Question 1: Budgeting
Your friend Peter is planning to set up a new business which will manufacture and sell wooden tables. The parts that make up the table consist of a wooden table top measuring 1m by 0.5m, four legs and 3m of trim. The wooden table top supplied by the vendor measures 1m by 1m and has to be cut into two halves before assembly. The legs are also supplied by the same vendor. The trim is supplied by another supplier and comes in rolls of 30m.
Peter knows you are a management accountant and has asked you to help him prepare a budget for his new business so that he knows whether he can make any profit in the first six months. The following is Peter’s plan and estimates:
The new business will begin operations on 1 Jan 2013.
Peter will put in $65,000 of his personal funds into the business and he has obtained a loan of $50,000 from a bank to be available on 1 Jan 2013. The loan interest is 5% per annum on the loan outstanding and interest is to be paid on the last day of each month. A principal payment of $1,000 will also be made at the end of each month.
Plant and machinery will be purchased on 1 Jan at a cost of $36,000, to be paid in three equal monthly installments interest free. The plant and machinery is to be depreciated on a straight line basis over 5 years. Office equipment will be purchased on 1 Jan at a cost of $30,000 to be paid in full in Feb. The office equipment will be depreciated on a straight line basis over 3 years.
Sales will start in Feb and Peter estimates that sales volume will be 400 units in Feb, increasing by 100 units every month until it reaches the production capacity of 1,000 units per month. Selling price is set at $145 per unit. 75% of the sales is expected to be on credit and the rest for cash. For the credit sales, Peter predicts that 60% will pay in the month following the sale, 30% in the second month following the sale and 10% in the third month of the sale.
Unit costs for the parts are:
Table top (1m by 1m) $50
Leg (each) $4
Trim (30m roll) $100
Labour costs are:
Direct labour 1.5 hours per table
Direct labour rate $30 per hour
Peter wishes to have an ending finished goods inventory equal to 20% of the sales requirements of the following month. The ending inventory for table top and legs should equal 30% of the production requirement of the next month. As for trims, it should be 10% of the production requirement of the next month rounded down to the nearest roll. There are no WIP inventories. Terms on purchases are 40% cash on delivery (COD) and 60% payable in the next month. A 2% discount is available for COD payments. Discounts received are reported as “Other Income” in the income statement. The company follows the terms of payment to take advantage of the COD discount. Direct labour cost is paid one month in arrears.
Variable manufacturing overhead is estimated to be $2 per table. Fixed manufacturing overhead (excluding depreciation) is expected to be $6,000 per month. Variable selling & administration expenses are expected to be 5% of sales. Fixed selling & administration expenses (excluding depreciation) are budgeted to be $3,000 per month.
All manufacturing overhead and selling & administration expenses are paid in the month incurred.
The company uses absorption costing to determine its product cost.
Required:
Based on the information given, and ignoring GST and taxation, prepare the following from Jan to June 2013 for Peter’s company:
a) A monthly sales budget
b) A monthly production budget
c) A monthly purchase budget
d) A monthly cash receipts budget
e) A monthly cash disbursement budget for material purchase
f) A monthly cash disbursement budget for other items including the payment of long term loan principal and interest
g) A cash flow budget
h) A budgeted income statement for the six months from 1 Jan to 30 June 2013
i) A budgeted balance sheet as of 30 June 2013
j) A budgeted movement of owner’s equity for the six months
Question 2: Performance measurement:
Brabham Enterprises manufactures tires for the Formula One motor racing circuit. For August 2011, Brabham budgeted to manufacture and sell 3,000 tires at a variable cost of $74 per tire and a total fixed cost of $54,000. The budgeted selling price was $110 per tire. Actual results in August 2011 were 2,800 tires manufactured and sold at a selling price of $112 per tire. The actual total variable costs were $229,600 and the actual fixed costs were $50,000.
Required:
a) Prepare a performance report that uses a flexible budget and static budget showing the different variances between the actual and the static budget and the flexible budget
b) Discuss the difference between a static budget and a flexible budget and comment on the results based on the performance report you have prepared for Brabham.