Chapter 9, Problem 73P

Optima Company is a high-technology organization that produces a mass-storage system. The design of Optima’s system is unique and represents a breakthrough in the industry. The units Optima produces combine positive features of both compact and hard disks. The company is completing its fifth year of operations and is preparing to build its master budget for the coming year (20X1). The budget will detail each quarter’s activity and the activity for the year in total. The master budget will be based on the following information:

1. a. Fourth-quarter sales for 20X0 are 55,000 units.
2. b. Unit sales by quarter (for 20X1) are projected as follows:

The selling price is $400 per unit. All sales are credit sales. Optima collects 85% of all sales within the quarter in which they are realized; the other 15% is collected in the following quarter. There are no bad debts.

1. c. There is no beginning inventory of finished goods. Optima is planning the following ending finished goods inventories for each quarter:

1. d. Each mass-storage unit uses 5 hours of direct labor and three units of direct materials. Laborers are paid $10 per hour, and one unit of direct materials costs $80.
2. e. There are 65,700 units of direct materials in beginning inventory as of January 1, 20X1. At the end of each quarter, Optima plans to have 30% of the direct materials needed for next quarter’s unit sales. Optima will end the year with the same amount of direct materials found in this year’s beginning inventory.
3. f. Optima buys direct materials on account. Half of the purchases are paid for in the quarter of acquisition, and the remaining half are paid for in the following quarter. Wages and salaries are paid on the 15th and 30th of each month.
4. g. Fixed overhead totals $1 million each quarter. Of this total, $350,000 represents depreciation. All other fixed expenses are paid for in cash in the quarter incurred. The fixed overhead rate is computed by dividing the year’s total fixed overhead by the year’s budgeted production in units.
5. h. Variable overhead is budgeted at $6 per direct labor hour. All variable overhead expenses are paid for in the quarter incurred.
6. i. Fixed selling and administrative expenses total $250,000 per quarter, including $50,000 depreciation.
7. j. Variable selling and administrative expenses are budgeted at $10 per unit sold. All selling and administrative expenses are paid for in the quarter incurred.
8. k. The balance sheet as of December 31, 20X0, is as follows:

1. l. Optima will pay quarterly dividends of $300,000. At the end of the fourth quarter, $2 million of equipment will be purchased.

Required:

Prepare a master budget for Optima Company for each quarter of 20X1 and for the year in total. The following component budgets must be included:

1. 1. Sales budget
2. 2. Production budget
3. 3. Direct materials purchases budget
4. 4. Direct labor budget
5. 5. Overhead budget
6. 6. Selling and administrative expenses budget
7. 7. Ending finished goods inventory budget
8. 8. Cost of goods sold budget (Note: Assume that there is no change in work-in-process inventories.)
9. 9. Cash budget
10. 10. Pro forma income statement (using absorption costing) (Note: Ignore income taxes.)
11. 11. Pro forma balance sheet (Note: Ignore income taxes.)

To determine

Construct sales budget.

Explanation of Solution

Budgets:

Budgets are prepared for the planning and controlling purposes. Budgets facilitate planning and making decisions to achieve the desired objectives and are prepared to enable comparison between actual and expected outcomes.

Sales budget:

Particulars	Q1 ($)	Q2 ($)	Q3 ($)	Q4 ($)	Total ($)
Sales units (A)	65,000	70,000	75,000	90,000	300,000
Selling price (B)	400	400	400	400
Sales $\left(\text{A}\times \text{B}\right)$	26,000,000	28,000,000	30,000,000	36,000,000	120,000,000

Table (1)

To determine

Construct production budget.

Explanation of Solution

Production budget:

Particulars	Q1 ($)	Q2 ($)	Q3 ($)	Q4 ($)	Total ($)
Expected sales	65,000	70,000	75,000	90,000	300,000
Add: Closing units.	13,000	15,000	20,000	10,000	58,000
Less: Opening units.	0	13,000	15,000	20,000	48,000
Production units	78,000	72,000	80,000	80,000	310,000

Table (2)

Working Notes:

• Opening units are closing units of previous quarter.
• Production units are computed by adding closing units and subtracting opening units from the expected sales.

To determine

Construct direct material purchases budget.

