deposits and checks, Mr. Landers, who had taken some introductory accounting courses in college, was able to prepare an estimated income statement for 2007. In addition, based on discussions with Ms. Johnson, Mr. Landers had prepared a budget for 2008, assuming the new building would be in use for the full year. The 2006 actual figures, Mr. Lander's estimates for 2007, and the 2008 budget are all shown in Exhibit 1.
In preparing the 2008 budget, Mr. Landers made the following assumptions:
1. Winnbrook would charge a fee of $ 50 per week.
2. Seventy (70) children would enroll for forty (40) hours a week each.
3. There would be the equivalent of 6.5 hourly employees at $ 5 per hour (the same wage rate as in 2007). This was 2.5 FTEs (full-time equivalent employees) more than in 2007, and was due to the planned increase in enrollment. In addition, Ms. Johnson planned to hire a business manager (salaried) to keep Winnbrook's expenses under control. All employees worked 40 hours a week.
4. The center would be open the equivalent of 48 weeks a year. This was because during two weeks of the year, the corporation closed down and the employees were on vacation. In addition, the corporation was closed for another ten days (two weeks equivalent) during the year in conjunction with various national holidays, such as Labor Day, Columbus Day, and Thanksgiving.
Exhibit 1. Financial Data
(Year Ending December 31)
2006 (Actual) 2007(Estimated) 2008(Budget)
Revenue (net of estimated bad debts) $ 70,000 $ 84,000 $ 168,000
Expenses:
Salaried employees $ 20,000 $ 22,000 $ 44,000
Hourly employees 34,350 38,400 62,400
Food 4,198 12,000 16,800
Utilities 1,954 1,670 2,100
Interest (1) 413 6,400 6,000
Supplies (2) 6,350 7,200 10,080
Repairs & Maint. 124 544 1,000
Insurance 504 651 2,000
Depreciation (3) 1,108 826 4,000
Total expenses 69,001 89,691 148,380 Income (Loss) $ 999 $ (5,691) $ 19,620
Notes:
(1) 2006 interest was for an automobile, which had been purchased on an installment loan. 2007 interest was for the automobile and the mortgage. 2008 interest was for the mortgage only, since the auto loan would be paid off by the end of 2007.
(2) Child-related supplies, such as crayons, paper, paints, clay.
(3) Depreciation in 2006 and 2007 was for the automobile; in 2008, it was for the new building only.
Question 1
From the perspective of the corporation, what kind of responsibility center is Winnbrook ?
Question 2
Use variance analysis to explain the causes of the increase in revenue from 2007 to 2008. Show your computations neatly, and clearly label the appropriate variances.
Question 3
Using child-weeks as the appropriate measure of volume (e.g., 1 child enrolled for 48 weeks = 48 child weeks), indicate whether each item below is fixed (F), variable (V), or other (O), and explain your reasoning. For variable items, your explanation should show the rate per child-week. Use Mr. Lander's 2007 estimated amounts as the basis for your computations.
F/V/O Explanation
1. Revenue
2. Salaried Employees
3. Hourly Employees
4. Food
5. Utilities
6. Interest
7. Supplies
8. Repairs
9. Insurance
10. Depreciation
Question 4
Use your analysis in Question 3 to set up a flexible budget formula for Winnbrook. Show your computations where necessary.
Question 5
How, if at all, would a flexible budget be of use to Ms. Johnson in the management of Winnbrook?
Question 6
Ms. Johnson's budget for 2007 was based on an average attendance of 45 children per week, and had budgeted food costs totaling $ 8,640 for the year. Mr. Lander's estimate of $ 12,000 was based on an average attendance of 50 children per week. Prepare a variance analysis to explain the increase in food costs between Ms. Johnson's budget and Mr. Lander's estimate.
Question 7
Prepare a brief explanation to Ms. Johnson of why Mr. Lander's estimated food costs for 2007 differ from her budget.
Question 8
As a consultant to the corporation, you have been asked to recommend some non-financial information that Ms. Johnson and the corporation could use to assess Winnbrook's performance. List two items of non-financial information, giving a very brief (no more than 50 words) explanation for each of why you chose it.
Question 9
Ms. Johnson has asked you for a recommendation as to what is the best course of action for her to take in this matter. Your answer should focus on identifying problems that you see in the 2008 budget and recommending a course of action to resolve the problem.