Answer the following question based on the case facts below: (NOT MISSING ANYTHING)

1) What are major issues/problems?

2) What are the decision-makers goals and objectives?

3) Are there other stakeholder needs or preferences?

4) Are there any internal or external constraints to consider?

5) What ethical issues do you see in Morales' suggestion in Part 3 of the case?

6) If you wereHammerman, what business argument would you use to convince the executive team not to move forward with Morales' suggestion?

Denim Products Incorporated: Creating and Using a Master Budget

BACKGROUND are popular lines, and the increased selling price makes them as profitable as the BBJ. Eileen Hammerman looked around her new office and All three products are made in the United States, with sighed. This should have been an exciting day for her. After most of its production workforce coming from special-needs all, becoming a CFO (Chief Financial Officer) had been demographics such as high school dropouts looking for a her dream since she started taking accounting classes her second chance, those trying to overcome addictions, felons sophomore year of college. She had fallen in love with the looking for a way to start over after prison, and so forth. debits and credits in financial accounting, then again with DPI was also careful to buy denim and other materials from the spreadsheets and equations in managerial accounting. quality suppliers that also cared about social responsibility. She tried hard to fall in love with auditing and tax, too, but While it did not make a fortune on any one sale, its she just could not. So, while she had spent her first five reputation gave it a nice market share and very consistent years working for a large public accounting firm, she had sales in metropolitan areas along the west coast of the United never lost sight of her long-term goal to become a CFO States. DPI has always advertised its products as being and focus on the parts of accounting that she loved, like "100% American Made" because it had a nicer ring to it than financial reporting, budgeting, and using the numbers to the more technically accurate "Made in the USA." The make decisions. She had even become a CMA" (Certified management team also thought it made DPI stand out in the Management Accountant) before leaving the large public advertising campaigns. accounting firm. Much of its success was due to Aleksandra Slogel, the Now, though, Hammerman was not so sure about this former CFO. Slogel had helped secure DPI's line of credit to promotion. She had spent the last 10 years working for accommodate growth in production, arranged the mortgage Denim Products Incorporated (DPD). DPI was a relatively and other financing, and had cleaned up the books in order small manufacturer of jeans. Not a big player in the market, for DPI to go public two years ago. She had been a tireless but it enjoyed a comfortable niche because of its reputation worker behind the scenes, doing everything she could to as a socially responsible company. The company produces help the company succeed and leaving the limelight to three main products: basic blue jeans (BBJ), embroidered Jaxson Runkel, the CEO. Or so everyone had thought. blue jeans (EBJ; these jeans have decorative embroidery Two months ago, rumors started flying around the on the back pockets and down the legs), and jeweled blue company that the auditors had found some irregularities in jeans (JBJ; these jeans have some decorative embroidery but certain financial accounts. Hammerman had stayed out of the include rhinestones or other "bling" riveted into the pockets rumor mill. Not because she wanted to she usually loved and down one leg). The EBJ and JBJ lines require additional the conversations around the water cooler-but because she employee or machine time to add the decorations, but they had been part of the investigation. In fact, as the controller,Hammerman had been the one to suggest that the auditor dig no-organization of Hammerman's office. A moment later, they a little deeper into the accounts. Something just had not felt were sitting comfortably in large, leather chairs looking out right to her, and she felt it was her duty to report it. Since she through the floor-to-ceiling windows in Runkel's office. The could not talk to Slogel (whom she suspected) or Runkel (a budgets for the past few years were sitting on the mahogany good CEO but who might also have been part of the problem), table between them. she had tipped off the auditors and worked with them and "Now, Eileen, let me just say again how grateful we are DPT's audit committee throughout the investigation. for your help over the past few months. We would never Now the books were clean, Slogel was in police custody have caught this fraud without you; you were invaluable awaiting trial, and Hammerman had been promoted. Both in making sure the financial statements were properly Runkel and the Board had been 100%% behind promoting reported and done on time. I wish I could let you rest on Hammerman to the newly vacated CFO position. After all, your laurels for a few days and settle into your job, but we how better to send the signal that this behavior was not have a problem. Because of the mess we have been in, we appropriate than to put the woman who found the fraud into completely missed our normal budgeting process. Now, the top financial spot at the company? Everyone was happy. that may not seem like a big deal right now with everything Well, almost everyone. Hammerman looked again at her else that needs to be straightened out, but our banker is new office, the piles of paperwork, the computer missing a really pushing for