Master Budgeting: Case Study Stylistic Furniture

Consider Stylistic Furniture, a company that makes two types of granite-top coffee
tables: Casual and Deluxe. It is late 2020 and Stylistic’s CEO, Rex Jordan, is very
concerned about how he is going to respond to the board of directors’ mandate to
increase profits by 10% in the coming year.

To control the situation, Jordan goes through the following five-step decision-
making process:
1. Identify the problem and uncertainties. The problem is to identify a strategy
and to build a budget to achieve a 10% profit growth. There are several
uncertainties. Can Stylistic dramatically increase sales for its more profitable
Deluxe tables? What price pressures is Stylistic likely to face? Will the cost of
materials increase? Can costs be reduced through efficiency improvements?
2. Obtain information. Stylistic’s managers gather information about sales of
Deluxe tables in the current year. They are delighted to learn that sales have been
stronger than expected. Moreover, one of the key competitors in Stylistic’s Casual
tables line has had quality problems that are unlikely to be resolved until early
2021. Unfortunately, they also discover that the prices of direct materials have
increased slightly during 2020.
3. Make predictions about the future. Stylistic’s managers feel confident that
with a little more marketing, they will be able to grow the Deluxe tables business
and even increase prices slightly relative to 2020. They also do not expect
significant price pressures on Casual tables in the early part of the year, because
of the quality problems faced by a key competitor. They are concerned, however,
that when the competitor does start selling again, pressure on prices could
increase.
The purchasing manager anticipates that prices of direct materials will be about
the same as in 2020. The manufacturing manager believes that efficiency
improvements would allow costs of manufacturing tables to be maintained at 2020
costs despite an increase in the prices of other inputs. Achieving these efficiency
improvements is important if Stylistic is to maintain its 12% operating margin (that
is, operating income ÷ sales = 12%) and to grow sales and operating income.
4. Make decisions by choosing among alternatives. Jordan and his managers
feel confident in their strategy of pushing sales of Deluxe tables. This decision has
some risks but is easily the best option available for Stylistic to increase profits by
10%. 

5. Implement the decision, evaluate performance, and learn. Managers
compare actual to predicted performance to learn about why things turned out the
way they did and how to do things better. Stylistic’s managers would want to know
whether their predictions about prices of Casual and Deluxe tables were correct.
Did prices of direct materials increase more or less than anticipated? Did efficiency
improvements occur? Such learning would be very helpful as Stylistic plans its
budgets in subsequent years.

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Steps 1 to 4 –Operating Budgets for Direct Costs

Details needed to prepare the budget follow:

Stylistic sells two models of granite-top coffee tables: Casual and Deluxe. Revenue
unrelated to sales, such as interest income, is zero. 


Work-in-process inventory is negligible and is ignored. 


Direct materials inventory and finished goods inventory are costed using the first-
in, first-out (FIFO) method. Unit costs of direct materials purchased and unit costs
of finished goods sold remain unchanged throughout each budget year but can
change from year to year. 


There are two types of direct materials: red oak (RO) and granite slabs (GS). Direct
material costs are variable with respect to units of output—coffee tables. 


Direct manufacturing labor workers are hired on an hourly basis; no overtime is

worked. 


There are two cost drivers for manufacturing overhead costs—direct

manufacturing 
labor-hours and setup labor-hours. 


Direct manufacturing labor-hours is the cost driver for the variable portion of
manufacturing operations overhead. The fixed component of manufacturing
operations overhead is tied to the manufacturing capacity of 300,000 direct
manufacturing labor-hours that Stylistic has planned for 2021. 


Setup labor-hours is the cost driver for the variable portion of machine setup over-
head. The fixed component of machine setup overhead is tied to the setup capacity
of 15,000 setup labor-hours that Stylistic has planned for 2021. 


For computing inventoriable costs, Stylistic allocates all (variable and fixed)
manufacturing operations overhead costs using direct manufacturing labor-hours
and machine setup overhead costs using setup labor-hours. 


Nonmanufacturing costs consist of product design, marketing, and distribution

costs. All product design costs are fixed costs for 2021. The variable component
of marketing costs equals the 6.5% sales commission on revenues paid to
salespeople. The variable portion of distribution costs varies with cubic feet of
tables moved.

