REQUIREMENTS OF THE SECOND PART OF THE CASE The second part of this case is intended to demonstrate the importance of using a BUDGET process to plan, direct and control the organization.. 1) Using assumptions you made in the first part of the case regarding, sales price per unit, variable costs per unit and total fixed costs, as well as the information about sales volume presented below, prepare the following budgets for the first quarter: Sales budget Production budget Direct materials budget for JUST THE MILK - to save time I filled in the other raw material budgets necessary to make milk shakes Manufacturing Overhead budget Operating budget 2) Using the information from the budgets you prepared above, prepare a projected Income Statement for the first month. The Sales Budget must be prepared first as it affects all the other budgets. In order to prepare the sales budget an estimate of the expected number of units to be sold and the expected sales price needs to be determined. To prepare the sales budget we used the following assumptions. Statistics for tourism in Hawaii are available from the www.hawaiitourismauthority.org and the Department of Business, Economic Development and Tourism of the State of Hawaii (Hawaii.gov/debdt). Number of visitors to the island from January 2007 to May 2007 were 125,000, 125,000, 150,000, 125,000 and 125,000, respectively. (For simplicity, we assume each visitor, on average, purchases one milk shake. (Students can get more elaborate and research the average number of days visitors stay and the average number of couples, versus families with kids). The sales mix and the sales price will be consistent with the first part of the case at 40% small and 60% large with the sales price set at the competitors price of $10 for large and $7 for small (less the resort fee of 10%). SALES BUDGET for January February March 1stqtr Total April May 1st qtr Large shakes expected to be sold: (visitors*.60) Expected sales price ($10*90%) Total sales ($) Small shakes expected to be sold: (visitors * .40) Expected sales price ($7*90%) Total sales ($) TOTAL SALES produced (based on the sales budget) are determined. This will equal: The next budget to be prepared is the Production budget, where the number of milk shakes needed to be Number of milk shakes expected to be sold + safety stock (ending finished goods inventory) in case demand is higher than predicted Total milk shakes needed Less: Beginning finished goods inventory (which is zero at the start of business) Milk shakes needed to be produced To prepare the production budget we used the following assumptions: 10% of next months expected milk shake sales is desired to be left in ending inventory as a safety cushion. Remember, beginning inventory is last months ending inventory. PRODUCTION BUDGET - 1st QTR January February Large shakes (sales budget) + desired ending inventory Total needed Less: beginning inventory March 1st Qtr total April Large shakes to produce PRODUCTION BUDGET - 1st QTR January February March 1st Qtr total April Small shakes (sales budget) + desired ending inventory Total needed Less: beginning inventory Small shakes to produce After the number of milk shakes needed to be produced is determined, we can plan for the amount of direct materials, direct labor and manufacturing overhead that will be needed. DIRECT MATERIALS budget will need to be produced for each ingredient used to make the milk shakes. The direct materials budget for whole milk was prepared using the following assumptions: 10% of next months expected milk needs are desired to be left in ending inventory as a safety cushion. Remember, beginning inventory is last months ending inventory. Cost of whole milk was determined to be $0.02344 per ounce Large Milk Shake Production Milk required per shake (ounces) Milk Purchases Budget - 1st quarter Ounces Needed for Large Milk Shake Production Small Milk Shake Production Milk required per shake (ounces) Ounces needed for Small Milk Shake Production Total Ounces Required for Production Plus: Desired ending Inventory Total Ounces Available Less: Beginning Inventory Total Ounces to be Purchased Cost per Ounce Total Cost of Milk to be Purchased REQUIREMENTS OF THE SECOND PART OF THE CASE The second part of this case is intended to demonstrate the importance of using a BUDGET process to plan, direct and control the organization. 