Chapters Solutions by wuxiangyu


									10-1          Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E


 2-5. Budgets establish the amount of resources that are available for specific activities. However,
      budgets do not merely limit the resources that can be spent. They represent the detailed plan that
      supports the organization’s efforts to achieve its mission, and help the organization determine
      and achieve its goals and objectives. The budgeting process is one of exploring possibilities.
      Organizations determine what things they can and cannot do. They examine alternatives and
      choose those that are likely to yield the best results. They become attuned to possible problems
      and can work to find solutions. Budgeting forces managers to think ahead, to have clear
      expectations against which to measure performance, and to coordinate the activities of the
      organization so that everyone is working toward a common purpose.
          Budgets are also used to control results. That is, budgets not only create plans, but they are
      also used to help accomplish those plans. This is done by comparing actual results to the budget.
      Looking at results, we can assess what needs to be corrected. How good a job did the
      organization’s management do? How well did the organization itself do? In order to evaluate
      performance, one must have a standard or benchmark to compare with actual results. The budget
      establishes the organization’s expectations.

 2-6. An organization may consider undertaking an activity that was not planned for when the annual
      budget was prepared. At any time an organization can prepare a special budget for a specific
      purpose. Appropriate approval should be obtained before implementing the budget.

2-12. If targets are placed out of reach, people probably will not stretch to their utmost limits to come
      as close to the target as possible. When people work extremely hard and then fail, they often
      question why they bothered to work so hard. If hard work results in failure to achieve the target,
      then why not ease off? If you are going to fail anyway, must it be so painful?

 2-13. (1) The budget is first prepared. (2) After review by the body with adoption authority, it is
       adopted, either with or without changes. (3) Once approved, the budget is implemented. It is the
       responsibility of the management of the organization or the executive branch of the government
       to assure that the adopted budget is carried out. (4) Finally, the results must be evaluated.
       Accountability is an element of this evaluation.

 2-14. In some organizations, support and revenues are only acknowledged if they have been received
       in cash. In those cases, expenses are recognized when they have been paid. For organizations that
       record their revenues and expenses in that way, the cash budget would be identical to the
       operating budget. They are said to use a cash basis of accounting. In contrast, if revenue is
       recorded in the year the service is provided, whether cash has been received yet or not, then the
       organization is said to be using an accrual basis of accounting.
           Cash accounting is easier, but does it enable us to understand how well our organization is
       doing? With accrual accounting we accrue, or anticipate, the eventual receipt of money for
       services provided, as well as recording expenses for resources consumed, even if they have not
       yet been paid for. When accrual accounting is used, the operating budget gives us a good idea of
       how profitable we expect the organization to be. However, it does not give an accurate idea of
       how much cash we will have.
10-2           Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

2-17.                   Cash                     Accrual
                         Basis                    Basis
Revenue                 $ 15,000                 $ 20,000
Expense                 $ 16,000                 $ 18,000
Surplus/(Deficit)       ($ 1,000)                $ 2,000

Accrual better reflects the long-term stability of the organization.

2-19. Monroe Outpatient Surgery Center
            Operating Budget
               June 2012

Revenues                $200,000        (80 procedures x $2,500/procedure)
 Professional Fees      $120,000        (80 procedures x $1,500/procedure)
 Surgical Supplies        24,000        (80 procedures x $300/procedure)
 Salaries                 10,500        Given
 Occupancy                 8,200        Given
 Communication             1,200        Given
 Depreciation              4,000        ($240,000/60 months)
Total Expenses          $167,900
Profit                  $ 32,100

Operating budget                                 Cash budget

Revenue                 $240,000                 Beginning Balance                $26,000

                                                 Cash Receipts
Expenses                                         Collection from Feb.             150,000
Personnel                160,000                 Collection from March             60,000
Supplies                  48,000                 Cash from mortgage               250,000
Depreciation              12,000                 Total Cash Receipts              460,000
Interest                   6,000                 Available Cash                   486,000
                                                 Cash Disbursement
Total Expenses           226,000                 Payroll payment                  170,000
                                                 Payment to suppliers              45,000
Surplus/(Deficit)        $14,000                 Payment for building             250,000
                                                 Total Disbursements              465,000

                                                 Ending Cash Balance              $ 21,000
10-3          Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