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The following data are available for the 2021 budget:

Cost per unit variable costs

Direct Material:
Red Oak 7 $ per board foot (b.f.) (same as 2020)
Granite 10 $ per square foot (s.f.) (same as 2020)
Direct manufacturing labor 20 $ per hour

Content of each Product Unit Product

Unit Casual Granite table Deluxe Granite table
Red Oak Board feet 12 12
Granite Square feet 6 8
Direct manufacturing labor hours 4 6
Product
Expected sales in units number of units sold 50 000 10 000
Selling Price $ 600 800
Target Ending inventory units 11 000 500
Beginning Inventory units 1 000 500
Beginning Inventory $ 384 000 262 000
Direct Materials
Red Oak Granite
Beginning Inventory in quantity (b.f or s.f) 70 000 60 000
Targeted Ending Inventory in quantity (b.f or s.f) 80 000 20 000

Stylistic bases its budgeted cost information on the costs it predicts it will incur to
support its revenue budget, taking into account the efficiency improvements it
expects to make in 2021. Recall that efficiency improvements are critical to offset
anticipated increases in the cost of inputs and to maintain Stylistic’s 12% operating
margin.

Most companies have a budget manual that contains a company’s particular

instructions and relevant information for preparing its budgets. Although the
details differ among companies, the following basic steps are common for
developing the operating budget for a manufacturing company. Beginning with the
revenues budget, each of the other budgets follows step-by-step in logical fashion.

Work to do - Present the steps in preparing an operating budget for

Stylistic Furniture for 2021:
- Step 1: Prepare the Revenues Budget
- Step 2: Prepare the Production Budget (in Units)
- Step 3: Prepare the Direct Material Usage Budget and Direct Material
Purchases Budget.
- Step 4: Prepare the Direct Manufacturing Labor Costs Budget.

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Solution

Summary of the case:

Mr Jordan goes through a 5 steps process to implement his budget strategy.

1 – Identify the problems and uncertainties:

We can see 4 preoccupations of the CEO:
- Volume of sales
- Selling price per unit
- Cost of Direct Material
- Costs reductions through economies of scale

2 – Obtain information
Once gathered information, the budgets teams and the CEO have some answers
to their questions:
- Good news
o Sales volume have been stronger then expected
o A competitor has some (quality) problems
- Bad news
o Price of raw materials have increased

3 – Make predictions about the future

- Deluxe tables
o Volume can be increased (with more marketing efforts)
o Maybe Selling prices per unit too
- Casual tables
o No price pressure expected
o At least until the competitors has solved his quality problems
o Prices of raw materials should be the same
o Production cost should be maintained
- And globally:
o They want to maintain 12% Operating Margin
o Grow sales and operating income

4 – Make Decisions by choosing among alternatives

- Pushing sales of Deluxe Tables
- Risky but could help increase profits by 10%

5 – Implement the Decision, evaluate performance and learn

Through variances analysis, they should be later on able to check if the forecasts
were good, and among other things about:
- Predictions about prices of both models
- Increase in the price of raw materials
- Efficiency improvements

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Step 1: Prepare the Revenues Budget

Schedule 1 : Revenues Budget Casual Granite table Deluxe Granite table Total sales ($)
Units Per unit Total ($) Units Per unit Total ($)
Sales 50 000 600 30 000 000 10 000 800 8 000 000 38 000 000

Step 2: Prepare the Production Budget (in Units)

Schedule 2: Production Budget (in units) Casual Deluxe

Budgeted units sold 50 000 10 000
Targe ending inventory 11 000 500
Total required units 61 000 10 500
Beginning Inventory 1 000 500
Units of finished goods to be produced 60 000 10 000

Step 3: Prepare the Direct Material Usage Budget and Direct Material Purchases Budget.

