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Chapter 8_ Functional and Activity-Based Budgeting

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					                   CHAPTER 8
    FUNCTIONAL AND ACTIVITY-BASED BUDGETING
                      QUESTIONS FOR WRITING AND DISCUSSION

1. Budgets are the quantitative expressions of                manufacturing budgets, in turn, depend on
   plans. Budgets are used to translate the                   the production budget. The same is true for
   goals and strategies of an organization into               the financial budgets since sales is a critical
   operational terms.                                         input for budgets in that category.
2. Control is the process of setting standards,          8. For a merchandising firm, the production
   receiving feedback on actual performance,                budget is replaced by a merchandise pur-
   and taking corrective action whenever actual             chases budget. Merchandising firms also
   performance deviates from planned perfor-                lack direct materials and direct labor budg-
   mance. Budgets are standards, and they are               ets. All other budgets are essentially the
   compared with actual costs and revenues to               same. For a service firm (for-profit), the
   provide feedback.                                        sales budget doubles as the production
                                                            budget, and there is no finished goods in-
3. The planning and control functions of bud-               ventory budget. The rest of the budgets have
   geting can benefit all organizations regard-             counterparts.
   less of size. All organizations need to deter-
   mine what their goals are and how best to             9. A static budget is for a particular level of ac-
   obtain those goals. This is the planning func-           tivity. A flexible budget is one that can be es-
   tion of budgeting. In addition, organizations            tablished for any level of activity. For perfor-
   can compare what actually happens with                   mance reporting, it is necessary to compare
   what was planned to see if the plans are un-             the actual costs for the actual level of activity
   folding as anticipated. This is the control              with the budgeted costs for the actual level
   function of budgeting.                                   of activity. A flexible budget provides the
                                                            means to compute the budgeted costs for
4. Budgeting forces managers to plan, provides              the actual level of activity, after the fact.
   resource information for decision making,
   sets benchmarks for control and evaluation,          10.   A flexible budget is based on a simple for-
   and improves the functions of communica-                   mula: Y = F + VX, which requires knowledge
   tion and coordination.                                     of both fixed and variable components.
5. A master budget is the collection of all indi-       11.   Goal congruence is important because it
   vidual area and activity budgets. Operating                means that the employees of an organiza-
   budgets are concerned with the income-                     tion are working toward the goals of that or-
   generating activities of a firm. Financial                 ganization.
   budgets are concerned with the inflows and
   outflows of cash and with planned capital            12.   Frequent feedback is important so that cor-
   expenditures.                                              rective action can be taken, increasing the
                                                              likelihood of achieving budget.
6. The sales forecast is a critical input for build-
   ing the sales budget. However, it is not nec-        13.   Both monetary and nonmonetary incentives
   essarily equivalent to the sales budget. Upon              are used to encourage employees of an or-
   receiving the sales forecast, management                   ganization to achieve the organization’s
   may decide that the firm can do better than                goals. Monetary incentives appeal to the
   the forecast indicates. Consequently, actions              economic needs of an individual, and non-
   may be taken to increase the sales potential               monetary incentives appeal to the psycho-
   for the coming year (e.g., increasing adver-               logical needs. Since individuals are moti-
   tising). This adjusted forecast then becomes               vated by both economic and psychological
   the sales budget.                                          factors, both types of incentives ought to be
                                                              present in a good budgetary system.
7. Yes. All budgets are founded on the sales
   budget. Before a production budget can be            14.   Participative budgeting is a system of bud-
   created, it must have the planned sales. The               geting that allows subordinate managers a



