Accounting Exercises 6: Budgeting

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by Clemens Werkmeister

Information about Sales and Costs

Kitefun Inc. produces a single kite model for kitesurfing. At the end of March, Kitty, the owner, expects increasing sales in the months April to July:

March: 1,000 April: 1,500 May: 2,500 June: 3,000 July: 4,000.

Kitefun has to ship all kites for May to retailers at April 29. Expected unit price is $400/kite. Retailers will pay the kites sold in April at the end of the next month (May). The same lags apply to shipments and payments of the following months.

a. In order to enable quick reactions to demand, apart from the kites sent to retailers, Kitty requires finished goods ending inventory to be 25 % of the next month's sales. However, ending inventory of March is 500 units at a unit cost of goods sold of $250.

b. Kitefun uses the following direct materials for its kites:

Direct Material Per-Unit Usage Unit Cost ($)
Polyester 10 m² $9/m²
Flying lines 18 m $2/m

Raw material policy determines that at the end of a month materials be available for half of next months' sales. This is true for March 31.

c. The direct labor used per kite is five hours. Kitty pays $12 per average direct labor hour.

d. Monthly manufacturing overhead is estimated using a flexible budgeting formula with activity measured in direct labor hours.

Manufacturing
Overhead
Fixed
Cost ($)
Variable
Cost/DLH ($)
Supplies - $0.40
Maintenance $10,000 $0.60
Depreciation $50,000 -
Taxes $10,000 -
Other $40,000 $1.00

e. Selling and administrative expenses are determined using a flexible budgeting formula with kites sold as activity measure.

Selling &
Administration
Fixed
Cost ($)
Unit variable
cost ($)
Salaries $5,000 -
Commissions - $3.00
Depreciation $10,000 -
Shipping - $20.00
Other $12,000 $3.00

f. All purchases are for cash. The cash balance on March 31 equals $100,000. Due to the seasonal expansion of activity, Kitty expects the tentative ending cash balance to show a cash shortage by the end of April and May. In order to cover it, Kitty negotiates a loan limit with her bank. She agrees on a 12 percent annual interest rate for the amount used and on a 1.2 percent annual fee for the amounts unneeded. Interest and fees are calculated monthly, the loan limit has to be determined at March 31 for the next three months. Kitty agrees on a $600,000 limit.

Operating budgets

Prepare the monthly and the quarterly operating and financial budgets for the second quarter with the following schedules following the master budget approach. Assume that there is no change in work-in-process inventories.
B1. Sales budget
B2. Production budget in units
B3. Direct materials purchases budget (for each material and total)
B4. Direct labor budget
B5. Overhead budget with fixed and variable overhead
B6. Selling and administrative expenses budget with fixed and variable expenses
B7. Unit manufacturing cost. Calculate fixed cost per unit by dividing total fixed overhead of the month by total units produced during the month.
B8. Ending finished goods inventory budget and beginning finished goods inventory.
B9. Cost of goods sold budget.
B10. Budget income statement with operating income before interest and taxes (EBIT).

Financial budgets

F1. Cash budget including the adequate financing and the resulting monthly interest and fee payments.
F2. Budget net income (after interest expenses, financing fees and taxes). Assume a tax rate of 25 %.

Analysis of the master budget

A1. Unit manufacturing costs are decreasing from March to June. Explain why.
A2. Compare the change in cash with the net income. Why is the net income higher than the cash change?
A3. Paul is responsible for Marketing and Sales at Kitefun. He suggests a price increase by 10 % in June and expects to sell 2,800 units at this price. What do you think about Paul's suggestion? Estimate the financial effects and the underlying assumptions.
A4. Describe the budgeting approach of Kitefun with respect to typical features of budgets.


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References:
Burr/Stephan/Werkmeister: Unternehmensführung. 2. Aufl., München 2011, p. 162 ff.