Master Budget Case
Teddy Ltd. is a company that manufactures and sells a single product, which they call a Toodle. For planning and control purposes they utilize a monthly master budget, which is usually developed at least six months in advance of the budget year. Their fiscal year end is December 31.
During the summer of 2017, Chris Leigh, the Teddy controller, spent considerable time with Pat Frazer, the Manager of Marketing, putting together a sales forecast for the next budget year (January to December, 2018). Unfortunately, their collaboration worked so well they eloped to Las Vegas, were married by an Elvis impersonator, and settled down somewhere in the desert. Prior to their departure they e-mailed letters of resignation and a cryptic sales forecast to the President of Teddy.
Their sales forecast consisted of these few lines:
For the year ended December 31, 2017: 95,000 units at $50.00 each*
For the year ended December 31, 2018: 105,000 units at $50.00 each
For the year ended December 31, 2019: 110,000 units at $50.00 each
*Expected sales for the year ended December 31, 2017 are based on actual sales to date and budgeted sales for the duration of the year.
Teddy’s President felt certain that the marriage wouldn’t last, and expected Chris would be back any day. But the end of the year is quickly approaching, and there is still no word from the desert. The President, desperately needing the budget completed, has approached you, a management accounting student, for help in preparing the budget for the coming fiscal year. Your conversations with the president and your investigations of the company’s records have revealed the following information:
1. Salesareseasonalwiththepeakmonthsbeingsummerandwinterholidays. The following table shows expected distribution of sales for each month based on percentage of the total budgeted sales.
Months Jan, Feb, Mar Apr, Aug, Sept May, Jun, Jul Oct
Percentage of sales 3% each
10% each 11%
Frompreviousexperience,managementhasdeterminedthatanending inventory equal to 20% of the next month’s sales is required to fit the buyer’s demands.
Becausesalesareseasonal,Teddymustrentanadditionalstoragefacility from October to December to house the additional inventory on hand. The only related cost is a flat $10,000 per month, payable at the beginning of the month.
Space-age acrylic (SAA) is a very compact material that is purchased in powder form. Each toodle requires 0.5 kilograms of SAA, at a cost of $25.00 per kilogram. The supplier of SAA tends to be somewhat erratic so Teddy finds it necessary to maintain an inventory balance equal to 40% of the following month’s production needs as a precaution against stock- outs.
A plastic wheel assembly is purchased in kit form, and is attached during the assembly process. For a small premium, Teddy has made a JIT agreement with the supplier which includes on-time and quality assurances. Each toodle uses two kits, which cost $1.00 each.
The final component for the toy is a length of hemp rope which is used to pull the toy along the ground or floor. The rope is supplied by a student entrepreneur, who must be paid in cash. On the first day of every month she delivers exactly the right amount to manufacture the budgeted number of units for that month. It costs $2.00 per meter and Teddy uses one-half meter for each toodlle.
Thebeginningaccountspayable(associatedwithSAApurchasesonly)will consist of $95,700 arising from the following estimated material purchases for November and December of 2017:
Material purchases in November 2017:$ Material purchases in December 2017:$
Teddy pays for 50% of a month’s purchases in the month of purchase, 35% in the following month and the remaining 15% two months after the month of purchase. There is no early payment discount.
Themanufacturingprocessfortoodlesisdividedintothreeseparate activities. The first step is the forming process, during which the SAA is liquefied and formed into several shapes that snap together to make the toy. During the next stage, the molded pieces are fused together using heat. This step is referred to as the assembly stage. The last stage is for finishing, during which the wheel and the pull rope are attached and the toy is prepared for shipping.
Thefirsttwostepsofthemanufacturingprocessarehighlyautomated,sothe only employees are three supervisors, who are trained to operate the equipment and make repairs as required. The supervisors work shifts, allowing the plant to operate for longer hours during the busier months. They are also responsible for managing the employees who work in the finishing department.
Thelaststep,finishing,istheonlypartofthemanufacturingprocessthat employs direct labour. Most of the staff work on a part-time basis, so their hours can be set based on production requirements. This also eliminates the need for overtime.
These employees are paid based on the number of units produced. They receive an average of $18.00 per hour including employee benefits.
Each toodle spends 18 minutes in the finishing department.
