Requirements: Prepare a Pro Forma Master Budget for the first quarter of the year, which should include a sales budget, production budget, raw materials budget, direct labor production, MOH budget, selling and adminstrative budget, COGS/FG budget, cash budget, income statement and ending balance sheet.

Black Manufacturing Company Revisited Part I Mr. Black had promoted Lee High to vice president of finance. Lee had practically been running the firm for several years during which time sales and profit had been declining. On November 15. Mr. Black announced that his son, Trafalgar Black, would take over as owner and president on January 1. Trafalgar was a graduate of Hamline's MBA program and for several years had been working for a large consulting firm as a marketing specialist. In their private discussions, Mr. Black told his son that the problems in the family firm were marketing rather than financial so the situation was ready-made for Trafalgar. Mr. Black, it seems had been completely taken by Lee High When Trafalgar arrived on December 1, and began to read various internal report, he realized Black Manufacturing did not have a cash budget, and there didn't seem to be much in the way of financial planning. Trafalgar asked Lee about this. Lee's response was the Black Manufacturing ran on the basis of several well-developed decision rules, and budgets weren't necessary because if the firm ever ran out of funds, Mr. Black simply deposited $10,000 or $20,000 in the bank. Trafalgar's response was clear: "My father is a millionaire, but I am not!" Lee indicated he didn't know much about budgeting, but he would get an assistant to work up some "stuff." Trafalgar decided to call his old friend Crofton Brockley. Brockley was in charge of several large budgeting projects for a consulting firm, and Trafalgar knew Crofton to a recognized expert on budgeting for small companies. Fortunately for Trafalgar, Brockley wasn't busy that week and was able to fly down the next day. Crofton spent two days going over the accounting records, interoffice memos, and everything else he could find. On Friday morning, Trafalgar found the following note on his desk: Dear Trafalgar Had to leave last night for Pittsburg. During the two days I spent in the office. I discovered 1. You have no budget or control system at all. 2. Lee High's decision rules are all wrong. 3. High doesn't know the first thing about finance, budgeting or manufacturing Will be back on Monday morning to talk to you. By the way, if you can Adelaide Ladywell, I would like to speak to her. Your find Crofton Trafalgar was perplexed by the note but decided he had better find out who this Ladywell was. Lee told Trafalgar that Adelaide was a file clerk who had been fired a couple of years ago 1 Page because she refused to follow company policy. Trafalgar asked Lee if he could find Adelaide. Lee said that he heard she was working for some firm in town and would find out where Eventually, Trafalgar found Adelaide working as a bookkeeper for Maze Woolwich. During a phone conversation Adelaide explained about her being fired by Mr. Black. She went on to explain that after she got fired she went to see Mr. Woolwich. Apparently, Woolwich realized that Adelaide was right and that Lee High and Mr. Black were wrong. Adelaide went on to say that Mr. Woolwich felt bad about her getting fired. Woolwich had intended to retire but decided to hire Ms. Ladywell as a bookkeeper. Adelaide had been working for Woolwich ever since. Shortly after Trafalgar finished talking to Adelaide, Crofton entered the office. With his usual efficiency, he made the following points: We had better get a budgeting system immediately and try to see where we are. (Any complex cost accounting would have to wait.) Lee has got to go. We must decide on how to get a budgeting system put together quickly because Black's might be broken Crofton concluded by asking. "Did you find Adelaide Ladywell? She is the only person around here in the last three years who did anything right, and she got fired." Trafalgar indicated that Ms. Ladywell was going to stop by after work and talk to them. Crofton then suggested Trafalgar fire Lee High and try to rehire Adelaide as the bookkeeper-analyst. That afternoon Lee was fired, given two month's pay, and asked to leave the office by 3 o'clock. The same evening Adelaide agreed to work for Trafalgar on the condition she would not have to deal with either the older Mr. Black or Lee High. Trafalgar explained that Lee was already gone, and his father left for Florida several days previously. Adelaide agreed to be at work the following Monday morning. She indicated that Mr. Woolwich was all but out of business and no longer needed her services. 