223311

CHAPTER 8 BUDGETING FOR PLANNING AND CONTROL

QUESTIONS FOR WRITING AND DISCUSSION

1. Budgets are the quantitative expressions of plans. Budgets are used to translate the goals and strategies of an organization into operational terms.

2. Control is the process of setting standards, receiving feedback on actual performance, and taking corrective action whenever actual performance deviates from planned perfor-mance. Budgets are standards, and they are compared with actual costs and revenues to provide feedback.

3. The planning and control functions of bud-geting can benefit all organizations regard-less of size. All organizations need to de-termine what their goals are and how best to attain those goals. This is the planning func-tion of budgeting. In addition, organizations can compare what actually happens with what was planned to see if the plans are un-folding as anticipated. This is the control function of budgeting.

4. Budgeting forces managers to plan, pro-vides resource information for decision mak-ing, sets benchmarks for control and evalua-tion, and improves the functions of communication and coordination.

5. A master budget is the collection of all indi-vidual area and activity budgets. Operating budgets are concerned with the income-generating activities of a firm. Financial budgets are concerned with the inflows and outflows of cash and with planned capital expenditures.

6. The sales forecast is a critical input for build-ing the sales budget. However, it is not nec-essarily equivalent to the sales budget. Upon receiving the sales forecast, manage-ment may decide that the firm can do better than the forecast indicates. Consequently, actions may be taken to increase the sales potential for the coming year (e.g., increas-ing advertising). This adjusted forecast then becomes the sales budget.

7. Yes. All budgets are founded on the sales budget. Before a production budget can be created, it must have the planned sales. The

manufacturing budgets, in turn, depend on the production budget. The same is true for the financial budgets since sales is a critical input for budgets in that category.

8. For a merchandising firm, the production budget is replaced by a merchandise pur-chases budget. Merchandising firms also lack direct materials and direct labor budg-ets. All other budgets are essentially the same. For a service firm (for-profit), the sales budget doubles as the production budget, and there is no finished goods in-ventory budget. The rest of the budgets have counterparts.

9. A static budget is for a particular level of activity. A flexible budget is one that can be established for any level of activity. For per-formance reporting, it is necessary to com-pare the actual costs for the actual level of activity with the budgeted costs for the ac-tual level of activity. A flexible budget pro-vides the means to compute the budgeted costs for the actual level of activity, after the fact.

10. A flexible budget is based on a simple for-mula: Y = F + VX, which requires knowledge of both fixed and variable components.

11. Goal congruence is important because it means that the employees of an organiza-tion are working toward the goals of that or-ganization.

12. Frequent feedback is important so that cor-rective action can be taken, increasing the likelihood of achieving budget.

13. Both monetary and nonmonetary incentives are used to encourage employees of an or-ganization to achieve the organization’s goals. Monetary incentives appeal to the economic needs of an individual, and non-monetary incentives appeal to the psycho-logical needs. Since individuals are moti-vated by both economic and psychological factors, both types of incentives ought to be present in a good budgetary system.

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14. Participative budgeting is a system of bud-geting that allows subordinate managers a say in how the budgets are established. Par-ticipative budgeting fosters creativity and communicates a sense of responsibility to subordinate managers. It also creates a higher likelihood of goal congruence since managers have more of a tendency to make the budget’s goals their own personal goals.

15. Agree. Individuals who are not challenged tend to lose interest and maintain a lower level of performance. A challenging, but achievable, budget tends to extract a higher level of performance.

16. Top management should provide guidelines and statistical input (e.g., industrial fore-casts) and should review the budgets to mi-nimize the possibility of budgetary slack and ensure that the budget is compatible with the strategic objectives of the firm. Top management should also provide the incen-tive and reward system associated with the budgetary system.

17. By underestimating revenues and overesti-mating costs, the budget is more easily achieved.

18. To meet budget, it is possible to take actions that reduce costs in the short run but in-crease them in the long run. For example, lower-priced, lower-quality materials can be substituted for the usual quality of materials.

19. Other performance measures include prod-uctivity, personnel development, market

share, and product quality. A manager would have to be rewarded for improve-ments achieved in each area. A major diffi-culty is determining how much weight to as-sign to each performance area.

20. Behavioral factors can make or break a budgetary control system. It is absolutely essential to consider the behavioral ramifica-tions. Ignoring them can and probably will produce dysfunctional consequences.

21. Across-the-board cuts have the appearance of being fair, but they unfairly penalize good programs. In an era of scarce resources, an organization must decide what it wishes to emphasize and allocate resources accor-dingly. This may mean the complete elimina-tion of weak programs and the strengthening of strong programs. To cut each program equally without considering which ones are vital to the success of the organization is not good planning.

22. Activity-based budgeting requires three steps: (1) identification of activities; (2) esti-mation of activity output demands; and (3) estimation of the costs of resources needed to provide the activity output demanded.

23. Functional-based flexible budgeting relies on unit-based drivers to build cost formulas for various cost items. Activity flexible budgeting uses activity drivers to build a cost formula for the costs of each activity.

223333

EXERCISES

8–1

1. e 2. d 3. c 4. e 5. b

8–2

1. H, I 2. E 3. I, F 4. G 5. D

6. F 7. F 8. A 9. C 10. B

8–3

1. Freshaire, Inc. Sales Budget

For the Year 2008

Mint: 1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. Total Units 80,000 110,000 124,000 140,000 454,000 × Price × $3.00 × $3.00 × $3.00 × $3.00 × $3.00 Sales $240,000 $330,000 $372,000 $420,000 $ 1,362,000

Lemon: Units 100,000 100,000 120,000 140,000 460,000 × Price × $3.50 × $3.50 × $3.50 × $3.50 × $3.50 Sales $350,000 $350,000 $420,000 $490,000 $ 1,610,000

Total sales $590,000 $680,000 $792,000 $910,000 $ 2,972,000 2. Freshaire, Inc., will use the sales budget in planning as the basis for the pro-

duction budget and the succeeding budgets of the master budget. At the end of the year, the company can compare actual sales against the budget to see if expectations were achieved.

223344

8–4

Freshaire, Inc. Production Budget for Mint Freshener

For the Year 2008

1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. Total Sales 80,000 110,000 124,000 140,000 454,000 Des. ending inventory 11,000 12,400 14,000 9,000 9,000 Total needs 91,000 122,400 138,000 149,000 463,000 Less: Beginning inventory 4,000 11,000 12,400 14,000 4,000 Units produced 87,000 111,400 125,600 135,000 459,000

Freshaire, Inc. Production Budget for Lemon Freshener

For the Year 2008

1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. Total Sales 100,000 100,000 120,000 140,000 460,000 Des. ending inventory 20,000 24,000 28,000 22,000 22,000 Total needs 120,000 124,000 148,000 162,000 482,000 Less: Beginning inventory 6,400 20,000 24,000 28,000 6,400 Units produced 113,600 104,000 124,000 134,000 475,600

8–5

Pescado, Inc. Production Budget for Tuna

For the Year 20xx

January February March Total Sales 200,000 240,000 220,000 660,000 Des. ending inventory 84,000 77,000 70,000 70,000 Total needs 284,000 317,000 290,000 730,000 Less: Beg. inventory 38,000 84,000 77,000 38,000 Units produced 246,000 233,000 213,000 692,000

223355

8-6 Pescado, Inc.

