Practice Case- Kaboom Inc- managerial accounting PDF

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CPA Core 2 case study from Densmore which is similar to the exam. Covers cost accounting, performance management, capital budgeting....

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CPA MOCK Evaluation

Core 2 Module

KABOOM INC.

Page 1 Suggested Time (60 minutes)

Kaboom Inc. (KI) is a privately-owned producer and distributor of nutritional supplements. The company has established a strong market position in the industry with its two vitamin-enriched product offerings, Kaboom Kal protein bars and Kaboom Krisp cereal. In 2021, KI decided to develop a third product, Kaboom Kool, a sugar-free energy drink. This new product has been tested and is ready for commercial production beginning in January 2022. KI does not expect to introduce any additional products until 2023. Today is December 1, 2021. You, CPA, were recently hired by KI to work in a management accounting role. KI’s CFO, Deshi Chan, has just called you into his office. “Good morning CPA, I have some important tasks for you to perform this week. We have just drafted our preliminary operating budget for 2022 (Appendix I). I would like you to review a summarized version and make any changes that you feel are necessary, with support, before we finalize and approve it. “Overall, I feel that we have a strong information system in place for the creation and use of our budgets. However, given your expertise in this area, please identify any weaknesses that exist and provide recommendations for improvement. I suggest you meet with Kip Ramsey, our Finance Manager, to discuss the information system and our budgeting process (Appendix II). “Also, I have assembled projected year-end figures for our balance sheet (Appendix III) and income statement (Appendix I). I would like you to use these to compute some key financial ratios and assess KI’s performance. For example, KI’s owners believe liquidity is important and place strong emphasis on the current ratio, which typically sits around 2:1. “I also need you to determine whether to lease or purchase the equipment (Appendix IV) by preparing a quantitative analysis. I wonder what the impact of the new line of credit will be on KI’s weighted average cost of capital.” Prepare the report for Deshi.

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CPA MOCK Evaluation Core 2 Module  APPENDIX I PROJECTED 2021 INCOME STATEMENT AND 2022 OPERATING BUDGET

Page 2

Projected income statement 2021 Revenue Sales, net of rebates

$12,447,300

$14,936,760

6,099,200 1,682,600 418,200 288,000 1,847,900 1,020,500 472,050 338,420 12,166,870

8,663,321 1,707,839 383,100 252,000 1,847,900 1,035,808 479,131 149,368 14,518,467

Expenses Cost of goods sold Salaries and wages Depreciation Interest Research and development General and administrative Marketing Bad debt Total expenses Income before taxes

Operating budget 2022

$

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280,430

$

418,293

CPA MOCK Evaluation Core 2 Module  APPENDIX II NOTES FROM MEETING WITH KIP RAMSEY, FINANCE MANAGER

Page 3

Information System As per standard industry practice, KI’s budget is prepared in November to ensure it is discussed, approved and relayed to management prior to the beginning of the next fiscal year. To prevent unauthorized changes to the master budget, KI’s administrator, Lian, and the CEO are the only people that have access to the budget, which is kept in a password-protected file. Managers are provided with a hard copy of the final budget but cannot access it electronically. If changes to the budget are required during the year, managers must write in the requested change on their budget copy and provide it to Lian. She then updates the master spreadsheet. Once a month, the CEO reviews all changes. In the event that a hard copy of the budget is misplaced or a manager finds out that changes have been made and would like a newer version, managers can request another printed copy from Lian. This seems to work fine, except in a few instances where she was sick or on vacation, which has caused some delays in decision-making. Management meets quarterly to assess budget variances. Lian must manually assemble the variance reports since the budget is maintained separately and is not integrated with the accounting software. Each manager compiles “actual” figures for their department and sends the information to Lian by e-mail. She prints the e-mails and uses those figures to create a spreadsheet summary of budget-to-actual variances for the company, which is then used at these meetings. Most items in the preliminary budget are based on up-to-date information from KI’s accounting system. However, this is not possible in some instances. For example, as a cost efficiency, our inventory and cost of goods sold production records are compiled and maintained off-site by a third party. The third party sends us the data quarterly and just before year-end. It is sent in a file format that is not compatible with our software, and must be downloaded and manually reentered. To save time for budget purposes, we apply the 42% industry average gross margin percentage to calculate cost of goods sold. Going forward, we expect that the gross margin on Kaboom Kool will be similar to that of our existing products.

