Balakrishnan Mgrl Solutions Ch07

8/10/2019 Balakrishnan Mgrl Solutions Ch07

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CHAPTER 7

OPERATINGBUDGETS: BRIDGINGPLANNINGANDCONTROL

SOLUTIONS

REVIEWQUESTIONS

7.1 A plan for using limited resources.

7.2 Firms budget for (1) planning, (2) coordination, and (3) control (performance evaluationand feedback).

7.3 Operating budgets reflect the collective epression of numerous short!term decisions thatconform to the direction set b" long!term plans. Financial budgets #uantif" the outcomesof operating budgets in summar" financial statements.

7.4 $he revenue budget. Organi%ations begin &ith the revenue budget because it is the firstline on the income statement. Additionall", organi%ations begin &ith the revenue budgetbecause revenues dictate the volume of operations &hich, in turn, drive man" costs suchas those related to materials and labor.

7.5 $he production budget.

7.6 $he budgets for materials, labor, and overhead.

7.7 'ost of goods sold 'ost of beginning finished goods inventor" cost of goodsmanufactured * cost of ending finished goods inventor".

7.8 $he cash budget is important for managing a firm+s &orking capital. t allo&s companiesto determine &hether the" &ill have enough mone" on hand to sustain pro-ectedoperations.

7.9 (1) nflo&s from operations, (2) outflo&s from operations, and (3) special items.

7.1 ecause most businesses offer credit terms to their customers * as such, the" receive casha fe& da"s, &eeks, or months after the sale occurs. /oreover, a firm+s credit polic"affects the timing and amount of cash flo&s.

7.11 (1) 0urchases of direct materials, (2) pa"ments for labor, (3) ependitures on

manufacturing overhead, and () outflo&s for marketing and administration costs.

7.12 ome eamples include the purchase or sale of e#uipment, the purchase or sale of stock,and the pa"ment of dividends.

7.13 A responsibilit" center is an organi%ational subunit. $here are three t"pes of responsibilit"centers (1) cost centers, (2) profit centers, and (3) investment centers.

alakrishnan, /anagerial Accounting 1e FO4 5$46'$O4 67 O589

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7.14 $op!do&n is more of an authoritative approach, &hereas a bottom!up approach is moreparticipative, encouraging organi%ation!&ide input into the budgeting process.

7.15 An incremental approach to budgeting can be useful as past trends ma" help &ith futurepro-ections. t is pragmatic, as it focuses attention on making changes to the previous

"ear+s budget based on actual performance and ne& information. Finall", incrementalchanges are easier to -ustif" and communicate * it is human nature to compareperformance across people and periods.

DISCUSSIONQUESTIONS

7.16 $he span of the operation often determines the need for a formal budget. t is easier toplan and keep track of &hat is happening if the operation is small enough. As the businessepands to a point &here it is difficult one person can oversee the &hole operation andmultiple people have to make decisions &ith respect to different aspects of the business,

planning and coordination become necessar". /oreover, ho& can the o&ner of thisepanding business ensure that all other emplo"ees making the various decisions are infact making them as he &ould make them; ome control also becomes necessar"eviations can also occur because theorgani%ational actions and decisions are not in line &ith &hat the" &ere epected to do." providing a baseline for comparison, budgets allo& us to measure and anal"%e thesedeviations so that corrective actions can be taken &hen necessar".

7.19 f budgets can be used to create the right organi%ational incentives, and all decisionmakers in the organi%ations are motivated to do the right thing, then close supervisionma" not be necessar". =o&ever, as discussed in the chapter, budgets cannot be a perfectsubstitute for supervision monitoring because the" are susceptible to game!pla"ing? nobudget can be perfect &hen it comes to setting the right incentives. ome supervision andmonitoring is al&a"s beneficial.

7.2 udgets pla" a limited role as a benchmark for performance evaluation in settings &hereforecasting is difficult and there is a high level of inherent uncertaint". =o&ever, it isbetter to have rough budgets than no budgets at all, and supplement budgets &ith othermonitoring mechanisms such as close supervision.

7.21 >epending on the si%e of the organi%ation and the number of products it offers,forecasting sales is a difficult eercise because it re#uires careful eamination of marketconditions and trends. naccurate sales forecasts can thro& the entire planning process out


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of gear. o, man" organi%ations devote a lot of time to develop dependable salesforecasts. 7stimating overheads is also difficult especiall" in large organi%ations becausethere are multiple drivers of overhead. dentif"ing the right drivers and estimating theprecise relations bet&een the overhead and its drivers is a difficult but an important stepin the budgeting process.

7.22 @ust!in!s"stem is often referred to as a pullB s"stem because an order from a customertriggers all the production and procurement activities. $he idea is to carr" no inventor" inthe s"stem, but respond to demand #uickl" b" achieving b" coordinating all necessar"activities smoothl". $o the etent a perfect pull s"stem can be achieved there are minimalinventor" budgets that reconcile the difference bet&een sales and production. imilarl",there are minimal ra& and &ork!in!process inventories that account for the differencebet&een material purchase and use.

7.23 $he budgeting process is time consuming in most organi%ations. ome largeorgani%ations are kno&n to start their budgeting process si months ahead of time. $hebenefit of going through several iterations is that budgets become more accurate, serve asbetter benchmarks to evaluate performance, and there is better coordination across theorgani%ation because ever"bod" is a&are of &hat is in it. $he cost is that it takes time andeffort.

7.24 oth the cash budget and cash flo& statement reconcile the cash position of a compan" atthe beginning of a period to the cash position at the end of the period. ut there are man"differences. First, the cash flo& statement is prepared at the end of the period, and reportspast cash inflo&s and outflo&s. econd, the cash flo& statement reports cash flo&sassociated &ith investing, financing, and operating decisions of the firm. On the otherhand, a cash flo& budget presents a plan of cash inflo&s and outflo&s at a more detailedlevel, such as &hen and ho& much cash is epected from customers, &hen cash is to be

paid to suppliers, and &orking capital re#uirements.

7.25 ome believe that budgets promote a financial emphasis in organi%ations. t is true thatbudgets are mostl" financial plans of organi%ational activities. $he reason for this is thatultimatel" the performance of a compan" is -udged in terms of the financial returns itgenerates for its shareholders. ut budgets need not necessaril" be restricted to financialmeasures. /an" firms are no& benchmarking ke" non!financial measures to ensureorgani%ational success.

7.26 oth lines of reasoning have merit. For gro&th companies, it is often difficult to developprecise budgets because of the difficult" in forecasting outcomes from research and

development and other gro&th activities. /oreover, rigid budgets are often said to stifleinnovation and gro&th b" not giving enough room to eercise discretion to sei%eopportunities in a timel" fashion. On the other hand, budgets that allo& discretion arealso sub-ect to misuse because formal control is difficult. Often more informal controlmechanisms and closer supervision are needed to achieve a measure of control in suchorgani%ations.


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7.27 $he advantages of participative budgeting include benefiting of the epertise andkno&ledge of emplo"ees in all levels of the organi%ation b" involving them in thebudgeting process, promoting a sense of o&nership and empo&erment among allemplo"ees, ensuring that ever"bod" bu"s into the budget so that implementation issmooth, better communication and coordination. $he disadvantages are that participative

budgeting is time consuming, and can lead to conflicts and disagreements that are hard toresolve (as the sa"ing goes !! too man" cooks spoil the broth


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E!ERCISES

7.31

n solving budgeting eercises, &e repeatedl" use the inventor" e#uation.B n itssimplest form, the inventor" e#uation is

Beginning balance What we put in* What we take outEnding balance.

