Question 3b

Cortinas Retail Clothing (CRC): Company information
CRC started as a clothing retailer 20 years ago with one store. The business expanded steadily and had 10 stores after 18 years of trading. Since then, the rate of expansion has increased rapidly with an average of four stores opening per year.

CRC is planning to open its first large out of town store soon and is also considering the acquisition of a food retailing business. Both of these will be supplied with items using CRC’s existing central warehouse.

Introduction of RFID system
At the beginning of the 20X5 accounting year, to cope with this rapid growth, CRC acquired a RFID (radio frequency identification device) system at its single central warehouse. This was to help manage inventory more effectively and speed up the processes for receiving items from suppliers and despatching them to stores. Items are still moved manually by staff in the CRC warehouse where there is little automation compared to competitors. There has been some resistance from staff to the RFID system, which they find difficult to use. CRC is currently trying to reduce the number of suppliers it has to help increase efficiency in the warehouse.

Budgeting system
The budget setting process has remained unchanged since CRC was formed. All managers prepare draft budgets using spreadsheets and submit them to the CRC board for approval. Managers use the previous year results as a starting point when drafting the budgets and increase the variable costs in line with any anticipated growth in volumes. For example, when preparing the budget for the year ending 30 June 20X6, the manager of the central warehouse used the actual costs of running the warehouse from the previous year and increased them all by the same percentage. This was to reflect an anticipated increase in volumes in 20X6 over 20X5. Managers are appraised on their performance against the approved budgets.

CRC has needed all its financial resources to fund its expansion and so it has only old and basic IT systems which are not enterprise resource planning systems, unified databases or networked systems.

It has been suggested to the CRC board that the current system of budgeting is no longer suitable and that the business should move to activity-based budgeting (ABB). The CEO has asked you to evaluate the potential introduction of ABB at CRC.

Central warehouse activity in July 20X5
The board has never seen an activity-based budget before and is unsure how it could be used to explain variances between actual and budgeted performance in the central warehouse. As an example, they would like to see how an activity-based budget for the year ending 30 June 20X6 could be used to explain variances from the actual results for the month of July 20X5.

The two key activities which drive costs in the central warehouse are receipts of items into the goods inwards section and despatches of items from the goods outwards section. A receipt into good inwards involves accepting a delivery of items from a supplier, tagging those items and putting them away in the warehouse. Receipts from suppliers contain variable numbers of individual items. Despatches of items from goods outwards are to CRC’s own retail stores. Cost driver rates for these two activities will be used to set monthly cost budgets for the warehouse.

The board asked an analyst to prepare an activity-based budget for the central warehouse for the year ending 30 June 20X6. The analyst has collected relevant information on the costs for the year needed to prepare the activity-based budget and has begun the work (Appendix 1).

The total annual cost relating to goods inwards needs to be determined. This should be used to calculate the budgeted cost of each receipt into goods inwards, in order to explain the variance between the budgeted cost and the actual cost of receipts of goods inwards for the month of July 20X5. The analyst has already correctly included the costs of the warehouse manager’s salary and the lease of the RFID system into the incomplete activity-based budget in Appendix 1.
The board has asked you to complete the analyst’s work.

To enable you to complete your calculations, you are told that in July 20X5 there were 650 receipts into goods inwards. These receipts contained 100,000 items, which is the same as the budgeted number of items for the month. The actual total cost of activities driven by receipts into goods inwards for the month was $18,000.

It is now 1 September 20X5.

Required:
(b) Complete the analyst’s work in Appendix 1 as required by the board and explain the variance between the budgeted cost and the actual cost for each receipt into goods inwards for July 20X5. (12 marks)

Appendix 1
Analyst’s incomplete activity-based budget for the central warehouse for YE 30 June 20X6.

Total Goods inwards Goods outwards Other
$ $ $ $
Warehouse manager’s salary1 55,000 55,000
Lease of RFID system2 75,000 45,000 30,000

RFID tagging3
Warehouse staff wages4
Heating and lighting5

Sub-total cost of activities driven by the receipt of goods inwards

Analyst’s notes
Relevant information on costs in the central warehouse for the year ending 30 June 20X6

1. The cost of the warehouse manager’s salary relates to all sections of the warehouse and cannot be apportioned directly to goods inwards or goods outwards.

2. The cost for the RFID system is invoiced by a lease company. 60% of this cost is allocated to goods inwards and the remainder relates to goods outwards.

3. The cost of RFID tagging is the wages cost for specially trained staff, known as taggers. Their only job is to attach RFID tags to items when they are received, before the items are put away in the warehouse. All items received are RFID tagged and the costs of tagging are allocated entirely to the cost of goods inwards. Each tagger can attach 35,000 tags per month and is paid an annual salary of $24,000. The cost of each individual RFID tag is negligible.

4. There were 12 full-time warehouse staff throughout the year to 30 June 20X5 who were each paid an annual salary of $22,500. Two more staff will be recruited at the beginning of the new budget year. 50% of the warehouse staff work in goods inwards and 50% in goods outwards.

5. The cost of heating and lighting relates to all sections of the warehouse and cannot be apportioned directly to goods inwards or goods outwards. The actual heating and lighting cost for last year was $10,000 and the warehouse manager has proposed a budget of $10,500 for the coming year. The general cost of inflation though is expected to be zero.

6. The annual number of receipts into goods inwards expected is 9,000, containing a total of 1,200,000 items. These are expected to occur evenly over the year.