1) Using assumptions you made in the first part of the case regarding, sales price per unit, variable costs per unit and total fixed costs, as well as the information about sales volume presented below, prepare the following budgets for the first quarter: Sales budget Production budget Direct materials budget for JUST THE MILK to save time I filled in the other raw material budgets necessary to make milk shakes Manufacturing Overhead budget Operating budget 2) Using the information from the budgets you prepared above, prepare a projected Income Statement for the first month. The Sales Budget must be prepared first as it affects all the other budgets. In order to prepare the sales budget an estimate of the expected number of units to be sold and the expected sales price needs to be determined. To prepare the sales budget we used the following assumptions. Statistics for tourism in Hawaii are available from the www.hawaiitourismauthority.org and the Department of Business, Economic Development and Tourism of the State of Hawaii (Hawaii.gov/debdt). Number of visitors to the island from January 2007 to May 2007 were 125,000, 125,000, 150,000, 125,000 and 125,000, respectively. (For simplicity, we assume each visitor, on average, purchases one milk shake. (Students can get more elaborate and research the average number of days visitors stay and the average number of couples, versus families with kids). The sales mix and the sales price will be consistent with the first part of the case at 40% small and 60% large with the sales price set at the competitors price of $10 for large and $7 for small (less the resort fee of 10%). SALES BUDGET for January February March 1st qtr Total April May 1st qtr Large shakes expected to be sold: (visitors*.60) Expected sales price ($10*90%) Total sales ($) Small shakes expected to be sold: (visitors * .40) Expected sales price ($7*90%) Total sales ($) TOTAL SALES The next budget to be prepared is the Production budget, where the number of milk shakes needed to be produced (based on the sales budget) are determined. This will equal: Number of milk shakes expected to be sold + safety stock (ending finished goods inventory) in case demand is higher than predicted Total milk shakes needed Less: Beginning finished goods inventory (which is zero at the start of business) Milk shakes needed to be produced To prepare the production budget we used the following assumptions: 10% of next months expected milk shake sales is desired to be left in ending inventory as a safety cushion. Remember, beginning inventory is last months ending inventory. PRODUCTION BUDGET - 1st QTR January February Large shakes (sales budget) + desired ending inventory Total needed Less: beginning inventory March 1st Qtr total April Large shakes to produce PRODUCTION BUDGET - 1st QTR January February March Small shakes (sales budget) + desired ending inventory Total needed Less: beginning inventory 1st Qtr total April Small shakes to produce After the number of milk shakes needed to be produced is determined, we can plan for the amount of direct materials, direct labor and manufacturing overhead that will be needed. A DIRECT MATERIALS budget will need to be produced for each ingredient used to make the milk shakes. The direct materials budget for whole milk was prepared using the following assumptions: 10% of next months expected milk needs are desired to be left in ending inventory as a safety cushion. Remember, beginning inventory is last months ending inventory. Cost of whole milk was determined to be $0.02344 per ounce Milk Purchases Budget-1" quarter Large Milk Shake Production Milk required per shake (ounces) Ounces Needed for Large Milk Shake Production Small Milk Shake Production Milk required per shake (ounces) Ounces needed for Small Milk Shake Production Total Ounces Required for Production Plus: Desired ending Inventory Total Ounces Available Less: Beginning Inventory Total Ounces to be Purchased Cost per Ounce Total Cost of Milk to be Purchased DIRECT MATERIALS BUDGET-CREAM. The direct materials budget for cream was prepared using the following assumptions: 10% of next months expected cream