those numbers. She is even threatened to hard drive, and filing cabinets still open with folders askew. take away our line of credit, or adjust the risk rating of our How was she supposed to get her office cleaned up, let alone mortgage, mising the interest rate, if we cannot show her a the finances budget that will allow us to use and repay that line." "We have always been very successful," Hammerman PART 1: CREATING A MASTER BUDGET said, frowning. "What is the bank worried about?" "The underwriters are worried that our success was all MEETING WITH JAXSON RUNKEL, CEO a fraud. We have to convince them we are still a legitimate Runkel stepped into the CFO's office just minutes after business. That is one of the reasons we promoted you. The Hammerman first went in. "Eileen," he started, "I cannot bank adjusters have worked with you, and they trust you tell you how grateful we all are for your hard work these past because you stood up and spoke out. If you put out a budget two months and how excited I am to be working with..." his with solid numbers, they will trust it and we can move on. So, voice trailed off as he looked around the room. "What in the I know there are other things that you will need to work on as world... they did not clean up in here?" His voice got louder well, setting up new internal controls and everything, but please as he spoke. Runkel was a great CEO for a small business, make sure that we get the budget put together quickly" but Hammerman thought he did have one major flaw: a "A master budget is a tall order, especially when I have terrible temper. It took a lot to set him off, but if you did, been doing financial accounting for the company for so long. watch out! It might take me a while to build one from scratch." "It is okay, Jaxson," Hammerman said reassuringly, "Oh, do not worry about that," Runkel said with a smile. hoping to head off the possible explosion. "I will get it "Aleksandra may have been stealing from us, but she was cleaned up in no time." good at her job. She had started the process and had the "No, you will not." Runkel took a deep breath and let it basics for the budget all put together before the authorities out slowly before he continued. "You are not staff anymore, walked her out of the building. I have had the rest of Eileen; you are part of the executive team. You do not have the team check her numbers, and they have made a few time to clean up physical messes or organize files. We have adjustments to take out the slack she built into the budget to accounting staff and administrative assistants that do that cover her fraud, but the accurate amounts are ready to go. We stuff. Your job, like mine and Steve's and other executive even have a basic template that you can use." team members, is to focus on direction and decision making. "Well, that is different. I will get right to work on it, as So, let's you and I step into my office to talk about your first soon as I can get into my office." project, and we will get the staff going on cleaning this up." Runkel laughed. "I suppose I can give you that much She nodded and headed down the hall toward Runkel's time. In the meantime, though, you might think about office. He followed her, stopping at Syife's desk and talking with Harry. He is our cost accounting expert." politely asking the administrative assistant to prioritize theMEETING WITH HAROLD JAMES, FINANCIAL ANALYST Interest payments are made at the beginning of each Hammerman stopped hocfly by Syifa's desk, her hand-selected quarter to satisfy the loan requirements. Principal assistant, in get an update on the condition of her office. The payments are made at the end of each quarter, also IT department had already installed a new computer and in US$1,000 increments, to ensure all estimated cash peripheral equipment for her office, the tech was inside getting inflows have been received. everything working. Several clerks were working on the filing system, and a couple of accounting interns were going through He looked up at Hammerman and continued, "For the paperwork, getting it all reorganized. It looked like she example, if we draw on the line in January, then on April 1 would be able to move in by tomonow and really get started, we would have to send a check to pay off the interest from which meant that right now what she needed to do was to get Q1. If I remember right, Aleksandra had a set of equations information from Harold James, DPI's senior financial analyst that she used in the cash budget to determine how much to and lead cost accountant pull from the line, but sometimes she would just type it in. Hammerman knocked on James' door just minutes after The equations could get complicated. Just do not forget that leaving Runkel's office. "Harry" she called. "It is Eileen. Do when we budget, we assume that all borrowing takes place you have a minute?" on the first day of the quarter and that we have to pay the The door opened a second later. "For the CFO? Of interest accrued on our balance that quarter on the first day course, I have time. Come on in." of the next quarter, even if we have to bonow move principal Hammerman smiled as she followed him into the office to do so." and took a seat by his desk. James had always been a good "Also, be sure to take some time to review last year's friend. His good attitude and desire to see the company balance shoot as you work through this budget." He added a succeed had been a great help all through the recent few more bullets to his list: challenges, and she expected he would continue to be an The accounts payable balance has to be included in asset to her as she settled into her now position. expected cash