The last few years have been very difficult for the company, and it has survived through the support of its parent company, to whom it currently owes a significant debt. However, the company now intends to engage in a number of income generating, cost-saving and efficiency measures in order to improve its financial performance. Although these may increase costs in the short-term, management hope they will enhance awareness of the company’s products, increase sales and reduce costs and return the company to profitability.
After discussions with a number of senior managers at Agnew Agricultural Ltd, you have concluded that the current budgeting system is not operating effectively and you believe it requires significant reform.
You have therefore carried out some background research on budgeting and strategic planning and have obtained the following documents.
Document 1 – A copy of Agnew Agricultural Ltd’s budgeting manual which contains guidance for staff on how the budgeting process should be carried out. Currently the company uses an incremental budgeting process, but you believe that a zero-base budgeting approach may be more beneficial.
Document 2 – New product line
Agnew Agricultural Ltd are considering introducing a new line of autonomous mower. The mower has been developed and is ready to go into production. However, management need to decide whether to manufacture the mower in a new factory unit near their main premises in North West England or to outsource production to a supplier company.
Information relevant to this decision is given in the following table:
| In-house manufacture | Outsourced manufacture | |
| Sales price (per mower) | £2,500.00 | £2,500.00 |
| Direct materials cost (per mower) | £1,250.00 | £0.00 |
| Direct labour cost (per mower) | £700.00 | £0.00 |
| Buy-in cost from outsourced manufacturer | £0.00 | £2,200.00 |
| Fixed manufacturing overheads | £600,000 | £0 |
| Fixed administrative overheads | £204,000 | £204,000 |
| Fixed selling and distribution overheads | £408,000 | £408,000 |
| Break-even point (mowers) | 2,204 | 2,040 |
| Margin of safety at budgeted profit level | 17% | 29% |
| Unit sales required to achieve budgeted profit of £250,000 (mowers) | 2,659 | 2,874 |
In addition the following profit-volume chart has been produced:
Document 3 – Cash budget
Agnew Agricultural Ltd’s Finance Department has prepared the following cash budget and budgeted income statement for the first 3 months of 2020, a period in which the company is expected to return to profit.
| Cash budget | January | February | March |
| £ | £ | £ | |
| Opening balance | (4,976) | 15,051 | 1,513 |
| RECEIPTS: | |||
| Cash sales | 181,936 | 184,442 | 188,617 |
| Credit sales | 569,250 | 549,464 | 560,758 |
| Total receipts | 751,186 | 733,906 | 749,376 |
| PAYMENTS: | |||
| Materials cash purchases | (155,456) | (170,972) | (188,148) |
| Materials credit purchases | (146,676) | (139,247) | (136,249) |
| Operating expenses | (28,368) | (29,786) | (30,900) |
| Fixed overheads | (160,000) | (160,000) | (160,000) |
| Production labour | (165,279) | (169,796) | (175,146) |
| Administration costs | (75,380) | (77,641) | (78,371) |
| Total payments: | (731,159) | (747,444) | (768,814) |
| Net cash flow | 20,027 | (13,538) | (19,439) |
| Balance c/f | 15,051 | 1,513 | (17,926) |
|
Budgeted income statement |
January |
February |
March |
| £ | £ | £ | |
| Sales | 731,400 | 745,200 | 765,900 |
| Cost of sales | (424,000) | (432,000) | (444,000) |
| Gross profit | 307,400 | 313,200 | 321,900 |
| Operating expenses | (29,786) | (30,900) | (31,671) |
| Fixed overheads | (210,000) | (210,000) | (210,000) |
| Administration costs | (75,380) | (77,641) | (78,371) |
| Total expenses | (315,166) | (318,542) | (320,043) |
|
Operating profit/(loss) |
(7,766) |
(5,342) |
1,857 |
The following information is relevant to the cash budget:
- Credit customers are allowed one month’s credit on sales;
- Credit suppliers allow one month credit on raw materials purchases;
- Materials and production labour costs are included in the cost of sales in the budgeted income
This document is for Coventry University students for their own use in completing their assessed work for this module and should not be passed to third parties or posted on any website. Any infringements of this rule should be reported to [email protected]
The following information from the budgeted Statement of Financial Position is also available.