2 Page Part II After Lee High had left the office, Crofton Brockley went through all the available records and files and, as a result, was able to establish the following information as a basis to begin the budgeting process. Items about which Lee High seemed to be correct: Variable Direct Costs Direct materials cost per unit Direct labor cost per unit Total .75 1.25 $2.00 Variable Overhead Indirect labor cost per unit Electricity cost per unit Other overhead per unit produced Total $.20 .10 5.80 Fixed Costs Indirect labor per week Indirect materials per week Electricity per week Factory insurance per week Other overhead per week Total $100 300 75 125 110 $ 710 The office expenses are very close to $781 per week. Of this amount, the breakdown seems to be: 400 200 Salaries (including fringe benefits and payroll tax) Rent on office Depreciation on office equipment Utilities Total 100 $ 781 Direct labor is paid on a piece-rate (or "piecework") basis. Workers are paid $1.25 per unit produced Average rate of accounts receivable collection is as follows: During the month in which sale is made 1" month after sale 2nd month after sale 3 month after sale 30% 40% 20% 10% 100% 31 Page Several other notations made by Crofton Brockley a) Trafalgar expected to draw $1,400 per month for personal use. b) Consulting fees will be billed at about $225 per week or $900 per month. c) A reasonable estimation of the value of factory and equipment is $70,000. Depreciation should be monthly on the basis of an average useful life of 5 years. This equipment will have a salvage value of $2,500. d) The production process to produce the Great Beast is fairly simple. Raw materials consist of a single item, which is usually entered into the process in the morning. Various machining operations take place during the day. At the end of each day, all the finished units are moved into the storeroom. Because started units are always finished before the workers go home, there is never a work-in-process inventory overnight. e) Assume that this coming year's net income will be relatively low and, therefore, compute income tax on the basis of 25% of net income. Taxes will be paid quarterly at the end of the last day of the quarter. 1) The inventory of raw materials at the beginning of the coming year will be 800 units, and there will be 750 units of finished product. General guidelines set by Crofton Brockley These guidelines should be followed through the year, at which time they are to be review and revised. a) The estimates of variable costs of production are almost certainly correct. b) Fixed costs of production are almost certainly correct at $710 per week, except that there is no estimation or allowance for depreciation. Take fixed cost of production to equal $710 plus depreciation. c) Charge fixed factory overhead on a monthly basis. Since the $710 per week amount seems reasonable, charge a monthly amount of $710 times 4.5 (four and one-half times). The over-or under-applied overhead existing at the end of a month will be charged as part of that month's cost of goods sold. d) Establish cost accounting records on the basis of full cost, assuming that normal output is 500 units per week, or 2,250 units per month. Thus, budgeted full cost is $4.72 per unit. e) Selling commission should be 10% on all sales, and the price on regular sales should be set at $7.00 per unit. f) All depreciation should be on a straight-line basis. Following is an estimation of the balance sheet as it will appear on January 1, when Trafalgar Black takes complete control of the business: Cash Receivables Raw material inventory Finished goods inventory (54.72/unit) Office equipment Factory equipment Land Total Assets $ 10,000 14.700 600 3,540 13,122 70,000 5.000 $116.962 Accounts Payable Notes Payable Capital: Trafalgar Black Total Liabilities and Owners' Equity $ 1,275 30.000 85,687 S116.962 Production Adelaide's first important step in budgeting was to develop a production budget and a raw materials schedule for the first quarter of the coming year. Actual sales for the prior October and November were available, and reasonable estimates of sales for December and the first four months of the coming year were made. Actual sales (units) October November 1,500 2,300 Expected sales (units) December January (of the coming year) February (of the coming year) March (of the coming year) April of the coming year) 1,800 2,000 2,200 1,900 2,100 Since there was no established policy on production scheduling, inventory planning, or raw materials inventory, it was necessary to establish one. Crofton. Trafalgar, and Adelaide agreed that a policy based on experience would have to wait until some data were collected over the next 6 to 8 months. In an effort to get things going." they settled on a two-part operational statement of policy: a) Production in any month should be scheduled so that an ending inventory of Great Beast will equal one-half of the next month's expected sales. b) Purchase of raw material should be made so that on average there are enough raw materials on hand to produce 700 Great Beasts. Thus, no end-of-month inventory should have fewer than 700 units of raw material. Cost of Production Adelaide's next task was to prepare a flexible budget that could later be used to prepare a budgeted income statement and would also