                                                  233
      say in how the budgets are established. Par-             share, and product quality. A manager would
      ticipative budgeting fosters creativity and              have to be rewarded for improvements
      communicates a sense of responsibility to                achieved in each area. A major difficulty is
      subordinate managers. It also creates a                  determining how much weight to assign to
      higher likelihood of goal congruence since               each performance area.
      managers have more of a tendency to make
                                                         20.   Behavioral factors can make or break a
      the budget’s goals their own personal goals.
                                                               budgetary control system. It is absolutely es-
15.   Agree. Individuals who are not challenged                sential to consider the behavioral ramifica-
      tend to lose interest and maintain a lower               tions. Ignoring them can and probably will
      level of performance. A challenging, but                 produce dysfunctional consequences.
      achievable, budget tends to extract a higher
                                                         21.   Across-the-board cuts have the appearance
      level of performance.
                                                               of being fair, but they unfairly penalize good
16.   Top management should provide guidelines                 programs. In an era of scarce resources, an
      and statistical input (e.g., industrial fore-            organization must decide what it wishes to
      casts) and should review the budgets to mi-              emphasize and allocate resources accor-
      nimize the possibility of budgetary slack and            dingly. This may mean the complete elimina-
      ensure that the budget is compatible with the            tion of weak programs and the strengthening
      strategic objectives of the firm. Top man-               of strong programs. To cut each program
      agement should also provide the incentive                equally without considering which ones are
      and reward system associated with the bud-               vital to the success of the organization is not
      getary system.                                           good planning.
17.   By underestimating revenues and overesti-          22.   Activity-based budgeting requires three
      mating costs, the budget is more easily                  steps: (1) identification of activities; (2) esti-
      achieved.                                                mation of activity output demands; and (3)
                                                               estimation of the costs of resources needed
18.   To meet budget, it is possible to take actions
                                                               to provide the activity output demanded.
      that reduce costs in the short run but in-
      crease them in the long run. For example,          23.   Functional-based flexible budgeting relies on
      lower-priced, lower-quality materials can be             unit-based drivers to build cost formulas for
      substituted for the usual quality of materials.          various cost items. Activity flexible budgeting
                                                               uses activity drivers to build a cost formula
19.   Other performance measures include prod-
                                                               for the costs of each activity.
      uctivity, personnel development, market




                                                   234
                                      EXERCISES

8–1

1.                                 Fresh-n-Clean, Inc.
                                      Sales Budget
                                    For the Year 2006
      Detergent:
                        1st Qtr.      2nd Qtr.    3rd Qtr.    4th Qtr.     Total
      Units              40,000        55,000      62,000      70,000      227,000
       Price           $3.00        $3.00      $3.00      $3.00        $3.00
         Sales         $120,000      $165,000    $186,000    $210,000    $ 681,000
      Presoak:
      Units              50,000        50,000      60,000      70,000        230,000
       Price           $3.50        $3.50      $3.50      $3.50          $3.50
         Sales         $175,000      $175,000    $210,000    $245,000    $   805,000
      Total sales      $295,000      $340,000    $396,000    $455,000    $ 1,486,000

2.    Fresh-n-Clean, Inc., will use the sales budget in planning as the basis for the
      production 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.




                                        235
8–2

                             Fresh-n-Clean, Inc.
                       Production Budget for Detergent
                              For the Year 2006
                             1st Qtr.    2nd Qtr.   3rd Qtr.      4th Qtr.    Total
Sales                        40,000       55,000    62,000        70,000     227,000
Des. ending inventory         5,500        6,200      7,000         4,500      4,500
Total needs                  45,500       61,200    69,000        74,500     231,500
Less: Beginning inventory     2,000        5,500      6,200         7,000      2,000
   Units produced            43,500       55,700    62,800        67,500     229,500


                             Fresh-n-Clean, Inc.
                        Production Budget for Presoak
                              For the Year 2006
                             1st Qtr.    2nd Qtr.   3rd Qtr.      4th Qtr.    Total
Sales                        50,000       50,000    60,000        70,000     230,000
Des. ending inventory        10,000       12,000    14,000        11,000      11,000
Total needs                  60,000       62,000    74,000        81,000     241,000
Less: Beginning inventory     3,200       10,000    12,000        14,000       3,200
   Units produced            56,800       52,000    62,000        67,000     237,800