Schedule 3 Direct Material Budget Red Oak Granite Total

Quantity Cost per unit Total ($) Quantity Cost per unit Total ($)
Casual 720 000 7 5 040 000 360 000 10 3 600 000
Deluxe 120 000 7 840 000 80 000 10 800 000
Quantity need for production 840 000 7 5 880 000 440 000 10 4 400 000 10 280 000
Targeted Ending Inventory 80 000 7 560 000 20 000 10 200 000
Total Needed 920 000 7 6 440 000 460 000 10 4 600 000 11 040 000
Beginning Inventory 70 000 7 490 000 60 000 10 600 000
Purchases needed 850 000 7 5 950 000 400 000 10 4 000 000 9 950 000

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Step 4: Prepare the Direct Manufacturing Labor Costs Budget.

Schedule 4 Direct Labor Budget Labor Cost

Quantity Cost per hour Total ($)
Casual 240 000 20 4 800 000
Deluxe 60 000 20 1 200 000
Total Direct Labor Budget 300 000 20 6 000 000

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Step 5 - Manufacturing Overheads costs budgets

As said earlier, Direct manufacturing labor-hours is the cost driver for the variable
portion of manufacturing operations overhead and setup labor-hours is the cost
driver for the variable portion of machine setup overhead costs. The use of activity-
based cost drivers such as these gives rise to activity-based budgeting. Activity-
based budgeting (ABB) focuses on the budgeted cost of the activities necessary
to produce and sell products and services.

For the 300,000 direct manufacturing labor-hours, Stylistic’s manufacturing

managers estimate various line items of overhead costs that constitute
manufacturing operations overhead (that is, all costs for which direct
manufacturing labor-hours is the cost driver). Managers identify opportunities for
process improvements and determine budgeted manufacturing operations
overhead costs in the operating department. They also determine the resources
that they will need from the two support departments—kilowatt hours of energy
from the power department and hours of maintenance service from the
maintenance department. The support department managers, in turn, plan the
costs of personnel and supplies that they will need in order to provide the operating
department with the support services it requires. The costs of the support
departments are then allocated (first-stage cost allocation) as part of
manufacturing operations overhead.

Stylistic’s managers determine how setups should be done for the Casual and
Deluxe line of tables, taking into account past experiences and potential
improvements in setup efficiency.

For example, managers consider the following:

- Increasing the length of the production run per batch so that fewer batches
(and therefore fewer setups) are needed for the budgeted production of
tables 

- Decreasing the setup time per batch 

- Reducing the supervisory time needed, for instance by increasing the skill
base of workers

Stylistic’s managers forecast the following setup information for the Casual and
Deluxe tables: 


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Using an approach similar to the one described for manufacturing operations
overhead costs, Stylistic’s managers estimate various line items of costs that
comprise machine setup overhead costs—that is, all costs that are caused by the
15,000 setup labor-hours (the cost driver). Note how using activity-based cost
drivers provide additional and detailed information that improves decision-making
compared with budgeting based solely on output-based cost drivers. Of course,
managers must always evaluate whether the expected benefit of adding more cost
drivers exceeds the expected cost. 


Manufacturing Overhead Costs Budget for the year ending December 31,
2021 (Step 5) is provided below (No work to do for this step):

Step 6: Prepare the Ending Inventories Budget

The management accountant prepares the ending inventories budget, calculated

in Schedules 6A and 6B. In accordance with generally accepted accounting
principles, Stylistic treats both variable and fixed manufacturing overhead as
inventoriable (product) costs. Stylistic is budgeted to operate at capacity.

Manufacturing operations overhead costs are allocated to finished goods

inventory at the budgeted rate of $30 per direct manufacturing labor-hour (total
budgeted manufacturing operations overhead, $9,000,000 ÷ 300,000 budgeted
direct manufacturing labor-hours).

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Machine setup overhead costs are allocated to finished goods inventory at the budgeted rate of $200 per setup-hour (total
budgeted machine setup overhead, $3,000,000 ÷ 15,000 budgeted setup labor-hours).

Prepare the Schedule 6A showing the computation of the unit cost of coffee tables started and completed in 2021.
Prepare the Schedule 6B showing Ending Inventories Budget.

