Master Budget Case: MKD Ltd.

MKD Ltd. is a company that manufactures and sells a single product, which they call a Sera. 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 2007, Chris Leigh, the MKD controller, spent considerable time with Pat Frazer, the Manager of Marketing, putting together a sales forecast for the next budget year (January to December, 2008). 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 MKD.

Their sales forecast consisted of these few lines:

For the year ended December 31, 2007: 475,000 units at $10.00 each*

For the year ended December 31, 2008: 500,000 units at $10.00 each

For the year ended December 31, 2009: 500,000 units at $10.00 each

*Expected sales for the year ended December 31, 2007 are based on actual sales to date and budgeted sales for the duration of the year.

MKD 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:

Peak months for sales correspond with gift-giving holidays. History shows that January, March, May and June are the slowest months with only 1% of sales for each month. Sales pick up over the summer with July, August and September each contributing 2% to the total. Valentines Day in February boosts sales to 5%, and Easter in April accounts for 10%. As Christmas shopping picks up momentum, winter sales start at 15% in October, move to 20% in November and then peak at 40% in December. This pattern of sales is not expected to change in the next two years.

From previous experience, management has determined that an ending inventory equal to 25% of the next month's sales is required to fit the buyer's demands.

Because sales are seasonal, MKD must rent an additional storage facility from September to December to house the additional inventory on hand. The only related cost is a flat $20,000 per month, payable at the beginning of the month.

There is only one type of raw material used in the production of Sera. Space-age acrylic (SAA) is a very compact material that is purchased in powder form. Each Sera requires 5 kilograms of SAA, at a cost of $0.45 per kilogram. The supplier of SAA tends to be somewhat erratic so MKD finds it necessary to maintain an inventory balance equal to 40% of the following month's production needs as a precaution against stock-outs. MKD pays for 20% of a month's purchases in the month of purchase, 45% in the following month and the remaining 35% two months after the month of purchase. There is no early payment discount.

Beginning accounts payable will consist of $208,406.50 arising from the following estimated direct material purchases for November and December of 2007:

SAA purchases in November 2007: $223,875.00

SAA purchases in December 2007 $162,563.50

MKD's manufacturing process is highly automated, so their direct labor cost is low. Employees are paid on a per unit basis. Their total pay each month is, therefore, dependent on production volumes and averages $9.00 per hour. This rate already includes the employer's portion of employee benefits. All payroll costs are paid in the period in which they are incurred.

Each unit spends a total of 18 minutes in production.

Due to the similarity of the equipment in each of the production stages and the company's concentration on a single product, manufacturing overhead is allocated based on volume (i.e. the units produced). The unit variable overhead manufacturing rate is $1.30, consisting of: Utilities--$0.60; Indirect Materials--$0.20; Plant maintenance--$0.30; environmental fee--$0.14; and Other--$0.06.

The fixed manufacturing overhead costs for the entire year are as follows:

Training and development $ 43,200

Property and business taxes 39,000

Supervisor's salary 149,400

Amortization on equipment 178,800

Insurance 96,000

Other 117,600

$ 624,000

The property and business taxes are paid on June 30 of each year. The expected payment for next year is $39,600.

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.

MKD uses the straight line method of amortization.

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:

Lowest level of sales: 375,000 units Total Operating Expenses: $778,710

Highest level of sales: 750,000 units Total Operating Expenses: $1,022,460

These costs are paid in the month in which they occur. Not included in the above expenses is bad debt expense.

Sales are on a cash and credit basis, with 55% collected during the month of the sale, 35% the following month, and 9.5% the month thereafter. of 1% of sales are considered uncollectible (bad debt expense).

Sales in November and December 2007 are expected to be $700,000 and $1,500,000 respectively. Based on the above collection pattern this will result in Accounts Receivable of $734,000 at December 31, 2007 which will be collected in January and February, 2008.

During the fiscal year ended December 31, 2008, MKD will be required to make monthly income tax installment payments of $5,000. Outstanding income taxes from the year ended December 31, 2007 must be paid in April 2008. Income tax expense is estimated to be 25% of net income. Income taxes for the year ended December 31, 2008, in excess of installment payments, will be paid in April, 2009.

MKD is planning to acquire additional manufacturing equipment for $204,300 cash. 40% of this amount is to be paid in November 2008, the rest, in December 2008. The manufacturing overhead costs shown above already include the amortization on this equipment.

An arrangement has been made with the local bank that if MKD 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.

MKD 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.

A listing of the estimated balances in the company's ledger accounts as of December 31, 2007 is given below:

Assets Cash $ 83,365

Accounts receivable 734,000

Inventory-raw materials 9,000

Inventory-finished goods 9,125

Prepaid Insurance 64,000

Prepaid property and business taxes 19,200

Capital assets (net) 724,000

Total assets $1,642,690

Liabilities and Shareholders' Equity Accounts payable $ 208,407

Income taxes payable 21,500

Capital stock 1,000,000

Retained Earnings 412,783

Total liabilities and shareholders' equity $1,642,690

Required:

1. How do you find the monthly master budget for MKD for the year ended December 31, 2008, including the following schedules:

Sales Budget & Schedule of Cash Receipts

Production Budget

Direct Materials Budget & Schedule of Cash Disbursements

Direct Labor Budget

Manufacturing Overhead Budget

Ending Finished Goods Inventory Budget

Selling and Administrative Expense Budget

Cash Budget