8–3

                              Cap’n Ahab, Inc.
                  Production Budget for Whole-Bean Coffee
                         For the First Quarter, 20XX
                             January        February            March         Total
Sales                        200,000         140,000           180,000       520,000
Des. ending inventory         28,000          36,000            42,000        42,000
Total needs                  228,000         176,000           222,000       562,000
Less: Beginning inventory     35,000          28,000            36,000        35,000
   Units produced            193,000         148,000           186,000       527,000




                                   236
8–4

                                 Cap’n Ahab, Inc.
                        Direct Materials Purchases Budget
                            For January and February
1.    Bags:
                               January       February          Total
     Production                193,000        148,000        341,000
      1 bag                         1             1              1
     Bags for production       193,000        148,000        341,000
     Des. ending inventory       14,800         18,600         18,600
     Total needs               207,800        166,600        359,600
     Less: Beginning inventory   19,300         14,800         19,300
     Cans purchased            188,500        151,800        340,300
2.    Roasted beans:
                                January      February         Total
     Production                  193,000       148,000        341,000
      10 ounces                     10           10            10
     Ounces for production    1,930,000     1,480,000       3,410,000
     Des. ending inventory       148,000       186,000        186,000
     Total needs              2,078,000     1,666,000       3,596,000
     Less: Beginning inventory 193,000         148,000        193,000
     Ounces purchased         1,885,000     1,518,000       3,403,000


8–5

                                   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




                                     237
8–6

                                Lanning Company
                        Direct Materials Purchases Budget
                         For March, April, and May 20XX
                                   March           April             May        Total
Units to be produced               10,000          30,000            50,000      90,000
Direct materials per unit
   (yards)                            25              25            25           25
Production needs                  250,000          750,000      1,250,000     2,250,000
Desired ending inventory
   (yards)                         150,000       250,000           30,000        30,000
Total needs                        400,000     1,000,000        1,280,000     2,280,000
Less beginning inventory            50,000       150,000          250,000        50,000
Direct materials to be
   purchased (yards)              350,000        850,000        1,030,000     2,230,000
Cost per yard                      $0.15       $0.15           $0.15        $0.15
   Total purchase cost            $ 52,500     $ 127,500        $ 154,500     $ 334,500


8–7

                                   Lanning Company
                                  Direct Labor Budget
                             For March, April, and May 20XX
                                    March               April         May          Total
Units to be produced                10,000             30,000        50,000        90,000
Direct labor time per
   unit (hours)                     0.04             0.04         0.04         0.04
Total hours needed                     400            1,200         2,000         3,600
Cost per hour                       $12               $12          $12          $12
   Total direct labor cost         $ 4,800         $ 14,400      $ 24,000      $ 43,200




                                       238
8–8

                                       Norton, Inc.
                                     Sales Budget
                                  For the Coming Year
Model                    Units                    Price          Total Sales
LB-1                     50,400                  $29.00          $1,461,600
LB-2                     19,800                   15.00             297,000
WE-6                     25,200                   10.40             262,080
WE-7                     17,820                   10.00             178,200
WE-8                      9,600                   22.00             211,200
WE-9                      4,000                   26.00             104,000
   Total                                                         $2,514,080


8–9

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




                                       239
8–9      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      13
         Needed                                  203          162     200
         Less: Beginning inventory                10            8       9
             Purchases                           193          154     191

      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




                                     240
8–9         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.


