Chapter 9, Problem 66P

Operating Budget, Comprehensive Analysis

Allison Manufacturing produces a subassembly used in the production of jet aircraft engines.

The assembly is sold to engine manufacturers and aircraft maintenance facilities. Projected sales in units for the coming 5 months follow:

The following data pertain to production policies and manufacturing specifications followed by Allison Manufacturing:

1. a. Finished goods inventory on January 1 is 32,000 units, each costing $166.06. The desired ending inventory for each month is 80% of the next month’s sales.
2. b. The data on materials used are as follows:

Inventory policy dictates that sufficient materials be on hand at the end of the month to produce 50% of the next month’s production needs. This is exactly the amount of material on hand on December 31 of the prior year.

1. c. The direct labor used per unit of output is 3 hours. The average direct labor cost per hour is $14.25.
2. d. Overhead each month is estimated using a flexible budget formula. (Note: Activity is measured in direct labor hours.)

1. e. Monthly selling and administrative expenses are also estimated using a flexible budgeting formula. (Note: Activity is measured in units sold.)

1. f. The unit selling price of the subassembly is $205.
2. g. All sales and purchases are for cash. The cash balance on January 1 equals $400,000. The firm requires a minimum ending balance of $50,000. If the firm develops a cash shortage

by the end of the month, sufficient cash is borrowed to cover the shortage. Any cash borrowed is repaid at the end of the quarter, as is the interest due (cash borrowed at the end of the quarter is repaid at the end of the following quarter). The interest rate is 12% per annum. No money is owed at the beginning of January.

Required:

1. 1. Prepare a monthly operating budget for the first quarter with the following schedules. (Note: Assume that there is no change in work-in-process inventories.)
   1. a. Sales budget
   2. b. Production budget
   3. c. Direct materials purchases budget
   4. d. Direct labor budget
   5. e. Overhead budget
   6. f. Selling and administrative expenses budget
   7. g. Ending finished goods inventory budget
   8. h. Cost of goods sold budget
   9. i. Budgeted income statement
   10. j. Cash budget
2. 2. CONCEPTUAL CONNECTION Form a group with two or three other students. Locate a manufacturing plant in your community that has headquarters elsewhere. Interview the controller for the plant regarding the master budgeting process. Ask when the process starts each year, what schedules and budgets are prepared at the plant level, how the controller forecasts the amounts, and how those schedules and budgets fit in with the overall corporate budget. Is the budgetary process participative? Also, find out how budgets are used for performance analysis. Write a summary of the interview.

To determine

Prepare sales budget.

Explanation of Solution

Sales budget for the first quarter:

Particulars	January ($)	February ($)	March ($)	Total ($)
Sales units (A)	40,000	50,000	60,000	150,000
Selling price (B)	205	205	205	205
Sales $\left(\text{A}\times \text{B}\right)$	8,200,000	10,250,000	12,300,000	30,750,000

Table (1)

To determine

Prepare production budget.

Explanation of Solution

Production budget for the first quarter:

Particulars	January ($)	February ($)	March ($)	Total ($)
Expected sales	40,000	50,000	60,000	150,000
Add: Closing units. 80% of sales units of next month	$\left(50,000\times 80\%\right)$ 40,000	$\left(60,000\times 80\%\right)$ 48,000	$\left(60,000\times 80\%\right)$48,000	136,000
Less: Opening units. 80% of sales units of the current month	32,000	$\left(50,000\times 80\%\right)$40,000	$\left(60,000\times 80\%\right)$48,000	120,000
Production units	48,000	58,000	60,000	166,000

Table (2)

To determine

Prepare direct materials purchases budget.