Schedule 6A: Unit Costs of Ending Finished Goods Inventory

Casual Deluxe
Input per unit of
Cost per unit of Input Input per unit of output Total Cost per unit of Input output Total
Red Oak 7 12 84 7 12 84
Granite 10 6 60 10 8 80
Direct Manufacturing labor 20 4 80 20 6 120
Manufacturing overhead 30 4 120 30 6 180
Machine Setup overhead 200 0,2 40 200 0,3 60
Total 384 524

Schedule 6B: Ending Inventory Budget

Quantity Cost per unit Total
Direct Material:
Red Oak 80 000 7 560 000
Granite 20 000 10 200 000
Finished Goods:
Casual 11000 384 4 224 000
Deluxe 500 524 262 000
Total Ending Inventory 5 246 000

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Step 7: Prepare the Cost of Goods Sold Budget

The manufacturing and purchase managers, together with the management accountant, use information from Schedules 3
through 6 to prepare Schedule 7.

Prepare the Cost of Goods Sold Budget.

Schedule 7 - Cost of Goods Sold Total

Beginning finished good inventory 646 000
Direct material used 10 280 000
Direct manufacturing labor 6 000 000
Manufacturing overhead 12 000 000
Cost of goods manufactured 28 280 000 28 280 000
Cost of goods available for sale 28 926 000
Deduct ending finished goods inventory 4 486 000
Cost of goods sold 24 440 000

Step 8: Prepare the Nonmanufacturing Costs Budget

Schedules 2 through 7 cover budgeting for Stylistic’s production function of the value chain. For brevity, other parts of the
value chain—product design, marketing, and distribution—are combined into a single schedule. Just as in the case of
manufacturing costs, managers in other functions of the value chain build in process and efficiency improvements and prepare
nonmanufacturing cost budgets on the basis of the quantities of cost drivers planned for 2021.

Product design costs are fixed costs, determined on the basis of the product design work anticipated for 2021 for a total amount
of $1,024,000. The variable component of budgeted marketing costs is the commissions paid to sales people equal to 6.5% of
revenues. The fixed component of budgeted marketing costs equal to $1,330,000 is tied to the marketing capacity for 2021.
The cost driver of the variable component of budgeted distribution costs is cubic feet of tables moved (Casual: 18 cubic feet *

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50,000 tables + Deluxe: 24 cubic feet * 10,000 tables = 1,140,000 cubic feet). Variable distribution costs equal $2 per cubic
foot. The fixed component of budgeted distribution costs equals $1,596,000 and is tied to the distribution capacity for 2021.

Prepare the Nonmanufacturing Costs Budget

Schedule 8 - Nonmanufacturing Costs budget

Business function Variable costs Fixed costs Total costs

Product design 1 024 000 1 024 000
Marketing costs 2 470 000 1 330 000 3 800 000
Distribution costs 2 280 000 1 596 000 3 876 000
Total non manufacturing costs 8 700 000

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Step 9: Prepare the Budgeted Income Statement

The CEO and managers of various business functions, with help from the management accountant, use information in Schedules
1, 7, and 8 to finalize the budgeted income statement.

Prepare the Budgeted Income Statement.

Year 2021
Details Totals
Revenues Schedule 1 38 000 000
Cost of goods sold Schedule 7 24 440 000
Gross Margin 13 560 000
Operating Costs
Product design costs Schedule 8 1 024 000
Marketing costs Schedule 8 3 800 000
Disribution costs Schedule 8 3 876 000 8 700 000
Operating Income 4 860 000

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Additional parts

Sensitivity analysis

Suppose that to maintain its sales quantities, Stylistic needs to decrease selling prices to $582 per Casual table and $776 per
Deluxe table, a 3% decrease in the selling prices used in the chapter illustration. All other data are unchanged.

Prepare a budgeted income statement, including all necessary detailed supporting budget schedules that are different from the
schedules presented in the chapter. Indicate those schedules that will remain unchanged.

Year 2021
Details Totals
Revenues Schedule 1 36 860 000
Cost of goods sold Schedule 7 24 440 000
Gross Margin 12 420 000
Operating Costs
Product design costs 1 024 000
Marketing costs 3 725 900
Disribution costs 3 876 000 8 625 900
Operating Income 3 794 100

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Cash Budget

The budgeted cash flows for 2021 are as follows:

The quarterly data are based on the budgeted cash effects of the operations formulated in Schedules 1 through 8 in the chapter,
but the details of that formulation are not shown here to keep this illustration as brief and as focused as possible.