Ce replace these terms &ith the appropriate account!specific terms &hen computingspecific revenue and cost budgets.

For 0remium, &e have

eginning inventor" 1,:DE Cindo&s 0roduction ,EEE! ales ; 7nding inventor" 2,DEE &indo&s

$hus, &e find S"#$% &'( )"(*+ , 7-25 /0'%.

/ultipl"ing :,2DE &indo&s b" the GHE price per &indo& gives $$ )"(*+($$0$ '& 435-.

7.32

a. $his eercise illustrates that budgets allo& organi%ations to pro-ect results for variousoptions, helping them make the profit!maimi%ing choice. elo&, &e calculate theannual sales and revenues for each price.

S"#$% R$$0$%

)'0+ Price = $60 Price = $57 Price = $60 Price = $57

@anuar" 2,DEE 2,HEE G1DE,EEE G1,2EE

Februar" 2,HEE 2,:2D 1DH,EEE 1DD,32D

/arch 2,:EE 2,DE 1H2,EEE 1H2,DE

April 2,EE 2,I:D 1H,EEE 1HI,D:D

/a" 2,IEE 3,1EE 1:,EEE 1:H,:EE

@une 3,EEE 3,22D 1E,EEE 13,2D

@ul" 3,1EE 3,3DE 1H,EEE 1IE,IDE

August 3,2EE 3,:D 1I2,EEE 1I,E:D

eptember 3,EDE 3,32D 13,EEE 1I,D2D

October 2,IEE 3,1:D 1:,EEE 1E,I:D

5ovember 2,:DE 3,E2D 1HD,EEE 1:2,2D

>ecember 2,HEE 2,:D 1DH,EEE 1H3,:D

T'"#% 34-1 36-7 2-46- 2-91-9


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Ce see that pricing at GD: maimi%es 0remium+s revenues. 7ven though the compan"receives a smaller amount for each Cindo&, the increased volume compensates for thelo&er price.

b. 0erhaps the most important factor to consider is cost * after all, 0remium is interested

in maimi%ing profit, not -ust revenues. 0ricing its product at GD:, 0remium &ill beselling additional 2,HEE &indo&s (3H,:EE * 3,1EE) over the course of the "ear.=o&ever, reducing the price &ill not increase profit unless the additional costs ofproducing and selling the etra &indo&s are less than GD,IEE ( G2,EI1,IEE !G2,EH,EEE) or about GD,IEEJ2,HEE G1:.HD per &indo&. Along these lines,0remium must consider &hether it has enough capacit" to produce the higher volume,and if the higher volume might add to congestion in the factor".

0remium also needs to consider the accurac" of its demand forecasts and &hether a pricecut &ould adversel" affect the perceived #ualit" of its product. Finall", 0remium needs toconsider &hat its competitors &ill do in terms of their pricing strateg" * if competitors

also reduce their prices, 0remium ma" not en-o" the increase in forecasted demand.

7.33

Ce can appl" the inventor" e#uation to find the missing data, as follo&s

Number of Window !pril"eptembe

r #ecember

>esired ending inventor" 1,EE 2,EEE 3,2EE udgeted sales 1E,EEE 1D,EEE 2E,EEE $otal re#uirements 11,EE 1:,EEE 23,2EE! eginning inventor" 1,2EE 3,EEE 2,2EE

udgeted production 1-6 1,EEE 21,EEE

n each instance, &e perform the suitable arithmetic to rearrange the terms and solve forthe re#uired item.

7.34

$o begin, &e kno& that

eginning inventor" (/arch) 7nding inventor" (Februar")and,

>esired ending inventor" (Februar") 1DK of /arch sales.

E.1D L 1D,EEE 2,2DE.


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Cith this step, &e can fill in the table partiall"

Number of Windowebruar

% &arch !pril

>esired ending inventor"M 2-25 3- 3,EEE

udgeted sales 1E,EEE 1D,EEE 2E,EEE $otal re#uirements 12,2DE 1,EEE 23,EEE! eginning inventor"MM 1,DEE 2-25 3- udgeted production

M 2,2DE E.1D L 1D,EEE? 3,EEE E.1D L 2E,EEE

MM eginning inventor" (/arch) 7nding inventor" (Februar").

Ce then use the inventor" e#uation to fill in the missing data, as follo&s

Number of Windowebruar

% &arch !pril

>esired ending inventor" 2-25 3- 3,EEE

udgeted sales 1E,EEE 1D,EEE 2E,EEE $otal re#uirements 12,2DE 1,EEE 23,EEE! eginning inventor" 1,DEE 2-25 3- udgeted production 1-75 15-75 2-

n each instance, &e perform the suitable arithmetic to rearrange the terms and solve forthe re#uired item. n particular, &e first solve for Februar" ending inventor" and Februar"production. n turn, this gives us the eginning inventor" for /arch. Ce repeat theprocess for /arch to get /arch production, and so on.

7.35

a. $he follo&ing table provides the re#uired revenue budget, and income statement.August eptember October 5ovember

ndividuals :EE HIE HE H:D

Famil" memberships 3EE 3EE 2ID 2IE

4evenue ! ndividual G :E,EEE1 G HI,EEE G H,EEE G H:,DEE

4evenue ! Famil" G ,EEE1 G ,EEE G :,2EE G H,EE

$otal 4evenue G 11,EEE G 11:,EEE G 11D,2EE G 113,IEENariable cost *ndividual G 2,DEE1 G 2,1DE G 23,EE G 23,H2D

Nariable cost ! Famil" G 1,EEE1 G 1,EEE G 1:,:EE G 1:,EE

'ontribution margin G :D,DEE G :,DE G :3,:EE G :2,:DFied cost G E,EEE G E,EEE G E,EEE G E,EEE

0rofit before taes G 3D,DEE G 3,DE G 33,:EE G 32,:D1G:E,EEE :EE L 1EE? G,EEE 3EE L G1HE? G2,DEE :EE L G3D? G1,EEE 3EE L GHE.


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b. $he follo&ing table provides the re#uired revenue budget, and income statement.

Augusteptember October

5ovember

ndividuals :EE :EE HIE HDFamil" memberships 3EE 3ED 3EE 2ID

4evenue ! ndividual G:E,EEE G:E,EEE GHI,EEE GH,DEE

4evenue ! Famil" ,EEE ,EE ,EEE :,2EE

$otal 4evenue G11,EEE G11,EE G11:,EEE G11D,:EE

Nariable cost ! ndividual G2,DEE G2,DEE G2,1DE G23,I:D

Nariable cost ! Famil" 1,EEE 1,3EE 1,EEE 1:,:EE

'ontribution margin G:D,DEE G:H,EEE G:,DE G:,E2D

Fied cost E,EEE E,EEE E,EEE E,EEE

Ad campaign 1E,EEE

0rofit before taes G3D,DEE G2H,EEE G3,DE G3,E2D

c. ased on the above, it &ould appear that profits have decreased. ased on pro-ectionin part aP, =ercules epected to earn G13H,I2D ( G3D,DEE G3,DE G33,:EE G32,:D). $he pro-ection in part bP sho&s a cumulative profit of G13E,3:D (G3D,DEE G2H,EEE G3,DE G3,E2D) onl", a decrease of about GH,DDE. =o&ever,&e cannot conclude that the ad campaign is a bad idea. $his is because the ne&members &ill continue to benefit =ercules in the future as &ell (but not indefinitel").uppose that the average ne& membership is for 12 months. $hen, the epectedbenefit from the campaign is 12 months L 1E individuals L (G1EE!G3D) D familiesL

(G1HE *GHE) P G13,EE, &hich eceeds the cost of the ad campaign.