Explanation of Solution

Materials purchases budget:

Particulars	January ($)	February ($)	March ($)	Total ($)
Expected production (sub-part b)	48,000	58,000	60,000	166,000
Add: Closing units. 50% of production units of next month 1	$\left(58,000\times 50\%\right)$ 29,000	$\left(60,000\times 50\%\right)$ 30,000	$\left(61,600\times 50\%\right)$30,800	89,800
Less: Opening units. 50% of production units of the current month	$\left(48,000\times 50\%\right)$24,000	$\left(58,000\times 50\%\right)$29,000	$\left(60,000\times 50\%\right)$30,000	83,000
Production units for which material is required to be purchased	53,000	59,000	60,800	172,800
Metal cost: 10 lbs. per unit @ $8 (A)	$\left(\begin{array}{l}53,000\\ \times 10\times 8\end{array}\right)$ 4,240,000	$\left(\begin{array}{l}59,000\\ \times 10\times 8\end{array}\right)$ 4,720,000	$\left(\begin{array}{l}60,800\\ \times 10\times 8\end{array}\right)$ 4,864,000	13,824,000
Component cost: 6 per unit @ $5 (B)	$\left(\begin{array}{l}53,000\\ \times 6\times 5\end{array}\right)$ 1,590,000	$\left(\begin{array}{l}59,000\\ \times 6\times 5\end{array}\right)$ 1,770,000	$\left(\begin{array}{l}60,800\\ \times 6\times 5\end{array}\right)$ 1,824,000	5,184,000
Total material cost $\left(\text{A}+\text{B}\right)$	5,830,000	6,490,000	6,688,000	19,008,000

Table (3)

Working Notes:

1. Computation of production units of April:

$\begin{array}{c}\text{Production}\text{units}=\left(\begin{array}{l}\text{Sales}\text{units}\\ +\text{Closing}\text{units}\text{of}\text{finished}\text{goods}\\ -\text{Opening}\text{units}\text{of}\text{finished}\text{goods}\end{array}\right)\\ =60,000+\left(80\%\times 62,000\right)-\left(80\%\times 60,000\right)\\ =60,000+49,600-48,000\\ =61,600\end{array}$

To determine

Prepare direct labor budget.

Explanation of Solution

Direct labor budget:

Particulars	January ($)	February ($)	March ($)	Total ($)
Expected production (sub-part b)	48,000	58,000	60,000	166,000
Hours per unit	3	3	3
Number of hours	$\left(\begin{array}{l}48,000\\ \times 3\end{array}\right)$ 144,000	$\left(\begin{array}{l}58,000\\ \times 3\end{array}\right)$ 174,000	$\left(\begin{array}{l}60,000\\ \times 3\end{array}\right)$ 180,000	498,000
Rate per hour	14.25	14.25	14.25
Labor cost	$\left(\begin{array}{l}144,000\\ \times 14.25\end{array}\right)$ 2,052,000	$\left(\begin{array}{l}174,000\\ \times 14.25\end{array}\right)$ 2,479,500	$\left(\begin{array}{l}180,000\\ \times 14.25\end{array}\right)$ 2,565,000	7,096,500

Table (4)

To determine

Prepare overhead budget.

Explanation of Solution

Overhead budget:

Particulars	January ($)	February ($)	March ($)	Total ($)
Number of hours (sub-part d)	144,000	174,000	180,000	498,000
Variable overhead1$\left(\begin{array}{l}\text{OH}\text{rate}\\ \times \text{Number}\\ \text{of}\text{hours}\end{array}\right)$(A)	$\left(\begin{array}{l}2.4\\ \times 144,000\end{array}\right)$ 345,600	$\left(\begin{array}{l}2.4\\ \times 174,000\end{array}\right)$ 417,600	$\left(\begin{array}{l}2.4\\ \times 180,000\end{array}\right)$ 432,000	1,195,200
Fixed overhead2 (B)	338,000	338,000	338,000	1,014,000
Total overhead $\left(\text{A}+\text{B}\right)$	683,600	755,600	770,000	2,209,200

Table (5)

Working Notes:

1. Computation of variable overhead rate per hour per month:

$\begin{array}{c}\text{Variable}\text{OH}\text{per}\text{hour}=\left(\begin{array}{l}\text{Supplies}\text{cost}+\text{Power}\text{cost}\\ +\text{Maintenance}\text{cost}+\text{Other}\text{variable}\text{cost}\end{array}\right)\\ =\$1+\$0.5+\$0.4+\$0.5\\ =\$2.4\end{array}$

2. Computation of fixed overhead rate per month:

$\begin{array}{c}\text{Fixed}\text{OH}\text{rate}\text{per}\text{month}=\left(\begin{array}{l}\text{Maintenance}\text{cost}+\text{Supervision}\text{cost}+\\ \text{Deprecioation}\text{cost}+\text{Taxes}+\text{Other}\text{fixed}\text{costs}\end{array}\right)\\ =\$30,000+\$16,000+\$200,000+\$12,000+\$80,000\\ =\$338,000\end{array}$

To determine

Prepare selling and administrative expenses budget.