Capital budget

Building      $250,000
Mortgage      $250,000

2-23. (Special Purpose Budget)
      Revenue                           700 screenings
         Supermarket Subsidy                    $1,000
      Total Revenue                             $1,000
      Less Expenses
         Equipment rental                       $ 500
         Nurses $50  10 hours  7 days          3,500
         Test Costs 700  $1                       700
      Total Expenses                            $4,700
      Surplus/loss                           $ (3,700)

No, it is not necessarily financially bad. This program may discover patients with hypertension or other
medical problems who will become patients of the hospital, generating additional revenues. Also it
provides the hospital with a way to advertise their services, generating future patient volume and
10-4          Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E


3-4. A top-down budget is one that is prepared by top management. The budgeted amount is given to
     responsibility center managers, who are expected to achieve the budgeted result. However, it is
     very difficult for top managers to be aware of all of the likely factors affecting spending in each
     responsibility unit. An alternative approach is bottom-up, in which responsibility unit managers
     propose budgets for their unit and provide justification for the requested spending.
           A bottom-up approach makes better use of the expertise of employees throughout the
     organization, is more likely to result in employees who want to achieve the budget, and is more
     likely to be achieved. However, it requires top management willing to accept some degree of
     decentralization. In very autocratic, centralized organizations where top management desires
     retention of high levels of control, a top-down budget is more likely to be employed.

3-9. Performance budgeting is an approach designed to improve the budget process by focusing more on
     what we hope to accomplish than simply on inputs used. The method calls upon the manager and
     organization to define goals, plan the amount of resources needed to accomplish those goals, and
     then assess how well the goals have been achieved. The method is particularly useful when it is
     possible to apparently do the same amount of work with different budgeted amounts of resources
     (e.g., maintain ten parks), yet the underlying quality of worked performed does not remain
           The first step is to clearly define objectives, referred to as performance areas. Next, one must
     identify the operating budget. Then the percent of operating budget resources that will be devoted
     to each objective must be determined. The operating budget resources can then be allocated to the
     performance areas. Measures of performance for each objective or performance area must be
     established. Then a performance budget can be developed.

3-11. This is a technique that argues that all costs in the budget must be justified each year, not just
      budget increases from year to year. The method also focuses on the evaluation of alternatives and
      their costs and benefits.

3-13. A flexible budget is an operating budget for varying workload levels. It gives managers an
      understanding of what is likely to happen to revenues, expenses, and profits (surpluses or
      deficits) if the volume of services provided varies from the expected level.

3-19   1. i Zero-Based
       2. vi Flexible
10-5            Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

3-24. (Flexible Budget)
.     Price                                         $   5.00         $    6.00     $    7.00
      Volume                                         20,000           18,000       16,000
      Revenue                                      $ 100,000         $ 108,000     $ 112,000
      Less Fixed Cost                                 32,000            32,000        32,000
      Less Variable Cost $4  Volume                  80,000            72,000        64,000
      Surplus/(Deficit)                            $(12,000)         $ 4,000         $16,000

        Change the price to $6. Assuming this is a Not-for-Profit organization with a mission to provide
        care, a price of $5 puts it at risk of closing. A price of $7 makes a larger profit, but fewer patients
        receive care. The $6 price balances the need to make a profit with the desire to maximize care


D.       ACCRUAL

   Revenue                        10% Decrease        Base [5000]          10% Increase
      Grant                           $100,000          $100,000              $100,000
      Fares (V*.8*.75)                   2,700              3,000                 3,300
                                      $102,700          $103,000              $103,300
        Supervisor                $36,000                 $36,000                 $36,000
        Coordinators (6*17*10*50) 51,000                   51,000                  51,000
        Insurance (1750*2)          3,500                   3,500                   3,500
        Supplies/copying            2,500                   2,500                   2,500
        Mileage (V*.35*5)           7,875                   8,750                   9,625
                                 $100,875                $101,750                $102,625
     Excess/(Deficit)              $1,825                $ 1,250                     $675
10-6          Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E


4-2.   Full cost refers to the total of all costs associated with a cost objective. This includes direct and
       indirect costs. Direct costs are the costs incurred within the organizational unit for which the
       manager has responsibility, or the costs of resources for direct production of a good or service.
       Indirect costs are costs that are assigned to an organizational unit from elsewhere in the
       organization, or costs of resources that are not used for direct production of a good or service.
       Direct and indirect costs are particularly difficult to understand because their definitions relate to
       the object of the analysis. If one is interested in the direct cost of the public works department, it
       is appropriate to include department supervisory personnel in that cost. In contrast, if one is
       interested in the direct cost per mile of road plowed, that would include the plow, the driver, and
       the cost of the salt spread on the road, but not the cost of supervisory personnel. In that example,
       the supervisors are direct costs of the public works department (i.e., what it costs to operate the
       public works department) but indirect costs of plowing the road (i.e., what it costs to plow the
       roads). The various scheduling and other administrative activities carried out by supervisory
       personnel are essential to running the department, but they are not a direct cost of plowing snow.