Direct Materials Purchases Budget For January and February

Cans: January February Total Production 246,000 233,000 479,000 × 1 can × 1 × 1 × 1 Cans for production 246,000 233,000 479,000 Des. ending inventory 46,600 42,600 42,600 Total needs 292,600 275,600 521,600 Less: Beg. inventory 49,200 46,600 49,200 Ounces purchased 243,400 229,000 472,400 246,000 * 20% = 49,200 Tuna: January February Total Production 246,000 233,000 479,000 × 4 ounces × 4 × 4 × 4 Ounces for production 984,000 932,000 1,916,000 Des. ending inventory 186,400 170,400 170,400 Total needs 1,170,400 1,102,400 2,116,400 Less: Beg. Inventory 196,800 186,400 196,800 Ounces purchased 973,600 916,000 1,889,600 984,000 * 20% = 196,800

8–7

Carson, Inc. Production Budget

For the First Quarter, 20XX

January February March Total Sales 200,000 240,000 220,000 660,000 Desired ending inventory 36,000 33,000 30,000 30,000 Total needs 236,000 273,000 250,000 690,000 Less: Beginning inventory 18,000 36,000 33,000 18,000 Units to be produced 218,000 237,000 217,000 672,000

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8–8

Manning Company Direct Materials Purchases Budget

For March, April, and May 20XX

March April May Total Units to be produced 20,000 60,000 100,000 180,000 Direct materials per unit (yards) × 25 × 25 × 25 × 25 Production needs 500,000 1,500,000 2,500,000 4,500,000 Desired ending inventory (yards) 300,000 500,000 60,000 60,000 Total needs 800,000 2,000,000 2,560,000 4,560,000 Less beginning inventory 100,000 300,000 500,000 100,000 Direct materials to be purchased (yards) 700,000 1,700,000 2,060,000 4,460,000 Cost per yard × $0.30 × $0.30 × $0.30 × $0.30 Total purchase cost $210,000 $ 510,000 $ 618,000 $1,338,000

8–9

Manning Company Direct Labor Budget

For March, April, and May 20XX

March April May Total Units to be produced 20,000 60,000 100,000 180,000 Direct labor time per unit (hours) × 0.04 × 0.04 × 0.04 × 0.04 Total hours needed 800 2,400 4,000 7,200 Cost per hour × $12 × $12 × $12 × $12 Total direct labor cost $ 9,600 $ 28,800 $ 48,000 $ 86,400

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8–10

Swasey, Inc. Sales Budget

For the Coming Year

Model Units Price Total Sales LB-1 33,6001 $30.00 $1,008,000 LB-2 21,6002 15.00 324,000 WE-6 25,2003 10.40 262,080 WE-7 19,4404 10.00 194,400 WE-8 9,6005 22.00 211,200 WE-9 4,0006 26.00 104,000 Total $2,103,680

1 16,800 units * 200% = 33,600; Price increased to $30 2 18,000 + (18,000 * 20%) = 21,600; no change in price 3 Quantity remains the same; price decreases by 20%; $13 * 80% = $10.40 4 16,200 + (16,200 * 20%) = 19,440; no change in price 5 Oct, Nov, and Dec represent 3 months of sales; 2,400 / 3 = 800 sales per

month for 12 months = 9,600 units; no change in price. 6 1,000 / 3 * 12 = 4,000 units; no change in price

8–11

1. Raylene’s Flowers and Gifts Production Budget for Gift Baskets

For September, October, November, and December

Sept. Oct. Nov. Dec. Sales 200 150 180 250 Desired ending inventory 15 18 25 10 Total needs 215 168 205 260 Less: Beginning inventory 20 15 18 25 Units produced 195 153 187 235

223388

8–11 Continued

2. Raylene’s Flowers and Gifts Direct Materials Purchases Budget

For September, October, and November

Fruit: Sept. Oct. Nov. Production 195 153 187 × Amount/basket (lbs.) × 1 × 1 × 1 Needed for production 195 153 187 Desired ending inventory 8 9 12 Needed 203 162 199 Less: Beginning inventory 10 8 9 Purchases 193 154 190 Small gifts: Sept. Oct. Nov. Production 195 153 187 × Amount/basket (items) × 5 × 5 × 5 Needed for production 975 765 935 Desired ending inventory 383 468 588 Needed 1,358 1,233 1,523 Less: Beginning inventory 488 383 468 Purchases 870 850 1,055 Cellophane: Sept. Oct. Nov. Production 195 153 187 × Amount/basket (feet) × 3 × 3 × 3 Needed for production 585 459 561 Desired ending inventory 230 281 353 Needed 815 740 914 Less: Beginning inventory 293 230 281 Purchases 522 510 633

223399

8–11 Concluded

Basket: Sept. Oct. Nov. Production 195 153 187 × Amount/basket (item) × 1 × 1 × 1 Needed for production 195 153 187 Desired ending inventory 77 94 118 Needed 272 247 305 Less: Beginning inventory 98 77 94 Purchases 174 170 211 3. A direct materials purchases budget for December requires January produc-

tion which cannot be computed without a February sales forecast.

8–12

1. Credit sales in May = $240,000 x 0.9 = $216,000 Credit sales in June = $230,000 x 0.9 = $207,000 Credit sales in July = $246,000 x 0.9 = $221,400 Credit sales in August = $250,000 x 0.9 = $225,000 2. Lawrence, Inc. Schedule of Cash Receipts

July August Cash sales 24,600 25,000 Payments on account: From May credit sales (0.07 x $216,000) 15,120 --- From June credit sales (0.60 x $207,000) 124,200 (0.07 x $207,000) 14,490 From July credit sales (0.30 x $221,400) 66,420 (0.60 x $221,400) 132,840 From August credit sales (0.30 x $225,000) --- 67,500

Cash receipts $230,340 $239,830

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8–13

1. Janzen, Inc. Cash Receipts Budget

For July

Payments on account: From May credit sales (0.15 × $220,000) ................................. $ 33,000 From June credit sales (0.60 × $230,000) ............................... 138,000 From July credit sales (0.20 × $210,000) ................................. 42,000 Less: July cash discount (0.02 × $42,000) .............................. (840) Cash receipts ............................................................................ $212,160 2. Janzen, Inc. Cash Receipts Budget

For August

Payments on account: From June credit sales (0.15 × $230,000) ............................... $ 34,500 From July credit sales (0.60 × $210,000) ................................. 126,000 From August credit sales (0.20 × $250,000) ........................... 50,000 Less: August cash discount (0.02 × $50,000) ......................... (1,000) Cash receipts ............................................................................. $209,500

8–14

MarvelI agree with comment Company Schedule of Cash Payments for August

Payments on accounts payable: From July purchases (0.75 x $25,000) $18,750 From August purchases (0.25 x $30,000) 7,500 Direct labor payments: From July (0.10 x $40,000) 4,000 From August (0.90 x $50,000) 45,000 Overhead ($70,000 - $5,500) 64,500 Loan repayment [$10,000 + ($10,000 x 0.12 x 4/12)]10,400 Cash payments $150,150

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8–15

Cash Budget For the Month of June 20XX

Beginning cash balance $ 345 Collections: Cash sales 20,000 Credit sales: Current month ($30,000 × 50%) 15,000 May credit sales ($25,000 × 30%) 7,500 April credit sales* 3,778 Total cash available $46,623 Less disbursements: Inventory purchases: Current month ($50,000 × 60% × 40%) $12,000 Prior month ($40,000 × 60% × 60%) 14,400 Salaries and wages 8,700 Rent 1,200 Taxes 5,500 Total cash needs 41,800 Excess of cash available $ 4,823

*$25,000 × 15% = $3,750 $3,750/2 × 0.015 = $28 $3,750 + $28 = $3,778

2. No. Without the possibility of short-term loans, the owner should consider

taking less cash salary.

