You have just started a new job as general manager of Schultz Seating Ltd a UK-based company whose principal activity is the manufacture and distribution of soft furnishings.

After discussions with a number of senior managers at Schultz Seating Ltd, you have concluded that the current budgeting system is not operating effectively and you believe it requires significant reform.

You have therefore carried out some background research on budgeting and strategic planning and have obtained the following documents (available on the module Moodle page).

Document 1 – A journal article on budgeting and Beyond Budgeting (Rickards, R.C. (2006).

‘Beyond Budgeting: Boon or Boondoggle?’ Investment Management and Financial

Innovations 3, (2) 62-76)

Document 2     Income statements

The following income statements relate to Schultz Seating Ltd.

Year-ended	30/09/18	30/09/17	30/09/16	30/09/15	30/09/14	30/09/13	30/09/12
	£000	£000	£000	£000	£000	£000	£000
Turnover	6,304	6,367	6,431	6,495	6,560	6,626	6,692
Cost of Sales	(5,989)	(6,049)	(6,109)	(6,170)	(6,232)	(6,294)	(6,357)

Gross Profit 315            318            322            325            328            331              335

Operating Expenses Operating Profit/(loss)

(490)         (495)          (500)          (505)          (510)          (515)          (520)

(175)         (177)          (178)          (180)          (182)          (184)          (186)

The last seven years have been very difficult for the company, and it has survived through the support of its parent company, to whom it currently owes a significant debt. However, the company now intends to engage in a number of income generating, cost-saving and efficiency measures in order to improve its financial performance. Although these may increase costs in the short-term, management hope they will enhance awareness of the company’s products, increase sales and reduce costs and return the company to profitability.

Document 3 – New product line

Schultz are considering introducing a new line of sofa. The sofa has been developed and is ready to go into production. However, management need to decide whether to manufacture the sofa in a new factory unit near their main premises in North West England or to outsource production to a supplier company.

Information relevant to this decision is given in the following table:

	In-house Outsourced manufacture manufacture
Sales price (per sofa)		£550.00	£550.00
Direct materials cost (per sofa)		£220.00	£0.00
Direct labour cost (per sofa)		£200.00	£0.00
Buy-in cost from outsourced manufacturer		£0.00	£500.00
Fixed manufacturing overheads		£550,000	£0
Fixed administrative overheads		£150,000	£150,000
Fixed selling and distribution overheads		£125,000	£125,000
Break-even point (sofas)		6,347	5,500
Unit sales required to achieve budgeted profit of £500,000 (sofas)	10,193	15,500
Margin of safety at budgeted profit level	38%	65%

In addition the following profit-volume chart has been produced:

Document 4     Cash budget

Schultz Seating Ltd’s Finance Department has prepared the following cash budget and budgeted income statement for the first 6 months of 2019, a period in which the company is expected to return to profit.

Cash budget	January	February	March	April	May	June
	£	£	£	£	£	£
Opening balance	(4,976)	(5,182)	(16,736)	(30,421)	(43,095)	(55,467)
RECEIPTS:
Cash sales	65,655	66,559	68,066	68,946	69,209	69,467
Credit sales	205,425	198,285	202,361	208,324	212,424	214,651
Total receipts		271,080	264,844	270,427	277,270	281,632	284,118
PAYMENTS:
Cash purchases		(66,128)	(69,093)	(72,171)	(74,751)	(77,165)	(79,662)
Credit purchases		(65,583)	(64,173)	(65,039)	(65,866)	(66,108)	(66,094)
Operating expenses		(16,800)	(17,640)	(18,300)	(18,756)	(18,994)	(19,003)
Fixed overheads		(10,500)	(10,500)	(10,500)	(10,500)	(10,500)	(10,500)
Production labour		(106,096)	(108,627)	(111,677)	(113,715)	(115,076)	(116,478)

Administration costs Total payments:

Net cash flow	(206)	(11,554)	(13,685)	(12,674)	(12,371)	(13,472)
Balance c/f	(5,182)	(16,736)	(30,421)	(43,095)	(55,467)	(68,939)
Budgeted income
statement	January	February	March	April	May	June
	£	£	£	£	£	£
Sales	263,940	268,920	276,390	281,370	283,860	286,350