5ote Firms develop life!c"cleB models to account for such future effects. uch modelsare crucial in service firms such as cable operators and &ireless providers &ho epect toget a continuing stream of revenue from each ne& customer. $hus, these firms are &illingto take a lossB in the first fe& months b" spending a lot to get ne& customers.


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7.36

$he follo&ing table provides the re#uired information. 5otice the use of the inventor"e#uation to back out the amount of purchases.

August eptember October

ndividuals :EE HIE HE

Famil" memberships 3EE 3EE 2ID

upplies needed 13,HEE1 13,DEE 13,2IE

7nding inventor" D,EEE ,DEE ,DEE

$otal needed 1,HEE 1,EEE 1:,:IE

!eginning inventor" D,EEE D,EEE ,DEE

0urchases 13-6 13- 13-29113,HEE :EE L 1E 3EE L 22.

5otice that the beginning inventor" in eptember is the ending inventor" in August. Cealso calculate supplies needed as Q of individual memberships L G1E Q of famil"memberships L G22. Finall", notice that &e cannot compute the purchases in 5ovemberbecause &e do not kno& the re#uired ending inventor".

7.37

8et us begin b" calculating the operating cash flo&.

Item Detail September

ndividual fees (HIE!1E)L G1EE GD1,EEE

Famil" (3EE * HE) L G1HE 3,EE0repaid (individual) (1EJ12) M (12 L 1EE L IEK) 1H,2EE0repaid (famil") (HEJ12) L (12 L 1HE L IEK) ,HE

$otal inflo&s G11,2E

0urchase (current) E.H L G13,EEE G :,EE0urchases (prior) E. L G13,HEE D,ENariable costs (HIE L G2D) (3EE L GD) 3E,:DEFied costs G1,EEE !G12,DEE 2,DEE

$otal outflo&s G:2,IE

Operating cash flo& G1,:DE


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Ce can no& prepare the cash budget.

Item September

eginning balance G H,EEEOperating cash flo& 1,:DE

pecial items ! e#uipment (2E,EEE)Amount taken out (1D,EEE)

7nding balance G12,:DE

7.38

$his eercise is trick"B in the sense that &e cannot directl" appl" the inventor" e#uationto the ne& sales pro-ection for April. $his is because &e do not kno& the original orrevised sales for April. =o&ever, &e kno& the original production for April. 6sing thisdata, &e can back out the original sales as 113,EEE units (as sho&n in the table belo&).

$he revised sales therefore IEK of 113,EEE 1E1,:EE units. Ce could then back outthe ($/%$ ('*/'0 &'( A(/# "% 16-5 0/%. 5otice that there is no change in thebeginning inventor" for April. $his is because /arch is almost over and Rant% &ouldhave alread" built up inventor" as per the original budget. =o&ever, because /a"+sestimates are do&n 1EK, the desired ending inventor" for April &ould be do&n 1EK,from 22,EEE to 1I,EE.

A(/# '#; A(/# 0$;

>esired ending inventor" 22,EEE E.I L 22,EEE 1I,EE udgeted sales 113,EEE1 E.I L 113,EEE 1E1,:EE $otal re#uirements 13D,EEE 121,DEE

! eginning inventor" 1D,EEE 1D,EEE udgeted production 12E,EEE 16-5

1113,EEE 12E,EEE 1D,EEE * 22,EEE.

7.39

$he ke" point in this problem is that &e have to perform the calculations separatel" foreach t"pe of bo (although &e use the same inventor" e#uation for all boes).Additionall", it+s important to remember that the ending inventor" for an" one monthe#uals the beginning inventor" of the follo&ing month * thus, &e can calculate thebeginning inventor" for /arch as 2EK of /arch+s sales (&hich is the ending inventor" ofFebruar").


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7.4

a. Once again, &e appl" the inventor" e#uation to solve this problem. 6sing theinformation provided, &e have (units in linear feet)

)"(*+ >etail>esired ending inventor"(in linear feet)

:D,E EK of April needs E.E L 1D,EE boes L12 feetJbo.

5eeded for production 1,EEE 12,EEE boes to beproduced L 12 feetJbo.

$otal re#uirements 21I,E! eginning inventor" DE,EEE Riven B$$ (*+"%$%

(linear feet) 169-84

P(*+"%$% $budgeted purchases L GE.:Dper foot

127-38

b. os&orth &ould use 1,EEE linear feet of cardboard strips to produce the boes. T+$'"#


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5ote $he usage budget for /arch &ould not change if os&orth uses the 8FO method.$he firm &ould not be dipping into the la"er of beginning inventor", meaning that all1,EEE linear feet used &ould be valued at GE.:D per foot.

7.41

Ce compute budgeted cash inflo&s using the follo&ing table

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. orro&ing needed (if an") /inimum balance * balance prior to financing.D. 7nding balance (October) eginning balance (5ovember)

$he follo&ing table provides the completed cash budget.

C"%+ B$ > ?'(+ Q"($('ctobe

rNo(embe

r#ecembe

reginning cash balance GI,DEE GI,DEE GI,DEE'ash receipts 1,1EE 17-9 18-4

$otal cash available 23-6 G2:,EE G2:,IEE'ash disbursements

0a"ments for materials ,EE 3-63 ,1EE0a"ments for labor ,DE :,2DE 7-210a"ments for overhead 5-45 D,I2E D,:2E

$otal disbursements 1,3EE 1H,EE 1:,E3E

alance prior to financing 5-3 1-6 1-87/inimum cash balance I,DEE I,DEE I,DEEFinancing

orro&ingJ(repa"ment) 4-2 1-1; 1-37;

7nding cash balance 9-5 9-5 9-5

$he firm+s ending loan balance is therefore G,2EE ! G1,1EE ! G1,3:E 1-73.

7.44

$he follo&ing table provides Rilbert+s cash budget for 5ovember and >ecember.

No(ember #ecemberOpening balance of cash G1H,EEE G2:,EEE

4eceipts from current sales (:EK ofcurrent revenues)

3D,EEE 2,EEE

4eceipts from prior month sales (3EK ofprior month revenues)

12,EEE 1D,EEE

$otal available GH3,EEE G,EEE

! 0urchase cost( 'OR HEK of revenues) 3E,EEE 3H,EEE! /arketing and admin. epenses H,EEE D,EEE

7nding balance of cash 27- 43-

5otice that Rilbert+s 5ovember collections include :EK of 5ovember sales (G3D,EEE)and 3EK of October sales (G12,EEE). ased on our anal"sis, it appears that Rilbert &illhave plent" of cash on hand and, thus, &ill not need to borro& mone".


