Question

The company sells a single product at a price of $60 per unit. The estimated sales volume for the next six months is as follows:

September October . . November December January . . February. .

13,000 units 12,000 units 14,000 units 20,000 units

9,000 units 10,000 units

All sales are on account. The company’s collection experience has been
that 32% of a month’s sales are collected in the month of sale, 64% are collected in the month following the sale, and 4% are uncollectible. It is expected that the net realizable value of accounts receivable (i.e., accounts receivable less allow- ance for uncollectible accounts) will be $499,200 on September 30, 2013. Management’s policy is to maintain ending finished goods inventory each month at a level equal to 40% of the next month’s budgeted sales. The fin- ished goods inventory on September 30, 2013, is expected to be 4,800 units. To make one unit of finished product, 5 pounds of materials are required. Management’s policy is to have enough materials on hand at the end of each month to equal 30% of the next month’s estimated usage. The raw materials inventory is expected to be 19,200 pounds on September 30, 2013.
The cost per pound of raw material is $4, and 70% of all purchases are paid for in the month of purchase; the remainder is paid in the following month. The accounts payable for raw material purchases is expected to be $75,960 on September 30, 2013.

Required:

1. Prepare a sales budget in units and dollars, by month and in total, for the fourth quarter (October, November, and December) of 2013.

2. Prepare a schedule of cash collections from sales, by month and in total, for the fourth quarter of 2013.

3. Prepare a production budget in units, by month and in total, for the fourth quarter of 2013.

4. Prepare a materials purchases budget in pounds, by month and in total, for the fourth quarter of 2013.

5. Prepare a schedule of cash payments for materials, by month and in total, for the fourth quarter of 2013.

a.  Sales Budget				Quarter Ended December 31, 2013
			September	October	November	December	Total		January	February
		Expected sales in units:	13,000	12,000	14,000	20,000	46,000		9,000	10,000
		Selling price per unit:	$60	$60	$60	$60	$60
		Total Sales:	$780,000	$720,000	$840,000	$1,200,000	$2,760,000
b.  Cash Collections from:				Quarter Ended December 31, 2013
		Sales	% Collected	October	November	December	Total
	September sales:	$780,000	64% Collected	$499,200			$499,200
	October sales:	$720,000	32% Collected	230,400			230,400
	October sales:	$720,000	32% Collected		460,800		460,800
	November sales:	$840,000	0% Collected		268,800		268,800
	November sales:	$840,000	0% Collected			537,600	537,600
	December sales:	$1,200,000	0% Collected			384,000	384,000
		Total cash collections:		$729,600	$729,600	$921,600	$2,380,800
c.  Production Budget				Quarter Ended December 31, 2013
	Finished Goods		% Budgeted	October	November	December	Total		January
		Beginning Inventory:		4,800	5,600	8,000	4,800		3,600
		Units to be produced:		12,800	16,400	15,600	44,800		9,400
		Goods available for sale:		17,600	22,000	23,600	49,600		13,000
		Desired ending inventory:	40% Budgeted	5,600	8,000	3,600	3,600		4,000
		Quantity of goods sold:		12,000	14,000	20,000	46,000		9,000
d.  Materials Purchases Budget				October	November	December	Total		January
		Units to be produced:		12,800	16,400	15,600	44,800		9,400
		Pounds required for each unit:	5
		Total pounds used in production:		64,000	82,000	78,000	224,000		47,000
				Quarter Ended December 31, 2013
	Raw Materials		% Budgeted	October	November	December	Total
		Beginning Inventory:		19,200	24,600	23,400	19,200
		Purchases of materials:		69,400	80,800	68,700	218,900
		Materials available for use:		88,600	105,400	92,100	238,100
		Desired ending inventory:	30% Budgeted	24,600	23,400	14,100	14,100
		Total pounds used in production:		64,000	82,000	78,000	224,000
e.  Cash Payments for:				October	November	December	Total
		Purchases of materials:		69,400	80,800	68,700	218,900
		Cost per pound of raw material:	$4.00
		Total cost of raw material purchases:		$277,600	$323,200	$192,360	$869,120
				Quarter Ended December 31, 2013
		Purchases	% Paid	October	November	December	Total
	September Net A/P:			$75,960			$75,960
	October purchases:	$277,600	70% Paid	194,320			194,320
	October purchases:	$277,600	70% Paid		83,280		83,280
	November purchases:	$323,200	0% Paid		226,240		226,240
	November purchases:	$323,200	0% Paid			96,960	96,960
	December purchases:	$192,360	0% Paid			192,360	192,360
		Total cash payments:		$270,280	$309,520	$289,320	$869,120

