Frank Lennard, the snow removal department supervisor for the City of Hamtramck, stared at the memo he had just received from the director of public works. The opening paragraphs were anything but reassuring:

“As you know, I have instituted a new responsibility accounting system. From now on, you will receive quarterly reports that compare the cost of operating your department with your budget. The reports will highlight the variance so you can easily zero in on any departures from your budget. Responsibility accounting means you are to keep the costs in your department within your budget. The variances will help you identify those costs that are out of line, and the sizes of the variances will indicate the most important cost items to address. Your first report accompanies this memo. Your report indicates several of your costs are significantly above your quarterly budget. You need to pay particular attention to the salaries of your snowplow drivers. Please get back to me by the end of next week with a plan for making the needed reductions.”

Frank knew he needed a plan, yet midwinter was the busiest time of the year for snow removal, and a big storm had been predicted for the weekend.

Frank had been with the city for more than 20 years. Previously, cost data had been presented to department heads only infrequently. Still, the new director was sure that more frequent information would incentivize his department heads to keep their costs under control. The new director had also prepared a budget for each department for the current fiscal year and had computed quarterly budgets as one-fourth of each department’s annual budget. To prepare the budgets, he had analyzed the prior three years’ costs and, in doing so, had learned that almost all of them had increased each year, with more rapid increases in the last two years. His first thought had been to establish the budgeted line items at an average of the prior three years’ costs, hoping that such an approach would encourage his department heads to reduce their operating costs to his level. However, because of the rapid cost increases during the past two years, he based the current year’s budget on the prior year’s costs of less than three percent. For the snow removal department, he also estimated the cubic miles of snow to be removed, which he set at an average of the past three years.

Lennard received the report shown in Exhibit 1 in mid-January. He reflected on its content:

“Some of my costs don’t change, even if there’s a change in the cubic miles of snow we plow. On the other hand, drivers, supplies, fuel, and maintenance vary almost directly with changes in cubic miles. Shouldn’t my budget reflect this distinction? Also, my budget didn’t include my October salary increase – was I supposed to refuse it to keep my budget in balance? It’s also important to note that I had to pay overtime to the drivers because of some very heavy storms we had in mid-December. Because of this, my average hourly rate for the whole three months was $21 instead of the $18 that was in my budget. In fact, and maybe this is a little picky, the average number of minutes it took my drivers to plow a cubic mile of snow during the quarter dropped from 48, which was my budget target, to 47. Somehow, even though it’s pretty small, I think this improvement should be considered.”

Notes:

1. Days when there was at least one inch of snow. Less than that, and no snow plowing took place.
2. Computed, for each storm, by multiplying the depth of snowfall (according to the official measure by the City Clerk) by miles of roadways to be plowed.
3. Drivers were paid hourly, not by the mile. However, the number of hours needed to clear the roadways depended to a great extent on cubic miles of snow. For example, an inch of snow from a relatively light storm would take less time to plow than six inches of snow from a moderate storm. The amount of time needed to clear the roadways also depended on the length of the storm. For example, if a storm deposited six inches of snow in a few hours, the drivers would wait until the storm had ended, and then clear the roads with one pass of the plows. However, if a storm deposited six inches of snow over, say, a 24-hour period, two or more passes of the plows would be needed to keep the roads clear. When drivers worked more than eight hours in a 24-hour period, they were paid a 50 percent overtime premium for the additional hours.
4. Mainly sand and salt. Office and other administrative supplies were part of the administrative cost allocation.
5. Was almost directly related to miles driven. Thus, a 24-hour storm, requiring several passes, would lead to more maintenance costs than a storm of only a few hours, even if the cubic miles of plowed snow were the same.
6. Based on the town’s full cost accounting system. The system used different allocation bases for different city services, such as custodial work, administrative salaries and supplies, and repairs and maintenance.
7. Exclusively for snowplows. The department had no other assets to be depreciated.

ASSIGNMENT

1. What is your assessment of the method the public works director used to construct the budget? Prepare a flexible budget for the snow plowing department. What does it tell you?
2. Compute the appropriate variances for drivers. What do they tell you?
3. What plan should Frank present to the public works director for making cost reductions?