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7.45

a. Ce can do this problem in t&o &a"s. $he short method is to recogni%e that Tris&ould have collected all of her sales for /arch and April b" /a" 31. he also &ouldhave collected DEK of /a" sales in /a". $hus, her accounts receivable &ould be

DEK of /a" sales or 23-( GH,EEE L E.DE).

$he longer method is to &rite do&n her accounts receivable, using a format similar tothat for inventor" accounts. Ce have

A(/# )"@

Opening balance for receivables G2D,EEE G2E,EEE

'urrent sales E,EEE H,EEE

$otal collectible GHD,EEE GHH,EEE

! 'ollections for prior month 2D,EEE 2E,EEE

! 'ollections for current month 2E,EEE 23,EEE

'losing balance for receivables 2- 23-

b. Again, &e can do this problem in t&o &a"s. $he short method is to recogni%e thatTris &ould have paid for all of her purchases in /arch and April b" /a" 31. he also&ould have paid for EK of purchases in /a". $hus, her accounts pa"able &ould be2EK of /a" purchases or E.2E L GE,EEE 8-.

$he longer method is to &rite do&n her accounts pa"able, using a format similar to thatfor inventor" accounts. Ce have

A(/# )"@

Opening balance for pa"ables GH,EEE GH,EE

'urrent purchases 32,EEE E,EEE

$otal pa"able 3,EEE H,EE

! 0a"ments for prior month H,EEE H,EE

! 0a"ments for current month 2D,HEE 32,EEE

'losing balance for pa"ables 6-4 8-

7.46

$his is an open!ended #uestion &ith man" possible vie&s on the Cilma+s best course ofaction. Ce summari%e some possible arguments belo&.

ome might argue that Cilma should follo& cott Ford and @ake+s 8e&is lead and padher budget as &ell. $he problem appears to be ver" rigid standards and a formulaicapproach to incentive compensation. $he founder+s approach, some ma" argue, leaves themanagers no choice, but to build in some cushion. ndeed, &e might -ustif" @ake+s actionsas beneficial in the long term, although &e onl" have his &ord that the cushion is forlong!term improvements. ome might #uestion cott+s ecessiveB lo&!balling, althoughho& much is OTB and ho& much is ecessiveB is not resolved easil".


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At the other etreme, clearl" the firm+s plans contain information kno&n to be false.7thical standards for accounting professionals preclude Cilma from kno&ingl"compromising the integrit" of information. $hus, she might have no choice but to tr" andrectif" the situation as much as possible. >oing so, ho&ever, might pit her against the

other managers, limiting her effectiveness.

Overall, a pragmatic approach might involve attempting to educate the o&ner about thepitfalls of his methods. ndeed, Cilma might find that 4o" is &ell a&are of the paddingb" his managers and that this is the Ugame+ that all in the firm agree to (implicitl"). n thiscase, Cilma+s conscience is clear and, in our opinion, she &ould compl" &ith accountingstandards as &ell. $hus, our recommendation is for Cilma to speak &ith 4o" and feelhim out on his vie&s about budget padding before taking the net step.

7.47

$his #uestion is likel" to provoke a range of ans&ers. 'learl", the manager eperienced

an unfavorable and uncontrollable event. 9et, should 'arrie revise the budget; Ce see theissue as t&o separate problems. $he first is a planning problem in terms of schedulingproduction, ordering materials, and so on. 5aturall", the firm should take the latestinformation into account for such decisions.

$he second problem is &hether the manager+s performance targets should be changed.One could argue either for or against a change * &e are inclined to not change theperformance targets in this instance. First, as 'arrie notes, a change re#uires that shedefine a Ubig+ event, and this is a slipper" slope. t &ould not be long before an" adverseevent triggered a re#uest for a target reset. econd, good managers are supposed to deal&ith risk. nsulating them against risk defeats the purpose. $hird, managers often are ver"innovative &hen their back is against the &all. $his event might spur management intoun!chartered territor". And, the final argument is &ill the manager ask for a target resetif the fire &ere in a competitor)plant;B


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PROBLE)S

7.48

a. lueteel appears to have enough capacit" to meet its annual sales forecast. Annual

sales are 112,DEE units (2,EEE 2,DEE 33,EEE 2:,EEE) and the firm hasinstalled capacit" for 12E,EEE units (12 months L 1E,EEE units per month).

b. 'learl", lueteel needs to build up inventor" to meet the demand surge in V3.lueteel could do this b" building up inventor" in V1 and V2. $he compan" &ouldneed to begin in V1 because there is limited ecess capacit" is V2 * the ecesscapacit" in V2 is not enough to make the etra units to meet the demand for V3.

$he follo&ing table illustrates one possible production schedule that enables the firm tomeet its sales forecast.

Q"($( 1 Q"($( 2 Q"($( 3 Q"($( 4ales for #uarter 2,EEE 2,DEE 33,EEE 2:,EEE0roduction for #uarter 2D,DEE 3E,EEE 3E,EEE 2:,EEEnventor" at end of #uarter 1,DEE 3,EEE E E

n realit", the firm might &ish to build up more inventor" in V1 so that the factor" hassome slack in V2 and V3 to deal &ith unanticipated problems.

Another alternative is to produce something like 2,DEE? 2,DEE? 2,DEE, 2:,EEE cabinetsin the four #uarters. $his schedule smoothes out production (from a hiring standpoint),leaves some additional capacit" in V2 and V3 if needed, and lightens a bit in V, perhaps

for additional maintenance, and to secure desired "ear!end inventor".

c. $he '7O+s basic approach appears to be sound. /odern management practice is tolimit the amount of inventor" as much as possible. uch curtailing of capacit" hasseveral advantages. First, it reduces the capital tied up. econd, it reducesobsolescence. $hird, a lo& inventor" polic", if done in con-unction &ith suitablechanges to production processes, could help the firm improve #ualit" and increaseresponsiveness.

=o&ever, the lo& inventor" polic" comes &ith a cost. For lueteel, a %ero inventor"polic" &ould curtail V3 sales to 3E,EEE units. Other than building inventor", the onl"

&a" to meet demand is b" adding to capacit", &hich &ill increase capacit" for all four#uarters.

d. nventor" gives firms a &a" to moveB capacit" across periods, as sho&n in part bP.=o&ever, such movement is costl" because of storage costs and the cost of capitaltied up in inventor", as &ell as intangible #ualit" costs. $he best solution is, of course,situation specific, but the problem highlights that holding inventor" has both costsand benefits.


:!1:


18/50

7.49

t is convenient to compute /ina+s epected cash inflo&s using a table such as thefollo&ing

O*'$( N'$


19/50

5ote Ash&ini+s problem is similar, in principle, to depositing a check at a bank but nothaving access to the funds until the check clears.

7.51

a. $he follo&ing table provides Rar"+s income statement for October through>ecember. n this statement, notice that the cost of purchases EK of sales. (Rar"marks up G1 of cost to G1.2D in sales. o, G1 in sales G1J1.2D GE.E in cost.)

O*'$( N'$ecember.

b. $he follo&ing table provides Rar"+s cash budget for October * >ecember. n thisstatement, 'ollections * 1 month are the collections from prior month sales (e.g.,October E.3E of eptember sales) and 'ollections * 2 months are the collectionsfrom sales 2 months ago (October E.:E L August sales). 8ike&ise, purchases *current month DEK of current month purchases and purchases * 1 month are DEKof the prior months purchases.