help Trafalgar tell whether actual expenditures were as they should be. She decided to use the format shown in the variable budget table below. On the left she would write in the cost formula, which would show how much should be spent on each item for any given production volume. Projected number of units produced January February March Cost Formula Cost Item Materials used Direct labor Indirect labor Electricity Indirect materials Factory insurance Other overhead Depreciation Total cost Cost per unit Income Statements Having developed this data, Adelaide decided to project income statements for January, February and March Cash budgets After developing the income statements, Adelaide decided to see what would happen to the cash position of Black during the quarter. When Mr. Black actually turns the business over to Trafalgar, Mr. Black will withdraw all cash. All receivables will be due to Trafalgar, and all payables will be his responsibility. Trafalgar expects to pay $30,000 for the business, which will be a liability of the business, and he intends to deposit $10,000 in the firm's checking account to establish a working balance. Raw materials are always purchased on a 30-day-due basis. Consequently, payments are always made in the month following the purchase of materials. It is expected that 1,700 units of materials will be purchased during the December prior to the coming year. Direct labor, all overhead, commissions, salaries, rent and utilities are paid in the month incurred 6 Page Balance Sheet As a final step in the general budget process Adelaide decided to project a balance sheet as of the coming year's April 1. Evaluation of the Budget Armed with the material developed to date, Adelaide, Crofton, and Trafalgar had a meeting to discuss problems that were likely to arise. What points would be likely to dominate such a meeting? Why? January Activity In early February, the following information was available on January's activity. Sales: 2.250 units @ $7.00 Actual productions: 2,250 units Expenses actually paid: Direct materials bought Direct labor Indirect labor Electricity Indirect materials Factory insurance Other overhead Office expense Commissions $1,660.00 2,812.50 895.00 325.00 1,570.00 562.50 1,600,00 2,260.00 1.400.00 Ending raw materials were 600 units Neither Crofton nor Trafalgar had been paid anything yet. Requirements: Prepare a Pro Forma Master Budget for the first quarter of the year. which should include a sales budget, production budget, raw materials budget, direct labor production, MOH budget, selling and administrative budget, COGS/FG budget, cash budget, income statement and ending balance sheet. 7 Page Black Manufacturing Company Revisited Part I Mr. Black had promoted Lee High to vice president of finance. Lee had practically been running the firm for several years during which time sales and profit had been declining. On November 15. Mr. Black announced that his son, Trafalgar Black, would take over as owner and president on January 1. Trafalgar was a graduate of Hamline's MBA program and for several years had been working for a large consulting firm as a marketing specialist. In their private discussions, Mr. Black told his son that the problems in the family firm were marketing rather than financial so the situation was ready-made for Trafalgar. Mr. Black, it seems had been completely taken by Lee High When Trafalgar arrived on December 1, and began to read various internal report, he realized Black Manufacturing did not have a cash budget, and there didn't seem to be much in the way of financial planning. Trafalgar asked Lee about this. Lee's response was the Black Manufacturing ran on the basis of several well-developed decision rules, and budgets weren't necessary because if the firm ever ran out of funds, Mr. Black simply deposited $10,000 or $20,000 in the bank. Trafalgar's response was clear: "My father is a millionaire, but I am not!" Lee indicated he didn't know much about budgeting, but he would get an assistant to work up some "stuff." Trafalgar decided to call his old friend Crofton Brockley. Brockley was in charge of several large budgeting projects for a consulting firm, and Trafalgar knew Crofton to a recognized expert on budgeting for small companies. Fortunately for Trafalgar, Brockley wasn't busy that week and was able to fly down the next day. Crofton spent two days going over the accounting records, interoffice memos, and everything else he could find. On Friday morning, Trafalgar found the following note on his desk: Dear Trafalgar Had to leave last night for Pittsburg. During the two days I spent in the office. I discovered 1. You have no budget or control system at all. 2. Lee High's decision rules are all wrong. 