“Phenix Federal Credit Union”

(a) Compute the 1997 and 1998 budget variances for both the income statement and balance

sheet using Sheet1 of the phenix.xls spreadsheet. What were the key differences in the balance

sheet accounts? What were the significant static budget variances in the income statement?

Static Budget Variances Phenix Federal Credit Union

Actual Budget Actual Budget

12/31/199 12/31/199 Differenc 6/30/9 Differenc
BALANCE SHEET 7 7 e 8 12/31/98 e
Total Loans 20,103 21,293 (1,190) 20,023 21,861 (1,838)
Allowance for Loan Losses (168) (124) (44) (167) (183) 16
Cash and Cash Equivalents 740 699 41 504 751 (247)
Total Investments 5,610 4,558 1,052 7,307 5,857 1,450
Land and Building 304 304 0 301 298 3
Other Fixed Assets 524 446 78 494 563 (69)
Other Real Estate Owned
(Foreclosed) 0 0 0 0 0 0
Other Assets 178 484 (306) 234 191 43
TOTAL ASSETS 27,291 27,659 (368) 28,695 29,338 (643)

Accrued Dividends Payable on

Shares 129 213 (84) 131 208 (77)
Accounts Payable 480 (19) 499 631 (408) 1,039
TOTAL LIABILITIES 609 194 415 762 (200) 962
Total Shares and Deposits 23,299 23,927 (628) 24,579 25,719 (1,140)
Regular Reserves 1,026 1,064 (38) 1,021 1,064 (43)
Undivided Earnings 2,357 2,474 (117) 2,334 2,755 (421)
TOTAL LIABILITIES AND
EQUITY 27,291 27,659 (368) 28,696 29,338 (642)

Static Static
budget budget
6
Month Full-
INCOME STATEMENT Full-Year Full-Year variance s Year variance
Interest on Loans 2,107 2,187 80 1,005 2,176 (83)
Income from Investments 307 244 (63) 174 320 14
Fee Income 461 482 21 241 521 (20)
Late Charges on Loans 40 21 (19) 18 41 (3)
TOTAL GROSS INCOME 2,916 2,934 18 1,437 3,058 (92)
Employee Compensation and 768 831 63 383 783 (9)
Benefits
Travel and Conference Expenses 40 50 10 38 43 17
Office Occupancy Expense 92 27 (65) 31 29 17
Office Operations Expense 484 413 (71) 265 484 23
Educational and Promotional
Expenses 43 41 (2) 21 46 (2)
Loan Servicing Expense 26 26 0 6 28 (8)
Professional and Other Services 257 248 (9) 165 276 27
Loan Loss Provision 205 143 (62) 119 176 31
Operating Fees 6 8 2 3 6 0
Other Miscellaneous Operating 68 34 (34) 22 73 (15)
TOTAL OPERATING EXPENSES 1,990 1,820 (170) 1,052 1,944 80
INCOME FROM OPERATIONS 925 1,114 189 385 1,114 (172)
Gain on Disposal of Fixed Assets 0 0 0 0 0 0
Dividends on Shares** (806) (843) (37) (413) (833) 4
NET INCOME *** 120 271 151 (28) 281 (169)

The key differences in Balance sheet for 1997 are Total Loans, Total Investments, Total shares and
deposits. The variance of Total Loans unfavorable because we couldn’t reach planned total assets.
The positive variance figure of the Total investments is favorable, and the difference in total shares
and deposits is unfavorable. In total, variances of the total amount of assets, liabilities and equity are
unfavorable for the institution.
In the Balance sheet for the year 1998, we can still observe unfavorable variance and that the
budgeted amount is more than the actual. A key unfavorable variance is also seen in total shares and
deposits that is negative 1140. However, the total investments figure is still favorable.   
The static budget variance for the income statement of 1997 consists of unfavorable variances for
total gross income and total income from operations, subsequently resulting in an unfavorable
variance in Net Income. Also, it is clearly seen that the expenses in 1997 were a way more than
planned due to the movement of the office to another place.   
In 1998 situation with net income is worsened with an unfavorable variance of 169 compared with
1998 159. Total gross income and income from operations also have unfavorable differences. As
expected, the operating expenses decreased in 1998.   
(b) I have calculated the volume variance like this Volume Variance = (Actual Loan Balance x
Actual Interest Rate) - (Budgeted Loan Balance x Budgeted Interest Rate)
Volume variance for interest on loans as follows:

Year 1997 1998

Actual loan
Balance 20,103 21,861
10.48
Actual interest rate % 10.04%
Budgeted loan 21,293 21,861
balance
Budgeted interest 10.27
rate % 9.95%
18.5068
Volume variance -80 2
Rate variance 0.21% 0.08%

(c) Dividends on Shares** (806) (843) 37 (413) (833) 4

Dividends on shares has favorable difference. According to the information given we cannot
calculate volume and rate variance due to the lack of total quantity of shares

