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Flexible Budget and Cash Budget: A Case Study Analysis

Question 1

Question 1

Fluffy is a division of Cleaning Products plc which makes and sells a single product, the Fluffy Duster. The original budget for the Fluffy Duster was to produce and sell 20,000 units in December. The company actually produced and sold 23,000 units. Details of the original budget and actual results are given below

 Original budget (20,000 units) £ Actual results (23,000 units) £ Variance   £ Sales 620,000 671,000 51,000 F Variable costs: Materials 160,000 149,600 10,400 F Labour 280,000 352,000 (72,000) A Semi variable costs (refer to Note) Heat, light & power 26,200 26,750 (550) A Fixed costs: Rent & rates 60,000 60,300 (300) A Net profit 93,800 82,350 11,450 A

(F = Favourable; A = Adverse)

Note:

Heat, light and power are semi variable costs. Budgeted costs are calculated using the high-low method of cost estimation. The costs and output for the previous seven months are as follows:

 Month Budgeted output (units) Budgeted costs (£) May 16,800 23,700 June 22,300 26,500 July 15,000 22,200 August 19,500 24,600 September 20,900 26,300 October 24,000 29,400 November 18,600 23,400

The supervisor of the company is quite pleased with the actual results for December compared to the original budget, as shown in the first table above, and has been congratulating the marketing manager in particular. The company accountant however is not so sure about the comparison being made and has decided to undertake some further work. As a result she has asked you for the following:

Requirements:

a. A flexible budget for 23,000 units compared with the actual results, showing all variances, indicating whether the variance is favourable or adverse. (15 marks)

b. An explanation of how flexible budgets are used to achieve effective budgetary control using the above example to illustrate your answer. (6 marks)

c. A brief explanation as to why the (least-squares) regression method is considered to be superior to the high-low method for estimating the cost function of a semi-variable cost. (4 marks)

Question 2

Corola Limited manufactures, amongst other things, surgical masks (the CorMask), gloves and disinfectants for medical and public use.  Due to recent potential outbreaks of a global virus and shortages due to huge demand they now see an opportunity to expand further and quickly into Asian markets.  To do this, they are seeking short term and speedy bank finance to expand up to their maximum production capacity in order to maximise their sales to their retailers while the opportunity exists and demand and pricing is extraordinarily high. To consider the potential increase in financial support, the bank requires Corola Limited to provide a cash budget for the six months beginning 1 July 2021. The company has provided the following information:

1. Corola Limited will sell the CorMask to retailers for £10 and projects the following sales (in units) for the next six months:

 July August September October November December 160,000 300,000 400,000 240,000 320,000 360,000

2. To encourage prompt payment from retailers, effective from 1 July 2021, the company has decided to give a discount for cash payments. Corola Limited expects that 40% of all customers will take up this offer and will receive a discount of 5%, 50% of all customers will pay one month after sale, and the remaining 10% of all customers will pay two months after the month of sale.

3. Each mask uses materials of £2 and the company has agreed to pay 30% of all purchases in cash with the remainder paid in the month after purchase. All purchases will be made in the month of sale to match the sales volumes.

4. Salary and wage costs per month are expected to be £400,000 each month for the first two months and to increase by £40,000 per month for each of the next four months, as the company hires new staff.

5. Administration costs are projected to be £1,380,000 for the year, including depreciation of £144,000. Administration costs are incurred evenly throughout the year.

6. The company has decided to upgrade equipment to support its production staff in meeting the new volumes, and in future production. Equipment costing £700,000 will be purchased and paid for in July.

7. At 1 July 2021, Corola Limited projects that it will have the following balances:

 Bank overdraft £79,000 Accounts receivable (in July 2021) £1,400,000 Accounts receivable (in August 2021) £731,000 Accounts payable (due in July 2021) £570,000

Requirements:

a. Prepare a monthly cash budget for Corola Limited for the six-month period ending 31 December 2021, clearly showing the closing balance at the end of each month. (20 marks)

b. Outline TWO advantages of a company preparing cash budgets or forecasts. (5 marks)

Question 3

Tremble plc is considering investing in a new product, a fitness machine, and has asked you, its management accountant, to undertake analyses using different methods of investment appraisal.

You have gathered the following data:

• Cost of equipment at start of project - £5,100,000
• Scrap value of equipment after 3 years - £300,000
• Straight line depreciation over 3 years
• Working capital requirements - £200,000 at the start of the project, fully recovered after 3 years
• Selling price per unit - £200
• Variable costs per unit - £80 in year 1, £90 in year 2, £100 in year 3
• Incremental fixed costs per annum (excluding depreciation) - £300,000
• Cost of capital – 10%
• Annual demand

- Year 1: 20,000 units

- Year 2: 25,000 units

- Year 3: 20,000 units

 Present value of £1 Year 10% 20% 1 0.909 0.833 2 0.826 0.694 3 0.751 0.579 4 0.683 0.482

Requirements

a. By determining the net annual cashflows or profits as appropriate, calculate the project’s

• Payback period
• Net Present Value (NPV)
• Internal Rate of Return (IRR)
• Accounting Rate of Return (ARR)        (17 marks)

b. Evaluate the investment appraisal techniques used in (a) above. (8 marks)