3. High doesn't know the first thing about finance, budgeting or manufacturing Will be back on Monday morning to talk to you. By the way, if you can Adelaide Ladywell, I would like to speak to her. Your find Crofton Trafalgar was perplexed by the note but decided he had better find out who this Ladywell was. Lee told Trafalgar that Adelaide was a file clerk who had been fired a couple of years ago 1 Page because she refused to follow company policy. Trafalgar asked Lee if he could find Adelaide. Lee said that he heard she was working for some firm in town and would find out where Eventually, Trafalgar found Adelaide working as a bookkeeper for Maze Woolwich. During a phone conversation Adelaide explained about her being fired by Mr. Black. She went on to explain that after she got fired she went to see Mr. Woolwich. Apparently, Woolwich realized that Adelaide was right and that Lee High and Mr. Black were wrong. Adelaide went on to say that Mr. Woolwich felt bad about her getting fired. Woolwich had intended to retire but decided to hire Ms. Ladywell as a bookkeeper. Adelaide had been working for Woolwich ever since. Shortly after Trafalgar finished talking to Adelaide, Crofton entered the office. With his usual efficiency, he made the following points: We had better get a budgeting system immediately and try to see where we are. (Any complex cost accounting would have to wait.) Lee has got to go. We must decide on how to get a budgeting system put together quickly because Black's might be broken Crofton concluded by asking. "Did you find Adelaide Ladywell? She is the only person around here in the last three years who did anything right, and she got fired." Trafalgar indicated that Ms. Ladywell was going to stop by after work and talk to them. Crofton then suggested Trafalgar fire Lee High and try to rehire Adelaide as the bookkeeper-analyst. That afternoon Lee was fired, given two month's pay, and asked to leave the office by 3 o'clock. The same evening Adelaide agreed to work for Trafalgar on the condition she would not have to deal with either the older Mr. Black or Lee High. Trafalgar explained that Lee was already gone, and his father left for Florida several days previously. Adelaide agreed to be at work the following Monday morning. She indicated that Mr. Woolwich was all but out of business and no longer needed her services. 2 Page Part II After Lee High had left the office, Crofton Brockley went through all the available records and files and, as a result, was able to establish the following information as a basis to begin the budgeting process. Items about which Lee High seemed to be correct: Variable Direct Costs Direct materials cost per unit Direct labor cost per unit Total .75 1.25 $2.00 Variable Overhead Indirect labor cost per unit Electricity cost per unit Other overhead per unit produced Total $.20 .10 5.80 Fixed Costs Indirect labor per week Indirect materials per week Electricity per week Factory insurance per week Other overhead per week Total $100 300 75 125 110 $ 710 The office expenses are very close to $781 per week. Of this amount, the breakdown seems to be: 400 200 Salaries (including fringe benefits and payroll tax) Rent on office Depreciation on office equipment Utilities Total 100 $ 781 Direct labor is paid on a piece-rate (or "piecework") basis. Workers are paid $1.25 per unit produced Average rate of accounts receivable collection is as follows: During the month in which sale is made 1" month after sale 2nd month after sale 3 month after sale 30% 40% 20% 10% 100% 31 Page Several other notations made by Crofton Brockley a) Trafalgar expected to draw $1,400 per month for personal use. b) Consulting fees will be billed at about $225 per week or $900 per month. c) A reasonable estimation of the value of factory and equipment is $70,000. Depreciation should be monthly on the basis of an average useful life of 5 years. This equipment will have a salvage value of $2,500. d) The production process to produce the Great Beast is fairly simple. Raw materials consist of a single item, which is usually entered into the process in the morning. Various machining operations take place during the day. At the end of each day, all the finished units are moved into the storeroom. Because started units are always finished before the workers go home, there is never a work-in-process inventory overnight. e) Assume that this coming year's net income will be relatively low and, therefore, compute income tax on the basis of 25% of net income. Taxes will be paid quarterly at the end of the last day of the quarter. 