Analysis of Shoe Shop and Cash Budget for Sports Shoe Production

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Stephen has recently opened The Shoe Shop in Loughborough, a store that specializes in sports shoes. Stephen has just received a degree in Sports Management from Loughborough University and he is anxious to apply the principles he has learned to his business. In time, he hopes to open a chain of sports shoe shops. As a first step, he has prepared the following analysis for his new store:

 

Required:

• How many pairs of shoes must be sold each year to break even? What does this represent in total revenue?              

(b) Stephen has decided that he must earn at least £18,000 the first year to justify his time and effort. How many pairs of shoes must be sold to reach his target profit?  

(c) Refer to the original data. During the first year, the store sold only 3,000 pairs of shoes and reported the following operating results:

What is the store’s degree of operating leverage? Comment on the result obtained.                                     

(d) Stephen now has two salespersons working in the store – one full-time and one part-time. It will cost him an additional £8,000 per year to convert the part-time position to a full-time position. Stephen believes that the change would bring in an additional £25,000 in sales each year. Should he convert the position? You should assume that fixed costs are not changed by changing the position to full-time.

(e) What other financial and non-financial factors should Stephen take into consideration before deciding to convert the part-time position into a full-time one?

Brothers Hamza and Selim Eliwa have recently won a design award for their ‘Besty’ sports shoes and have established a company, HS Eliwa Ltd, to commence production of the footwear. The ‘Besty’ shoes have an innovative design and are made of a resilient, cushioning material, which reduces the possibility of injury. Hamza has just read a newspaper article about the importance of cash budgets in highlighting the finances required for business operations. Consequently, he has asked for your assistance in preparing a cash budget for the first four months of operations, from May to August 2018. The following information has been obtained from a planning meeting with the Eliwa brothers:

Details of selling prices and projected sales for the four-month period of ‘Besty’ shoes are shown below.

It is expected that all sales will be on credit to department stores and shops specialising in sports shoes. The brothers estimate that 30% of customers will pay after one month while the remaining customers will take two months to pay.

Section B

Production of the ‘Besty’ shoes is based on sales demand. The company follows a zero inventory policy at the end of each month. As the company is just commencing operations there are no opening inventories of shoes.

The shoes comprise cushioning fabric and specially treated rubber for the sole. The materials and labour costs required to meet the demand of shoes are shown in the following table.  

Both of the materials are supplied by a company based in Egypt. This supplier requires that 50% of the purchase total is paid in cash with the order, and allows one month’s credit for the remaining amount. Labour costs are paid in the month incurred.

The company has signed a rental agreement for the production facility. The total factory rent for the year will be £360,000, which will be paid in equal monthly instalments. A security deposit amounting to £25,000 must also be paid in May. Other operational costs including power, insurance, and administration expenses, which must be paid in equal monthly instalments, are expected to be £93,600 for the year.

To promote the Besty shoes a marketing campaign for television, radio, newspaper and social media has been organised. The total cost of the marketing campaign has been agreed at £33,600 for the four-month period payable in equal monthly instalments from May 2018. A commission of 5% of projected sales is also payable one month in arrears.

Hamza and Selim Eliwa will introduce capital of £50,000 at the commencement of the company’s operations.         

Required:

• Prepare a cash budget for HS Eliwa Ltd on a monthly basis for the four month period commencing 1 May 2018, clearly showing the closing cash balance at the end of each month.                                                                                                                 
• What cash flow problem is HS Eliwa Ltd likely to face in the next four months?  Provide suggestions as to how the business might deal with this problem.                    

Matthew Walker started a new business in 2017 to produce domestic solar water heating panels.  The solar panel can be mounted on a roof and is intended to work alongside a conventional water heater.  Matthew’s accountant prepared the following variable costing income statement after the first year in order to help him make decisions.

 

During the year, the following variable production costs per unit were recorded:  direct materials, £800; direct labour, £300; and overhead, £200.

Mr Walker was upset about the net loss because he had wanted to borrow funds to extend capacity.  His friend who teaches accounting at a local university suggested that the use of absorption costing could change the picture.

Required:

• Prepare an absorption costing income statement.
• Explain the source of the difference between the net income (loss) figures under the two costing systems.
• Would it be appropriate to present an absorption costing income statement to the local banker in light of Mr Walker’s knowledge of the net loss determined under variable costing?  Explain.

Assume that during the second year of operations, Mr Walker’s company produced 1,750 panels, sold 1,850, and experienced the same total fixed costs.

1. Prepare a variable costing income statement.
2. Prepare an absorption costing income statement.

You are a trainee accountant in an accounting firm who offer specialised services to small and medium sized enterprises (SMEs). Recently, the firm was approached for assistance by a number of managing directors of SMEs, who wish to recruit an accountant to their companies but who were unsure of the difference between a financial accountant and a management accountant. As a first step, the partner in charge has decided to give a short presentation to the managing directors to provide information and clarification about financial accounting and management accounting.

You have been asked by the partner in charge to prepare a briefing note for the presentation.

Required:

Draft a briefing note for the partner in charge that:

1. Suggests reasons why management accounting is so important in the current business environment. (6 marks)
2.  Outlines the key differences between financial accounting and management accounting. (15 marks)

Please consider the following scenario:

The management accountant at Arden Ltd is faced with a dilemma.  He has discovered that approximately one third of the finished goods stock currently held is damaged and therefore not fit for sale.  The managing director (and majority shareholder) is trying to sell the firm and has informed him that it is not necessary to write down stock at this time.  

Explain why it would not be ethical for the management accountant to follow the instruction of the managing director and state what steps need to be taken in order to reach a satisfactory solution.

 

‘Costs may be classified in a variety of ways according to their nature and information needs of management’.  Explain and discuss this statement and provide examples of the classifications required for different purposes.