Air Boats, Inc. produces small inflatable boats. Management is concerned about the upcoming years financial performance. Last year there were two very expensive situations that management wants to avoid this year:

(1) Inventory dropped too low. As a result, Airboats lost customers and had to find a short-term supplier to meet inventory needs

(2) It ran out of cash in August. To prevent defaulting on payments to employees and vendors, Airboats needed to take out a short term loan.

The company is convinced that preparing a well thought-out budget is essential to avoiding last years near disasters. Its fiscal year ends on December 31. It is beginning its budgeting process in August for the following fiscal year. The company makes sales and production budgets as well as budgeted income statements and balance sheets. It uses a cash flow budget to determine whether it needs to borrow or temporarily invest funds. It is currently finishing up its budgets for the 2014 fiscal year.

Information about this process and the information it collected follows.

Sales Forecast

The budgeting process began by asking the sales manager to forecast sales for the upcoming fiscal year. The sales manager provided the following information for FY 2014.

Planned 2014 selling price: $150 per boat

Sales forecast (in units) Q1?100,000 Q2?110,000 Q3?125,000 Q4?90,000

Information from the Production Manager

Air Boats is a manufacturer, so it not only needs to be sure that it has boats on hand when customers want to purchase them, but also needs to be sure that it has the necessary inputs on hand to manufacture the boats when needed. It uses the production budgets (production, direct materials, direct labor, overhead) to plan these resources. The production manager provided the following information.

Inventory Policy

Ending finished goods inventory is maintained at a level equal to 25% of the next quarters sales.

Ending raw materials inventory is maintained at a level equal to 15% of the next quarters materials needed for production.

Inventory Levels at the End of the Forecasting Period

The ending finished goods inventory on December 31 of the new fiscal year should be 13,000 units.

The ending raw materials inventory on December 31 of the new fiscal year should be 30,000 pounds.

Input Requirements for Finished Units

Forecasted direct materials usage: 4 pounds per boat

Forecasted direct labor usage: 0.5 direct labor hours per boat

Information from the Purchasing Manager

Forecasted 2014 direct materials cost $5 per pound

Information from the Human Resources Manager

Forecasted 2014 labor cost $15 per hour

Information from the Production Accounting Team

The company starts with prior year information to estimate manufacturing overhead costs. The production accounting team has examined that information, updated it for known changes, and provided the following information for FY 2014.

Variable manufacturing overhead

Indirect materials $2.10 per boat

Indirect labor $1.10 per boat

Other $1.70 per boat

Fixed manufacturing overhead per quarter

Salaries $250,000

Other $300,000

Depreciation $613,250

Fixed manufacturing overhead is allocated using a predetermined overhead rate. The rate is determined for each fiscal year based on the estimated annual direct labor hours for that year.

Information from Corporate Management

The corporate accounting team provided the following FY 2014 information after consulting with corporate management.

Selling and Administrative Expenses

Selling and administrative expenses are primarily fixed and are made up of the following quarterly costs

Salaries $3,000,000

Rent $1,000,000

Advertising $900,000

Depreciation $1,200,000

Other $1,600,000

Capital Expenditures

Management is evaluating two large expenditures at the end of FY 2014. Both these expenditures would take place at the end of the fourth quarter and will not affect depreciation during FY 2014. Management wants to know whether it will have enough cash to pay for these projects or whether it will need to find financing (borrowing or selling stock). These projects are:

Install new selling and administrative equipment at a total cost of $5,000,000.

Automate production by installing new equipment at a cost of $20,000,000.

Cash Receipt and Expenditure Policies and Information

Sales are 80% credit. Accounting records indicate that 60% of credit sales are collected in the same quarter as the sale. 35% are collected in the quarter following the sale. The rest are uncollectible.

The ending accounts receivable balance on December 31, 2013 is estimated to be $1,400,000. 85% is expected to be collected in January 2014 and the rest is expected to be collected in February 2014.

All direct materials are purchased on credit. The company expects to pay 75% of purchases in the quarter of the purchase and the rest in the following quarter.

The ending accounts payable balance on December 31, 2013 is estimated to be $400,000. It will all be paid in the first quarter of FY 2014.

The ending cash balance on December 31, 2013, is estimated to be $75,000.

Other Information

No dividends are planned for FY 2014. Ending balances on the December 31, 2013, balance sheet are expected to be:

Property, Plant, and equipment (net) $14,238,632

Common Stock $13,500,000

Retained Earnings $2,641,400

QUESTIONS:

1.Prepare the quarterly production budgets and supporting budgets. Include all the following budgets

Production budget showing units to be produced

Direct materials budget showing direct materials used and purchased and the cost of purchasing those direct materials.

Direct labor budget showing direct labor used the cost of purchasing that direct labor.

How does this budget differ from the direct materials budget?

Why does this difference exist?

A calculation of the budgeted absorption unit cost of a boat.

Will this differ from quarter to quarter? Why or why not?

2. Prepare the quarterly budgeted income statements in contribution margin format.

Normally the firm would prepare a gross margin income statement so that it is simple to see how the actual results compare to the plan (budget). However, its easier to understand the report describing the differences (variances) when the income statement is prepared using contribution margin format, so we will focus on that.