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QUESTION

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Part 1

Always aspiring to be an entrepreneur, you finally believe you may have found your niche.

You brainstorm with your two roommates and come together with a plan to prepare for the birth of SABCO, Inc., a name created as an abbreviation for Sand Art Brownie Company.

It is early April 2021, and the three of you research the holiday market and decide that all products to be sold for the holiday season must be ready to ship to retailers by October 1, 2021. This will allow the three of you to spend the remainder of the year processing orders.

The three of you determine the following:

A.             Each of you will contribute \$15,000 on July 1, 2021 (borrowed from relatives) to form a corporation. You realize that another form of business may be less expensive but know that this is just the beginning of a wildly successful business and want to go ahead right away with the incorporation of the business. The par value of the stock is \$1.00 and each of you purchase 5,000 shares of stock.

B.             You estimate that you can sell the brownies for \$15 per container. You believe this price will make the product attractive enough to sell 100,000 containers of product for the 2021 holiday season. All the shareholders agree this would be a competitive price and a fine start to your business.

C.             Fifty percent of sales are expected to be taken online and paid by credit card immediately upon ordering. The bank charges a credit card fee of 2% of the transaction. This is considered a selling expense. The other 50% of sales will be sold to a wholesaler who will purchase in bulk at \$13.50 per container.  They will pay 60% at time of delivery and the remaining 40% will be collected the following month.

D.             Your roommate gets to work on building a great website and lays the groundwork to get your website to pop-up based on several appropriate key-word searches such as “holiday gifts” and “brownies”. Her hard work results in a one-time website fee of \$10,500 in July, and \$100 per month in maintenance fees from July – December 2021. These costs are not capitalized but expensed immediately because you are sure that the website will have to be completely revamped after the holiday to gear up for the future.

E.             Factory space will be rented for a period of five months (July, August, September, October, and November) at \$800 per month for production of the Sand Art Brownies. Utilities for the space are estimated to be \$300 each month which you are also responsible for per the lease agreement. After the five months of production, the equipment will be stored in your garage, until the next holiday production rush. Due to the perishability of your product, your production must also be seasonal.

F.              Equipment required to run the factory is needed up front and will cost \$18,000. The equipment will be depreciated over 5 years under the straight-line method. The salvage value will be negligible.

G.             Each day, after production, the finished product will be shipped to a fulfillment house that will store the containers until they are shipped. The rent for the agreed upon space at the fulfillment house is \$2,500 per month. The rental agreement is for July through December 2021. Included in this fee are order processing charges and shipping and handling fees. Minimal returns after the holiday season are expected, but a return policy on the website instructs customers to ship returned items to your home.

H.             A small office will be rented downtown to handle administrative issues, field sales calls, and process online orders. The rent for this space is \$250 per month and is leased from July – December 2021. Utilities are included in the rent.

I.               All bills will be paid immediately with cash, as you suspect credit will not be established early on by your suppliers and this will be the most conservative approach in estimating your cash needs.

J.               Each of you will take a salary per month of \$3,000. These three salaries will be the only salaries besides the direct labor and factory overhead personnel. (The tax consequences of these salaries will be ignored in this project).

K.             To be conservative, you expect to sell the same number of containers each week for 8 weeks (4 weeks in November and 4 weeks in December). You only have capacity to produce 6,000 containers in a week and you want to have at least two weeks of inventory on hand in advance of any sales. Additionally, you would like to run your production at maximum capacity in July, August and September, prior to sales beginning to allow for the unexpected. You only produce enough in October and November to have the expected two weeks of inventory on hand.  For simplicity, assume there are four production weeks per month.

L.             To make sure that there will be enough product for production, all materials are purchased ahead of production.  You decide that after the first month you would like to have enough materials for the first two weeks of production on hand at the end of the preceding month.

M.            You know that you will not have enough money to finance the operation until the money from the sales starts to come in. You are in the process of putting together a business plan to include the following for the period from July through December 2021:

1.     Direct labor worksheet

3.     Job Cost Detail

4.     Production Budget

5.     Direct Materials Budget

6.     Direct Labor Budget

7.     Selling and Administrative Expense Budget

8.     Cash Budget

9.     Budgeted Financial Statements

You mean to provide the business plan to the bank. You expect they will grant you a line of credit to make up your cash shortfalls through the end of the selling season. You will be applying for a line of credit that you can access at the beginning of each month to meet your cash flow needs. Because you are only allowed to draw on your line once a month, you decide that you would like to maintain a cash balance at the end of the month equal to your required purchases the subsequent month. You will make one lump payment at the end of December to pay off your borrowings plus interest at the rate of 6%. Simple interest is accrued and paid at the end of the year.

N.             The three shareholders feel comfortable with the plan outlined above; however, no cost studies have been done on the product to determine the cost of sales for each container. The information you do have is a recipe jotted down on the back of a napkin that your sister scrawled out when you asked her for the recipe. The napkin reads as shown in Figure 1.

O.             You plan to use a job cost system to capture the costs per batch. A job cost system is chosen over a different cost system because you and your business partners expect the same machinery and production lines will be used for off-season products in 2021 and beyond. Those products are yet to be determined.

Instructions:

Determine the standard cost of your product, prepare the master budget materials for the bank, and compute financing needs by completing the following items. Note: payroll taxes, interest, and taxes are purposely excluded from this project. All of the Figures and Tables are contained in the attached excel document.  You will turn in the excel workbook and the Word document to D2L.

