Play Time Toy faces a highly seasonal pattern of sales. In the past, Play Time has used a seasonal production schedule, where the amount produced each month matches the sales for that month. Under this production plan, inventory is maintained at a constant level. The production manager, Thomas Lindop, is proposing a switch to a level, or constant, production schedule. This schedule would result in significant savings in production costs but would have higher storage and handling costs, fluctuating levels of inventories, and would also have implications for financing. Jonathan King, president of Play Time Toy, has been reviewing pro forma income statements, cash budgets, and balance sheets for the coming year under the two production scenarios. Table 1 shows the pro forma analysis under seasonal production, and Table 2 shows the pro forma analysis under level production.
Greg Cole, chief financial officer of Play Time, prepared the two tables. He explained that the pro forma analyses in Tables 1 and 2 take fully into account the 11% interest payments on the unsecured loan from Bay Trust Company and the 3% interest received from its cash account. An interest charge of 11%/12 on the balance of the loan at the end of a month must be paid the next month. Similarly, an interest payment of 3%/12 on the cash balance at the end of a month is received in the next month.
The inventory available at the end of December 1990 is $530,000 (measured in terms of cost to produce). Mr. Cole assumed that this inventory represents a sales value of $530,000/0.651667 = $813,300.
The inventory and overtime costs in Tables 1 and 2 are based on the cost information developed by Mr. Lindop. This information is summarized in Table 3.
Mr. Cole further explained how the cost information was used in the pro forma analyses. For example, in Table 1, the production in August is $1,458,000. The overtime cost in August is therefore calculated to be $61,000 (=0.15 x (1,458,000 -1,049,000)). Play Time uses LIFO (last-in, first-out) accounting, so overtime costs