Becauseofthelargedifferenceinthemanufacturingstages,Teddyusestwo separate variable manufacturing overhead rates. The forming and assembly departments use similar equipment and with the company’s concentration on a single product, the manufacturing overhead is allocated based on volume (i.e. the units produced). The combined unit variable overhead manufacturing rate for forming and assembly is $6.50, consisting of: Utilities–$3.00; Indirect Materials–$1.00; Plant maintenance–$1.50; environmental fee–$0.70; and Other–$0.30.
The best cost driver for the finishing department is considered to be direct labour hours. Here the predetermined variable manufacturing overhead is expected to be $4.00 per hour.
10.Fixed manufacturing overhead costs are not separated between departments. The total costs for the entire year are as follows:
Training and development Supervisor’s salary Depreciation on equipment Insurance
43,620 269,400 178,800
96,000 117,600 $ 705,420
The annual insurance premium is paid at the beginning of September each year. There should be no change in the premium from last year.
All other “cash-related” fixed manufacturing overhead costs are incurred evenly over the year and paid as incurred.
Teddy uses the straight line method of depreciation.
11.Selling and administrative expenses are known to be a mixed cost; however, there is a lot of uncertainty about the portion that is fixed. Previous year’s experience has provided the following information (rounded):
Lowest level of sales: 70,000 units Total Operating Expenses: $769,800 Highest level of sales:110,000 units Total Operating Expenses: $1,009,800
The annual amount of depreciation on office furniture and equipment is only $21,000—and this amount is already included in the fixed portion of the selling and administration expenses. Not included in the above expenses is bad debt expense.
Payments for selling and administrative expenses occur in the month in which they are incurred.
12.Sales are on a cash and credit basis, with 70% collected during the month of the sale, 20% the following month, and 9.5% the month thereafter. 1⁄2 of 1% of sales are considered uncollectible (bad debt expense).
13.Sales in November and December 2017 are expected to be $712,500 and $950,000 respectively. Based on the above collection pattern this will result in Accounts Receivable of $347,938 at December 31, 2017 which will be collected in January and February, 2018.
14.During the fiscal year ended December 31, 2018, Teddy will be required to make monthly income tax installment payments of $5,000. Outstanding income taxes from the year ended December 31, 2017 must be paid in April 2018. Income tax expense is estimated to be 30% of net income. Income taxes for the year ended December 31, 2018, in excess of installment payments, will be paid in April, 2019.
15.Teddy is planning to acquire additional manufacturing equipment for $306,000 cash. They have a special agreement to pay the supplier in three equal installments starting in February, 2018. The manufacturing overhead costs shown above already include the depreciation on this equipment.
16.An arrangement has been made with the local bank that if Teddy maintains a minimum balance of $20,000 in their bank account, they will be given a line of credit at a preferred rate of 6% per annum. All borrowing is considered to happen on the first day of the month, repayments are on the last day of the month. All borrowings and repayments from the bank should be in multiples of $1,000 and interest must be paid at the end of each month. Interest is calculated on the balance at the beginning of the month, which includes any amounts borrowed that month.
15.Teddy Ltd. has a policy of paying dividends at the end of each quarter. The president tells you that the board of directors is planning on continuing their policy of declaring dividends of $50,000 per quarter.
16.A listing of the estimated balances in the company’s ledger accounts as of December 31, 2017 is given below:
Accounts receivable Inventory-raw materials (SAA) Inventory-finished goods Prepaid Insurance
Capital assets (net)
64,000 724,000 $1,257,418
Liabilities and Shareholders’ Equity
Income taxes payable
Total liabilities and shareholders’ equity
$ 96,210 22,500 1,000,000
PrepareamonthlymasterbudgetforTeddyfortheyearendedDecember31, 2018, including the following schedules:
Sales Budget & Schedule of Cash Receipts (cash collections) Production Budget
Direct Materials Budget & Schedule of Cash Disbursements Direct Labour Budget
Manufacturing Overhead Budget
Ending Finished Goods Inventory Budget Selling and Administrative Expense Budget Cash Budget
Prepareabudgetedincomestatementandabudgetedstatementofchanges in equity for the year ended December 31, 2018, using absorption costing.
Prepareabudgetedstatementoffinancialposition(balancesheet)at December 31, 2018.