224422

8–16

1. Performance Report

Actual Budgeted Variance Units produced 1,100 1,000 100 F Direct materials cost $11,200 $10,000a $1,200 U Direct labor cost 4,400 4,000b 400 U Total $15,600 $14,400 $1,600 U a. 1,000 units * 2 leather straps * $5 = $10,000 b. 1,000 units * .5 hours per unit * $8 = $4,000 2. The performance report compares costs at two different levels of activity and so cannot be used to assess efficiency.

8–17

1. Pet-Care Company Overhead Budget

For the Coming Year

Activity Level Formula 55,000 Hours* Variable costs: Maintenance $0.40 $22,000 Power 0.50 27,500 Indirect labor 1.60 88,000 Total variable costs $137,500 Fixed costs: Maintenance $17,000 Indirect labor 26,500 Rent 18,000 Total fixed costs 61,500 Total overhead costs $199,000

*BasicDiet: (0.25 × 100,000) 25,000 SpecDiet: (0.30 × 100,000) 30,000

Total DLH 55,000

224433

8–17 Concluded

2. 10% higher: Pet-Care Company Overhead Budget

For the Coming Year

Activity Level Formula 60,500 Hours* Variable costs: Maintenance $0.40 $24,200 Power 0.50 30,250 Indirect labor 1.60 96,800 Total variable costs $151,250 Fixed costs: Maintenance $17,000 Indirect labor 26,500 Rent 18,000 Total fixed costs 61,500 Total overhead costs $212,750

*55,000 DLH × 110% = 60,500

20% lower: Pet-Care Company Overhead Budget

For the Coming Year

Activity Level Formula 44,000 Hours* Variable costs: Maintenance $0.40 $17,600 Power 0.50 22,000 Indirect labor 1.60 70,400 Total variable costs $110,000 Fixed costs: Maintenance $17,000 Indirect labor 26,500 Rent 18,000 Total fixed costs 61,500 Total overhead costs $171,500

*55,000 DLH × 80% = 44,000

224444

8–18

1. Pet-Care Company Performance Report

For the Current Year

Actual Budget Variance Units produced 220,000 220,000 0 Production costs*: Maintenance $ 40,500 $ 41,000 $ 500 F Power 31,700 30,000 1,700 U Indirect labor 119,000 122,500 3,500 F Rent 18,000 18,000 0 Total costs $209,200 $211,500 $2,300 F

*Flexible budget amounts are based on 60,000 DLH: (0.25 × 120,000) + (0.30 × 100,000) = 60,000 DLH Maintenance: $17,000 + $0.40(60,000) = $41,000 Power: $0.50(60,000) = $30,000 Indirect labor: $26,500 + $1.60(60,000) = $122,500 Rent: $18,000 + 0 = $18,000

2. All of the variances are within 5 to 10 percent of budgeted amounts. Most

would probably view the variances as immaterial. There are numerous rea-sons for variances. For example, a favorable maintenance variance could be caused by less preventive maintenance or by increased efficiency by individ-ual maintenance workers. Indirect labor could be favorable because (among other things) lower-priced labor was used to carry out higher-skilled jobs. Power could be more expensive than planned because of a rate increase. An investigation would be needed to know exactly why the variances occurred.

224455

8–19

1. a. An imposed budgetary approach does not allow input from those who are directly affected by the process. This can tend to make the employees feel that they are unimportant and that management is concerned only with meeting budgetary goals and not necessarily with the well-being of their employees. The employees will probably feel less of a bond with the or-ganization and will feel that they are meeting standards set by others. An imposed budgetary approach is impersonal and can give employees the feeling that goals are set arbitrarily or that some people benefit at the ex-pense of others. Goals that are perceived as belonging to others are less likely to be internalized, increasing the likelihood of dysfunctional beha-vior. Furthermore, imposed budgets fail to take advantage of the know-ledge subordinate managers have of operations and local market condi-tions.

b. A participative budgetary approach allows subordinate managers consi-derable say in how budgets are established. This communicates a sense of responsibility to the managers and fosters creativity. It also increases the likelihood that the goals of the budget will become the manager’s per-sonal goals, due to their participation. This results in a higher degree of goal congruence. Many feel that there will be a higher level of performance because it is felt that individuals who are involved in setting their own standards will work harder to achieve them. When managers are allowed to give input in developing the budget, they tend to feel that its success or failure reflects personally on them.

2. a. In an imposed budgetary setting, communication flows from the top to the

bottom and is mostly a one-way flow. Any upward flow would have to do with understanding the budgets being communicated. For participative budgeting, the communication flows are necessarily in both directions, with much of the communication being initiated by subordinate managers.

b. The first communication process (imposed budgeting) leaves the impres-sion that the opinions and thoughts of lower-level managers are unim-portant. Subordinate managers may feel that no input is being solicited because their input is not valued. The second process (participative budgeting), however, conveys the impression that opinions and views are important and valued. This tends to create a greater feeling of worth to the organization and a stronger commitment to achieving its goals.

224466

8–20

1. First, calculate the inspection hours needed: (50,000 units/1000 units per batch) × 100 testing hours per batch = 5,000 projected testing hours. This requires the hiring of three inspectors (5,000 projected testing hours/2,000 inspector hours per year) = 2.5 required inspectors and the lease of one piece of testing equipment. Thus, the budget for 5,000 in-spection hours is given as follows:

Resource Formula 5,000 inspection hours Fixed Variable

Salaries $150,000 — $150,000 Lease 10,000 — 10,000 Power -- $2.00 10,000 Total $160,000 $2.00 $170,000

2. Inspection hours needed: (60,000 units/1,000 units per batch) × 100 hours per batch = 6,000 projected testing hours. Inspectors needed = 6,000/2,000 = 3; equipment needed = 6,000/5,00 = 1.2 (rounds up to 2). Thus, the budget is as follows:

Resource Formula 6,000 inspection hours Fixed Variable

Salaries $150,000 — $150,000 Lease 20,000 — 20,000 Power -- $2.00 12,000 Total $170,000 $2.00 $182,000

3. First determine the capacity need to service: (80,000/1,000) × 100 = 8,000 inspection hours. Inspectors required = 8,000/2,000 = 4. Equipment needed = 8,000/5,000 = 1.6 (rounded up to 2).

Letting Y = total cost, the flexible formula is

Y = $220,000 + $2X.

Fixed expenses = Salaries of 4 * $50,000 = $200,000 2 Equipment Leases = $20,000 Total Fixed Expenses = $220,000

224477

The formula is only valid for this range because of the step-cost nature of the “fixed resources.” Outside this range the number of inspectors and equipment needed may change.

8–21

1. Resource Formula 60,000 Moves (activity output) Fixed Variable

Salaries $400,000 — $400,000 Lease 24,000 — 24,000 Crates — $1.00 60,000 Fuel — 0.06 3,600 Total $424,000 $1.06 $487,600

Note: Cycles, instead of moves, could have been used as the output meas-ures. In this case, the variable cost per unit would double. In some ways, cycles is a better measure because crates then become a strictly variable cost (for moves, it is a step-variable cost treated as a variable cost). For either moves or cycles, salaries and leases are step-fixed costs. Also, capacity is determined by operators: 3 × 2,000 × 10 = 60,000 moves. The forklifts actually supply more potential capacity: 3 × 24 × 280 × 3 = 60,480, but they cannot move without operators.

