1. Prepare a COGS budget for January, February, and March

2. Prepare a projected income statement for January, February, and March

3. Prepare a cash budget for the quarter

4. Prepare a projected balance sheet as of April 1

5. How would the net profit change if Adelaide were to prepare the income statement under variable costing?

BLACKHEATH MANUFACTURING COMPANY-REVISITED Part 1 Mr. Blackheath had promoted Lee High to vice president of finance. Lee had practically been running the firm for several years, during which time sales and profit had been declining. On November 15, Mr. Blackheath announced that his son, Trafalgar Blackheath, would take over as owner and president on January 1. Trafalgar was a graduate of an MBA program, and for several years had been working for a large consulting firm as a marketing specialist. In their private discussions, Mr. Blackheath told his son that the problems in the family firm were marketing rather than financial, so the situation was ready-made for Trafalgar. Mr. Blackheath, it seems, had been completely taken by Lee High. When Trafalgar arrived on December 1 and began to read various internal reports, he realized Blackheath Manufacturing did not have a cash budget, and there didn't seem to be much in the way of financial planning. Trafalgar asked Lee about this. Lee's response was that Blackheath Manufacturing ran on the basis of several well-developed decision rules, and budgets weren't necessary because if the firm ever ran out of funds, Mr. Blackheath simply deposited $10,000 or $20,000 in the bank. Trafalgar's response was clear: "My father is a millionaire, but I am not!' Lee indicated he didn't know much about budgeting, but he would get an assistant to work up some "stuff." Trafalgar decided to call his old friend Crofton Brockley. Brockley was in charge of several large budgeting projects for a consulting firm, and Trafalgar knew Crofton to be a recognized expert on budgeting for small companies. Fortunately for Trafalgar, Brockley wasn't busy that week and was able to fly down the next day. Crofton spent two days going over the accounting records, interoffice memos, and everything else he could find. On Friday morning, Trafalgar found the following note on his desk: Dear Trafalgar: Had to leave last night for Pittsburgh. During the two days I spent in the 1 office, I discovered 1. You have no budget or control system at all 2. Lee High's decision rules are all wrong, 3. High doesn't know the first thing about finance, budgeting, or manufacturing Will be back on Monday morning to talk to you. By the way, if you can find Adelaide Ladywell. I would like to speak to her. Your friend, Crofton Trafalgar was perplexed by the note but decided he had better find out who this Ladywell was. Lee told Trafalgar that Adelaide was a file clerk who had been fired a couple of years ago because she refused to follow company policy. Trafalgar asked Lee if he could find Adelaide. Lee said that he heard she was working for some firm in town and would find out where Eventually, Trafalgar found Adelaide working as a bookkeeper for Maze Woolwich. During a phone conversation Adelaide explained about her being fired by Mr. Blackheath. She went on to explain that after she got fired, she went to see Mr. Woolwich. Apparently, Woolwich realized that Adelaide was right, and that Lee High and Mr. Blackheath were wrong. Adelaide went on to say that Mr. Woolwich felt bad about her getting fired. Woolwich had intended to retire but decided to hire Ms. Ladywell as a bookkeeper. Adelaide had been working for Woolwich ever since. Shortly after Trafalgar finished talking to Adelaide, Crofton entered the office. With his usual efficiency, he made the following points: "We had better get a budgeting system immediately and try to see where we are. (Any complex cost accounting would have to wait.)" "Lee has got to go." "We must decide on how to get a budgeting system put together quickly because Blackheath's might be broken." Crofton concluded by asking. "Did you find Adelaide Ladywell? She is the only person around here in the last three years who did anything right, and she got fired." Trafalgar indicated that Ms. Ladywell was going to stop by after work and talk to them. Crofton then suggested Trafalgar fire Lee High and try to rehire Adelaide as the bookkeeper/analyst . That afternoon, Lee was fired, given two months pay, and asked to leave the office by 3:00 p.m.. The same evening, Adelaide agreed to work for Trafalgar on the condition she would not have to deal with either the older Mr. Blackheath or Lee High. Trafalgar explained that Lee was already gone, and his father had left for Florida several days previously Adelaide agreed to be at work the following Monday morning. She indicated that Mr. Woolwich was all but out of business and no longer needed her services. Part 2 After Lee High had left the office, Crofton Brockley went through all the available records and files and, as a result, was able to establish the following information as a basis to begin the budgeting process. Items about which Lee High seemed to be correct Variable Direct Costs Direct materials cost per unit Direct labor cost per unit Total $2.00 $0.75 1.25 Variable Overhead Indirect labor cost per unit Electricity cost per unit Other overhead per unit produced Total 5.80 $ 0.20 0.10 0.50 Fixed Costs Indirect labor per week $100 Indirect materials per week 300 Electricity per week 75 Factory insurance per week 125 Other overhead per week 110 Total $710 The office expenses are very close to $781 per week. Of this amount, the breakdown seemed to be Salaries (including fringe benefits and payroll tax) $400 Rent on office 200 Depreciation on office equipment 81 Utilities 100 Total $781 Direct labor was paid on a piece-rate (or "piecework") basis. Workers were paid $1.25 per unit produced Average rate of accounts receivable collection was as follows: During the month in which sale is made 30% 1 month after sale 40% 2 month after sale 20% 39 month after sale 100% 10% Several other notations made by Crofton Brockley (a) Trafalgar expected to draw $1,400 per month for personal use. (b) Consulting fees will be billed at about $225 per week or 5900 per month. (c) A reasonable estimation of the value of factory and equipment is $70,000. Depreciation should be monthly on the basis of an average useful life of five years. This equipment will have a salvage value of $2,500. (d) The production process to produce the Great Heath is fairly simple. Raw materials consist of a single item, which is usually entered into the process in the morning. Various machining operations take place during the day. At the end of each day, all the finished units are moved into the storeroom. Because started units are always finished before the workers go home, there