8–10

1.    Credit sales in May = $240,000  0.8 = $192,000
      Credit sales in June = $230,000  0.8 = $184,000
      Credit sales in July = $246,000  0.8 = $196,800
      Credit sales in August = $250,000  0.8 = $200,000

2.                                                Ebert, Inc.
                                             Cash Receipts Budget
                                                                                        July         August
      Cash sales .................................................................    $ 49,200      $ 50,000
      Payments on account:
      From May credit sales
         (0.08  $192,000) ..................................................           15,360           —
      From June credit sales:
         (0.60  $184,000) ..................................................          110,400
         (0.08  $184,000) ..................................................                         14,720
      From July credit sales:
         (0.30  $196,800) ..................................................           59,040
         (0.60  $196,800) ..................................................                        118,080
      From August credit sales:
         (0.30  $200,000) ..................................................             —            60,000
      Cash receipts ............................................................      $ 234,000     $ 242,800




                                                        241
8–11

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


8–12

                                         Topper Company
                               Schedule of Cash Payments for August
Payments on accounts payable:
   From July purchases (0.70  $25,000) .....................................                     $ 17,500
   From August purchases (0.30  $30,000) ................................                           9,000
Direct labor payments:
   From July (0.10  $57,000) ........................................................               5,700
   From August (0.90  $63,000) ...................................................                 56,700
Overhead ($110,000  $5,500) ........................................................              104,500
Loan repayment [$10,000 + ($10,000  0.12  4/12)] .....................                            10,400
   Cash payments ..........................................................................       $203,800




                                                      242
8–13

1.                                               Cash Budget
                                         For the Month of June 20XX
     Beginning cash balance ..........................................                $ 1,345
     Collections:
        Cash sales ...........................................................         20,000
        Credit sales:
            Current month ($90,000  50%) ....................                         45,000
            May credit sales ($85,000  30%)..................                         25,500
            April credit sales* ..........................................              8,060
     Total cash available ..................................................                     $ 99,905
     Less disbursements:
        Inventory purchases:
            Current month ($110,000  80%  40%) .......                              $ 35,200
            Prior month ($100,000  80%  60%) ............                             48,000
        Salaries and wages .............................................                10,300
        Rent ......................................................................      2,200
        Taxes ....................................................................       5,500
            Total cash needs ............................................                         101,200
     Excess of cash available over needs ......................                                  $( 1,295)
     *Payments for April credit sales = $50,000  16% = $8,000
      Late fees remitted = ($8,000/2)  0.015 = $60
      Total Payments for April credit sales and late fees = $8,000 + $60 = $8,060

2.   Yes, the business does show a negative cash balance for the month of June.
     Without the possibility of short-term loans, the owner should consider taking
     less cash salary.




                                                        243
8–14

1.   Part A23 = (12/60)(35,000) = 7,000 direct labor hours
     Part B14 = (24/60)(10,000) = 4,000 direct labor hours
     Total direct labor hours = 7,000 + 4,000 = 11,000

2.
                                    Roberoy, Inc.
                                  Overhead Budget
                             For the Month of November
                                                         Activity Level
                                       Formula           11,000 Hours
     Variable costs:
        Maintenance                     $1.40              $ 15,400
        Supplies                         0.70                 7,700
        Power                            0.12                 1,320
            Total variable costs                                          $ 24,420
     Fixed costs (1/12 of
        annual amount):
        Depreciation                                       $     650
        Salaries                                               5,500
            Total fixed costs                                                6,150
     Total overhead costs                                                 $ 30,570




                                      244
8–15

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).




                                       245
8–15     Concluded

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 opera-
     tors (3  2,000  3 = 18,000), assuming that part-time help is not permitted,
     and one forklift (24  280  3 = 20,160). If part-time operators are allowed, then
     the cost for salaries would be budgeted at $100,000. This illustrates the lum-
     py nature of resources and their role in budgeting.


8–16

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




                                        246
8–16     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




                                        247
8–17

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

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.




                                     248
8–18

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.




                                      249
8–18     Concluded

     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.