payments for direct materials. "So," James said, interrupting her thoughts. "What can I Taxes payable need to be paid in the first quarter. help with today?" The accounts receivable balance will be received based "I have to create a master budget, and I am pretty nervous. on the expected cash receipts schedule. I have not done one in a long time, since I have really focused The predetermined overhead rate (FOHR) is the more on financial accounting. Do not worry," she said before estimated manufacturing overhead divided by estimated he could offer, "I do not need anyone else to do it. I remember machine hours needed, so the rate changes every year how a budget works," she grinned at him, "and I have depending on our estimates, then we use that POHR all Aleksandra's template. I just need some information." year until we recalculate for the following year. James frowned. "What information? Aleksandra was good at her job, that is how she hid her fraud for so long. All the He glanced up. "We use machine hours from the information you need is there, especially now that we all have Cutting and Assembly departments for our POHR, and taken a look and fixed her estimates so that they are accurate." we use a single-plantwide rate. It is not as accurate is "I am not talking about basic information. I am asking the departmental method, but we have not seen a big about the stuff I do not know. For example, what are the terms enough difference between the two in past years to make of our line of credit, how is our predetermined overhead rate departmental worth the extra work." calculated, and what other details might I need to know as I Hammerman examined the list, then looked back at move over from the financial side?" James. "Anything else I should know or look out for?" James nodded. "Oh, that stuff. Well, let's see. The line of James leaned back in his chair and thought a minute. credit is with First National. The terms are pretty simple." "Well, make sure you remember to convert from minutes to He scratched out a few bullet points on a tablet of paper. hours. The departments think in terms of minutes of labor and machine use, so that is what they report. One year an We draw on the line in US$1,000 increments. intern helped with the budget and mixed that up. Pretty We have to pay accrued interest each quarter for any depressing estimates when you budget six hours of labor for balance from the previous quarter. pair of jeans!" He grabbed the list and added to it. We do not want to accrue interest if we do not have to, so Data are given in minutes, but the production budget we pay off as much of the line of credit as possible each uses hours. quarter.He chuckled and Hammerman smiled. "Also, make PART 2: CALCULATING SALES MIX sure that you finish up the amortization schedule for the mortgage on the basic information tah; you will need that information for the cash budget and financials." "Your budget looks good, Hammerman, but I do not agree with the numbers." Finish the amortization schedule. Hammerman paused her presentation to look over at "You will also need to calculate depreciation, since you Jose Morales, DPI's sales manager. "I beg your pardon?" she will not have it on the new equipment being purchased asked. "Everything is based on the numbers you gave me." during the year. We use partial year depreciation, so you "I know," Morales agreed. "But the move I think about it, will need to add those numbers to depreciation expenses the more messed up I think those numbers are." as you move from quarter to quarter" Runkel frowned, as did several other members of the Calculate depreciation on the new equipment. executive team. "Explain," Runkel said shortly. "Oh, and I remember talking with collections about our "Well," Morales cleared his throat, then continued. "We accounts receivable numbers from last year. I have put have had the same basic sales mix since we introduced the those numbers in the basic information tab for you. I am JBJ line several years ago, but the more I think about it and such a nice guy that I listed the revenue, collections, bad the more I talk with our clients, the more I think we are debt, and remaining accounts receivables for the last two making a mistake. By focusing on BBJ and EBJ first, I do not quarters. All you need to do is use the same collections think we are making as much money as we could be." formulas we calculated. Those are based on the averages "Why not?" James asked. "We have about the same profit over the last five years." margin on all of our products, and we are meeting all of our demand." Calculate collections for the next year. "Thanks a heap; you are such a saint." Hammerman shook her head, *The profit margins are not the sime," she interjected. "Yeah, I know. The only other thing I can tell you is to "Right," Morales nodded at Hammerman. "And we are ake sure you estimate production into Q1 and Q2 of next not meeting all of our demand. We could sell more of the ar. Do not stop with Q4 of this year." specialty line, the demand is there, but we have not been Hammerman frowned. "Why?" able to produce enough of them." "Because you will need production numbers from Q1 of "Why not?" Runkel asked. "If we could sell more, why ext year to estimate ending inventory needs for this year." don't we make more?" a smiled. "I forgot to send that to Aleksandra one year, and "Because of our assembly machine," Kishawn Pontzer, a was very upset, so I am especially glad that you are doing head of production, answered. "We only have so many hours yourself this year." of production time on that machine, and we are at capacity. Hammerman shook her head. "Do not worry," she said Right now, we