2. Resource Formula 54,000 Moves (activity output) Fixed Variable

Salaries $400,000 — $400,000 Lease 24,000 — 24,000 Crates — $1.00 54,000 Fuel — 0.06 3,240 Total $424,000 $1.06 $481,240

The reduction in output reduces the demand for crates and fuel, but the num-ber of operators and forklifts would stay the same (even if the reduction in ac-tivity output were permanent).

3. Resource Formula 15,000 Moves (activity output) Fixed Variable

Salaries $120,000 — $120,000 Lease 8,000 — 8,000 Crates — $1.00 15,000 Fuel — 0.06 900 Total $128,000 $1.06 $143,900

Note: Reducing demand permanently to 15,000 moves requires three operators (3 × 2,000 × 3 = 18,000), assuming that part-time help is not per-mitted, and one forklift (24 × 280 × 3 = 20,160). If part-time operators are al-

224488

lowed, then the cost for salaries would be budgeted at $100,000. This illu-strates the lumpy nature of resources and their role in budgeting.

224499

PROBLEMS

8–22

First, separate fixed and variable costs for each category using the high-low me-thod. Maintenance:

V = ($13,100 – $10,100)/(2,000 – 1,000) = $3.00 F = Y2 – VX2 = $13,100 – $3(2,000) = $7,100 Maintenance cost = $7,100 + $3X Supplies:

V = ($4,800 – $2,400)/1,000 = $2.40 F = $4,800 – $2.40(2,000) = 0 Supplies cost = $2.40X Power:

V = ($2,000 – $1,000)/1,000 = $1.00 F = $2,000 – $1.00(2,000) = 0 Power cost = $1.00X Other:

V = ($14,240 – $12,940)/1,000 = $1.30 F = $14,240 – $1.30(2,000) = $11,640 Other costs = $11,640 + $1.30X

1,800 Direct Labor Hours Maintenance $12,500 Depreciation 7,000 Supervision 16,000 Supplies 4,320 Power 1,800 Other 13,980 Total $55,600

225500

8–23

Kendall Law Firm Cash Receipts Budget

August September Cash fees ..................................................................... $ 72,000 $ 90,000 Received from sales in: June: (0.7)($255,000)(0.17)(1.02) ............... 30,952 — July: (0.7)(0.7)($204,000) ........................... 99,960 — (0.7)(0.17)($204,000)(1.02) ............... — 24,762 August: (0.7)(0.1)($240,000) ........................... 16,800 (0.7)(0.7)($240,000) ........................... 117,600 September: (0.7)(0.1)($300,000) ........................... — 21,000 Total ............................................................................. $219,712 $253,362

8–24

Briggs Manufacturing For the Quarter Ended March 31, 20XX

1. Schedule 1: Sales Budget

January February March Total Units 40,000 50,000 60,000 150,000 Selling price × $215 × $215 × $215 × $215 Sales $8,600,000 $10,750,000 $12,900,000 $32,250,000 2. Schedule 2: Production Budget

January February March Total Sales (Schedule 1) 40,000 50,000 60,000 150,000 Desired ending inventory 40,000 48,000 48,000 48,000 Total needs 80,000 98,000 108,000 198,000 Less: Beginning inventory 32,000 40,000 48,000 32,000 Units to be produced 48,000 58,000 60,000 166,000

225511

8–24 Continued

3. Schedule 3: Direct Materials Purchases Budget

January February Metal Components Metal Components Units to be produced (Schedule 2) 48,000 48,000 58,000 58,000 Direct materials per unit (lbs.) × 10 × 6 × 10 × 6 Production needs 480,000 288,000 580,000 348,000 Desired ending inventory 250,000 150,000 300,000 180,000 Total needs 730,000 438,000 880,000 528,000 Less: Beginning inventory 200,000 120,000 250,000 150,000 Direct materials to be purchased 530,000 318,000 630,000 378,000 Cost per pound × $8 × $2 × $8 × $2 Total cost $4,240,000 $636,000 $5,040,000 $756,000 (Schedule 3 continued)

March Total Metal Components Metal Components Units to be produced (Schedule 2) 60,000 60,000 166,000 166,000 Direct materials per unit (lbs.) × 10 × 6 × 10 × 6 Production needs 600,000 360,000 1,660,000 996,000 Desired ending inventory 300,000 180,000 300,000 180,000 Total needs 900,000 540,000 1,960,000 1,176,000 Less: Beginning inventory 300,000 180,000 200,000 120,000 Direct materials to be purchased 600,000 360,000 1,760,000 1,056,000 Cost per pound × $8 × $2 × $8 × $2 Total cost $4,800,000 $720,000 $14,080,000 $2,112,000

225522

8–24 Continued

4. Schedule 4: Direct Labor Budget

January February March Total Units to be produced (Schedule 2) 48,000 58,000 60,000 166,000 Direct labor time per unit (hours) × 4 × 4 × 4 × 4 Total hours needed 192,000 232,000 240,000 664,000 Cost per hour × $9.25 × $9.25 × $9.25 × $9.25 Total cost $1,776,000 $2,146,000 $2,220,000 $6,142,000 5. Schedule 5: Overhead Budget

January February March Total Budgeted direct labor hours (Schedule 4) 192,000 232,000 240,000 664,000 Variable overhead rate × $3.40 × $3.40 × $3.40 × $3.40 Budgeted variable overhead $652,800 $ 788,800 $ 816,000 $2,257,600 Budgeted fixed overhead 338,000 338,000 338,000 1,014,000 Total overhead $990,800 $1,126,800 $1,154,000 $3,271,600 6. Schedule 6: Selling and Administrative Expenses Budget

January February March Total Planned sales (Schedule 1) 40,000 50,000 60,000 150,000 Variable selling and administrative expenses per unit × $3.60 × $3.60 × $3.60 × $3.60 Total variable expense $144,000 $180,000 $216,000 $540,000 Fixed selling and administrative expenses: Salaries $ 50,000 $ 50,000 $ 50,000 $150,000 Depreciation 40,000 40,000 40,000 120,000 Other 20,000 20,000 20,000 60,000 Total fixed expenses $110,000 $110,000 $110,000 $330,000 Total selling and administrative expenses $254,000 $290,000 $326,000 $870,000

225533

8–24 Continued

7. Schedule 7: Ending Finished Goods Inventory Budget

Unit cost computation: Direct materials: Metal (10 @ $8) = $80 Comp. (6 @ $2) = 12 $ 92.00 Direct labor (4 × $9.25) 37.00 Overhead: Variable (4 @ $3.40) 13.60 Fixed (4 × $1,014,000/664,000) 6.11 Total unit cost $148.71

Finished goods inventory = Units × Unit cost = 48,000 × $148.71 = $7,138,080 8. Schedule 8: Cost of Goods Sold Budget

Direct materials used (Schedule 3) Metal (1,660,000 × $8) $13,280,000 Components (996,000 × $2) 1,992,000 $15,272,000 Direct labor used (Schedule 4) 6,142,000 Overhead (Schedule 5) 3,271,600 Budgeted manufacturing costs $24,685,600 Add: Beginning finished goods (32,000 × $148.71) 4,758,720 Goods available for sale $29,444,320 Less: Ending finished goods (Schedule 7) 7,138,080 Budgeted cost of goods sold $22,306,240 9. Schedule 9: Budgeted Income Statement