Explanation of Solution

Selling and administrative expenses budget:

Particulars	January ($)	February ($)	March ($)	Total ($)
Number of sales units	40,000	50,000	60,000	150,000
Variable expense1$\left(\begin{array}{l}\text{Expense}\text{per}\\ \text{unit}\\ \times \text{Number}\\ \text{of}\text{units}\end{array}\right)$ (A)	$\left(\begin{array}{l}3.6\\ \times 40,000\end{array}\right)$ 144,000	$\left(\begin{array}{l}3.6\\ \times 50,000\end{array}\right)$ 180,000	$\left(\begin{array}{l}3.6\\ \times 60,000\end{array}\right)$ 216,000	540,000
Fixed expense2 (B)	110,000	110,000	110,000	330,000
Total overhead $\left(\text{A}+\text{B}\right)$	254,000	290,000	326,000	870,000

Table (6)

Working Notes:

1. Computation of variable selling and administrative expense rate per unit:

$\begin{array}{c}\text{Variable}\text{selling}\text{and}\text{administrative}\text{expenses}\text{per}\text{unit}=\left(\begin{array}{l}\text{Commission}+\text{Shipping}\\ +\text{Other}\text{selling}\text{and}\\ \text{administrative}\text{expense}\end{array}\right)\\ =\left(\$2+\$1+\$0.6\right)\\ =\$3.6\end{array}$

2. Computation of fixed selling and administrative expense per month:

$\begin{array}{c}\left(\begin{array}{l}\text{Fixed}\text{selling and}\\ \text{administrative expense}\text{per}\text{month}\end{array}\right)=\left(\begin{array}{l}\text{Salaries}+\text{Depreciation}\\ +\text{Other}\text{selling}\text{and}\\ \text{administrative}\text{expense}\end{array}\right)\\ =\$50,000+\$40,000+\$20,000\\ =\$110,000\end{array}$

To determine

Prepare ending goods inventory budget.

Explanation of Solution

Ending goods inventory budget:

Particulars	Amount ($)
Material cost:
Metal $\left(10\text{per}\text{unit}\times \$8\right)$	80
Add: Component $\left(6\text{per}\text{unit}\times \$5\right)$	30
Add: Labor cost $\left(3\text{hour}\text{per}\text{unit}\times \$14.25\right)$	42.75
Add: Variable overheads $\left(3\text{hour}\text{per}\text{unit}\times \$2.4\right)$	7.2
Add: Fixed overheads1	6.11
Unit cost	166.06
Cost of ending goods $\left(48,000\times 166.06\right)$	7,970,880

Table (7)

Working Notes:

1. Computation of fixed overhead per unit:

$\begin{array}{c}\text{Fixed}\text{OH}\text{per}\text{unit}=\text{Fixed}\text{OH}\text{per}\text{hour}\times \text{Hour}\text{per}\text{unit}\\ =\frac{\text{Fixed}\text{Overhead}}{\text{Number}\text{of}\text{hours}}\times \text{Hour}\text{per}\text{unit}\\ =\frac{\$1,014,000}{498,000}\times 3\\ =\$6.108\end{array}$

To determine

Prepare COGS budget.