1.         Use the Materials Requirements Worksheet (Table A2) to estimate the total cost of materials you expect to consume through the end of production by making the product in batches of 4.  Also compute the total materials cost per container. All normal scrap and waste for each batch are included in the recipe for the batch and need not be accounted for further. The amounts (quantity) and cost (price paid) for ingredients will be used to determine the standard direct material cost for your product. All materials are purchased according to the shopping list at Table A1 to complete batches of four. You will complete the actual cost during Part II. Note: tags for container lids were donated by a family member in the office supply business.

2.         Use the Direct Labor Requirements Worksheet to estimate the total cost of labor that it will take to produce a batch of 4 containers (Table A3). You have considered the following operational factors when determining your direct labor cost estimates. You estimate that it will take you 15 minutes to do each batch. Your assembly line will include the following personnel.

·       Direct Labor Worker 1 –Salt, Flour II, chocolate chips

·       Direct Labor Worker 2–Flour I, Brown sugar, vanilla chips

·       Direct Labor Worker 3–Cocoa, granulated sugar, lid

All direct labor is hired through a temporary employment service which has guaranteed the workers needed for the time of production. The temporary agency charges \$15.00 per hour for each direct laborer. The standard rate of pay is \$15.00 per hour.

3.         Use the Factory Overhead Rate Worksheet provided (Table A4) to determine the cost charged to each container for Factory Overhead (your cost object will be each good container produced). The Factory Overhead consists of the rent for the factory space, the cost of factory utilities, the monthly depreciation on the factory equipment, and indirect labor salaries and benefits of \$40,000 for each month of production. The indirect labor is hired through a temporary professional placement firm and you are pleased with their guarantee of available workers for the production period of July through the second week in November. The workers needed are as follows:

·                Logistics Coordinator

·                Material Handler I

·                Inventory Specialist

·                Quality Control I

·                Engineer I

·                Maintenance I

·                Production Supervisor

Again, the cost object for your predetermined factory overhead rate is based on the number of good containers produced.

4.         Complete the Job Cost Detail Sheet template (Table A5) by populating the estimate column, which shows the standards from items 1, 2, and 3 above, to use during production to track how you are meeting your expectations. You will complete this table in Part II of the case.

5.         Using the information above, complete the production budget (Table A6).

6.         Using the information above regarding materials purchasing policies and the shopping list, complete the direct materials budget (Table A7).

7.         Using the information from the Job Cost Detail and the Production Budget, complete the Direct labor budget (Table A8).

8.         Using the information above complete the Selling and administration budget (Table A9).

9.         Using the information provided in the narrative and the preceding schedules. complete the Cash Budget to determine your need to borrow from the line of credit offered by the bank (Table A10).

10.       Use the journal entry and T-account templates (Table A11 and A12 respectively), complete the information for July to project financial information for July. Reference your postings with the journal entry number. You will have to post all entries in order to complete the budgeted financial statements (Table A13), discussed next. The July journal entries have been provided for you.  You may need to delete entries and/or add entries to other months depending on the transactions that occur.

11.       Put the resulting balances from step 5 into the Financial Statement Projections template (Table A13). Important: Make sure the balance sheet section of this template balances before moving on to the next month. Do just one month at a time to assure that errors are caught before continuing to the next month. This is very important for this project. You are not required to do closing entries.

12.       Repeat step 10 and 11 for August through December, to produce the Financial Projections you will need to secure financing. Make sure you start with the beginning balances in your balance sheet accounts, assuming the closing process has been done from one month to the next. The Income Statement accounts will have been closed, so there is no beginning balance, and the Retained Earnings is updated. Note: You will be using a copy of Table 11 and Table 12 six times for each month, July – December.  Remember that you may need to add or delete entries in subsequent months depending on the transactions that occurred.

13.       From the Financial Projections Template, prepare projected financial statements to take to your potential lender—Projected Income Statement (Table 14), Projected Balance Sheet (Table 15), Projected Statement of Cash Flows (Table 16).

14.       Complete a Microsoft Word document detailing the answers to the following questions:

a.              How much money do the three stockholders have to borrow from the bank before they start to pay it back? When is the loan first needed, and when will it be completely paid back?

b.              How do you feel about this plan? Is there anything not included in the projections besides payroll taxes, interest and taxes, which we purposely excluded? What would interest expense be in 2021, assuming a 6% rate, with borrowings or payments at the end of each month? Show your calculation. What would income tax expense be, assuming a tax rate of 30%? Would you be comfortable in starting the business?

c.              SABCO, Inc. chose to use a job order cost system due to smaller production runs and potential shared machinery and equipment with other potential products in the future. Explain why a different cost system might be more appropriate if SABCO decided to customize the brownies by the optional additions of either candy-coated chocolates and/or nuts? How would its production data have looked different using an alternative cost system?

d.              Calculate the break-even in dollars and units for the company.  You and your partners decide that you would each like to make \$30,000 in the first year (\$90,000 total net profit).  Calculate the break-even in dollars and units for the target profit.

e.              Why is there a remaining raw materials inventory in your budget?  Is this appropriate? If no, why?  Should you change some of your assumptions about raw materials?

Figure 2 contains a checklist to help you progress through part 1 of the project.