Master Budget Case: ToyWorks Ltd.

ToyWorks Ltd. is a company that manufactures and sells a single product, which they call a toodle. For planning and control purposes they utilize aquarterlymaster budget, which is usually developed at least six months in advance of the budget period. Their fiscal year end is December 31.

During the summer of 2018, Chris Leigh, the ToyWorks controller, spent considerable time with Pat Frazer, the Manager of Marketing, putting together a sales forecast for the first quarter of next year (January to March, 2019). 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 ToyWorks.

Their sales forecast consisted of these few lines:

• For the year ended December 31, 2018: 475,000 units at $10.00 each*
• For the year ended December 31, 2019: 500,000 units at $10.00 each
• For the year ended December 31, 2020: 500,000 units at $10.00 each

*Expected sales for the year ended December 31, 2018 are based on actual sales to date and budgeted sales for the duration of the year.

ToyWorks'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 first quarter. Your conversations with the President and your investigations of the company's records have revealed the following information:

1. Sales of toodles are seasonal. History shows that January, March, May, and June are the slowest months with only 5% of sales for each month. Sales pick up over the summer with July, August, and September each contributing 6% to the total. Valentine's Day in February boosts sales to 10%, and spring break in April accounts for 7%. As Christmas shopping picks up momentum, winter sales start at 10% in October, move to 15% in November, and then peak at 20% in December. This pattern of sales is not expected to change in the next two years.
2. 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.
3. There is only one type of raw material used in the production of toodles. Space-age acrylic (SAA) is a very compact material that is purchased in powder form. Each toodle requires 5 kilograms of SAA at a cost of $0.45 per kilogram. The supplier of SAA tends to be somewhat erratic, so ToyWorks finds it necessary to maintain an inventory balance equal to 40% of the following month's production needs as a precaution against stock-outs. ToyWorks 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.
4. Beginning accounts payable will consist of $167,084, arising from the following estimated direct material purchases for November and December of 2018:
7. ToyWorks's manufacturing process is highly automated, so their direct labour 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.
8. Each unit spends a total of 18 minutes in production.
9. 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.
10. The fixed manufacturing overhead costsfor the entire yearare as follows:

• Theannualinsurance premium of $96,000 will be paid at the beginning of January. There is 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.
• ToyWorks uses the straight line method of amortization.

1. 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 years' experience has provided the following information:
4. These costs are paid in the month in which they occur. Not included in the above expenses is bad debt expense.
5. 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. Half of 1% of sales are considered uncollectible (bad debt expense).
6. Sales in November and December 2018 are expected to be $712,500 and $950,000 respectively. Based on the above collection pattern, this will result in Accounts Receivable of $490,438 by December 31, 2018, which will be collected in January and February, 2019.
7. During the fiscal year ended December 31, 2019, ToyWorks will be required to make monthly income tax installment payments of $1,500. Outstanding income taxes from the year ended December 31, 2018 must be paid in March 2019. Income tax expense is estimated to be 25% of net income. Income taxes for the year ended December 31, 2019 in excess of installment payments will be paid in March, 2020.
8. ToyWorks is planning to acquire additional manufacturing equipment for $304,200 cash. 40% of this amount will be paid in January 2019; the rest will be paid in February 2019. The manufacturing overhead costs shown above already include the amortization on this equipment.
9. An arrangement has been made with the local bank that if ToyWorks 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.
10. ToyWorks 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.
11. A listing of the estimated balances in the company's ledger accounts as of December 31, 2018 is given below:

Cash $ 64,165 Accounts receivable 490,438 Inventory-raw materials 28,125 Inventory-finished goods 45,625 Capital assets (net) 724,000 $ 1,352,353 Accounts payable $ 167,084 Income tax payable 21,500 Capital stock 1,000,000 Retained earnings 163,769 $ 1,352,353