4-3.   Average cost is the full cost of any cost objective divided by the number of units of service
       provided. Fixed costs: those costs that do not change in total as the volume of service units
       changes over a relevant range of activity. Variable costs: those costs that vary directly with
       changes in the volume of service units over a relevant range of activity. If all of the costs of
       plowing snow, both direct and indirect, are added and the total is divided by the number of units,
       the result is the cost per unit or the average cost. So, the total cost could be divided by the
       number of miles to find the cost per mile plowed. Once Meals for the Homeless (Meals) rents
       space for a soup kitchen, the rent will not change from day to day, even if the number of meals
       provided varies by a substantial amount. Perhaps Meals is serving 300 people a day at a given
       soup kitchen. If Meals were to feed another person, the rent would stay the same. Therefore, it is
       a fixed cost. In contrast, the amount of food that Meals must purchase represents a variable cost.
       If more people are served, meals will need more food. Activity represents the volume of services

4-4.   Marginal costs are the extra costs incurred as a result of providing one more service unit (such as
       one more meal). At first, marginal costs would appear to be identical to variable costs. In both
       cases, if there is one more unit of activity, there will be an increase only in variable costs.
       Marginal costs, however, more broadly look at all costs that might change as a result of a
       decision. Suppose that HOS has an x-ray machine that can take 5,000 x-rays per year. What is
       the cost of doing one more x-ray? If HOS has to buy another machine to do the 5,001st x-ray,
       then on the margin, the costs of the additional patient are the variable cost of one more patient
       plus the cost of acquiring another machine.

4-5.   Cost per unit depends on volume. If volume is low, the cost per unit is higher than if volume is
       high. This is because as volume rises, fixed costs get shared resulting in less fixed cost per unit.
       Furthermore, for historical purposes measuring the average cost may be adequate. For
       prospective decision making, we are often interested in the marginal costs. Therefore the
       appropriate measure of cost depends in part on the reason we want to know the cost.

4-12. a. Fixed: depreciation, doctor, nurse, cooks and camp director
10-7          Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

        b. Step-Fixed or Semi-Variable costs: counselors
        c. Variable: food and transportation
        d. Not included in the camp’s cash budget: depreciation

4-15.   1. BEQ = FC/(VR – VC) = ($5,000 per week/5 days per week)/((15-5)) = 1000/10
                                                                           = 100 per day
        2. b. decreases

4-20. 1. Full Cost.
      2. Average Cost.
      3. Marginal Cost.

4-22. 1. d. Unit variable cost remains constant and unit fixed cost decrease
      2. d. Relevant range

4-26. 1. ___total revenue__ equals __total expense____
      2. ___price or variable revenue___ minus __variable cost_____.
      3. b. decreases

4-28. b. reduce the contribution margin per unit of service.

4-34.    Weighted Average Price
         .30 * $100         = 30
         .70*.80*$100       = 56
         FC = $210,000
         VC = $65 per exam
         P = $86 per exam
         BEQ = $210,000 / (86 – 65) = 10,000 exams

Or: (100-65) x .3 + (80-65) x .7 = $21 = WACM

        1. Breakeven
10-8             Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

        Number of = Total Fixed Expenses/Unit Contribution Margin
        People =    ($5,000 + $1,000) / ($150 - $50) = 60 people

        2. Average cost = Total cost / volume
        TC= 6,000 + (50*100) = 11,000
        AC= 11,000 / 100 = $110 per person

        1.       Fixed costs = $180 VC= 5 Q=12
                 Q = FC/(P – VC)

        2.       Fixed costs = $180+300 = $480 treat profit as a fixed cost
                 VC= 5
                 Q = FC/(P – VC)

4-40. 1. BEQ = (FC-City revenue)/(Weighted VR – Weighted VC) or
                              BEQ = (FC-City revenue)/(Weighted CM)

