Question

Endless Mountain Company manufactures a single product that is popular with outdoor recreation enthusiasts. The company sells its product to retailers throughout Northern England. It is in the process of creating a master budget for 2017 and reports a balance sheet at December 31, 2016 as follows:

Endless Mountain Company Balance Sheet December 31, 2016
Assets
Current assets:
Cash	$ 46,200
Accounts receivable (net)	260,000
Raw materials inventory (4,500 yards)	11,250
Finished goods inventory (1,500 units)	32,250
Total current assets		$ 349,700
Plant and equipment:
Buildings and equipment	900,000
Accumulated depreciation	(292,000)
Plant and equipment, net		608,000
Total assets		$ 957,700
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$ 158,000
Stockholders’ equity:
Common stock	$ 419,800
Retained earnings	379,900
Total stockholders’ equity		799,700
Total liabilities and stockholders’ equity		$ 957,700

The company’s chief financial officer (CFO), in consultation with various managers across the organization has developed the following set of assumptions to help create the 2017 budget:

1. The budgeted unit sales are 12,000 units, 37,000 units, 15,000 units, and 25,000 units for quarters 1-4, respectively. The budgeted selling price for the year is $32 per unit. The budgeted unit sales for the first quarter of 2018 is 13,000 units.

2. 75% of all credit sales are collected in the quarter of the sale and 25% are collected in the subsequent quarter.

3. Each quarter’s ending finished goods inventory should equal 15% of the next quarter’s unit sales.

4. Each unit of finished goods requires 3.5 pounds of raw material that costs $3.00 per pound. Each quarter’s ending raw materials inventory should equal 10% of the next quarter’s production needs. The estimated ending raw materials inventory on December 31, 2017 is $5,000.

5. 70% of each quarter’s purchases are paid for in the quarter of purchase. The remaining 30% of each quarter’s purchases are paid in the following quarter.

6. Workers are paid £18 an hour and each unit of finished goods requires 0.25 direct labor- hours to complete.

7. The budgeted variable manufacturing overhead per direct labor-hour is $3.00. The quarterly fixed manufacturing overhead is $150,000 including $20,000 of depreciation on equipment. The number of direct labor-hours is used as the allocation base for the budgeted plantwide overhead rate. All overhead costs (excluding depreciation) are paid in the quarter incurred.

8. The budgeted variable selling and administrative expense is $1.25 per unit sold. The fixed selling and administrative expenses per quarter are $117,000 including depreciation expense ($8,000). All selling and administrative expenses (excluding depreciation) are paid in the quarter incurred.

9. The company plans to maintain a minimum cash balance at the end of each quarter of

$30,000. Assume that any borrowings take place on the first day of the quarter and repay principal and interest on any borrowings on the last day of the fourth quarter. The bank imposes a simple interest rate of 3% per quarter.

10. Dividends of $15,000 will be declared and paid in each quarter.

The company’s CFO has asked you to prepare the 2017 budgeted Income Statement and Balance Sheet as of December 31, 2017 (the intermediate steps for which include preparing a full master budget).

However, when you reached the end of 2017 the actual sales figures turned out to be different:

Quarter I – 10,000 units Quarter II – 35,000 units Quarter III – 12,000 units Quarter IV – 30,000 units

And the actual Income Statement showed the following values:

Income statement	2017
Sales	$2,784,000
CoGS	2,241,213
Gross Margin	542,787
S&A expenses	576,750
Operating Income	-33,963
Interest expense	16,632
Income	-50,595

Compare the budgeted Income Statement with the actual one. Prepare the Flexible Budget for 2017 and find out why you have such Income variance. Recommend a way to improve the financial situation.

Explain the advantages and disadvantages of budgetary control (i.e. cash budget, fixed budget, and flexible budget).

Answer 1

Finished Goods Production Budget
	Particluars	Q1	Q2	Q3	Q4
	Budgeted Sales	12,000	37,000	15,000	25,000
Add:	Closing Stock Level (15% of next Quarter Sales)	5,550	2,250	3,750	1,950
Less :	Opening Stock	1,500	5,550	2,250	3,750
	Units to be produced	16,050	33,700	16,500	23,200

Raw Material Procurement Budget
	Particluars	Q1	Q2	Q3	Q4
	Units to be produced	16,050	33,700	16,500	23,200
	Material Requirement ( 3.5 Yards per Unit)	56,175	117,950	57,750	81,200
Add:	Closing Stock Level (10% of next quarter production needs)	11,795	5,775	8,120	5,000
Less :	Opening Stock	4,500	11,795	5,775	8,120
	Material to be Purchased	63,470	111,930	60,095	78,080

Labour Hours and Variable Manufacturing OH Budget
Particluars	Q1	Q2	Q3	Q4
Units to be produced	16,050	33,700	16,500	23,200
Labour Hours Required ( 0.25 hours per unit)	4,013	8,425	4,125	5,800
Labour Cost @$18 per hour	$                                        72,225	$            151,650	$          74,250	$ 104,400
Variable Manufacturing OH ( @ $3 per hour)	$                                        12,038	$              25,275	$          12,375	$    17,400

Particulars	Q1	Q2	Q3	Q4
Sales ( Units)	12,000	37,000	15,000	25,000
Budgeted Selling Price	$            32	$                32	$              32	$              32
Budgeted Sales	$ 384,000	$ 1,184,000	$   480,000	$   800,000
Cash Collection
Current Quarter	$ 288,000	$        96,000	$   296,000	$   120,000
Previous Quarter	$ 260,000	$        96,000	$   296,000	$   120,000
Cash Collection	$ 548,000	$     192,000	$   592,000	$   240,000
Material to be Purchased ( In Yards)	63,470	111,930	60,095	78,080
Cost per Yard	$               3	$                  3	$                3	$                3
Purchases	$ 190,410	$     335,790	$   180,285	$   234,240
Paid in current quarter (70%)	$ 133,287	$     235,053	$   126,200	$   163,968
Paid in next Quarter (30%)	$ 158,000	$        57,123	$   100,737	$      54,086
	$ 291,287	$     292,176	$   226,937	$   218,054

	Cash Budget
	Particulars	Q1	Q2	Q3	Q4
	Opening Cash	$    46,200	$        30,000	$      30,000	$      30,000
Add :	Cash Collection ( Debtors)	$ 548,000	$     192,000	$   592,000	$   240,000
	Borrowings	$    80,350	$     579,761	$      14,115	$   405,330
	Total Cash Reciepts	$ 674,550	$     801,761	$   636,115	$   675,330
Less :	Paid for Material Procurement	$ 291,287	$     292,176	$   226,937	$   218,054
	Labour Cost	$    72,225	$     151,650	$      74,250	$   104,400
	Variable Manufacturing OH	$    12,038	$        25,275	$      12,375	$      17,400
	Variable Selling and Administrative Expenses	$    15,000	$        46,250	$      18,750	$      31,250
	Fixed Manufacturing OH	$ 130,000	$     130,000	$   130,000	$   130,000
	Fixed Selling OH	$    25,000	$        25,000	$      25,000	$      25,000
	Fixed Insurance Expenses	$    12,000	$        12,000	$      12,000	$      12,000
	Property Tax	$      8,000	$          8,000	$        8,000	$        8,000
	Executive Salaries	$    64,000	$        64,000	$      64,000	$      64,000
	Dividends Paid	$    15,000	$        15,000	$      15,000	$      15,000
	Interest Expense	$             -	$          2,410	$      19,803	$      20,227
	Principal Repayment
		$ 644,550	$     771,761	$   606,115	$   645,330
	Closing Balance	$    30,000	$        30,000	$      30,000	$      30,000