needs are desired to be left in ending inventory as a safety cushion. Remember, beginning inventory is last months ending inventory. Cost of cream was determined to be $0.15625 per ounce Cream Purchases budget - 1st Quarter Large Milk Shake production Cream required per shake(ounces) Ounces Needed for Large Milk Shake Production Small Milk Shake Production Cream required per shake(ounces) Ounces Needed for Small Milk Shake Production 3 ounces 3 ounces January 82,500 February 76,500 March 88,500 3 ounces 247,500 229,500 265,500 55,000 51,000 59,000 Total 247,500 3 ounces 742,500 165,000 April 75,000 3 ounces 225,000 50,000 2 ounces 2 ounces 2 ounces 2 ounces 2 ounces 110,000 102,000 118,000 330,000 100,000 Total Ounces Required for Production 357,500 331,500 383,500 1,072,500 325,000 Plus: Desired Ending Inventory 33,150 38,350 32,500 32,500 32,500 Total Ounces Available 390,650 369,850 416,000 1,105,000 357,500 Less: Beginning Inventory -0- 33,150 38,350 -0- 32,500 Total Ounces to be Purchased 390,650 336,700 377,650 1,105,000 325,000 Cost per Ounce $0.15625 $0.15625 $0.15625 $0.15625 $0.15625 Total Cost of Cream to be Purchased $61,039.06 $52,609.38 $59,007.81 $172,656.25 $50,781.25 DIRECT MATERIALS BUDGET-SUGAR. The direct materials budget for sugar was prepared using the following assumptions. 10% of next months expected sugar needs are desired to be left in ending inventory as a safety cushion. Remember, beginning inventory is last months ending inventory. Cost of sugar was determined to be $0.33333 per cup. Large Milk Shake Production Sugar required per shake (in cups) Cups Needed for Large Milk Shake Production Small Milk Shake Production Sugar required per shake (in cups) Cups Needed for Small Milk Shake Production Total Cups Required for Production Plus: Desired Ending Inventory Total Cups Available Less: Beginning Inventory Total Cups to be Purchased Cost per Cup Total Cost of Sugar to be Purchased Sugar Purchases Budget 1" Quarter January 82.500 February March 76,500 88,500 Total 247,500 April 75.000 cup cup cup cup cup 61,875 57,375 66,375 185,625 56,250 55,000 51,000 59,000 165,000 50,000 cup cup cup cup cup 27,500 25,500 29,500 82,500 25,000 89,375 82,875 95,875 268.125 81,250 8,288 9,588 8,125 8,125 8,125 97,663 92,463 104,000 276,250 89.375 -0- 8,288 9,588 -0- 97,663 84,175 94,412 276,250 8,125 81,250 $ 0.33333 $32,554.01 $ 0.33333 $28,058.05 $ 0.33333 $31,470.35 $ 0.33333 $92,082,41 $ 0.33333 $27,083.06 DIRECT MATERIALS BUDGET - ICE CREAM. The direct materials budget for ice cream was prepared using the following assumptions: 10% of next months expected ice cream needs are desired to be left in ending inventory as a safety cushion. Remember, beginning inventory is last months ending inventory. Cost of ice cream was determined to be $0.04 per ounce. Large Milk Shake Production Ice Cream Required per shake Ounces needed for Large Milk Shake Production Small Milk Shake Production Ice Cream Required per shake Ounces needed for Small Milk Shake Production Ice Cream Purchases Budget - 1st Quarter January 82,500 9 ounces 742,500 February 76,500 9 ounces 688,500 March 88,500 9 ounces 9 ounces 796,500 55,000 51,000 59,000 Total 247,500 2,227,500 165,000 April 75,000 9 ounces 675,000 50,000 6 ounces 330,000 6 ounces 306,000 6 ounces 354,000 6 ounces 6 ounces 990,000 300,000 Total Ounces Required for 1,072,500 994,500 1,150,500 3,217,500 975,000 Production Plus: Desired Ending Inventory 99,450 115,050 97,500 97,500 97,500 Total Ounces Available 1,171,950 1,109,550 1,248,000 3,315,000 1,072,500 Less: Beginning -0- 99,450 115,050 -0- 97,500 Total Ounces to be Purchased 1,171,950 1,010,100 1,132,950 Cost per ounce $ 0.04 $ 0.04 $0.04 3,315,000 $ 0.04 975,00 $ 0.04 Total Cost of Ice Cream to be Purchased $46,878.00 $40,404.00 $45,318.00 $132,600.00 $39,000.0 DIRECT MATERIALS BUDGET FLAVORINGS. The direct materials budget for flavorings was prepared using the following assumptions: . . . 