Brown Company is a start-up manufacturing company that has been conducting busin

Question

Brown Company is a start-up manufacturing company that has been conducting business with very little accounting and finance information. Top management has realized that their business will fail unless they implement a budgeting process which will help them control their business and manage their cash flows. They have collected historical information and hired you to act as its consultant. During your interview with top management you gather the following information:

Brown Company plans to sell their product in July of 2015 for $10 per unit. It anticipates a growth rate in sales units of 10% per month beginning in July (i.e., July sales in units will be 10% more than June sales, and so on). However, unit costs and sales prices are constant. The target monthly ending inventory in units of finished product is 80% of the next month’s estimated sales. There are 150,000 finished units in inventory on June 30, 2015 (costed at $750,000 total). Each unit of finished product requires four pounds of direct materials at a cost of $1.20 per pound. There are 800,000 pounds of direct materials in inventory on June 30, 2015. The target monthly ending inventory for direct materials is equal to the same equivalent units of finished goods in inventory (e.g., a 1:4 ratio so for example, if target ending FG inventory is 100 units then the target ending DM inventory is 400 lbs). Overhead is allocated at $0.25 per lb of direct material used. Assume there is no labor required. During the second quarter Brown recorded the following data:

                        Sales                DM Purchases

            June     $1,800,000      $950,000

            June     180,000 units

Required: Management has asked for your help in putting together a budget for the month of July. They are hoping that if you can get them started on the right path that they can continue on with the budgeting process. They have asked not only for information but for calculations in a format that they will be able to use to model their continuing budget process thereafter. They are looking for the following specific information:

What are the estimated sales in dollars for the month of July (prepare a sales budget)?

How many units should the production manager produce during July (prepare a production budget)?

How many pounds of direct materials should the purchasing manager order during July (prepare a materials budget)? How much will it cost?

What will be the cost of goods sold for July assuming they use the FIFO inventory method (prepare a COGS statement)?

What is the gross margin for the month of July (prepare a partial income statement that shows sales – cogs = gross margin)?  

Summarize the information gleaned from the above analyses in a cover letter to Brown Company. Attached to the cover letter should be the budgets that you prepared as well as the budgets printed showing their formulas.

Remember to have a separate data input section. The budgets should only include formulas. Thus if asked to rerun a budget schedule with a different assumption you will only need to change a number in the data input and all of your budget schedules will recalculate. The budgets must use proper format and style. For appropriate formats of the budgets refer to class examples and to your textbook.

Explanation / Answer

Number of units sold in June = 180000 units

Expected number of units to be sold in July

= 180000 units + 10 % of 180000 units

= 198000 units.

There will be no change in the sale price of $10 per unit.

Expected sales in dollars in July = 198000 units x $10 per unit = $1980000

Target monthly ending inventory of finished goods = 80% of next month’s sale.

With a growth rate of 10%, the number of units expected to be sold in August

= 198000 + 10 % of 198000 = 217000 units.

Therefore,

Ending inventory in July = 80% of 217000 units = 174240 units

Production Budget

units

Ending inventory

174240

Add: Units expected to be sold

198000

372240

Less: Beginning inventory

-150000

Units to be produced

222240

Material Budget:

Target ending inventory of finished goods in July = 174240 units

Target ending inventory of raw materials in July = 174240 x 4 = 696960 units

Raw materials required for 222240 units to be produced during the month = 222240 x 4 = 888960 pounds

Material Purchase Budget for July

Pounds

ending Inventory

696960

materials required for production

888960

1585920

less: beginning inventory

800000

Purchase (pounds)

785920

price per pound of material ($)

1.20

Cost of materials purchased

943104

Cost of goods sold:

Number of units sold

198000

Less: Number of units in beginning inventory

-150000

Number of units to be sold from July production

48000

Cost of material for 48000 units (48000*4*$1.20)

230400

Overhead cost (48000*4*$0.25)

48000

Cost of 48000 units ($)

278400

Cost of goods sold budget for July

$

Cost of 150000 units of beginning inventory ($)

750000

Cost of 48000 units of July production ($)

278400

Cost of Goods sold in July ($)

1028400

Income Statement (Partial) for July

$

Sales (198000 units @ $10 per unit)

1980000

Less: Cost of goods sold

1028400

Gross Profit

951600

Production Budget

units

Ending inventory

174240

Add: Units expected to be sold

198000

372240

Less: Beginning inventory

-150000

Units to be produced

222240

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