Explanation of Solution

Cost of goods sold budget:

Particulars	Amount ($)
Material cost:
Metal $\left(10\text{per}\text{unit}\times \$8\times 166,000\text{Units}\right)$	13,280,000
Add: Component $\left(6\text{per}\text{unit}\times \$5\times 166,000\text{Units}\right)$	4,980,000
Add: Labor cost $\left(3\text{hour}\text{per}\text{unit}\times \$14.25\times 166,000\text{Units}\right)$	7,096,500
Add: Variable overheads $\left(3\text{hour}\text{per}\text{unit}\times \$2.4\times 166,000\text{Units}\right)$	1,195,200
Add: Fixed overheads	1,014,000
Manufacturing cost (A)	27,565,700
Add: Beginning finished goods $\left(32,000\times 166.06\right)$(B)	5,313,920
Cost of goods available for sale $\left(\text{A}+\text{B}\right)$(C)	32,879,620
Less: Ending goods (sub-part g) (D)	7,970,880
COGS $\left(\text{C}-\text{D}\right)$	24,908,740

Table (8)

To determine

Prepare budgeted income statement.

Explanation of Solution

Budgeted income statement:

Particulars	Amount ($)
Sales $\left(150,000\times 205\right)$	30,750,000
Less: COGS (sub-part h)	24,908,740
Operating profit	5,841,260
Less: Selling and administrative expenses	870,000
Income	4,971,260

Table (9)

To determine

Prepare budgeted income statement.

Explanation of Solution

Budgeted income statement:

Particulars	Amount ($)
Sales $\left(150,000\times 205\right)$	30,750,000
Less: COGS (sub-part h)	24,908,740
Operating profit	5,841,260
Less: Selling and administrative expenses	870,000
Income	4,971,260

Table (10)

To determine

Prepare cash budget.

Explanation of Solution

Cash Budget:

Particulars	January ($)	February ($)	March ($)	Total ($)
Opening balance	400,000	50,000	524,900	400,000
Sales (sub-part a)	8,200,000	10,250,000	12,300,000	30,750,000
Less: Material purchase (sub-part c)	5,830,000	6,490,000	6,688,000	19,008,000
Less: labor cost (sub-part d)	2,052,000	2,479,500	2,565,000	7,096,500
Less: Overhead cost (sub-part e)	483,600	555,600	570,000	1,609,200
Less: Selling and administrative expense (sub-part f)	214,000	250,000	286,000	750,000
Cash available	20,400	524,900	2,715,900	2,686,300
Amount borrowed	29,600	0	0	29,600
Amount repaid1	0	0	30,488	30,488
Closing balance	50,000	524,900	2,685,412	2,685,412

Table (11)

Working Notes:

1. Computation of amount repaid:

$\begin{array}{c}\text{Amount}\text{repaid}=\text{Principal}+\text{Interest}\\ =\text{\$29,600}+\left(\$29,600\times 12\%\times \frac{3}{12}\right)\\ =\$29,600+\$888\\ =\$30,488\end{array}$

Depreciation is not considered in cash payments since it is a non-cash expense.

To determine

Prepare summary regarding budgets used in ABC incorporation.

Explanation of Solution

In ABC incorporation, participative budgeting is used; all the supervisors and department heads are involved in preparation of the relevant budgets to increase the probability of meeting the budgets.

However, preparation of budgets is not entirely delegated to the sub-ordinate managers and supervisors, their issues and reasonable figures are asked and on that basis, higher management decides budgetary figures.

After expiry of the period, budgets are adjusted according to actual units sold and thereafter, such budget is prepared with actual budget to find out discrepancies.

Thereafter, reasons behind all the variances are observed. Amount of variance, attributable to managerial performances are considered as one of the factors in performance analysis.

All the operating budgets like; sales, production, material purchase, labor, overhead, selling and administrative overhead, finished goods inventory, COGS as well as cash budget is prepared for planning and controlling purposes.

All these budgets help in determination of budgeted income and cash requirements. This can be explained as follows:

• Sales budget is used to prepare production budget and selling and administrative expenses budget.
• Production budget is used to prepare material purchase budget and labor budget.
• Labor budget (labor hours) is used to prepare manufacturing overhead budget.
• Production, material, labor, and production overhead budgets are used to compute ending finished goods inventory budget and based on these budgets COGS budget is prepared.
• Budgeted income statement is prepared by using sales budget, COGS budget and selling and administrative expenses budget.
• Sales, material, labor, production overhead, and selling overhead budgets are used to prepare cash budget.

Budgets are forecasted by using past year data. Past year data is adjusted with inflation and other economic factors like availability of new clients, to prepare budgets for the current year.