2. (a) Examine the proposed 1999 annual budget for Phenix in the appendices. Were the key
financial ratios set in September 1998 for the 1999 fiscal year readily achievable? What other
budget assumptions, if any, would you have recommended be changed? 
Financial ratios
  Budget proposed
Loss Provision/Total Assets 6.25% 6.34%
Capital/Total assets 12% 11.37%
Annual Asset growth 5% 0.36%
Deliquent loans/TL 1% 1.40%
Charge-offs/Total Loans 0.75% 1.76%
Return on average assets 0.65% 0.98%
Total loans/Total shares 85.00% 85.00%
Total shares/Total Assets 87.66% 85.50%

The first thing that is considered incorrect in a proposed budget for 1999 is the mismatch in balances
of total assets and total liability and equity (the financial ratios were computes based on the number
of Appendix C). Further, looking at the assumptions and the proposed budget there can be seen
some mismatches. The total assets are 29444, while the total liabilities and equity is 29703. The
office operating expenses that are supposed to be unchanged according to the assumptions of the
CEO is not the same as in 1998 looking at the actual proposed budget for 1999. It can be seen that
the expense increased to 495 (supposed to remain unchanged at 484). Also, regular reserves also are
not the same as were told in the assumptions of the CEO. Undivided earnings supposed to be 3043=
2755+288 as mentioned in the key assumptions “Undivided earnings=undivided earnings from
1998+1999 net income”, but it is 2582. If we take into account this change, we get almost 13% in
Capital/Total assets ratio instead of 11.37% with the numbers on the Appendix C. However, the
Total loans/Total shares and Total shares/Total Assets ratios are achieved exactly as were assumed
by the CEO. Overall, the assumptions were neglected when forming an annual budget for the 1999.
(b)It would be better for Phenix to hire a financial expert to help the CEO in the budgeting process
and ensure that the calculations are correct and based on the proposed assumptions. Also, they can
try a partially bottom-up approach that would give the CEO and the financial expert more
knowledge about the institution’s cash outflows and inflows.
3 (a) Examine the loan and deposit rates and fees. What loan and deposit rates and fees should
the Board have accepted in order to boost profitability in the next year?

Previously, Phenix had a one-rate policy for its loan products, offering one fixed and one variable
rate per product instead of using risk-based pricing. This approach was common in the credit union
industry, as some credit unions were hesitant to adopt risk-based lending, feeling that it went against
the cooperative and equal principles of credit unions. However, more recently, Phenix Federal Credit
Union began offering credit to marginal borrowers at a higher rate to account for the increased risk.
For long-term loans, Phenix charged an extra 0.5% if borrowers did not repay using payroll
deductions.
In order to increase profits next year, the Board could implement a lending and deposit rate system
that maximizes the difference between the two rates. This could involve raising lending rates while
keeping deposit rates steady or even lowering them. The Board could also think about introducing
fees on certain deposit products to boost revenue from non-interest sources.
 
(b) Consider, in turn, raising and lowering loan, deposit, and fee rates. What were the most
likely short-versus long-term consequences on volume, mix, credit quality, and profitability?
Suggestion: Consider any opportunity costs as well as effects on quality. 

Raising the interest rates on loans may lead to a short-term reduction in the amount of loans issued,
but it could have a positive impact on the quality of borrowers attracted. However, in the long run,
higher interest rates may negatively impact the total amount of loans issued and the profitability of
the lender.
Reducing the interest rates on deposits may initially result in a decrease in the amount of deposits,
but it could increase the net interest margin and profitability in the short term. Nevertheless, this
strategy may not be sustainable in the long term since customers may switch to other institutions
with better deposit rates.
Increasing commission rates could lead to an increase in non-interest income, but it may also lead to
a decrease in the amount of loans issued as customers may prefer lower commission rates offered by
other institutions.

4 Consider Phenix's costing system and the information available to the CEO and Board to
make pricing and product mix decisions. What additional internal costing information would
you like to have had? What additional external information (e.g., competitor data) would you
like to have had? 

The CEO for the preparation of the budget for 1999 collected all the latest historical data as well as
information on the budget for 1998. An analysis of Phenix's revenue and cost structure showed that
most of its operating expenses were relatively fixed. In terms of activity-based costing, supply
exceeded resource use. The move of the office in 1997 greatly affected the company's budget, as
there were expenses for the maintenance and operation of the office. In order to cut costs, they
decided to cut expenses on various conferences and trips. In addition to operating expenses, a key
area of the budget was the pricing of deposits, loans and fees. 

About internal costing information:

I think it's a detailed cost analysis (COGS) that determines the direct and indirect costs associated
with each Phenix product produced. That is, cost analysis and the information obtained from the
analysis will help us determine the profitability of each product. And also determine which products
need to be re-evaluated or even stopped producing them altogether.