Explanation of Solution

Materials purchases budget:

Particulars	Q1 ($)	Q2 ($)	Q3 ($)	Q4 ($)	Total ($)
Expected material required for production	234,000	216,000	240,000	240,000	930,000
Add: Closing units. 30% of sales units of next month	63,000	67,500	81,000	65,700	65,700
Less: Opening units.	65,700	63,000	67,500	81,000	65,700
Material units expected to be purchased (A)	231,300	220,500	253,500	224,700	930,000
Material cost: $80 per unit $\left(\text{A}\times \$80\right)$	18,504,000	17,640,000	20,280,000	17,976,000	74,400,000

Table (3)

To determine

Construct direct labor budget.

Explanation of Solution

Direct labor budget:

Particulars	Q1 ($)	Q2 ($)	Q3 ($)	Q4 ($)	Total ($)
Expected production (A)	78,000	72,000	80,000	80,000	310,000
Hours per unit (B)	5	5	5	5	5
Number of hours $\left(\text{A}\times \text{B}\right)$	390,000	360,000	400,000	400,000	1,550,000
Rate per hour	10	10	10	10	10
Labor cost	3,900,000	3,600,000	4,000,000	4,000,000	15,500,000

Table (4)

To determine

Construct overhead budget.

Explanation of Solution

Overhead budget:

Particulars	Q1 ($)	Q2 ($)	Q3 ($)	Q4 ($)	Total ($)
Number of hours (sub-part 4) (A)	390,000	360,000	400,000	400,000	1,550,000
Variable overhead $\left(\text{\$6}\times \text{A}\right)$ (B)	2,340,000	2,160,000	2,400,000	2,400,000	9,300,000
Fixed overhead (C)	1,000,000	1,000,000	1,000,000	1,000,000	4,000,000
Total overhead $\left(\text{B}+\text{C}\right)$	3,340,000	3,160,000	3,400,000	3,400,000	13,300,000

Table (5)

To determine

Construct selling and administrative expenses budget.

Explanation of Solution

Selling and administrative expenses budget:

Particulars	Q1 ($)	Q2 ($)	Q3 ($)	Q4 ($)	Total ($)
Number of sales units (A)	65,000	70,000	75,000	90,000	300,000
Variable expense $\left(\text{\$10}\times \text{A}\right)$ (B)	650,000	700,000	750,000	900,000	3,000,000
Fixed expense(C)	250,000	250,000	250,000	250,000	1,000,000
Total overhead $\left(\text{B}+\text{C}\right)$	900,000	950,000	1,000,000	1,150,000	4,000,000

Table (6)

To determine

Construct ending finished goods inventory budget.

Explanation of Solution

Ending goods inventory budget:

Particulars	Amount ($)
Material cost $\left(3\text{per}\text{unit}\times \$80\right)$	240
Add: Labor cost $\left(5\text{hour}\text{per}\text{unit}\times \$10\right)$	50
Add: Variable overheads $\left(5\text{hour}\text{per}\text{unit}\times \$6\right)$	30
Add: Fixed overheads $\left(\frac{\$4,000,000}{310,000}\right)$	12.90
Unit cost	332.90
Cost of ending goods $\left(10,000\times 332.90\right)$	3,329,000

Table (7)

To determine

Construct COGS budget.

Explanation of Solution

Cost of goods sold budget:

Particulars	Amount ($)
Material cost	74,400,000
Add: Labor cost	15,500,000
Add: Variable overheads	9,300,000
Add: Fixed overheads	4,000,000
Manufacturing cost (A)	103,200,000
Add: Beginning finished goods	0
Cost of goods available for sale (A)	103,200,000
Less: Ending goods (sub-part 7) (B)	3,329,000
COGS $\left(\text{A}-\text{B}\right)$	99,871,000

Table (8)

To determine

Construct cash budget.