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CPA MOCK Evaluation Core 2 Module  APPENDIX II (continued) NOTES FROM MEETING WITH KIP RAMSEY, FINANCE MANAGER

Page 4

Budgeting Process For certain items that typically do not fluctuate annually, such as general and administrative expenses, salaries and wages, and marketing expenses, a 1.5% increase for inflation was applied to the 2021 projected totals. Depreciation was calculated on a straight-line basis using the 2021 property, plant and equipment ending balances. KI’s sales typically increase about 4% annually, but we have projected a 20% increase in 2022 because of the expected success of Kaboom Kool. To help ensure the immediate success of Kaboom Kool, senior management just approved a $150,000 marketing initiative for the new product, which will take effect in the first quarter of 2022. KI spent a significant amount of money in 2021 developing this product but we believe it will be worth it. Our experience indicates that for every $1 we spend on research and development for a new product, KI will yield 30 cents of sales in the first year after product launch, increasing up to $1.50 within five years. Once products are launched, no further development costs are necessary, which helps increase future profitability. All of KI’s sales are on a credit basis. In late October, we began offering our customers significant rebates (up to 20%) in an effort to speed up receivables collection and decrease our average collection period below 45 days. The response has been great so far, and we believe this will enable us to reduce our bad debt expense to about 1% of sales, which is reflected in the 2022 budget. Apparently, there is a feature in our accounting software that enables receivable tracking by customer but it is only enabled at year-end. As a result, we use a percentage estimate for budget purposes. In June 2021, we began using a cheaper vitamin additive in our two existing products, which significantly lowered our production costs. At the time, it had not yet been approved for use by the industry’s regulatory body. The additive did get approved in November 2021, with a condition that requires all products to maintain a maximum 28-day expiry period from the time of production, commencing in 2022. This is significantly lower than the current 45-day expiry period for our products. KI requires new equipment for the production of Kaboom Kool, which will be purchased on January 1, 2022. The equipment is expected to last 10 years. KI will be using a line of credit in the amount of $1,250,000 to fund the purchase. Interest will be charged at 7.5% over five years, with equal annual principal repayments due on December 31. KI is expected to ratify a new union agreement this month, which will increase all employee salaries by 3% annually for the next three years.

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CPA MOCK Evaluation Core 2 Module  APPENDIX III PROJECTED BALANCE SHEET AS AT DECEMBER 31, 2021 Assets Cash Accounts receivable Inventory

Property, plant and equipment, net Intangible assets

Total assets Liabilities Accounts payable Deferred revenue Current portion of long-term debt

Long-term debt

Equity Common shares Retained earnings  Total liabilities and equity

Page 5

$ 328,300 1,246,500 579,100 2,153,900

[1] [2]

3,652,000 1,170,700 4,822,700 $6,976,600

$1,074,800 223,500 400,000 1,698,300 2,400,000 [3] 4,098,300

1,200,000 [4] 1,678,300 2,878,300 $6,976,600

Notes: [1] The accounts receivable balance was $1,594,300 as at January 1, 2021. [2] The inventory balance was $739,800 as at January 1, 2021. [3] KI’s existing bank loan has an interest rate of 9% and requires $400,000 principal repayments at the end of each year. The loan requires a maximum 1.5:1 debt-to-equity ratio be maintained at all times, which is aligned with the industry average. [4] The risk-free rate is 3%, beta is 2.0, and the market risk premium is 6%.

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CPA MOCK Evaluation  APPENDIX IV EQUIPMENT

Core 2 Module

Page 6

KI is investigating the replacement of an aging piece of equipment used to manufacture nutritional supplements as the current equipment is only expected to last one more year. The manufacturer has offered to either sell or lease the equipment. The benefit is that the relevant interest rate of 5% is much lower than the rate that KI is being charged from its bank. In either case, the equipment will be acquired on January 1, 2023. The equipment is expected to last for six years. If the equipment is purchased, the $325,000 payment will be due on January 1, 2023. If the equipment is leased, the lease term will be 5 years with annual payments of $75,000 due at the beginning of the year. There is an option to purchase the equipment at the end of the lease for the equipment’s fair value of $20,000. KI’s tax rate is 27%. The relevant CCA class is 53 with a 50% CCA rate.

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