Question:
Mr McAdams had promoted Chris Lee to Vice-president of Finance, Lee had been practically running the business for several years during which time sales and profit has been declining. On November 15, 2016, Mr McAdams announced that his son Lachlan McAdams would take over as owner and president on January 1, 2017. Lachlan was a graduate of a MBA program and for several years had been working for a large consulting firm as a marketing specialist.
In their private discussions, Mr McAdams told his son that the problems in the family firm were marketing rather than financial, so the situation was ready made for Lachlan. Mr McAdams, it seems, has been completely taken in by Chris Lee. When Lachlan finally arrived at McAdams Manufacturing Company on December 1, 2016,and began to read various internal reports he realised that McAdams Manufacturing Company did not have a cash budget and there didn’t seem to be much in the way of financial planning.
Lachlan asked Chris Lee about this. Lee’s response was that McAdams Manufacturing Company ran on the basis of several well-developed decision rules and budgets weren’t necessary because the firm never ran out of funds, Mr McAdams simply deposited $10,000 or $20,000 in the company’s bank account. Lachlan’s response was swift and 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 accountant to work up some “stuff”.
Lachlan decided to call his old friend, Stephanie Singh. Stephanie was in charge of several large budgeting projects for a consulting firm and Lachlan knew Stephanie to be a recognized expert on budgeting for small companies. Fortunately for Lachlan, Stephanie wasn’t busy that week and was able to fly in the next day.Stephanie spent two days going over the accounting records, interoffice emails and everything else she could find. On Friday morning, Lachlan read the following email Dear Lachlan Had to leave last night for Brisbane. During the two days I spent in the office I discovered:
1. You have no budget or control system at all.
2. Chris Lee’s decision rules are all wrong.
Answer:
| January 2017 |
750 |
2,350 |
| February 2017 |
1,100 |
2,200 |
| March 2017 |
1,100 |
2,200 |
| January 2017 |
800 |
700 |
| February 2017 |
700 |
700 |
| March 2017 |
700 |
700 |
| Cost of Production and Flexible Budget |
January |
February |
| Projected number of units produced |
2,350 |
2,200 |
| Direct materials cost per unit |
$1,762.50 |
$1,650.00 |
| Direct labour cost per unit |
2,937.50 |
2,750.00 |
| Indirect labour cost per unit |
470.00 |
440.00 |
| Electricity cost per unit |
235.00 |
220.00 |
| Other overhead cost per unit produced |
1,175.00 |
1,100.00 |
| Total variable costs |
$6,580.00 |
$6,160.00 |
| Indirect labour per month - Fixed cost |
450.00 |
450.00 |
| Indirect materials per month - Fixed cost |
1,350.00 |
1,350.00 |
| Electricity cost per month - Fixed cost |
337.50 |
337.50 |
| Factory insurance per month - Fixed cost |
562.50 |
562.50 |
| Other overhead per month - Fixed cost |
495.00 |
495.00 |
| Depreciation |
1,125.00 |
1,125.00 |
| Total fixed costs |
$4,320.00 |
$4,320.00 |
| Total costs |
$10,900.00 |
$10,480.00 |
| Cost per unit |
$1.61 |
$1.55 |
| Income Statements |
January |
February |
| Units |
750 |
1,100 |
| Cost at $4.72 per unit (see balance sheet) |
$3,540.00 |
$5,192.00 |
| Cost of units produced (see total costs above) |
$10,900.00 |
$10,480.00 |
| Units |
1,100 |
1,100 |
| Cost at $4.72 per unit (see balance sheet) |
$5,192.00 |
$5,192.00 |
| Cost of units (goods) sold |
$9,248.00 |
$10,480.00 |
| Units sold |
2,000 |
2,200 |
| Selling price per unit |
$7.00 |
$7.00 |
| Sales revenue |
$14,000 |
$15,400 |
| Less cost of goods sold |
9,248.00 |
10,480.00 |
| Gross Margin |
$4,752.00 |
$4,920.00 |
| Office expenses |
$3,514.50 |
$3,514.50 |
| Commissions |
1,400.00 |
1,540.00 |
| Consulting fees |
900.00 |
900.00 |
| Total operating expenses |
$5,814.50 |
$5,954.50 |
| Net Profit |
-$1,062.50 |
-$1,034.50 |
| Cash Budgets |
January |
February |
| Sales Revenue (see income statements) |
$14,000 |
$15,400 |
| Opening Cash Balance (see balance sheet) |
$10,000 |
$8,772.50 |
| Current month in which sale is made Cash Collected |
$4,200 |
$4,620 |
| First month after sale |
December |
January |
| Sales (units) |
1,800 |
2,000 |
| Selling price per unit |
$7.00 |
$7.00 |
| Sales revenue |
$12,600 |
$14,000 |
| Cash Collected |
$5,040 |
$5,600 |
| Second month after sale |
November |
December |
| Sales (units) |
2,300 |
1,800 |
| Selling price per unit |
$7.00 |
$7.00 |
| Sales revenue |
$16,100.00 |
$12,600.00 |
| Cash Collected |
$3,220.00 |
$2,520.00 |
| Sales (units) |
1,500 |
2,300 |
| Selling price per unit |
$7.00 |
$7.00 |
| Sales revenue |
$10,500 |
$16,100 |
| Cash Collected |
$1,050.00 |
$1,610.00 |
| Total Collections |
$13,510.00 |
$14,350.00 |
| Production costs except materials and depreciation |
$8,012.50 |
$7,705.00 |
| Material purchases |
December |
January |
| (pay for previous months purchases in current month) |
1,700 |
2,250 |
| Material purchases |
1,275.00 |
1,687.50 |
| Office expenses except depreciation |
3,150.00 |
3,150.00 |
| Commissions |
1,400.00 |
1,540.00 |
| Consulting |
900.00 |
900.00 |
| Total cash outlays |
$14,737.50 |
$14,982.50 |
| Ending Balance |
$8,772.50 |
$8,140.00 |
| If you include cash drawings of $1,400 per month |
1,400.00 |
1,400.00 |
| Ending Balance |
$7,372.50 |
$5,340.00 |
| Cash |
$10,000.00 |
$3,415.00 |
| Receivables |
14,000.00 |
15,330.00 |
| Raw materials inventory |
600.00 |
525.00 |
| Finished goods inventory |
3,540.00 |
5,192.00 |
| Office Equipment |
13,122.00 |
13,122.00 |
| Factory equipment |
70,000 |
70,000.00 |
| Land |
5,000 |
5,000.00 |
| Total Assets |
$1,16,262.00 |
$1,08,115.50 |
| Accounts Payable |
$1,275.00 |
$1,650.00 |
| Notes Payable |
30,000.00 |
30,000.00 |
| Capital |
85,687.00 |
81,487.00 |
| Total Liabilities and Capital |
$1,16,962.00 |
$1,08,115.50 |