O*'$( N'$


20/50

Overall, Rar" appears to be facing a cash crunch. Available cash dips from G11,2DE inOctober to an anticipated shortfall of (G33,12D) in >ecember. $his occurs even thoughsales have increased in this time period.

c. Rar"+s problem is common among firms &hich eperience gro&th. n essence, Rar"

is pumping mone" into &orking capital because he is financing his customers+purchases. =e is pa"ing his suppliers faster than his customers are pa"ing him. $hus,&hen his business gro&s, he has to put more mone" into the business. Ce can see thisb" calculating that the accounts receivable at the start of October is G:IH,:D ( :EKof August sales eptember sales), &hereas it is GI3E,EEE ( :EK of 5ovember sales >ecember sales) at the start of @anuar" net "ear.

Rar" needs to find &a"s to manage this imbalance. One avenue is to borro&, but hehas to consider interest costs. $he other avenue is to accelerate collections or deferpa"ments, but then customers might cut back on orders and suppliers might raiseprices. oth actions are costl" to Rar". Rar" &ould need to estimate his epected

profit to evaluate each option.

7.52

Ce kno& that the 'OR/ is the outflo& from the C0 inventor" account. >irectmaterials, direct labor, and overhead are the inflo&s into this account. Appl"ing theinventor" e#uation then helps us fill in the re#uired data.

8ike&ise, &e kno& that the 'OR is the cost of the items removed from finished goodsinventor". $hus, &e can compute 'OR b" appl"ing the inventor" e#uation to the FRinventor" account.

5otice that 'OR/ is the linking number bet&een the t&o accounts. $his amount is theoutflo& from the C0 account and is the inflo& into the FR account.

8et us begin &ith the C0 account. Ce have

)"@ 0$

Opening C0 G1E,EEE 275-5 >irect materials usage 2DE,EEE 2E,EEE >irect labor 2HD,DEE 3D,EEE Nariable overhead 12D,EEE 1D,EEE

$otal inflo& into C0 2E,DEE 1,ED,DEE! Nariable cost of goods manufactured DD,EEE D:,EEE 7nding C0 275-5 471-5

eginning &ith /a", &e appl" the standard inventor" e#uation to obtain endinginventor" as G2:D,DEE. $he ending inventor" in /a" is the beginning inventor" for @une.$his allo&s us to calculate the remaining ;+sB for @une.


:!2E


21/50

5et, let us appl" the inventor" e#uation to the FR inventor" account.

)"@ 0$

Opening FR G22E,EEE 15- 'ost of goods manufactured DD,EEE D:,EEE

'ost of goods available for sale :HD,EEE :2,EEE! 'ost of goods sold H1D,EEE 499- 7nding FR inventor" 15- G22D,EEE

Once again, our computation uses the fact that the ending inventor" in /a" thebeginning inventor" in @une.

7.53

$his problem highlights the planning role for budgets. 8et us first determine the variableand fied costs corresponding to 5aomi+s operations.

I$< D$"/# C(($0 *'% E=$*$ *'%>irect materials GE,EEEJ12E,EEE units GJunit G.EJunit>irect labor G:2E,EEEJ12E,EEE units GHJunit GH.3EJunitelling W Adm. G12E,EEEJG2. million DK of sales G DK of sales GFied costs G,EEE G,EEE

Cith this data in hand, let us prepare a pro-ected income statement if 5aomi raises herprice to G22 per unit.

Price = $22 & Number of units sold = 120,000

4evenues (12E,EEE units L G22) G2,HE,EEE

Nariable costs>irect materials GD2,EEE

>irect labor :DH,EEE

elling and administration 132,EEE G1,1H,EEE

'ontribution /argin G1,22,EEE

Fied costs

/anufacturing DE,EEE

/arketing and sales 12E,EEE

Reneral administration 22,EEE G,EEE

P('&/ $&'($ "=$% 336-

4eturn on sales(G33H,EEEJG2,HE,EEE) 12.:3K


:!21


22/50

8et us repeat the eercise &ith the lo&er!price, high!volume strateg".

Price = $19 & Number of units sold = 17,000

4evenues (1:D,EEE units L G1I) G3,32D,EEE

Nariable costs

>irect materials G::E,EEE>irect labor 1,1E2,DEE

elling and administration 1HH,2DE G2,E3,:DE

'ontribution /argin G1,2H,2DE

Fied costs

/anufacturing GDE,EEE

/arketing and sales 12E,EEE

Reneral administration 22,EEE G,EEE

P('&/ $&'($ "=$% 398-25

4eturn on sales

(G3I,2DEJG3,32D,EEE) 11.IK

oth strategies meet 5aomi+s goals of increasing her profit and return on sales. =o&ever,the t&o income statements conflict in terms of epected profit and epected profitabilit".$he higher!price, lo&er volume strateg" has lo&er profit but higher profitabilit".

5aomi+s choice therefore depends on her goals and the nature of the product market. nsome instances, such as often occurs &ith premium products, it can make most sense togo for a high margin strateg", sacrificing volume. n other instances, such as &ithconsumer goods, it might make more sense to lock up the market b" going for salesgro&th. 4egardless, pro-ecting future income statements under alternate formats help

firms put a number on the tradeoff and make a more informed choice.

n 5aomi+s case, she does not appear to have a sustainable competitive advantage for thet"pes of products she offers (the barriers to entr" are likel" minimal) * thus, &e &ouldargue for setting a lo&er price and getting a larger share of the market.

7.54

$he participative budget described here seems participative in name onl". $he goal forparticipative budgets is to take advantage of locali%ed kno&ledge that operatingpersonnel possess. n virtuall" ever" instance, the participative input is sub-ect tooversight and discussion. ome amount of revision is also common. =o&ever, ecessive

and arbitrar" revie& that substitutes a top!do&n target for a bottom!up estimate makes amocker" of the process, eliminating its value. uch a gutting appears to be the case in$im+s firm. /elanie+s statement hints at a ver" autocratic st"le that essentiall" sa"s, /"&a" or the high&a".B

$he revision process also appears to be arbitrar" and capricious. $here is little incentivefor the salespersons to spend much time and effort in pro-ecting the true epected salesbecause the" kno& that the target &ould be revised up&ards and $im+s estimate &ill


:!22


23/50

prevail.

$his problem la"s the foundation for an interesting discussion about the costs andbenefits of participative budgeting. Chile these budgets are useful, the" also give rise togame pla"ing and slack. 4evie&s b" top management cut do&n on slack, but also remove

some of the benefits. =o& best to manage the tradeoff is an open!ended problem &ith noclear ans&er. 4esearch has identified factors that increase game pla"ing (ecessivereliance on incentives, uncertain environment, lack of management eperience at the top,lack of trust) but eecuting the tradeoff &ell remains an art.

7.55

a. $he follo&ing tables provide the re#uired classifications. $he classification intomanufacturing and selling depends is some&hat intuitive. $he classification into fiedversus variable costs is sub-ective to some degree. Ce gain confidence in this estimateb" computing unit costs (for manufacturing epenses) and the cost per sales dollar(for selling epenses) * if these costs sta" mostl" the same as volume changes, then

&e classif" the epense as variable. f, ho&ever, these costs decrease markedl" asvolume increases, then &e classif" the epense as fied.