Cost of sales

Gross profit

Operating expenses		(17,640)	(18,300)	(18,756)	(18,994)	(19,003)	(18,784)
Fixed overheads		(15,500)	(15,500)	(15,500)	(15,500)	(15,500)	(15,500)
Administration costs		(6,180)	(6,365)	(6,425)	(6,356)	(6,162)	(5,854)
Total expenses	(39,320)	(40,165)	(40,682)	(40,850)	(40,665)	(40,138)
Operating profit/(loss)	(1,028)	(1,150)	(583)	(28)	518	1,406

The following information is relevant to the cash budget:

Credit customers are allowed one month’s credit on sales;

Credit suppliers allow one month credit on raw materials purchases;

Production labour is included in the cost of sales in the budgeted income statement.

The following information from the budgeted Statement of Financial Position is also available.

	Jan	Feb	Mar	Apr	May	Jun
	£	£	£	£	£	£
Trade receivables	198,285	202,361	208,324	212,424	214,651	216,883
Trade payables Finished goods	64,173	65,039	65,866	66,108	66,094	66,046
inventory Raw materials	39,594	45,183	51,069	57,365	64,451	72,327
inventory	55,637	62,901	70,437	78,167	86,738	96,241

Document 5     Full (absorption) costing

Schultz Seating Ltd’s product costing team have provided you with the following information on the current method used to charge overhead costs to products. The table shows each overhead cost and the apportioned and reapportioned costs by cost centre together with the apportionment bases used.

Department	Lounge   Furniture	Dining furniture	Bedroom   Furniture	Mainte   -nance	Adminis   -tration	Total
Direct materials (£)	437,102	669,033	557,528	0	0	1,663,663
Direct labour (£)	184,691	282,690	235,575	0	0	702,956
Direct costs	621,793	951,724	793,103	0	0	2,366,619
Overheads   Indirect labour (direct
labour)	10,299	15,764	13,137	0	0	39,200
Rent (floor area)	14,377	17,775	17,644	1,359	1,046	52,200
Machine insurance (machine value)	979	1,489	3,779	254	–	6,500
Heating (floor area)   Machine power	2,864	3,541	3,515	271	208	10,400
(machine hours)   Machine depreciation	3,675	3,325	2,800	0	0	9,800
(machine value)   Total apportioned	1,175	1,786	4,534	304	0	7,800
overhead costs Re-apportion maintenance (machine	33,370	43,680	45,409	2,188	1,254	125,900
hours) Re-apportion	820	742	625	(2,188)	0	0
administration   (employees) Total re-apportioned	462	429	363	0	(1,254)	–
overhead costs	34,652	44,851	46,397	0	0	125,900
Machine hours Overhead absorption rate per machine	21,356	19,322	16,271
hour (£)	1.62	2.32	2.85

The costing team have been reviewing the overhead costing methodology and have prepared the following proposal for a revised costing method.

Department	Lounge   Furniture	Dining furniture	Bedroom   Furniture	Mainte   -nance	Adminis   -tration	Total
Direct materials (£)	437,102	669,033	557,528	0	0	1,663,663
Direct labour (£)	184,691	282,690	235,575	0	0	702,956
Direct costs	621,793	951,724	793,103	0	0	2,366,619
Overheads   Indirect labour
(employees)	9,147	8,493	7,187	6,533	7,840	39,200
Rent (employees) Machine insurance	14,377	17,775	17,644	1,359	1,046	52,200
(machine hours)	2,438	2,205	1,857	0	0	6,500
Heating (employees) Machine power	2,427	2,253	1,907	1,733	2,080	10,400
(machine hours)   Machine depreciation	3,675	3,325	2,800	0	0	9,800
(machine hours)   Total apportioned	2,925	2,646	2,229	0	0	7,800
overhead costs Re-apportion maintenance (machine	34,987	36,698	33,623	9,626	10,966	125,900
value) Re-apportion administration (floor	1,509	2,294	5,823	(9,626)	0	0
area)   Total re-apportioned	3,166	3,914	3,885	0	(10,966)	0
overhead costs	39,662	42,906	43,331	0	0	125,900
Machine hours Overhead absorption rate per machine	21,356	19,322	16,271
hour (£)	1.86	2.22	2.66

The Sales Director has expressed the view that this new method is superior because it reduces the overheads chargeable to the Dining and Bedroom Furniture profit centres, both of which have struggled to increase sales and make profits over the past few years. The reduction in overhead costs charged to these departments will help them to increase sales, by reducing prices, and maintain or increase profits at the same time.