| Jan | Feb | Mar | |
| £ | £ | £ | |
| Trade receivables | 549,464 | 560,758 | 577,283 |
| Trade payables | 139,247 | 136,249 | 132,311 |
| Finished goods inventory | 101,878 | 126,105 | 154,653 |
| Raw materials inventory | 114,264 | 135,054 | 158,110 |
This document is for Coventry University students for their own use in completing their assessed work for this module and should not be passed to third parties or posted on any website. Any infringements of this rule should be reported to [email protected]
Document 4 – Full (absorption) costing
Agnew Agricultural Ltd’s product costing team have provided you with the following information on the current method used to charge overhead costs to products. The table shows each overhead cost and the apportioned and reapportioned costs by cost centre together with the apportionment bases used.
| Department | Large Machinery | Small Machinery | Hand Tools | Mainte
-nance |
Adminis
-tration |
Total |
| Direct materials (£) | 1,667,500 | 1,000,500 | 667,000 | 0 | 0 | 3,335,000 |
| Direct labour (£) | 1,000,500 | 600,300 | 400,200 | 0 | 0 | 2,001,000 |
| Direct costs | 2,668,000 | 1,600,800 | 1,067,200 | 0 | 0 | 5,336,000 |
| Overheads | ||||||
| Indirect labour (direct
labour) |
298,900 |
179,340 |
119,560 |
0 |
0 |
597,800 |
| Rent (floor area) | 361,350 | 203,260 | 169,383 | 33,877 | 28,230 | 796,100 |
| Machine insurance
(machine value) |
57,605 |
22,700 |
14,920 |
3,875 |
– |
99,100 |
| Heating (floor area) | 71,989 | 40,494 | 33,745 | 6,749 | 5,624 | 158,600 |
| Machine power (machine
hours) |
53,212 |
40,542 |
48,144 |
7,602 |
0 |
149,500 |
| Machine depreciation
(machine value) |
69,172 |
27,259 |
17,916 |
4,653 |
0 |
119,000 |
| Total apportioned
overhead costs |
912,228 |
513,594 |
403,668 |
56,755 |
33,855 |
1,920,100 |
| Re-apportion maintenance
(machine hours) |
20,201 |
15,391 |
18,277 |
(53,869) |
0 |
0 |
| Re-apportion
administration (employees) |
12,761 |
9,636 |
11,458 |
0 |
(33,855) |
– |
| Total re-apportioned
overhead costs |
945,190 |
538,621 |
433,403 |
2,886 |
0 |
1,920,100 |
| Machine hours | 21,000 | 16,000 | 19,000 | |||
| Overhead absorption rate
per machine hour (£) |
45.01 |
33.66 |
22.81 |
|||
The costing team have been reviewing the overhead costing methodology and have prepared the following proposal for a revised costing method.