10% of next months expected flavoring needs are desired to be left in ending inventory as a safety cushion. Remember, beginning inventory is last months ending inventory. Cost of flavorings was $ 0.40 for a large shake and $ 0.25 for a small shake. Flavorings Purchases Budget -1" Quarter January February Large Milk Shake Production Plus: Desired Ending Inventory Total Available Less: Beginning Inventory Total to be Purchased Cost per unit Total Cost of Flavorings to be Purchased for Large Milk Shakes Small Milk Shake Production March Total 82,500 76,500 88,500 7,650 8,850 7,500 247,500 7,500 April 75.000 7,500 90,150 85,350 96,000 255,000 82.500 -0- 7,650 8,850 -0- 7,500 90,150 77,700 87,150 255,000 75,000 $ 0.40 $36,060.00 $ 0.40 $31,080.00 $ 0.40 $34,860.00 $ 0.40 $102,000.00 $0.40 $30,000.00 Plus: Desired Ending Inventory Total Available 55,000 5,100 51,000 59,000 165,000 50,000 5,900 5,000 60,100 56,900 64,000 5,000 170,000 5,000 Less: Beginning Inventory 55,000 -0- 5,100 5,900 -0- Total to be Purchase 60,100 51,800 58,100 170,000 5,000 50,000 Cost per unit Total Cost of Flavorings to be Purchased for Small Milk Shakes $0.25 $15,025.00 $ 0.25 $12,950.00 $ 0.025 $14,525.00 $ 0.25 $42,500.00 $ 0.25 $12,500.00 Total Cost of Flavorings to be Purchased for ALL Milk Shakes $51,085.00 $44,030.00 $49,385.00 $144,500.00 $42,500.00 DIRECT MATERIALS BUDGET - STRAWS. The direct materials budget for straws was prepared using the following assumptions: 10% of next months expected straw needs are desired to be left in ending inventory as a safety cushion, Remember, beginning inventory is last months ending inventory. Cost per straw is $ 0.75. Straws Purchases Budget - 1st Quarter January February March Total April Large Milk Shake Production 82,500 76,500 88,500 247,500 75,000 Small milk shake Production 55,000 51,000 59,000 165,000 50,000 Total straws Required for Production 137,500 127,500 147,500 412,500 125,000 Plus: Desired Ending Inventory 12,750 14,750 12,500 12,500 12,500 Total Available 150,250 142,250 160,000 425,000 137,500 Less: Beginning Inventory -0- 12,750 14,750 -0- 12,500 Total Straws to be Purchased 150,250 129,500 145,250 425,000 125,000 Cost per straw $ 0.75 $ 0.75 $ 0.75 $ 0.75 $ 0.75 Total cost of straws to be Purchased $112,687.50 $97,125.00 $108,937.50 $318,750.00 $93,750.00 DIRECT MATERIALS BUDGET-CUPS. The direct materials budget for cups was prepared using the following assumptions: 10% of next months expected cup needs are desired to be left in ending inventory as a safety cushion. Remember, beginning inventory is last months ending inventory. Cost per cup is $ 0.50 for a large shake and $ 0.40 for a small shake. Cups Purchases Budget - 1" Quarter Large Milk Shake Production Plus: Desired Ending Inventory Total Available Less: Beginning Inventory January 82,500 February March Total April 76,500 88,500 247,500 7,650 8,850 7,500 7,500 75,000 7.500 90,150 85,350 96,000 255,000 82,500 -0- 7,650 8,850 -0- 7,500 90,150 77,700 87,150 255,000 75,000 $0.50 $0.50 $0.50 $ 0.50 $45,075.00 $38,850.00 $43,575.00 $127,500.00 $ 0.50 $37,500.00 Total cups to be Purchased Cost per Cup Total Cost of Cups to be Purchased Cups Purchases Budget - 1st Quarter January February March Total Small Milk Shake Production 55,000 51,000 59,000 Plus: Desired Ending Inventory 5,100 5,900 5,000 165,000 5,000 April 50,000 5,000 Total Available Less: Beginning Inventory Total cups to be Purchased 60,100 56,900 64,000 170,000 55,000 -0- 5,100 5,900 -0- 5,000 60,100 51,800 58,100 170,000 50,000 Cost per Cup Total Cost of Cups to be Purchased $ 0.40 $24,040.00 $ 0.40 $ 0.40 $ 0.40 $20,720.00 $23,240.00 $68,000.00 $ 0.40 $20,000.00 MANUFACTURING OVERHEAD BUDGET First, we need to determine whether each manufacturing overhead expense is variable or fixed. It has been determined that all the manufacturing overhead costs are fixed, although salary of part-time workers and utilities can be variable or mixed expenses as well. Manufacturing Overhead Budget-1" Quarter February January March Total Fixed manufacturing overhead costs: Salary of 2 part-time workers Rent and utilities expense Supplies for making milk shakes Depreciation - milk shake maker Depreciation-refrigerator/freezer Depreciation-counter tops TOTAL FIXED COSTS OPERATING BUDGET First we need to determine whether each operating budget expense is variable or fixed. It has been determined that all the operating costs are fixed. Operating Budget - 1st Quarter January February March Total Fixed operating expenses: Depreciation - tables and benches Insurance expense Interest expense Advertising