Sales (Schedule 1) $ 32,250,000 Less: Cost of goods sold (Schedule 8) 22,306,240 Gross margin $ 9,943,760 Less: Selling and admin. expenses (Schedule 6) 870,000 Income before income taxes $ 9,073,760

225544

8–24 Concluded

10. Schedule 10: Cash Budget

January February March Total Beg. balance $ 378,000 $ 1,321,200 $ 2,952,400 $ 378,000 Cash receipts 8,600,000 10,750,000 12,900,000 32,250,000 Cash available $8,978,000 $12,017,200 $15,852,400 $32,628,000 Less: Disbursements: Purchases $4,876,000 $5,796.000 $ 5,520,000 $16,192,000 Direct labor 1,776,000 2,146,000 2,220,000 6,142,000 Overhead 790,800 926,800 954,000 2,671,600 Selling & admin. 214,000 250,000 286,000 750,000 Total $7,656,800 $9,118.800 $ 8,980,000 $25,755,600

Tentative ending balance $1,321,200 2,952,400 $ 6,872,400 $6,872,400 Borrowed/(repaid) Interest paid — — Ending balance $1,321,200 $ 2,952,400 $ 6,872,400 $ 6,872,400

*(0.12 × 2/12 × $56,800) + (0.12 × 1/12 × $6,800)

225555

8–25

1. To determine accounts payable as of June 30, a schedule of purchases will be constructed. This schedule will also be used to build the cash budget.

Let X = Cost of sales, and sales = 1.00. If X + 0.25X = 1.00, then X = 0.80.

June July August September Cost of sales $ 96,000 $ 72,000 $ 80,000 $108,000 Desired end. inventory* 36,000 40,000 54,000 44,000 Total requirements $132,000 $112,000 $134,000 $152,000 Less: Beginning inventory 48,000 36,000 40,000 54,000 Purchases $ 84,000 $ 76,000 $ 94,000 $ 98,000

*0.50 × Next month’s cost of sales

Since purchases are paid for in the following month, accounts payable at the end of June is $84,000. Inventory for June 30 is $36,000.

Accounts receivable for June 30 is computed as follows:

From June: 0.7 × $120,000 × 0.8* = $67,200 From May: 0.7 × $100,000 × 0.3* = 21,000 Total $88,200

*By June 30, 20% of June credit sales and 70% of May credit sales have been collected, leaving 80% and 30%, respectively, to be collected.

Given accounts payable, the total liabilities plus stockholders’ equity must equal $562,750 ($84,000 + $210,000 + $268,750). Cash is the difference be-tween total assets and all other assets except cash ($562,750 – $425,000 – $36,000 – $88,200). This difference is $13,550.

Liabilities and Assets Stockholders’ Equity Cash $ 13,550 Accounts receivable 88,200 Inventory 36,000 Plant and equipment 425,000 Accounts payable $ 84,000 Common stock 210,000 Retained earnings 268,750 Total $562,750 $562,750

225566

8–25 Continued

2. Grange Retailers Cash Budget

For the Quarter Ending September 30, 2008

July August September Total Beginning cash balance $ 13,550 $ 10,450 $ 10,405 $ 13,550 Cash collections* 102,600 100,700 113,300 316,600 Total cash available $ 116,150 $ 111,150 $ 123,705 $ 330,150

Cash disbursements: Purchases** $ 84,000 $ 76,000 $ 94,000 $ 254,000 Salaries and wages 10,000 10,000 10,000 30,000 Utilities 1,000 1,000 1,000 3,000 Other 1,700 1,700 1,700 5,100 Property taxes 15,000 15,000 Advertising fees 6,000 6,000 Lease 5,000 5,000 Total disbursement $ 111,700 $ 94,700 $ 111,700 $ 318,100 Minimum cash balance 10,000 10,000 10,000 10,000 Total cash needs $ 121,700 $ 104,700 $ 121,700 $ 328,100 Excess (deficiency) $ (5,550) $ 6,450 $ 2,005 $ 2,050 Financing: Borrowings $ 6,000 $ 6,000 Repayments $ (6,000) (6,000) Interest*** (45) $ 0 (45) Total financing $ 6,000 $ (6,045) $ 0 $ (45) Ending cash balance $ 10,450 $ 10,405 $ 12,005 $ 12,005

*Cash collections: Cash sales $ 27,000 $ 30,000 $ 40,500 $ 97,500 Credit sales: Current month 12,600 14,000 18,900 45,500 Prior month 42,000 31,500 35,000 108,500 From two months ago 21,000 25,200 18,900 65,100 Total collections $ 102,600 $ 100,700 $ 113,300 $ 316,600

**Taken from the purchases schedule developed in Requirement 1. ***$6,000 × 0.09/12

225577

8–25 Concluded

3. Grange Retailers Pro Forma Balance Sheet

September 30, 2008

Liabilities and Assets Stockholders’ Equity Cash $ 12,005 Accounts receivablea 96,600 Inventoryb 44,000 Plant and equipmentc 413,000 Accounts payableb $ 98,000 Common stock 210,000 Retained earningsd 257,605 Total $565,605 $565,605

a(0.7 × $135,000 × 0.8) + (0.7 × $100,000 × 0.3). bFrom purchases schedule prepared in Requirement 1. c[$425,000 – 3($4,000)]. dIf total assets equal $565,605, then liabilities plus stockholders’ equity must also equal that amount. Subtracting accounts payable and common stock from total liabilities and stockholders’ equity gives retained earnings of $257,605.

8–26

1. Participative budgeting communicates a sense of responsibility to subordi-nate managers and fosters creativity. Since the subordinate manager creates the budget, it also increases the likelihood that the goals of the budget will become the manager’s personal goals, resulting in a higher degree of goal congruence. Many believe that the increased responsibility and challenge provide nonmonetary incentives that lead to a higher level of performance because it is felt that individuals who are involved in setting their own stan-dards work harder to achieve them. It also involves individuals whose know-ledge of local conditions may enhance the entire planning process.

225588

8–26 Concluded

There are also certain disadvantages or problems associated with participa-tive budgeting. Some managers may tend to either set the budget too loosely or too tightly. Participative budgeting also creates the opportunity for manag-ers to build slack into the budget by underestimating revenues or overesti-mating costs. Another problem is that top management may assume total control of the budgeting process and, simultaneously, seek superficial partic-ipation of lower-level managers. The participation is generally limited to an endorsement activity, and no real input is sought. In this case, the advantag-es of participation are negated.

2. Scott Weidner’s participative budgetary policy has certain deficiencies. They

are as follows: a. Managers do not participate in setting the appropriation target figure.

Recommendation: Managers should have the opportunity to give some in-put as to what the target figure will be.

b. Setting an upper spending constraint gives indirect approval to spending up to that level whether justified or not. Recommendation: Zero-based budgeting could be used.

c. Setting prior constraints, such as maximum limits and inclusion of non-controllable fixed expenditures prior to departmental input, defeats the pur-pose of participative management. Recommendation: Divisional constraints should be known to management prior to budgeting, but individual limits should be determined with the input of managers.

d. Arbitrary allocation of the approved budget defeats the purpose of a parti-cipative budget process. Recommendation: The department managers should be involved in the reallocation of the approved budget.

e. The division manager holds back a specified percentage of each depart-ment’s appropriation for discretionary use. Recommendation: Contingen-cy funds should not be a part of a departmental budget. These funds should be identified and provided for before the allocation process to de-partments.

f. Exception reporting and evaluation based on performance must be ac-companied by rewards. Recommendation: Recognition should be given to those attaining budget goals, not just exceptions. (Part 2 is adapted from CMA unofficial answers.)