8–19

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




                                     250
                                      PROBLEMS

8–20

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

Maintenance:
V = ($12,100 – $9,100)/(2,000 – 1,000) = $3.00
F = Y2 – VX2 = $12,100 – $6(2,000) = $6,100
Maintenance cost = $6,100 + $3X

Supplies:
V = ($4,300 – $2,150)/1,000 = $2.15
F = $4,300 – $2.15(2,000) = 0
Supplies cost = $2.15X

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

                            1,700 Direct Labor Hours
Maintenance                          $11,200
Depreciation                           5,000
Supervision                           15,000
Supplies                               3,655
Power                                  1,700
Other                                 13,850
   Total                             $50,405




                                        251
8–21

                                                  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


8–22

                                          Woodruff 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                         $180                     $180                $180           $180
         Sales                         $7,200,000                $9,000,000          $10,800,000     $27,000,000

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




                                                           252
8–22    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




                                       253
8–22    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




                                      254
8–22    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)                                           $27,000,000
     Less: Cost of goods sold (Schedule 8)                         22,306,240
     Gross margin                                                 $ 4,693,760
     Less: Selling and admin. expenses (Schedule 6)                   870,000
        Income before income taxes                                $ 3,823,760




                                    255
8–22   Concluded

10. Schedule 10: Cash Budget
                           January           February         March          Total
   Beg. balance          $ 400,000          $         0   $         0     $   400,000
   Cash receipts          7,200,000           9,000,000    10,800,000      27,000,000
   Cash available        $7,600,000         $9,000,000    $10,800,000     $27,400,000
   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    $   (56,800)       $ (118,800)   $ 1,820,000     $ 1,644,400
   Borrowed/(repaid)          56,800           118,800       (175,600)              0
   Interest paid               —                 —             (2,324)*        (2,324)
       Ending balance    $         0        $        0    $ 1,642,076     $ 1,642,076
   *(0.12  2/12  $56,800) + (0.12  1/12  $118,800)




                                      256
8–23

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




                                      257
8–23     Continued

2.                                Grange Retailers
                                    Cash Budget
                     For the Quarter Ending September 30, 2006
                                      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




                                       258
8–23     Concluded

3.                                Grange Retailers
                              Pro Forma Balance Sheet
                                 September 30, 2006
                                                                   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
      (0.7  $135,000  0.8) + (0.7  $100,000  0.3).
     a

     b
       From purchases schedule prepared in Requirement 1.
     c
      [$425,000 – 3($4,000)].
     d
       If 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.


8–24

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.




                                      259
8–24     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.)




                                      260
8–25

                                                Minota Company
                                                  Cash Budget
                                           For the Month of July 2006
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

  (0.7  $1,140,000)  0.6  0.5  0.98
a

  (0.7  $1,140,000)  0.6  0.5
b

  (0.7  $1,000,000)  0.2
c

  (0.7  $600,000)  0.2
d

  July requirements (0.24  $1,140,000) ...............................
e
                                                                                         $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.)




                                                         261
8–26

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, 2006
                                            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




                                      262
8–26     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.


8–27

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.




                                     263
8–28

1.                                 Westcott, Inc.
                                Performance Report
                                 For the Year 2006
                           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)




                                     264
8–28     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).




                                       265
8–29

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




                                      266
8–29     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




                                      267
8–29    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       3,300       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




                                    268
8–29       Concluded

j.                                          Optima Company
                                      Pro Forma Income Statement
                                 For the Year Ending December 31, 2006
     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, 2006
                                                          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
     a
      Beginning 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
     b
      Beginning 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.




                                                          269
8–30

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
     c
     Change 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




                                        270
8–30   Concluded
   d
   Change 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
   e
   Change 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




                                 271
                         MANAGERIAL DECISION CASES

8–31

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.




                                      272
8–32

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.




                                                        273
8–32     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




                                      274
8–32    Continued

   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.
                                                   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).




                                                      275
8–32    Continued

   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.

   c. A third possibility is to increase the fees charged for the various dental
      services. 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
       other two approaches, (e.g., a 10 percent increase in fees and working an
       extra 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 man-
   ages the organization. To a large extent, his goals are the goals of the organi-
   zation.




                                                     276
                     RESEARCH ASSIGNMENTS

8–33

Answers will vary.


8–34

Answers will vary.




                           277

				
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