This is the main question I'm having trouble with

Question

a

Assume that Freese, Inc. decided that because of strong economic conditions in general, a 10% increase in the
expected number of units to be sold each month was realistic.  Explain the effect, in general, on each of the budgets
presented of a 10% increase in the number of units sold.

b

	Assuming that the number of units sold would not change, explain the effect on the budgets presented of a 5%
	increase in the selling price of the product.  How does this price change effect differ from the sales volume
	effect you described above?

c

The purchasing manager is evaluating an alternative supplier that would provide a slightly lower grade of raw

material at a savings from the current price of $4 per pound.  The new price would be at $3.50 per pound but

the product would now require six pounds of the lower grade of raw material to produce the same number of

good finished units as currently achieved.  Would you recommend the change to the new supplier?  What if the

new price was to be $3.00?  How about a price of $3.285307?  Explain your answers.

Answer 1

Scenario (a):

Under scenario (a), when the number of units sold is increased by 10%, it would have the following impact:

- Sales Budget: Sales realization will increase (Refer table below)

- Cash Collections: It will increase (Refer table below)

- Production Budget: It will also increase due to increase in units of production (Refer table below)

- Materials purchase budget: It will increase due to increase in umber of units (Refer table below)

- Cash Payments: It will increase to higher payouts for higher quantity of purchase

Scenario (b)

Since only sale price is changing, it would impact the only the following:

- Sales Budget: It will increase following the increase in sale price

- Cash collections: Consequent to increase in sales budget as above

Rest of the budget will not change as there is no impact on the purchase quantity / rate due to change in sale price of finished product.

Revised budget under scenario (b) is as under:

a.  Sales Budget				Quarter Ended December 31, 2013
			September	October	November	December	Total		January	February
		Expected sales in units:	13,000	12,000	14,000	20,000	46,000		9,000	10,000
		Selling price per unit:	63	63	63	63	63
		Total Sales:	819000	756000	882000	1260000	28,98,000
b.  Cash Collections from:				Quarter Ended December 31, 2013
		Sales	% Collected	October	November	December	Total
	September sales:	8,19,000	64% Collected	5,24,160			5,24,160
	October sales:	7,56,000	32% Collected	2,41,920			2,41,920
	October sales:	7,56,000	64% Collected		4,83,840		4,83,840
	November sales:	8,82,000	0% Collected		2,82,240		2,82,240
	November sales:	8,82,000	0% Collected			5,64,480	5,64,480
	December sales:	12,60,000	0% Collected			4,03,200	4,03,200
		Total cash collections:		7,66,080	7,66,080	9,67,680	24,99,840

Note: This differs from scenario (a) in the following way:

- Scenario (a) led to change in units basis which cost of materials was also impacted, while scenario (b) impacted only sale price and hence no change in vendor payment / procurement part

Scenario (c):

At the new purchase price of 3.5, I would not recommend the vendor change since this will effectively increase my overall cost vs initial budget by 6.5% which will negatively impact my profit (Table below):

d.  Materials Purchases Budget				October	November	December	Total		January
		Units to be produced:		12,800	16,400	15,600	44,800		9,400
		Pounds required for each unit:	6
		Total pounds used in production:		76,800	98,400	93,600	2,68,800		56,400
				Quarter Ended December 31, 2013
	Raw Materials		% Budgeted	October	November	December	Total
		Beginning Inventory:		19,200	29,520	28,080	19,200
		Purchases of materials:		87,120	96,960	82,440	2,66,520
		Materials available for use:		1,06,320	1,26,480	1,10,520	2,85,720
		Desired ending inventory:	30% Budgeted	29,520	28,080	16,920	16,920
		Total pounds used in production:		76,800	98,400	93,600	2,68,800		56,400
e.  Cash Payments for:				October	November	December	Total
		Purchases of materials:		87,120	96,960	82,440	2,66,520
		Cost per pound of raw material:	3.5
		Total cost of raw material purchases:		3,04,920	3,39,360	2,88,540	9,32,820
				Quarter Ended December 31, 2013
		Purchases	% Paid	October	November	December	Total
	September Net A/P:			75,960			75,960
	October purchases:	3,04,920	70% Paid	2,13,444			2,13,444
	October purchases:	3,04,920	70% Paid		91,476		91,476
	November purchases:	3,39,360	0% Paid		2,37,552		2,37,552
	November purchases:	3,39,360	0% Paid			1,01,808	1,01,808
	December purchases:	2,88,540	0% Paid			2,01,978	2,01,978
		Total cash payments:		2,89,404	3,29,028	3,03,786	9,22,218

If the purchase rate is 3, I would recommend since the procurement cost would reduce by 8.7% which will increase the profits.

If the purchase rate is 3.285307, it is indifference point (i.e. cost of material as per original budget would be same as in this scenario). The organisation may stick to original vendor or switch to new vendor, it would not impact the profits.