225599

8–27

Minota Company Cash Budget

For the Month of July 2008

Beginning cash balance ....................................................... $ 27,000 Collections: Cash sales (0.3 × $1,140,000) ......................................... 342,000 Credit sales: July: With discounta ....................................................... 234,612 Without discountb ................................................. 239,400 Junec ........................................................................... 140,000 Mayd ............................................................................. 84,000 Sale of old equipment .......................................................... 25,200 Total cash available ........................................................ $1,092,212

Less disbursements: Raw materials: Julye ............................................................................. $ 144,000 Junef ............................................................................ 136,800 Direct labor ...................................................................... 110,000 Operating expenses ........................................................ 280,000 Dividends ......................................................................... 140,000 Equipment ........................................................................ 168,000 Total disbursements .................................................. $ 978,800 Minimum cash balance ........................................................ 20,000 Total cash needs ................................................................... $ 998,800

Excess of cash available over needs .................................. $ 93,412

Ending cash balance ............................................................ $ 113,412 a(0.7 × $1,140,000) × 0.6 × 0.5 × 0.98 b(0.7 × $1,140,000) × 0.6 × 0.5 c(0.7 × $1,000,000) × 0.2 d(0.7 × $600,000) × 0.2 eJuly requirements (0.24 × $1,140,000) ............................... $273,600 Desired ending inventory (0.24 × $1,200,000) ................... 288,000 Total requirements .............................................................. $561,600 Less: Beginning inventory ................................................. 273,600 Purchases ............................................................................ $288,000 July payment: $288,000/2 = $144,000 f$273,600/2 = $136,800 (June purchases are computed as shown for July.)

226600

8–28

1. a. The new budget system allows the managers to focus on those areas that need attention. By dividing the annual budget into 12 equal parts, manag-ers can take corrective action before the error is compounded (frequent feedback is provided). Also, the company has segregated costs into fixed and variable components, an essential step for good control. A major weakness of the budget is the failure to properly define responsibility. Be-cause of this, supervisors are being held accountable for areas over which they have no control.

b. The performance report should emphasize those items over which the manager has control. The report should also compare actual costs with budgeted costs for the actual level of activity. Currently, the report is at-tempting to compare costs at two different levels: the original budget for 3,000 units with the actual costs for production of 3,185 units. A flexible budgeting system needs to be employed.

2. Berwin, Inc. Machining Department Performance Report

For the Month Ended May 31, 2008

Budget* Actual Variance Volume in units 3,185 3,185 0

Variable manufacturing costs: Direct materials $ 25,480 $ 24,843 $ 637 F Direct labor 29,461 29,302 159 F Variable overhead 35,354 35,035 319 F Total variable costs $ 90,295 $ 89,180 $1,115 F

Fixed manufacturing costs: Indirect labor $ 3,300 $ 3,334 $ 34 U Depreciation 1,500 1,500 0 Taxes 300 300 0 Insurance 240 240 0 Other 930 1,027 97 U Total fixed costs $ 6,270 $ 6,401 $ 131 U

Total costs $ 96,565 $ 95,581 $ 984 F

*For the variable costs: 3,185 × $24,000/3,000; 3,185 × $27,750/3,000; 3,185 × $33,300/3,000

226611

8–28 Concluded

3. Berwin’s budgetary system could also be improved by offering monetary and nonmonetary incentives to reach budget goals. The managers and supervi-sors should be allowed and encouraged to participate in the budgetary process because they will be responsible for controlling the budget. The con-troller needs to be certain that the budget objectives are based on realistic conditions and expectations. The managers should be held accountable only for costs over which they have control.

8–29

1. Actual Costs Budgeted Costs Budget Variance Direct labor $210,000 $200,000 $ 10,000 U Power 135,000 85,000 50,000 U Setups 140,000 100,000 40,000 U Total $485,000 $385,000 $100,000 U

Note: Budgeted costs use the actual direct labor hours and the labor-based cost formulas. Example: Direct labor cost = $10 × 20,000 = $200,000; Power cost = $5,000 + ($4 × 20,000) = $85,000; and Setup cost = $100,000 (fixed).

2. Actual Costs Budgeted Costs Budget Variance

Direct labor $210,000 $200,000 $10,000 U Power 135,000 149,000 14,000 F Setups 140,000 142,000 2,000 F Total $485,000 $491,000 $ 6,000 F

Note: Budgeted costs use the individual driver formulas: Direct labor = $10 × 20,000 = $200,000; Power = $68,000 + ($0.90 × 90,000) = $149,000; and Setups = $98,000 + ($400 × 110) = $142,000.

3. The multiple-cost-driver approach captures the cause-and-effect cost rela-

tionships and, consequently, is more accurate than the direct-labor-based approach.

226622

8–30

1. Westcott, Inc. Performance Report

For the Year 2008

Actual Costs Budgeted Costs* Budget Variance Direct materials $ 440,000 $ 480,000 $40,000 F Direct labor 355,000 320,000 35,000 U Depreciation 100,000 100,000 0 Maintenance 425,000 435,000 10,000 F Machining 142,000 137,000 5,000 U Materials handling 232,500 240,000 7,500 F Inspections 160,000 145,000 15,000 U Total $1,854,500 $1,857,000 $ 2,500 F

*Budget formulas for each item can be computed by using the high-low me-thod (using the appropriate cost driver for each method). Using this ap-proach, the budgeted costs for the actual activity levels are computed as fol-lows:

Direct materials: $6 × 80,000 Direct labor: $4 × 80,000 Depreciation: $100,000 Maintenance: $60,000 + ($1.50 × 250,000) Machining: $12,000 + ($0.50 × 250,000) Materials handling: $40,000 + ($6.25 × 32,000) Inspections: $25,000 + ($1,000 × 120)

226633

8–30 Concluded

2. Pool rates: $1,100,000/100,000 = $11 per DLH $672,000/300,000 = $2.24 per MHr $290,000/40,000 = $7.25 per move $225,000/200 = $1,125 per batch

Note: The first pool has material and labor costs included.

Unit cost:

Pool 1: $11 × 10,000 = $110,000 Pool 2: $2.24 × 15,000 = 33,600 Pool 3: $7.25 × 500 = 3,625 Pool 4: $1,125 × 5 = 5,625 Total $152,850 Units ÷ 10,000 Unit cost $ 15.29*

*Rounded 3. Knowing the resources consumed by activities and how the resource costs

change with the activity driver should provide more insight into managing the activity and its associated costs. For example, if moves could be reduced to 20,000 from the expected 40,000, then costs can be reduced by not only eli-minating the need for four operators, but by reducing the need to lease from four to two forklifts. However, in the short run, the cost of leasing forklifts may persist even though demand for their service is reduced.

20,000 moves 40,000 moves Materials handling: Forklifts $ 40,000 $ 40,000 Operators 120,000 240,000 Fuel 5,000 10,000 Total $ 165,000 $ 290,000

The detail assumes that forklift leases must continue in the short run but that the number of operators may be reduced (assumes each operator can do 5,000 moves per year).