)"0&"*(/0 );

S$##/0 S;

?/=$ ?;

V"(/"#$ V;

>irect materials ) V>irect labor hours ) V0lant maintenance ) ?0lant depreciation ) ?ndirect labor ) V7ngineering design ) ?

6tilities ) V0lant administration ) ?/arketing administration S ?ales force commissions S V0lant supervision ) ?

ased on the above &e conclude that(1) Nariable manufacturing costs >irect materials, direct labor, indirect labor, utilities(2) Nariable selling costs ales commissions(3) Fied manufacturing costs 0lant maintenance, plant depreciation, engineering

design, plant administration, and plant supervision() Fied selling costs /arketing administration


:!23


24/50


25/50

5otice that &e have collapsed all of the increase in fied costs into one line item. $hisincrease reflects the additional capacit" costs that stem from increasing the firm+sproduction capabilities * as &e &ill learn in 'hapters I and 1E, cost allocations provideus &ith a &a" to estimate such changes in capacit" costs.

b. Ce could pro-ect the income statement for 12D,EEE units, using the estimates for fiedand variable costs that &e derived for the previous problem. Ce have

O(//0"# R$$0$C'% $( 0/

R$/%$

B$

6nits 1DE,EEE 125-

4evenues G,EE,EEE GDH.EE G:,EEE,EEE

Nariable manufacturing costs ,1DE,DEE G2:.H: per unit 3,D,:DE

Nariable selling costs 2D2,EEE GE.E3 per sales G 21E,EEE

'ontribution /argin G3,II:,DEE G3,331,2DE

$otal fied costs 2,1:,EEE 2,1:,EEE

P('&/ $&'($ "=$% 1-819-5 1-153-25

5otice that 7sse+s profit decreases substantiall", b" 3:K, if the firm produces 12D,EEEunits.

c. ased on our anal"sis, 7sse &ill more profitable situation if it produces 1DE,EEEunits and invests in additional capacit" resources. =o&ever, if the compan" decides togo ahead and make the investment to meet the budgeted volume of 1DE,EEE anddemand falls short of epectations, either in the coming "ear or in future "ears, then7sse &ill have to eatB the additional fied costs. $his problem helps us see ho&

budgets enable firms to evaluate options in terms of their potential risks and re&ards.

7.57

$he follo&ing table provides the re#uired income statement.

Q"($( 1 Q"($( 2 Q"($( 3 Q"($( 4 T'"#

ales GEH,EEE GD2I,2DE G2E,DEE GDI,DEE G1,IDE,2DE

>iscounts1 D2,I2D DI,DE 112,3:D

5et ales GEH,EEE G:H,32D G2E,DEE GD3D,EDE G1,3:,:D

'ost of merchandise2 2E,EEE 3HD,EEE 2IE,EEE 1E,EEE 1,3D,EEE

'redit card fees3 H,IH :,H21 H,:2 ,DH1 2I,EH

Fied costs 1ED,EEE 1ED,EEE 1ED,EEE 1ED,EEE 2E,EEE

P('&/ 14-54 1-296; 18-772 11-489 43-469

5otes1. >iscounts "aleL .DE L .2E in Vuarters 2 and .2. 'ost of merchandise alesJ1.D.3. 'redit card fees .E2 L .E LNet "ale.. Fied costs G3D,EEE L 3 months per #uarter.


:!2D


26/50

7.58

a. $he follo&ing table provides the re#uired monthl" budget.

I$< D$"/# A


27/50

7.59

5ot!for!profit organi%ations, &hich often operate multiple programs, face uni#ueplanning, control, and reporting needs.

From the output side, !'are needs to track budgets and actual results b" program so thatit could assess the effectiveness of individual activities.

From the input side, !'are also might need to track epenses and activities b" specificgrants. For eample, suppose 6A> gives !'are a grant of G1,EEE,EEE. !'are &ouldneed to submit periodic reports that sho& ho& it used these funds. Often, the mone" ma"be spent for multiple programs, &hich complicates the reporting process.

From a regulator" vie& point, !'are needs to submit reports to the 4 and otheragencies (e.g., Form IIE). $hese forms have specific epense categories such as fundraising epenses.

From a control perspective, a significant amount of cost is common across programs.uch costs often pertain to personnel because the same set of people might &ork onseveral programs simultaneousl". Of course, !'are also needs to have appropriateepense approval and reporting policies in place because of the significant fiduciar"responsibilit" it bears to&ards donors. Often, charities &ill voluntaril" undergo annualaudits (b" suitabl" #ualified accountants) to increase confidence among donors.

$hus, &e see that not!for!profit institutions such as !'are re#uire sophisticated budgetingand control s"stems to meet their various information needs. 6suall", such organi%ationsprepare a program!centered budget, &herein the" estimate costs for each of the man"programs the" might eecute during a "ear. n addition, the organi%ation needs to budgetfor common activities such as a fund!raising campaign or office administration.

Riven the number of eternal constituents, the budgeting process at !'are t"picall"&ould be more detailed and involved than the process for a for!profit organi%ation (&hoseprimar" goal is to make mone"). ndeed, for each program, !'are needs to estimate theactivit" volume and associated costs. /oreover, each program might comprise severalmodules (such as the number of senior centers visited, &ith each visit being a module)that might be scaled up or do&n based on the availabilit" of funds and actual epenses.

6suall", accounting s"stems in such organi%ations allo& the data to be aggregated alongmultiple dimensions. For eample, an" specific ependiture &ould be classified as toprogram ('orneal transplant), source of funds (Taufman Foundation grant Q1!DH:!2EED), and functional categor" ($ravel Airfare).

Overall, this problem looks at ho& budgeting needs might s"stematicall" differ acrossorgani%ations.

7.6


:!2:


28/50

$o prepare an income statement, &e need to be able to calculate the cost of goods sold('OR). $his is the outflo& from the finished goods (FR) inventor" account. =o&ever,&e do not have the inflo& into the FR account.

For 0eterson, the inflo&s into the FR account comprise materials and labor (because all

overhead epenses are fied). Once again, &hile &e kno& labor costs, &e do not kno&the materials used in production. =o&ever, &e do have information about the amount ofmaterials purchased and epected inventories.

$hus, &e can back out the materials issued, as sho&n belo&

Q"($( 1 Q"($( 2 Q"($( 3 Q"($( 4

Opening balance for materials GEE,EEE G2E,EEE G1D,EEE G2D,EEE 0urchases 23D,EEE 211,2EE 222,3EE 2E:,DEE $otal available GH3D,EEE GH31,2EE GH3:,3EE GH32,DEE! 7nding balance 2E,EEE 1D,EEE 2D,EEE 1E,EEE

/aterials used for production G21D,EEE G21H,2EE G212,3EE G222,DEE

n this table, notice that &e link #uarters b" the fact that ending inventor" in V1 beginning inventor" in V2. 8et us no& compute 0eterson+s 'OR/.

Q"($( 1 Q"($( 2 Q"($( 3 Q"($( 4

/aterials used for production G21D,EEE G21H,2EE G212,3EE G222,DEE >irect labor 2E,EEE 2,DEE 23,DEE 2,HEE 'ost of goods manufactured GDD,EEE GHE,:EE GDE,EE G:1,1EE

5et, &e use the inventor" e#uation for the FR inventor" to determine 'OR.