is never a work-in-process inventory overnight. (e) Assume that this coming year's net income will be relatively low and therefore, compute income tax on the basis of 25% of net income. Taxes will be paid quarterly at the end of the last day of the quarter. (f) The inventory of raw materials at the beginning of the coming year will be 800 units, and there will be 750 units of finished product. General guidelines set by Crofton Brockley These guidelines should be followed through the year, at which time they are to be reviewed and revised (a) The estimates of variable costs of production are almost certainly correct. (b) Fixed costs of production are almost certainly correct at $710 per week, except that there is no estimation or allowance for depreciation. Take fixed cost of production to equal $710 plus depreciation (c) Charge fixed factory overhead on a monthly basis. Since the $710 per week amount seems reasonable, charge a monthly amount of $710 times 4.5. The over- or underapplied overhead existing at the end of a month will be charged as part of that month's cost of goods sold (d) Establish cost accounting records on the basis of full cost, assuming that normal output is 500 units per week, or 2,250 units per month. Thus, budgeted full cost is $4.72 per unit. (e) Selling commission should be 10% on all sales, and the price on regular sales should be set at $7.00 per unit for at least the first quarter of the year. (1) All depreciation should be on a straight-line basis. Following is an estimation of the balance sheet as it will appear on January 1, when Trafalgar Blackheath takes complete control of the business Cash $10,000 Accounts payable S 1,275 Receivables 14,700 Notes payable 30,000 Raw material inventory 600 Capital: Trafalgar Blackheath 85,687 Finished goods inventory ($4.72/unit) 3.540 $116,262 Office equipment 13,122 Factory equipment 70,000 Land 5,000 $116.962 Required 1. Production Budget Adelaide's first important step in budgeting was to develop a production budget and a raw materials schedule for the first quarter of the coming year. Actual sales for the prior October and November were available, and reasonable estimates of sales for December and the first four months of the coming year were made Actual sales (units) Expected sales (units) October 1,500 December 1,800 November 2,300 January (of the coming year) 2,000 February (of the coming year) 2,200 March (of the coming year) 1,900 April (of the coming year) 2,100 Since there was no established policy on production scheduling, inventory planning, or raw materials inventory, it was necessary to establish one. Crofton, Trafalgar, and Adelaide agreed that a policy based on experience would have to wait until some data were collected over the next six to eight months. In an effort to "get things going," they settled on a two-part operational statement of policy: (a) Production in any month should be scheduled so that an ending inventory of Great Heaths will equal one-half of the next month's expected sales. (b) Purchase of raw material should be made so that on average there is enough raw material on hand to produce 700 Great Heaths. Thus, no end-of-month inventory should have fewer than 700 units of raw material. Prepare a production schedule, schedule of raw material use, and a schedule of raw material purchases for January, February, and March. 2. Cost of Production and Flexible Budget Adelaide's next task was to prepare a flexible budget that could later be used to prepare a budgeted income statement and would also help Trafalgar tell whether actual expenditures were as they should be. She decided to use the format shown in the variable budget table below. On the left she would write in the cost formula, which would show how much should be spent on each item for any given production volume. Then she would fill in the amounts for the volume of production she had projected for the first three months of the coming year. Projected number of units produced January February March Cost Formula Cost Item Materials used Direct labor Indirect labor Electricity Indirect materials Factory insurance Other overhead Depreciation Total cost Cost per unit 3. Income Statements Having developed the data in assignments 1 and 2. Adelaide decided to project income statements for January, February, and March 4. Cash Budgets After developing the income statements, Adelaide decided to see what would happen to the cash position of Blackheath during the quarter. When Mr. Blackheath actually turns the business over to Trafalgar, Mr. Blackheath will withdraw all cash. All receivables will be due to Trafalgar, and all payables will be his responsibility. Trafalgar expects to pay $30,000 for the business, which will be a liability of the business, and he intends to deposit $10,000 in the firm's checking account to establish a working balance. Raw materials are always purchased on a 30-day-due basis. Consequently, payments are always made in the month following the purchase of materials. It is expected that 1.700 units of materials will be purchased during the December prior to the coming year. Direct labor, all overhead, commissions, salaries, rent, and utilities are paid in the month incurred. . 5. Balance Sheet As a final step in the general budget process Adelaide decided to project a balance sheet as of the coming year's April 1. 6. Evaluation of the Budget Armed with the material developed in Items 1 through 5. Adelaide, Crofton, and Trafalgar had a meeting to discuss problems that were likely to arise. What points would be likely to dominate such a meeting? Why? 7. January Activity In early February, the following information was available on January's activity. Prepare an analysis of the results: Sales: 2,250 units @ $7.00 per unit Actual production: 2,250 units Expenses actually paid: Direct materials bought $1,660.00 Direct labor 2,812.50 Indirect labor 895.00 Electricity 325.00 Indirect materials 1.570.00 Factory insurance 562.50 Other overhead 1,600,00 Office expense 2,260.00 Commissions 1,400.00 Ending raw materials were 600 units Neither Crofton nor Trafalgar had been paid anything yet. 8. Variable Costing At a meeting in early February, Crofton suggested that Adelaide rework the data under an assumption of variable costing. He argued that seeing the data assuming variable costing would be useful. Furthermore, he suggested that after the variable costing data were developed for actual and projected sales at $7.00 per unit, it would be interesting to see what would happen to profit, cash, and retained earnings if 500 additional units could be sold at an average of $6.00 per unit each month. These additional units, he stressed, would be special offers and should not in any way affect regular sales or selling price. Furthermore, no credit would be given on such sales