An analysis of the company's overhead costs, including fixed and of course variable costs, helps
identify the factors that affect Phenix's overhead costs and determine where and when cost
reductions may be possible.

For product pricing decisions, internal and external cost information can help,because they include
different splittings of costs for each product. They can help so that the company can save money in
the future as well as about the correct pricing. The external includes all information about
competitors and their prices that would be useful. It can be useful in that the company can somehow
stand out from its competitors in the future.

5 Credit unions were cooperatives, rather than publicly traded firms. What would you
consider to have been the economic objective function of Phenix? What were the economic
constraints? 

Phenix's economic target function was that they were focused on meeting the needs of their
members rather than maximizing profits. Credit unions like Phenix are non-profit organizations,
meaning their goal is to provide financial services to their clients at a reasonable cost. As stated in
the case, one of the economic constraints of the company was the need to maintain their strong
financial position so that they could further ensure their ability to provide financial services to their
own clients in the long term. And of course, to maintain their lending activities, they would need to
have a sufficient level of capital, and for this they would need to manage credit risk. As we all know,
lending companies have their own regulatory restrictions regarding safety and reliability, which
must be observed. Probably another problem would be that they have to balance the interests of their
clients who have wide needs. Lenders also have a responsibility to ensure financial stability as well
as economic growth in the communities they serve. In conclusion, the economic goals were focused
on providing high quality financial services to its clients at a reasonable cost. But in order to do this,
they must maintain their financial strength and, as mentioned above, they must comply with the
regulatory requirement. The limitations were that they were faced with the need to manage credit
risk and maintain their capital.

6 (a) Compensation contracts were often viewed as an incentive tool used to better align the
interests of shareholders and managers. Was the PFCU employee compensation plan an
effective incentive mechanism in achieving the 1999 budget? 
The PFCU employee compensation plan aimed to better align the interests of shareholders and
managers, but it was not an effective incentive mechanism to achieve the 1999 budget. The plan was
focused solely on meeting the budget, which may have incentivized short-term thinking and a focus
on meeting targets rather than long-term profitability. In contrast, the traditional compensation
system of PFCU offered a salary and a bonus based on the credit union's financial performance in
the previous year. Therefore, the effectiveness of the PFCU employee compensation plan as an
incentive mechanism to achieve the 1999 budget is questionable, and alternative incentive systems
may need to be considered.

(b) Given Phenix's earnings outlook, future bonuses were expected to be modest at best. What
alternative incentive systems (other than bonuses) could the Board have considered for the
CEO, employees, and members? 

The Board has the option to explore different incentive systems such as profit-sharing plans based
on long-term performance, stock options, or performance-based bonuses linked to individual and
team performance metrics. These incentive systems can encourage employees to work towards long-
term profitability while aligning their interests with the company's shareholders. Here are some
potential options:

Stock options: Offering stock options could incentivize employees to work towards improving the
company's long-term performance and creating value for shareholders.

Profit-sharing plan: Implementing a profit-sharing plan based on long-term performance could

encourage employees to focus on creating sustainable growth and profitability.

Performance-based bonuses tied to individual and team performance metrics: The Board could
devise a bonus program based on meeting individual and team performance goals, rather than
relying solely on overall company performance.

Employee stock ownership plan (ESOP): An ESOP is a qualified retirement benefit plan that allows
employees to become owners of the company for which they work. An ESOP could help align the
interests of employees with those of the company and shareholders.

Non-monetary incentives: The Board could consider offering non-monetary incentives such as
additional vacation time, flexible work schedules, or other benefits that may be of value to
employees.

By offering alternative incentive systems, the Board can motivate employees to work towards the
company's long-term success and improve performance, even if future bonuses are expected to be
modest.

7 Phenix's actual loan quality was worse than the budgeted quality and might have worsened,
given the growing bankruptcy rate nationwide. What were the strengths and weaknesses of its
loan approval and monitoring systems, such as its credit standards, its multiple-stage appeals
process, and its collection practices?
The major weakness of loan approval is defining the credit score. The credit scores are defined
based on the credit bureau reports that included incorrect information. Moreover, the criteria for
credit scores that are acceptable were not defined so the lending officers were deciding based on
their judgment. Therefore, the lack of data analytics tools as computer systems is slowing down the
growth of the financial institution. The investment in computer systems would provide benefits such
as identifying risks, defining the credit scores and so on. The Phenix’s actual loan quality will
worsen with the growing bankruptcy rate.

One of the strengths of the institution is monitoring system of loan repayments and that the CEO is
constantly checking delinquent loans to define the potential problems in lending. Moreover, Phenix
contacts its borrowers and if they are late with their payments, they impose interest on late payments
which will encourage the borrowers to pay on time. They also offered other workable payment terms
as weekly payments and per paycheck terms for the borrowers. Furthermore, their counseling
services are a great way to educate their borrowers on how to make financial decisions. Regarding
the collection process is unclear how effectively the outside agent collects the payments