226644

8–31

a. Schedule 1: Sales Budget (units and total sales in thousands)

Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total Units 65 70 75 90 300 Unit price × $400 × $400 × $400 × $400 × $400 Total sales $26,000 $28,000 $30,000 $36,000 $120,000 b. Schedule 2: Production Budget

Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total Sales (Schedule 1) 65,000 70,000 75,000 90,000 300,000 Desired ending inventory 13,000 15,000 20,000 10,000 10,000 Total needs 78,000 85,000 95,000 100,000 310,000 Less: Beginning inventory 0 13,000 15,000 20,000 0 Production 78,000 72,000 80,000 80,000 310,000 c. Schedule 3: Direct Materials Purchases Budget (in thousands)

Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total Production 78.0 72.0 80.0 80.0 310.0 Materials/unit × 3 × 3 × 3 × 3 × 3 Production needs 234.0 216.0 240.0 240.0 930.0 Desired ending inventory 63.0 67.5 81.0 65.7 65.7 Total needs 297.0 283.5 321.0 305.7 995.7 Less: Beginning inventory 65.7 63.0 67.5 81.0 65.7 Purchases 231.3 220.5 253.5 224.7 930.0 Cost per unit × $80 × $80 × $80 × $80 × $80 Purchase cost $18,504 $17,640 $20,280 $17,976 $74,400

226655

8–31 Continued

d. Schedule 4: Direct Labor Budget (in thousands)

Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total Production 78 72 80 80 310 Hours per unit × 5 × 5 × 5 × 5 × 5 Hours needed 390 360 400 400 1,550 Cost per hour × $10 × $10 × $10 × $10 × $10 Total cost $3,900 $3,600 $4,000 $4,000 $15,500 e. Schedule 5: Overhead Budget (in thousands)

Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total Budgeted hours 390 360 400 400 1,550 Variable rate × $6 × $6 × $6 × $6 × $6 Budgeted VOH $2,340 $2,160 $2,400 $2,400 $ 9,300 Budgeted FOH 1,000 1,000 1,000 1,000 4,000 Total OH $3,340 $3,160 $3,400 $3,400 $13,300 f. Schedule 6: Selling and Administrative Expenses Budget (in thousands)

Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total Planned sales 65 70 75 90 300 Variable rate × $10 × $10 × $10 × $10 × $10 Variable expenses $ 650 $ 700 $ 750 $ 900 $3,000 Fixed expenses 250 250 250 250 1,000 Total expenses $ 900 $ 950 $1,000 $1,150 $4,000 g. Schedule 7: Ending Finished Goods Inventory Budget

Unit cost computation: Direct materials (3 units @ $80) $240.00 Direct labor (5 hours @ $10) 50.00 Overhead: Variable (5 hours @ $6) 30.00 Fixed ($4,000,000/310,000) 12.90* Total unit cost $332.90

Finished goods = 10,000 × $332.90 = $3,329,000

*Rounded

226666

8–31 Continued

h. Schedule 8: Cost of Goods Sold Budget

Direct materials used (Schedule 3) $ 74,400,000 Direct labor used (Schedule 4) 15,500,000 Overhead (Schedule 5) 13,300,000 Budgeted manufacturing costs $103,200,000 Add: Beginning finished goods inventory (Schedule 2) 0 Goods available for sale $103,200,000 Less: Ending finished goods inventory (Schedule 7) 3,329,000 Budgeted cost of goods sold $ 99,871,000 i. Cash Budget (in thousands) Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total Beginning cash bal. $ 250 $ 1,110 $ 3,128 $ 5,568 $ 250 Collections: Credit sales: Current quarter 22,100 23,800 25,500 30,600 102,000 Prior quarter 3,3001 3,900 4,200 4,500 15,900 Cash available $25,650 $28,810 $32,828 $40,668 $118,150 Less disbursements: Direct materials: Current quarter $ 9,252 $ 8,820 $10,140 $ 8,988 $ 37,200 Prior quarter 7,248 9,252 8,820 10,140 35,460 Direct labor 3,900 3,600 4,000 4,000 15,500 Overhead 2,990 2,810 3,050 3,050 11,900 Selling and admin. 850 900 950 1,100 3,800 Dividends 300 300 300 300 1,200 Equipment 2,000 2,000 Total cash needs $24,540 $25,682 $27,260 $29,578 $107,060 Ending cash bal. $ 1,110 $ 3,128 $ 5,568 $11,090 $ 11,090 1. 55,000 * 400 * .15 = 3,300

226677

8–31 Concluded

j. Optima Company Pro Forma Income Statement

For the Year Ending December 31, 2008

Sales (Schedule 1) .................................................................... $120,000,000 Less: Cost of goods sold (Schedule 8) ................................... 99,871,000 Gross margin ....................................................................... $ 20,129,000 Less: Selling and administrative expenses (Schedule 6) ..... 4,000,000 Income before income taxes .............................................. $ 16,129,000 k. Optima Company Pro Forma Balance Sheet

December 31, 2008

Assets Cash ........................................................................................... $11,090,000 Accounts receivable ................................................................. 5,400,000 Direct materials inventory ........................................................ 5,256,000 Finished goods inventory ........................................................ 3,329,000 Plant and equipment ................................................................. 33,900,000a Total assets ............................................................................... $58,975,000

Liabilities and Stockholders’ Equity

Accounts payable ..................................................................... $ 8,988,000 Capital stock .............................................................................. 27,000,000 Retained earnings ..................................................................... 22,987,000b Total liabilities and stockholders’ equity .......................... $58,975,000

aBeginning plant and equipment ............. $33,500,000 Add: New equipment ............................... 2,000,000 Less: Depreciation expense ................... (1,600,000) Ending plant and equipment .............. $33,900,000

bBeginning retained earnings .................. $ 8,058,000 Plus: Net income* .................................... 16,129,000 Less: Dividends paid ............................... (1,200,000) Ending retained earnings ................... $22,987,000

*Ignore taxes.

226688

8–32

1. The flexible budgets presented are based on three different activity levels, none of which coincide with the actual level of performance for November. The budget must be restated to a level of activity that matches the actual re-sults. The fixed and variable components of the mixed costs must be segre-gated and a budgeted cost calculated for the level of activity attained.

2. Patterson Company Selling Expenses Report

For the Month of November

Monthly Expenses Budget Actual Variance Advertising and promotion $1,200,000 $1,350,000 $150,000 U Administrative salaries 57,000 57,000 0 Sales salariesa 84,000 84,000 0 Sales commissionsb 327,000 327,000 0 Salesperson travelc 187,200 185,000 2,200 F Sales office expensed 500,500 497,200 3,300 F Shipping expensee 705,000 730,000 25,000 U Total $3,060,700 $3,230,200 $169,500 U

a($75,600/72)(80) = $84,000

b($300,000/$10,000,000)($10,900,000) = $327,000

cChange in cost: $175,000 – $170,000 = $5,000 Change in sales dollars: $10,625,000 – $10,000,000 = $625,000 Variable cost per dollar of sales = Change in cost divided by change in activity level

$5,000/$625,000 = $0.008 per dollar of sales Fixed cost at 72-person level: $170,000 – ($10,000,000 × 0.008) = $90,000 Fixed cost at 80-person level: ($90,000/72) × 80 = $100,000 Total travel budget: $100,000 fixed + ($10,900,000 × 0.008) variable = $187,200

226699

8–32 Concluded dChange in cost: $498,750 – $490,000 = $8,750 Change in number of orders: 4,250 – 4,000 = 250 Variable cost per order: $8,750/250 = $35 Fixed cost: $490,000 – (4,000 × $35) = $350,000 Total office expense budget: $350,000 + (4,300 × $35) = $500,500

eChange in cost: $712,500 – $675,000 = $37,500 Change in number of units: 425,000 – 400,000 = 25,000 Variable cost per unit: $37,500/25,000 = $1.50 Fixed cost: $675,000 – (400,000 × $1.50) = $75,000 Total shipping expense budget: $75,000 + (420,000 × $1.50) = $705,000

227700

MANAGERIAL DECISION CASES

8–33

1. Linda’s behavior is not ethical. In the budgeting process, she is deliberately misrepresenting the capabilities of her division for personal gain. To ensure that she achieves budget (either this year or next), she manipulates account-ing procedures. This manipulation is in opposition to generally accepted ac-counting principles. Her decisions are based on her own self-interest rather than on the interest of the company. Deceptive and manipulative behavior for personal gain is clearly wrong.