Q"($( 1 Q"($( 2 Q"($( 3 Q"($( 4

Opening balance G3E,EEE G3IE,EE G3D,HEE G3I1,2DE 'ost of goods manufactured DD,EEE HE,:EE DE,EE :1,1EE $otal available G3D,EEE GD1,1EE G3H,EE GH2,3DE! 7nding balance 3IE,EE 3D,HEE 3I1,2DE 3IH,DEE 'ost of goods sold G,HEE GHD,DEE GD,1DE GHD,DE

Again, notice that ending balance in V1 opening balance in V2.


:!2


29/50

Ce are finall" read" to prepare the 0eterson+s contribution margin income statement.

Q"($( 1 Q"($( 2 Q"($( 3 Q"($( 4

4evenue G:ID,2EE G3,2EE GH,DE GDH,2DE

! Nariable cost of goods sold ,HEE HD,DEE D,1DE HD,DE 'ontribution margin G3DE,HEE G3H,:EE G1I,3EE G3IE,EE! Fied manufacturing costs 1DE,EEE 1:2,2DE 1HI,2DE 1:,3EE! Fied selling epenses E,EEE ID,EEE 1EH,EEE 1EE,EEE 0rofit before taes 12-6 11-45 144-5 116-1

7.61

8et us begin b" first constructing 0eterson+s budgeted cash collections. Ce have

Q1 Q2 Q3 Q4

Openingreceivablesbalance G12D,EEE G1EH,E2: G111,22: G11D,2HE

ales :ID,2EE 3,2EE H,DE DH,2DE

$otal collectible GI2E,2EE GIE,22: GI:D,H:: GI:1,D1E

C'##$*/'0% 814-173 829- 86-417 857-343

7nding balance G1EH,E2: G111,22: G11D,2HE G11,1H:

5otice that collections include all of the opening balance. $he" also include all sales forthe first t&o months of the #uarter and HEK for the third month. Alternativel", &ecompute the ending balance as EK of the last month+s sales (all else &ould have beencollected) and back out the collections.

5et, &e compute the cash outflo& for purchases.

Q1 Q2 Q3 Q4

Opening pa"ablesbalance G12H,DEE G3I,1H: G3D,2EE G3:,EDE

0urchases 23D,EEE 211,2EE 222,3EE 2E:,DEE

$otal 0a"able G3H1,DEE G2DE,3H: G2D:,DEE G2,DDE P"@


30/50

Cith these estimates in hand, &e are no& read" to construct the overall cash budget.

Q1 Q2 Q3 Q4

Opening balance G:D,EEE 111,E G22,I23 G3:E,1E

'ollections 814-173 829- 86-417 857-343 $otal available GI,1:3 GIE,E G1,EI,3E G1,22:,3

0a"ments for purchases 322,333 21D,1H: 22E,DE 2EI,IH:

8abor costs 2E,EEE 2,DEE 23,DEE 2,HEE

Fied manufacturing costs 13D,EEE 1D:,2DE 1D,2DE 1DI,3EE

Fied selling costs E,EEE ID,EEE 1EH,EEE 1EE,EEE

, E0/0 "#"0*$ 111-84 228-923 37-14 59-616

n our computations, notice that &e have removed G1D,EEE each #uarter for non!cash

manufacturing overhead epenses.

5otice that the cash balance is gro&ing &hile income (see the prior problem) sta"srelativel" stable over the four #uarters. Ch" is this; $his occurs because &e assumed that0eterson hoards all of its cash * thus, the cash balance increases each #uarter b" theamount of income (there also is a G1D,EEE difference due to the non!cash overheadepense, &hich is accounted for in the income statement but not in the cash budget). nrealit", 0eterson &ould not maintain such a large cash balance but &ould reinvest theproceeds back in its o&n business or else&here.


:!3E


31/50

)INICASES

7.62 $his is a fairl" involved problem, best done on a spreadsheet. Ce follo& the sametemplate as in the tet. Ce begin &ith 0umpkin 0atch+s revenue budget

a.(see ehibits beginning net page)


:!31


32/50

E=+// 1

P


33/50

Ce net prepare 0umpkin 0atch+s production budget

E=+// 2

P


34/50

5et, &e prepare the materials usage budget

E=+// 3

P


35/50

For direct labor costs, &e have

E=+// 4

Pirect labor cost G2,EE GI2,EE G 1E3,2EE G12I,HEE G1D2,EEE G1H,EEE

D$#=$

6nits of production (see 7hibit 2) 3,H2D ,12D ,H2D D,12D D,H2D D,DDE8abor hours per unit E.:D E.:D E.:D E.:D E.:D E.:D8abor cost per hour G1H G1H G 1H G1H G1H G1H

>irect labor cost G3,DEE GI,DEE GDD,DEE GH1,DEE GH:,DEE GHH,HEE

$otal labor cost G12H,3EE G11,IEE G1D,:EE G1I1,1EE G21I,DEE G23,HEE

$he third component is manufacturing overhead costs

E=+// 5

P


36/50

$otal /anufacturing Overhead G,EEE G,EEE G,EEE G,EEE G ,EEE G ,EEE

Ce net compute the variable cost of goods manufactured

E=+// 6

P


37/50

As goods manufactured flo& through the FR inventor" account, let us eamine the cost flo& through the FR inventor" account as &ell.

E=+// 7

C'% '& ?/0/%+$ G''% I0$0'(@ "% '& 0$ 3- 28

"tandard #elue

Nariable cost per unit +gi(en- G12.EE G1:.EE

C'% '& ?/0/%+$ G''% I0$0'(@ "% '& #@ 31- 28"tandard #elue

V"(/"#$ C'% $( U0/

0lastic G3.EE G.DE

Other materials 1.EE 1.2D

>irect labor .EE 12.EE

$otal G12.EE G1:.:D

C'% '& B$/00/0 "0 E0/0 ?/0/%+$ G''% I0$0'(@ "%$ '0 ?I?O /0$0'(@ "**'0/0;

*ul% !ugut

"eptembe

r

'ctobe

r No(ember

#ecembe

r

S"0"(

eginning inventor" in units 2,DEE 2,DE 3,EEE 3,IEE ,DEE D,DEENariable cost per unit G12.EE G12.EE G12.EE G12.EE G12.EE G12.EE

eginning inventor" cost G3E,EEE G3,2EE G3H,EEE GH,EE GD,EEE GHH,EEE

7nding inventor" in units 2,DE 3,EEE 3,IEE ,DEE D,DEE ,DEENariable cost per unit G12.EE G12.EE G12.EE G12.EE G12.EE G12.EE

7nding inventor" cost G3,2EE G3H,EEE GH,EE GD,EEE GHH,EEE GD,EEE

D$#=$

eginning inventor" in units :D 1,EEE 1,12D 1,2DE 1,3:D 1,DEENariable cost per unit G1:.EE G1:.:D G1:.:D G1:.:D G1:.:D G1:.:D

eginning inventor" cost G1,:D G1:,:DE G1I,IHI G22,1 G2,EH G2H,H2D7nding inventor" in units 1,EEE 1,12D 1,2DE 1,3:D 1,DEE 1,EDENariable cost per unit G1:.:D G1:.:D G1:.:D G1:.:D G1:.:D G1:.:D

:.3:

:!3:


38/50


39/50

Ce are no& read" to compute the variable cost of goods sold.