1) The inventory of raw materials at the beginning of the coming year will be 800 units, and there will be 750 units of finished product. General guidelines set by Crofton Brockley These guidelines should be followed through the year, at which time they are to be review and revised. a) The estimates of variable costs of production are almost certainly correct. b) Fixed costs of production are almost certainly correct at $710 per week, except that there is no estimation or allowance for depreciation. Take fixed cost of production to equal $710 plus depreciation. c) Charge fixed factory overhead on a monthly basis. Since the $710 per week amount seems reasonable, charge a monthly amount of $710 times 4.5 (four and one-half times). The over-or under-applied overhead existing at the end of a month will be charged as part of that month's cost of goods sold. d) Establish cost accounting records on the basis of full cost, assuming that normal output is 500 units per week, or 2,250 units per month. Thus, budgeted full cost is $4.72 per unit. e) Selling commission should be 10% on all sales, and the price on regular sales should be set at $7.00 per unit. f) All depreciation should be on a straight-line basis. Following is an estimation of the balance sheet as it will appear on January 1, when Trafalgar Black takes complete control of the business: Cash Receivables Raw material inventory Finished goods inventory (54.72/unit) Office equipment Factory equipment Land Total Assets $ 10,000 14.700 600 3,540 13,122 70,000 5.000 $116.962 Accounts Payable Notes Payable Capital: Trafalgar Black Total Liabilities and Owners' Equity $ 1,275 30.000 85,687 S116.962 Production Adelaide's first important step in budgeting was to develop a production budget and a raw materials schedule for the first quarter of the coming year. Actual sales for the prior October and November were available, and reasonable estimates of sales for December and the first four months of the coming year were made. Actual sales (units) October November 1,500 2,300 Expected sales (units) December January (of the coming year) February (of the coming year) March (of the coming year) April of the coming year) 1,800 2,000 2,200 1,900 2,100 Since there was no established policy on production scheduling, inventory planning, or raw materials inventory, it was necessary to establish one. Crofton. Trafalgar, and Adelaide agreed that a policy based on experience would have to wait until some data were collected over the next 6 to 8 months. In an effort to get things going." they settled on a two-part operational statement of policy: a) Production in any month should be scheduled so that an ending inventory of Great Beast will equal one-half of the next month's expected sales. b) Purchase of raw material should be made so that on average there are enough raw materials on hand to produce 700 Great Beasts. Thus, no end-of-month inventory should have fewer than 700 units of raw material. Cost of Production Adelaide's next task was to prepare a flexible budget that could later be used to prepare a budgeted income statement and would also help Trafalgar tell whether actual expenditures were as they should be. She decided to use the format shown in the variable budget table below. On the left she would write in the cost formula, which would show how much should be spent on each item for any given production volume. Projected number of units produced January February March Cost Formula Cost Item Materials used Direct labor Indirect labor Electricity Indirect materials Factory insurance Other overhead Depreciation Total cost Cost per unit Income Statements Having developed this data, Adelaide decided to project income statements for January, February and March Cash budgets After developing the income statements, Adelaide decided to see what would happen to the cash position of Black during the quarter. When Mr. Black actually turns the business over to Trafalgar, Mr. Black will withdraw all cash. All receivables will be due to Trafalgar, and all payables will be his responsibility. Trafalgar expects to pay $30,000 for the business, which will be a liability of the business, and he intends to deposit $10,000 in the firm's checking account to establish a working balance. Raw materials are always purchased on a 30-day-due basis. Consequently, payments are always made in the month following the purchase of materials. It is expected that 1,700 units of materials will be purchased during the December prior to the coming year. Direct labor, all overhead, commissions, salaries, rent and utilities are paid in the month incurred 6 Page Balance Sheet As a final step in the general budget process Adelaide decided to project a balance sheet as of the coming year's April 1. Evaluation of the Budget Armed with the material developed to date, Adelaide, Crofton, and Trafalgar had a meeting to discuss problems that were likely to arise. What points would be likely to dominate such a meeting? Why? January Activity In early February, the following information was available on January's activity. Sales: 2.250 units @ $7.00 Actual productions: 2,250 units Expenses actually paid: Direct materials bought Direct labor Indirect labor Electricity Indirect materials Factory insurance Other overhead Office expense Commissions $1,660.00 2,812.50 895.00 325.00 1,570.00 562.50 1,600,00 2,260.00 1.400.00 Ending raw materials were 600 units Neither Crofton nor Trafalgar had been paid anything yet. Requirements: Prepare a Pro Forma Master Budget for the first quarter of the year. which should include a sales budget, production budget, raw materials budget, direct labor production, MOH budget, selling and administrative budget, COGS/FG budget, cash budget, income statement and ending balance sheet. 7 Page