meet demand for the other two lines, then use ith a smile. "I want to do it myself this year so that I know whatever time is left to produce the JB] line." hat is involved. But I will let you help next year, and I will James frowned. "That does not seem right." pect you to help check my work as we move forward." Pontzer shrugged. "That is how we have done it since we "I suppose I can do that," he paused and gave her a quick started the line a few years ago." mile, "if I have to." "But we can just add extra workers to the line to produce Stop here and complete DPI Part 1 more, right?" Runkel asked. Pontzer shook her head. "Not on that machine. It is already at capacity." "Wait," Morales said. "If we are at capacity, how come we are showing growth over the coming year?" Pontzer smiled. "Because of that new assembly machine, we are buying in Q1. It is not much compared with the large assembly machine that produces most of our units, but it will allow us to make some modest growth over the year. We estimated the first quarter a bit low and then assumed some reasonable growth after that to account for the learning curve of the new employees who will run that machine.""Why are we not buying more or looking for other "Well, labor in Colombia, my home country, is very solutions?" Runkel asked, his temperature obviously rising. cheap. Cheap enough that it would be cust effective to ship "I mean, we cannot just stop growing." the items there, have a local factory finish them, then ship "Because we did not have any money," Pontzer them back. We could pay per piece, and they would get answered. "Remember? It was all we could do to get the hundreds done in a very short time to keep their jobs." money for this small machine. Aleksandra was making all "Whoa," Hammerman said holding up her hands. our money disappear. Now we know that, but last year when "We are not starting a sweatshop in Colombia to relieve a we were talking with the vendor and placing our order, temporary constraint." there was no money to buy a big new machine. Since it is "Who is talking about a sweatshop?" Morales objected expensive to get the big machine we need, almost US$2 frowning. "It would be good for our economy. Those people, million, we settled for a smaller one worth US$500,000. But my people, need work. Even difficult work is worth it when that only takes us so far." you get to feed your family." "Oh," Runkel sighed, settling back in his chair. "This is Hammerman looked down. "I guess... that makes sense, gonna haunt us for a long time, isn't it?" Everyone nodded. but I just do not think I could support that kind of treatment He looked around the room. "Is there anything we can do?" of people." She looked back up. "And what about our The room was silent for a minute, then Morales looked reputation? I mean, we are successful because we are "100% over at Hammerman. "Is there some way you can find for American Made." That is important to our customers. This us to balance our sales mix so that we maximize our profits? would kill that." Does it have something to do with money made per unit of Morales waived his hand. "Colombia is part of America. constraint times demand or something:" You people here in the United States think you are the Hammerman smiled. "Something like that. I could run Americans and that 'American made" means the same as the numbers to find an ideal sales mix for Q1, then we could made in the USA, ' but we are all part of the Americas, from just plan on 2%% growth from there because of that learning Canada to Argentina. You are so proud in your country. As curve. That would help us make more money this year than long as we keep saying "100% American Made," we are still we had planned." completely honest if we use workers in Colombia. And what "And we could use that money to help finance another do you mean by 'that kind of treatment"? I am not suggesting new machine next year." Morales finished. "Then I could slave labor." meet customer orders and stop making excuses. That would "Okay." Hammerman conceded. "You are right. I be great!" apologize. But that does not change our branding." Runkel nodded. "Okay, Hammerman, run those numbers "Of course not, but as I said, they will still be American and get us a new budget. We will find a way to make it work made, just a different part of the Americas. And we do not until we can get rid of this constraint." have to tell anyone. It would not be a long-term solution, Stop here and complete DPI Part 2 just a short-term boost, both for my country and for our company. Two years, and then we will have the mancy to get the new machine, and we will be good to go. Surely it is PART 3: MEETING WITH JOSE MORALES worth considering. Think of how much we would benefit the people in Colombia. Would it be better to hire people and Hammerman looked up at the knock on her door to see give them honest work than to have them turn to crime or Morales coming into her office. "Do you have a minute?" he starve! Helping disadvantaged people is part of our mission, asked as he settled into a chair. right? I am going to bring it to the executive team at our "I guess so," Hammerman chuckled. Morales was meeting tomorrow, so you might want to run the numbers. certainly a character, funny and charismatic, the perfect sales You know Runkel will want to see them." manager for a company like DPI that had to compete with Stop here and complete DPI Part 3 the big guys. "What can I do for you?" Morales shuffled a little in his seat. "I think I have come up with a way to take care of our constraint now instead of waiting until we have the funding for a new machine." "Really? What is it?" Hammerman asked eagerly