E=+// 8

P


40/50


41/50

Administrative 'osts

:.1

:!1


42/50

Cith all of the data in hand, &e can construct the income statement, as follo&s.

P


43/50


44/50

5et, let us turn to pa"ments for purchases. $he other pa"ments are relativel" eas" to compute from earlier ehibits.

E=+// 1

P


45/50

b. Cith both of these pieces in hand, &e can no& compute the cash budget.

*ul% !ugut"eptembe

r 'ctober No(ember #ecembe

r

eginning 'ash G1H,EEE G1D,HD1 G1D,EI G1D,ID G1D,DED G1D,122 'ollections (ee 4eceivables udget) 23H,22E 2:E,3H 3EE,I2 3,:: E:,1I2 :D,EH2

$otal 'ash Available G2D2,22E G2H,E1I G31H,E13 G3H,:1I G22,HI: GIE,1

! 0urchases! plastic (see 7hibit 1E) DE,2 HE,D HD,D :H,I D,1 :I,D:D! Other materials (see 7hibit H) 1,1 1H,:EH 1,H1 22,HEH 2H,E31 2:,I3! >irect labor (see 7hibit ) 12H,3EE 11,IEE 1D,:EE 1I1,1EE 21I,DEE 23,HEE! /anufacturing overhead (see 7hibit D) 2H,EEE 2H,EEE 2H,EEE 2H,EEE 2H,EEE 2H,EEE! Nariable marketing W admin costs (7hibit I) 2H,1EE 2I,:E 32,1EE 3I,D2E ,IEE D3,EEE! alaries (see 7hibit I) 3,EEE 3,EEE 3,EEE 3,EEE 3,EEE 3,EEE! 4ent (see 7hibit I) :,EEE :,EEE :,EEE :,EEE :,EEE :,EEE

'ash balance before financing W special items (G1,3I) G1,EI G,ID (G1,ID) G11,122 GDI,E:1

! >ividend pa"out 2E,EEE

! 5otes pa"able (for e#uipment) 1D,EEE 'ash balance before financing (1H,3I) 1,EI (1D,EDH) (1,ID) 11,122 DI,E:1 8oanJ(8oan 4epa"ment) 32,EEE 1,EEE 31,EEE 1:,EEE ,EEE (,EEE)

7nding cash balance G1D,HD1 G1D,EI G1D,ID G1D,DED G1D,122 G1D,E:1

:.D

:!D


46/50

c. $his report summari%es the pro forma income statement and cash budget forthe second half of fiscal "ear 2EE.

I0*'ecember.

tandard unit sales are epected to be I,EEE &ith revenues of G1,D13,EEE. 'onsistent &ith thehistorical seasonalit" of tandard sets, revenue is epected to be G1:E,EEE in @ul" and gro&consistentl" throughout the period to G3:,EEE in >ecember. tandard+s overall contributionmargin is epected to be G2I3,:EE.

>elue unit sales are epected to be 2,DEE, &ith revenues of G:1,EEE. Also seasonal,>elue+s revenue is epected to be GI1,EEE in @ul" and gro& to G1DH,EEE in >ecember.>elue+s overall contribution margin is epected to be G1H1,H1.

Nariable /arketing and Administration costs for both tandard and >elue are epected toremain at a constant 1EK of sales. $otal fied costs are epected to remain constant at GDI,DEEper month during the period.

C"%+ B$

0umpkin 0atch+s month!end cash balances before financing are epected to be &eak &ith theeception of >ecember &hen the balance is epected to be GDI,E:1. /oreover, bank loanfinancing &ill be re#uired each month through 5ovember to maintain the 'ompan"+s G1D,EEEminimum balance re#uirement. $otal re#uired financing is epected to be GI,EEE for the period( G23,EEE G1,EEE G31,EEE G1:,EEE G,EEE), &ith GD,EEE ( GII,EEE ! GEEE) beingoutstanding at "ear!end.

Riven the 'ompan"+s poor epected cash performance for the period, it is recommended thatthe follo&ing actions be taken to improve &orking capital management.

4econsider the polic" to have each month+s ending plastic inventor" e#ual to the netmonth+s manufacturing needs. $his polic" results in the purchase of plastic inventor"sooner than is needed.

4econsider the practice of stocking 2DK of the net month+s forecasted demand in

finished goods inventor". A reduction from 2DK &ould improve cash flo&.

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5egotiate HE da" pa"ment terms &ith plastic and other material suppliers to defer more

pa"ments be"ond the month of purchase.

mplement 3E da" pa"ment terms for credit sales. $his &ould accelerate collection of the

12K of total sales that remain outstanding after 3E da"s. $he 'ompan" should also focus

on its collection activities to ensure sales are collected in 3E da"s.

Focus on reducing direct labor costs. >irect labor is the largest component of 0umpkin

0atch+s cost structure. $he 'ompan" should evaluate capital investments to automate themanufacturing process. Chile such investments &ould result in large upfront cashoutflo&s re#uiring financing, the" ma" be net present value positive &hen consideringdirect labor cost savings.

7.63

/ar"+s problem is common. Firms have to trade off several factors &hen setting budget

targets and designing incentive schemes. First, sales personnel often possess superiorinformation about sales prospects for the net fe& months, #uarters, or even "ears. $he"obtain this information via their dail" interactions &ith customers, other sales representatives,and trade association meetings. Obviousl", such information is of great value from a planningperspective. $he firm &ould like to have the most detailed and accurate information aboutsales estimates because these estimates form the basis for the firm+s entire budget.

=o&ever, sales personnel have incentives not to divulge this information. $his secondfactor arises because of the agenc" conflict that &e introduced in 'hapter 1. As &elearned there, sales personnel are risk ! and effort!averse. f the" give out information,then the" have to &ork hard to meet the resulting target. $here is no built!in slack to

guard against unanticipated adverse events. $hus, sales personnel often build in a littlecushion (padding or slack) in their sales forecasts. ales personnel must also be motivatedto &ork hard to meet the target. t is easier to get their private information if the data haveno effect on ho& the" are rated.

Firms use incentive contracts to induce the sales personnel to reveal their privateinformation and to &ork hard at meeting the resulting target. =o&ever, because suchcontracts are based on output targets and environmental factors affect the actual output,such contracts impose risk on the sales person. A &ell performing, hard!&orking salesperson might not meet her target simpl" because of unfavorable economic circumstancesoutside her control. $hus, the contract has to limit the risk imposed. =o&ever, imposing

some risk is critical to motivate the sales person to &ork hard. nducing information isalso a t&o!edged s&ord. On the one hand, &e can get good information if it &ill notaffect the sales compensation. ut, &e can set much better targets and incentive s"stemsif &e have good information.

/ar"+s suggested schemes are all compromises that reflect tradeoffs among these factors.8et us eamine each in turn.

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A salar" onl" scheme &ill induce the sales person to reveal private information

about sales targets. After all, their pa" is fied and there is no reason to buildcushions into the budget. =o&ever, once the target has been set, the salespersonnel have no incentive to &ork hard to meet the target. Ce have goodinformation, but &e cannot use it to motivate the sales force

Documents

Balakrishnan Mgrl Solutions Ch07