Explanation of Solution

Cash Budget:

Particulars	Q1 ($)	Q2 ($)	Q3 ($)	Q4 ($)	Total ($)
Opening balance	250,000	1,110,000	3,128,000	5,568,000	250,000
Receipt from sales of current quarter	$\left(\begin{array}{l}26,000,000\\ \times 85\%\end{array}\right)$ 22,100,000	$\left(\begin{array}{l}28,000,000\\ \times 85\%\end{array}\right)$23,800,000	$\left(\begin{array}{l}30,000,000\\ \times 85\%\end{array}\right)$ 25,500,000	$\left(\begin{array}{l}36,000,000\\ \times 85\%\end{array}\right)$30,600,000	102,000,000
Receipts from sales of previous quarter	3,300,000	$\left(\begin{array}{l}26,000,000\\ \times 15\%\end{array}\right)$ 3,900,000	$\left(\begin{array}{l}28,000,000\\ \times 15\%\end{array}\right)$ 4,200,000	$\left(\begin{array}{l}30,000,000\\ \times 15\%\end{array}\right)$ 4,500,000	15,900,000
Less: Payment for material purchased in preceding quarter1	7,248,000	9,252,000	8,820,000	10,140,000	35,460,000
Less: Payment for material purchased in current quarter	$\left(\begin{array}{l}18,504,000\\ \times 50\%\end{array}\right)$ 9,252,000	$\left(\begin{array}{l}17,640,000\\ \times 50\%\end{array}\right)$ 8,820,000	$\left(\begin{array}{l}20,280,000\\ \times 50\%\end{array}\right)$ 10,140,000	$\left(\begin{array}{l}17,976,000\\ \times 50\%\end{array}\right)$ 8,988,000	37,200,000
Less: labor cost	3,900,000	3,600,000	4,000,000	4,000,000	15,500,000
Less: Variable manufacturing Overhead cost	2,340,000	2,160,000	2,400,000	2,400,000	9,300,000
Less: Fixed manufacturing Overhead cost	650,000	650,000	650,000	650,000	2,600,000
Less: Variable Selling and administrative expense	650,000	700,000	750,000	900,000	3,000,000
Less: Fixed Selling and administrative expense	200,000	200,000	200,000	200,000	800,000
Less: Dividends	300,000	300,000	300,000	300,000	1,200,000
Less: acquisition of equipment				2,000,000	2,000,000
Closing balance	1,110,000	3,128,000	5,568,000	11,090,000	11,090,000

Table (9)

Working Notes:

1. Computation of payment for material purchased in quarter 4 of the last year:

$\begin{array}{c}\left(\begin{array}{l}\text{Payment}\text{for}\text{material}\\ \text{purchased}\text{in}\text{Q4}\text{of}\text{last}\text{year}\end{array}\right)=\left(\begin{array}{l}\text{Material}\text{for}\text{current}\text{Sales}\\ -\text{Opening}\text{material}\\ +\text{Closing}\text{material}\end{array}\right)\times 50\%\\ =\left(\begin{array}{l}\left(55,000\times 3\times \$80\right)\\ -\left(\left(55,000\times 3\times \$80\right)\times 30\%\right)\\ +5,256,000\end{array}\right)\times 50\%\\ =\$7,248,000\end{array}$

To determine

Construct pro forma income statement.

Explanation of Solution

Budgeted income statement:

Particulars	Amount ($)
Sales	120,000,000
Less: COGS (sub-part 8)	99,871,000
Operating profit	20,129,000
Less: Selling and administrative expenses	4,000,000
Income	16,129,000

Table (10)

To determine

Construct pro forma balance sheet.

Explanation of Solution

Budgeted Balance Sheet:

Particulars	Amount ($)
Assets:
Cash	11,090,000
Direct material inventory $\left(65,700\times \$80\right)$	5,256,000
Accounts receivable $\left(36,000,000\times 15\%\right)$	5,400,000
Finished goods inventory	3,329,000
Plant and equipment $\left(\$33,500,000-\left(\$400,000\times 4\right)+\$2,000,000\right)$	33,900,000
Total Assets	58,975,000
Liabilities and Equity:
Accounts payable	8,988,000
Capital stock	27,000,000
Retained Earnings $\left(\$8,058,{000}^1+\$16,129,000-\$1,200,000\right)$	22,987,000
Total liabilities and equity	58,975,000

Table (11)

Working Notes:

1.

Computation of opening retained earnings:

$\begin{array}{c}\text{Opening retained earnings}=\text{Total}\text{assets}-\text{Accounts}\text{payable}-\text{Capital}\text{stock}\\ =\$42,306,000-\text{\$7,248,000}-\text{\$27,000,000}\\ =\$8,058,000\end{array}$

Capital stock of $27,000,000 has been assumed.