The company wants to maintain a $350,000 minimum cash balance at the end of each quarter. The company can borrow or
repay money at an interest rate of 12% per year. Management does not want to borrow any more short- term cash than is
necessary.

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Suppose Stylistic Furniture had the following balance sheet for the year ended December 31, 2020:

Assume, for simplicity, that borrowing takes place at the beginning and repayment at the end of the quarter under consideration
(in multiples of $1,000). Interests are computed to the nearest dollar and are paid at the end of each quarter.

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Prepare a cash budget for 2021 by quarter. That is, prepare a statement of cash receipts and disbursements by quarter,
including details of borrowing, repayment, and interest. 

Stylistic Cash Budget for 2021
Quarters Year as a
1 2 3 4 whole
Cash balance, beginning 300 000 350 295 350 557 350 380 300 000
Add receipts
Collection from customers 9 136 600 10 122 000 10 263 200 8 561 200 38 083 000
Total cash available for needs 9 436 600 10 472 295 10 613 757 8 911 580 38 383 000
Deduct disbursements
Direct materials 2 947 605 2 714 612 2 157 963 2 155 356 9 975 536
Payroll 3 604 512 2 671 742 2 320 946 2 562 800 11 160 000
Manufacturing overhead costs 2 109 018 1 530 964 1 313 568 1 463 450 6 417 000
Nonmanufacturing costs 1 847 750 1 979 000 1 968 250 1 705 000 7 500 000
Machinery purchase 758 000 758 000
Income taxes 725 000 400 000 400 000 400 000 1 925 000
Total Disbursements 11 233 885 9 296 318 8 918 727 8 286 606 37 735 536
Minimum cash balance desired 350 000 350 000 350 000 350 000 350 000
Total cash needed 11 583 885 9 646 318 9 268 727 8 636 606 38 085 536
Cash excess (or deficiency) (2 147 285) 825 977 1 345 030 274 974 297 464
Borrowing (at beginning) 2 214 000 2 214 000
Repayment (at end) 759 000 1 301 000 154 000 2 214 000
Interest (at 12% per year) 66 420 66 420 43 650 4 620 181 110
Total effects of financing 2 147 580 (825 420) (1 344 650) (158 620) (181 110)
Cash balance, ending 350 295 350 557 350 380 466 354 466 354
Needed borrowing 2 211 703,55
Repayment possible 759 557 1 301 380 270 354
Outstanding balance 2 214 000 1 455 000 154 000

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Prepare a budgeted income statement for the year ending December 31, 2021. This statement should include interest
expense and income taxes (at a rate of 40% of operating income). 


Year 2021
Details Totals
Revenues Schedule 1 38 000 000
Cost of goods sold Schedule 7 24 440 000
Gross Margin 13 560 000
Operating Costs
Product design costs 1 024 000
Marketing costs 3 800 000
Distribution costs 3 876 000 8 700 000
Operating Income 4 860 000
Interest expense 181 110
EBT 4 678 890
Income taxes (40%) 1 871 556
Net Income 2 807 334

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Prepare a budgeted balance sheet on December 31, 2021. 


Budgeted Balance sheet

End Year 2021

Assets Details Totals

Current Assets
Cash 466 354
Accounts receivable 1 628 000
Direct material Inventory 760 000
Finished goods inventory 4 486 000 5 246 000
Total current assets 7 340 354
Property, Plant and Equipment
Land 2 000 000
Building and equipment 22 758 000
Accumulated depreciation 8 523 000 14 235 000
Total PPE 16 235 000
Total Assets 23 575 354
Liab. and Stockholders equity
Current liabilities
Accounts payable 878 464
Income Taxes payable 271 556 1 150 020
Total Current liabilities 1 150 020
Stockholders equity
Common stock 3 500 000
Retained Earnings 18 925 334 22 425 334
Total Stockholders equity 22 425 334
Total Liab. and Stockholders equity 23 575 354

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