|
Department |
Large Machinery | Small Machinery | Hand Tools | Mainte
-nance |
Adminis
-tration |
Total |
| Direct materials (£) | 1,667,500 | 1,000,500 | 667,000 | 0 | 0 | 3,335,000 |
| Direct labour (£) | 1,000,500 | 600,300 | 400,200 | 0 | 0 | 2,001,000 |
| Direct costs | 2,668,000 | 1,600,800 | 1,067,200 | 0 | 0 | 5,336,000 |
| Overheads | ||||||
| Indirect labour (employees) | 204,841 | 154,676 | 183,938 | 29,263 | 25,083 | 597,800 |
| Rent (indirect labour) | 398,050 | 238,830 | 159,220 | 0 | 0 | 796,100 |
| Machine insurance
(machine hours) |
35,273 |
26,875 |
31,914 |
5,039 |
0 |
99,100 |
| Heating (employees) | 54,345 | 41,036 | 48,800 | 7,764 | 6,655 | 158,600 |
| Machine power (machine
value) |
86,901 |
34,245 |
22,508 |
5,846 |
0 |
149,500 |
| Machine depreciation
(machine hours) |
42,356 |
32,271 |
38,322 |
6,051 |
0 |
119,000 |
| Total apportioned
overhead costs |
821,766 |
527,933 |
484,702 |
53,962 |
31,737 |
1,920,100 |
| Re-apportion maintenance
(machine value) |
32,643 |
12,864 |
8,455 |
(53,962) |
0 |
0 |
| Re-apportion
administration (floor area) |
15,624 |
8,789 |
7,324 |
0 |
(31,737) |
0 |
| Total re-apportioned
overhead costs |
870,034 |
549,585 |
500,481 |
0 |
0 |
1,920,100 |
| Machine hours | 21,000 | 16,000 | 19,000 | |||
| Overhead absorption rate
per machine hour (£) |
41.43 |
34.35 |
26.34 |
|||
The Sales Director has expressed the view that this new method is superior because it reduces the overheads chargeable to the Large Machinery profit centre, which has struggled to increase sales and make profits over the past few years. The reduction in overhead costs charged to this profit centre will help it to increase sales, by reducing prices, and maintain or increase profits at the same time.
The Small Machinery profit centre is considering purchasing a new piece of equipment to help save costs and make the production process more efficient.
There are two options for the new piece of equipment. The Weldmaster will further automate production processes for items with metal cases that need welding. The Solderking will improve production processes and product quality for items with electronic circuit boards requiring soldering.
The following information about the cash flows, profits and capital investment appraisal measures has been provided to you. The company’s cost of capital is currently 6%.
Weldmaster
Year Cash flow (£) 6%
Factors
Present value (£)
Depreciation (£) Profit (£) Cumulative cash
flow (£)
| 0 | (800,000) | 1.0000 | (800,000) | (800,000) | ||
| 1 | 256,000 | 0.9434 | 241,510 | (140,800) | 115,200 | (544,000) |
| 2 | 224,000 | 0.8900 | 199,360 | (140,800) | 83,200 | (320,000) |
| 3 | 200,000 | 0.8396 | 167,920 | (140,800) | 59,200 | (120,000) |
| 4 | 168,000 | 0.7921 | 133,073 | (140,800) | 27,200 | 48,000 |
| 5 | 144,000 | 0.7473 | 107,611 | (140,800) | 3,200 | 192,000 |
| 5* | 96,000 | 0.7473 | 71,741 | 288,000 | ||
| NPV = | 121,215 | 288,000 |
Payback period 3 years 9 months
Accounting rate of return 12.8%
Internal rate of return 11.3%
Solderking
Year Cash flow (£) 6%
Factors
Present value (£)
Depreciation (£) Profit (£) Cumulative cash
flow (£)
| 0 | (1,000,000) | 1.0000 | (1,000,000) | (1,000,000) | ||
| 1 | 187,000 | 0.9434 | 176,416 | (175,000) | 12,000 | (813,000) |
| 2 | 218,000 | 0.8900 | 194,020 | (175,000) | 43,000 | (595,000) |
| 3 | 259,000 | 0.8396 | 217,456 | (175,000) | 84,000 | (336,000) |
| 4 | 291,000 | 0.7921 | 230,501 | (175,000) | 116,000 | (45,000) |
| 5 | 332,000 | 0.7473 | 248,104 | (175,000) | 157,000 | 287,000 |
| 5* | 125,000 | 0.7473 | 93,413 | 412,000 | ||
| NPV = | 159,909 | 412,000 |
Payback period 4 years 2 months
Accounting rate of return 14.6%
Internal rate of return 10.7%
*The second cash flow in year 5 for each option represents the sales proceeds on the disposal of the equipment at the end of its life (residual value).
The Solderking will not be fully effective until a number of new product lines requiring stitching have been introduced over the next few years, whereas the Weldmaster will reduce costs and improve efficiency on existing product lines.
Only one of the two pieces of equipment can be purchased in the near future due to a lack of investment capital.