Document 6     Capital investment appraisal

The Bedroom Furniture  profit centre is considering purchasing a new piece of equipment to help save costs and make the production process more efficient.

There are two options for the new piece of equipment. The Stitchking will further automate production processes for items that needs stitching such as mattresses. The Gluegenie will improve production processes and product quality for items requiring adhesive, such as bed frames and chests of drawers.

The following information about the cash flows, profits and capital investment appraisal measures has been provided to you. The company’s cost of capital is currently 6%.

Stitchking
Cash flow        6%   Year (£)           Factors	Present         Depreciation value (£)        (£)	Profit (£)	Cumulative cash flow (£)
0      (500,000)      1.0000	(500,000)		(500,000)
1         160,000      0.9434	150,944            (88,000)	72,000	(340,000)
2         140,000      0.8900	124,600            (88,000)	52,000	(200,000)
3         125,000      0.8396	104,950            (88,000)	37,000	(75,000)
4         105,000      0.7921	83,171            (88,000)	17,000	30,000
5           90,000      0.7473	67,257            (88,000)	2,000	120,000
5*           60,000      0.7473	44,838		180,000
NPV =	75,760	180,000
Payback period	3 years 9 months
Accounting rate of return	12.9%
Internal rate of return	11.3%
Gluegenie
Cash flow        6%   Year (£)           Factors	Present         Depreciation value (£)        (£)	Profit (£)	Cumulative cash flow (£)
0           (700,000)      1.0000	(700,000)		(700,000)
1              127,000      0.9434	119,812          (123,000)	4,000	(573,000)
2              148,000      0.8900	131,720          (123,000)	25,000	(425,000)
3              176,000      0.8396	147,770          (123,000)	53,000	(249,000)
4              198,000      0.7921	156,836          (123,000)	75,000	(51,000)
5              226,000      0.7473	168,890          (123,000)	103,000	175,000
5*               85,000      0.7473	63,521		260,000
NPV =	88,548	260,000
Payback period	4 years 3 months
Accounting rate of return	13.2%
Internal rate of return	9.7%

*The second cash flow in year 5 for each option represents the sales proceeds on the disposal of the equipment at the end of its life (residual value).

The Stitchking will not be fully effective until a number of new product lines requiring stitching have been introduced over the next few years, whereas the Gluegenie will reduce costs and improve efficiency on existing product lines.

Only one of the two pieces of equipment can be purchased in the near future due to a lack of investment capital.

Assignment requirements

You are required to write a report for the Board of Directors of Schultz Seating Ltd (italicized words in brackets indicate the approximate word count for each section).

The report should cover the following key areas:

An executive summary outlining the key challenges that the company is facing and the main outcomes from the analysis work you have under taken so far (250-300 words) .

A critical discussion of the Beyond Budgeting model focusing on the benefits it could bring to Schultz Seating Ltd and the challenges they would face if they decided to introduce it (Document 1) (225-275 words) .

A discussion of the break-even analysis of the proposed new sofa (Document 3) with particular emphasis on the following areas :

An explanation of the different types of cost behaviour and why all fixed costs are in reality stepped fixed costs (90-110 words) .

A review of the risk and return offered by the two manufacturing options with reference to the concept of operating gearing and a recommendation on which option Schultz Seating Ltd should choose (210-240 words) .

A discussion of the reasons for the differences between the net cash flows and the operating profit in the statements above (Document 4), and in particular why net cash flow remains negative when the company returns to profit at the end of the six-month period (325-375 words) .

A discussion of the original and proposed costing methods above (Document 5) with particular emphasis on the following areas:

A critical appraisal of the reasons for the choice of apportionment bases used in both the original and proposed costing methods (275-325 words) ;

A critical appraisal of the Sales Director’s view that the proposed costing method is superior because it reduces the overheads chargeable to the Dining and Bedroom Furniture profit centres (180-210 words) .

A critical appraisal of the results of the capital investment appraisal of the Stitchking and Gluegenie (Document 6) with particular emphasis on the following areas:

A discussion of the reasons for the apparent conflicts between the investment advice provided by each method (375-425 words) ;

A discussion of the risk and return presented by each option and a recommendation as to which option should be chosen, given the lack of investment capital available to the company (170-200 words) .