2. There are few, if any, legitimate reasons for deferring the closing of sales.

Thus, if a marketing manager were asked to engage in this behavior, the first response must be to find out why the request is being made. If there is no sound reason offered, then a simple refusal should suffice. If it takes on the nature of an order and no sound reason exists, then the marketing manager should consider appealing to a higher-level manager. Certainly, deferral of closings so that it increases the likelihood of meeting budget for the coming year is not a sound reason, and, in fact, is wrong.

3. It would be hard to go against a common practice that seems to have the ap-

proval of the plant managers. The widespread knowledge of the practice may even suggest that higher-level management is aware of it and essentially condones the practice—or at least adjusts for it. If higher-level management is aware of the practice and adjusts for it, then the ability to achieve bonus may not be enhanced as much as believed. The plant manager could investi-gate and find out the extent to which upper-level management is aware of padding. At the same time, the manager could obtain some advice on what his behavior ought to be. If told that the practice is acceptable, then the man-ager has to decide whether to continue in an organization that accepts decep-tive behavior (or go against the grain and simply report what he or she feels is really achievable by the plant).

4. This is a clear violation of the ethical code for management accountants. A

management accountant is obligated to report information fairly and objec-tively and to disclose all information that can be expected to influence a us-er’s understanding of accounting reports. Moreover, management accoun-tants must perform their duties in accordance with relevant laws, regulations, and technical standards. Accelerating the recognition of expenses violates generally accepted accounting principles.

227711

8–34

1. Dr. Roger Jones Cash Budget

Cash collections and cash available* .......................... $21,360 Less cash disbursements: Salaries ...................................................................... $12,700 Benefits ..................................................................... 1,344 Building lease ........................................................... 1,500 Dental supplies ......................................................... 1,200 Janitorial .................................................................... 300 Utilities ....................................................................... 400 Phone ......................................................................... 150 Office supplies .......................................................... 100 Lab fees ..................................................................... 5,000 Loan payments ......................................................... 570 Interest payments ..................................................... 500 Miscellaneous ........................................................... 500 Total cash needs ............................................................ $24,264

Deficiency of cash available over needs ..................... $ (2,904)

*Total revenues for a month: Fillings ($50 × 90) .................. $ 4,500 Crowns ($300 × 19) ............... 5,700 Root canals ($170 × 8) .......... 1,360 Bridges ($500 × 7) ................. 3,500 Extractions ($45 × 30) ........... 1,350 Cleaning ($25 × 108) ............. 2,700 X-rays ($15 × 150) ................. 2,250 $21,360

The budget shows that there is $2,904 more cash going out than coming in.

227722

8–34 Continued

2. Dr. Jones must either increase revenues to make up the deficiency or cut costs or a combination of the two. Three possible approaches are outlined below:

a. Extend office hours so that a total of 40 hours are worked each week. This could increase revenues by as much as $5,340. Based on a four-week month, the current revenue earned per hour is $166.88 ($21,360/128). Thus, the total revenue increase possible is $166.88 × 32 hours = $5,340. Dr. Jones would need to inform his assistants and receptionist of the in-creased time and indicate that each will receive a 15% increase in salary for the additional time. (The office is currently open 34 hours per week.) Benefits (primarily FICA and unemployment insurance benefits) would al-so increase. Other expenses that will likely increase with an increase in sales are dental supplies, lab fees, and utilities (representing about 31% of sales). The remaining expenses appear to be fixed. Thus, the increase in cash flow is computed as follows:

Incremental revenues $ 5,340 Salary increases (0.15 × $3,400) (510) Benefits ($1,344/$12,700)($510) (54) Variable expenses (0.31 × $5,340) (1,655) Cash flow increase $ 3,121

Approach 1 carries with it some risk. Increasing office hours may not in-

crease business. If business does not increase as expected, the cash flow problems could be aggravated rather than relieved. The likelihood of increas-ing business would be increased if the additional hours are offered in the ear-ly evening instead of Friday afternoon. Evening hours are a major conveni-ence for patients who must work during the day and are reluctant to lose work hours.

227733

8–34 Continued

Dr. Roger Jones Revised Cash Budget

Cash collections and cash avail. ($21,360 + $5,340) ........ $26,700

Less cash disbursements: Salaries ($12,700 + $510) .................................................... $13,210 Benefits ($1,344 + $54) ........................................................ 1,398 Building lease ...................................................................... 1,500 Dental supplies ($1,200 + $300*) ........................................ 1,500 Janitorial ............................................................................... 300 Utilities ($400 + $100*) ......................................................... 500 Phone .................................................................................... 150 Office supplies ..................................................................... 100 Lab fees ($5,000 + $1,255*) ................................................. 6,255 Loan payments .................................................................... 570 Interest payments ................................................................ 500 Miscellaneous ...................................................................... 500 Total cash needs ................................................................. $26,483

Excess cash available over needs ..................................... $ 217

*Variable expenses increase by 25% (8 added hours/32 original hours).

b. Cut one dental assistant, eliminate the salary to Mrs. Jones and the activi-ties she does, and cut Dr. Jones’s salary back by $1,000 per month. The savings are given below:

Assistant (salary and benefits)...................... $1,051* Salaries ............................................................ 2,000 Total ............................................................. $3,051

*($1,900/2) + [($950/$12,700) × $1,344] = $1,051 (rounded) (This provides a reasonable approximation of the benefits assigned to an assistant.)

Although this achieves the savings, the solution may not be feasible. The solution depends to a large extent on how well the Jones family can do with a $2,000 per month cut in their income. In all likelihood, this would be unacceptable to the Jones family. Also, cutting an assistant would require the receptionist to become involved in assisting. This may not be possible without laying off the receptionist and hiring a person that has both sets of skills. Additionally, using the receptionist as an assistant would result in phone calls going unanswered and/or incoming patients being ignored.

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c. A third possibility is to increase the fees charged for the various dental ser-vices. Assuming a variable cost ratio of 31% (from Approach 1), the in-crease in revenues needed to cover the $2,900 deficiency can be com-puted as follows:

0.69R = $2,900 R = $2,900/0.69 R = $4,203

This increase would call for fees to increase an average of 19.7%. Whether this increase is possible or not depends to some extent on how Dr. Jones’s charges compare with other dentists in the area. If some increase is possible, then the increase could be combined with elements of the oth-er two approaches, (e.g., a 10 percent increase in fees and working an ex-tra four hours per week, say, on Wednesday evening). I would expect Dr. Jones to be more likely to accept a combination like the one just men-tioned rather than accepting any of the approaches in their pure form.

The behavioral principles discussed in the chapter do have a role in this type of setting. Dr. Jones’s personal goals must be in line with the goals of his professional organization, and he must have the motivation to achieve those goals. There is, however, a significant difference. Dr. Jones owns and manag-es the organization. To a large extent, his goals are the goals of the organiza-tion.

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Answers will vary.