expense Accounting and bookkeeping expense Owner's salary expense Dues and membership expense Licenses and Permits expense Maintenance expense Office supplies expense Depreciation - sign TOTAL FIXED COSTS So what is the BUDGETED MANUFACTURING COST FOR ONE UNIT: Direct Materials Variable Costs per unit: Ingredient Cost Small Large Whole milk Cream $15 for 640 oz. $20 for 128 oz. 0.02344 per oz. 0.15625 per oz. 0.05 0.07 0.31 0.47 Sugar $10 for 30 cups. 0.33333 per cup 0.17 0.25 Premium Vanilla Ice Cream. $24 for 600 oz. 0.04000 per oz.. 0.24 0.36 Flavorings 0.25 0.40 Flavored Specialty Straws 0.75 0.75 Cups-8 ounces $200 for 500 cups 0.40000 per cup 0.40 Cups-12 ounces $250 for 500 cups 0.50000 0.50 per cup TOTAL DIRECT MATERIAL COST PER UNIT $2.17 $2.80 LARGE MILK SHAKES - per the PRODUCTION budget we expect to produce 1,580,000 in the first Year: (125,000+125,000+150,000+125,000+125,000+150,000+160,000+150,000+110,000+110,000 +110,000+140,000). (1) Direct materials cost per milk shake: (2) Manufacturing overhead: Fixed ($2,234.00 *12months * 60% per quarter)/ 1,580,000 = milk shakes Cost of manufacturing each large milk shake 2.80 0.01 $2.81 SMALL MILK SHAKES - per the PRODUCTION budget we expect to produce 165,000 in the first quarter. (1) Direct materials cost per milk shake: (2) Manufacturing overhead: Fixed ($2,234.00 * 12 months * 40% per quarter)/ 1,580,000 = milk shakes 2.17 = 0.01 Cost of manufacturing each small milk shake Number of milk shakes expected to be sold Sales price per milk shake (less resort fee) Cost of goods sold per milk shake $2.18 PROJECTED INCOME STATEMENT - MONTH OF JANAURY Large (60%) Small (40%) Total 75,000 50,000 125,000 $9.00 $6.30 $2.81 $2.18 Sales Less: cost of goods sold Gross Profit Less: Operating expenses Operating Income Income tax expense (income tax rate = 35%) Net Income FLEXIBLE BUDGETING CASE-ACTIVITY VERSUS SPENDING VARIANCES Due to global warming, demand for milk shares was much larger than expected. The amount of large milk shakes actually sold in January were 85,000 (10,000 over budget) while the amount of small milk shakes actually sold in January were 45,000 (5,000 under budget). The budgets prepared above were planned prior to the beginning of the year and are valid for the planned level of sales activity. If the actual level of sales activity differs from the planned level, comparing our budgets above with actual results may lead to incorrect conclusions about performance. Therefore we must prepare a FLEXBLE budget that adjusts revenues and expenses given the actual level of sales activity that occurred. Please (1) Fill in the Flexible budget based on actual sales for both size milk shakes. (2) Fill in the activity variance and the spending variance amounts as well as indicate whether they are favorable or unfavorable for both size milk shakes. Large Milk Shakes - Flexible Budget Performance Report for the Month ended January 31 Planned Budget based on budgeted sales of 75,000 milk Activity Variances Flexible budget based on actual sales of 85,000 Spending Variances Actual results based on actual sales of 35,000 milk shakes milk shakes shakes Revenue ($9.00q) $675,000 Less: Cost of goods sold $210.750 $765,000 $220.000 ($2.81q) Gross Profit Less: Operating $464,250 8,764 $545,000 10.317 expenses Operating Income $455,486 Income tax expense (tax $159.420 $534.683 $187.139 rate = 35%) Net Income $296,066 $347.544 1) Remember in the flexible budget column multiply actual sales by the budget/stardard cost of which I gave you in one number Cost of goods sold.. 2) Operating expenses remain the same between the static and flexible budget as they do not change with changes in volume (sales level). Small Milk Shakes - Flexible Budget Performance Report for the Month ended January 31 Planned Budget based on Activity Flexible budget Spending based on actual Actual results based on actual budgeted sales of 50,000 milk shakes Variances sales of 45,000 Variances sales of 45,000 milk shakes milk shakes Revenue ($6.30q) $315,000 Less: Cost of goods sold $109,000 $283,500 $100,500 ($2.18q) Gross Profit Less: Operating $206,000 5,843 $183,000 5.928 expenses Operating Income $200,157 Income tax expense (tax $70,055 $177,072 $61,975 rate = 35%) Net Income $130,102 $115,097