                                   Base      Reading
             Daily Price           $10.00       $3.00
             Daily VC               $3.00       $5.00
             Days per week              5
             Fixed Costs          $36,000
             City Contract        $30,000
                                             Weekly   Weekly  Weekly    Weekly
                                   Mix        Price    VC      CM     Weighted CM
             non reading           70.0%       $50.00  $15.00  $35.00        $24.50
             reading               30.0%       $65.00  $40.00  $25.00         $7.50
             Total Weighted CM                                               $32.00

             Break Even               188

        2. a. increases
10-9          Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E


5-6. Compound interest simply refers to the fact that when money is invested going forward in time, at
     some point the interest earned on the money starts to earn interest itself. Discounting is just the
     reversal of this process as we go backward in time.

5-8. The net present cost method is very helpful for comparing projects that have identical lifetimes. If
      projects have differing lifetimes, you are not comparing equal benefits unless you equalize the
      lifetimes. We could use the lowest common denominator of the lifetimes, extending both
      alternatives until their lifetimes are equal. However, the uncertainties in replacement and operating
      costs going forward in time may be substantial. The annualized cost method overcomes these
      problems. In that approach, one first finds the Net Present Cost for each alternative. Then, that cost
      is translated into a periodic payment for the number of years of that individual project’s lifetime.
      The project with the lower annualized cost is less expensive, on an annual basis, in today’s dollars.

5-9. Aside from the complexity of calculations, when cash flows are uneven from year to year, there
     are two important limitations. IRR assumes that cash inflows during the project are reinvested at
     the same rate that the project earns. Second, sometimes use of the IRR method will cause you to
     chose incorrectly from two mutually exclusive projects by picking a smaller project with a higher
     IRR rather than a larger project with a somewhat smaller IRR.

5-10. The objection to the method is that it ignores everything that happens after the payback period. It
      also does not consider the time value of money.

5-22 (Annualized Cost)
   French Corp
      Annual Costs: PMT = $10,000, N = 10, I = 10%               PV = $61,446
       Net Present Cost: $275,000 (purchase cost) + $61,446 = $336,446
       Annualized Cost: PV = $336,446, N = 10, I = 10% PMT = $54,755

   Japan Rail Car
      Annual Costs: PMT = $15,000, N = 6, I = 10%               PV = $65,329
       Net Present Cost: $195,000 (purchase cost) + $65,329= $260,329

       Annualized Cost: PV = $260,329, N = 6, I = 10% PMT = $59,773

   Select French Corp. Their cars have a lower annualized cost
10-10          Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

5-24. (Annualized Cost)
                                Model A         Model B
Outlay                         ($80,000)      ($100,000)
Annual Payment                   $5,000          $2,500
 i=                                  5%              5%
 N=                             20 years        30 years

PV of a PMT of                   $5,000           $2,500
At 5% for                       20 years         30 years
                          =     $62,311          $38,431
Plus Outlay                      80,000          100,000
                          =    $142,311         $138,431

Annualized PMT for
N                               20 years         30 years
I                                    5%               5%
PV                             $142,311         $138,431
Annualized cost                 $11,419           $9,005

Spreadsheet Formula Solution

              Model A Present Value
              = PV(rate,nper,pmt,fv,type)-80000
              = PV(5%,20,5000)-80000
              = ($142,311.05)

              Model A Annualized Cost
              = PMT(rate,nper,pv,fv,type)
              = PMT(5%,20,142311.05)
              = $(11,419.41)

              Model B Present Value
              = PV(rate,nper,pmt,fv,type)-100000
              = PV(5%,30,2500)-100000
              = ($138,431,13)

              Model B Annualized Cost
              = PMT(rate,nper,pv,fv,type)
              = PMT(5%,30,138431.13)
              = ($9,005.14)
10-11          Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

              Model A will cost $11,419 per year in today’s dollars, and Model B will cost $9,005, so
              Model B is less expensive.


                   Cash In              Cash Out             Net cash flow          Year
                     0                    650                    –650                0
                    140                    25                     115                1
                    140                    25                     115                2
                    140                    25                     115                3
                    340                    25                     315                4

           NPV(12%, values…) -650 = (173.60)

                        NPV  102.68  9168  8185  20019  650  17360
                                         .      .       .                 .

                        Decision: Do NOT pursue the investment. It has a negative net present value.

5-31.    (IRR)

Spreadsheet Formula Solution

                 = Rate(nper,pmt,pv,fv,type,guess)
                 = Rate(7,800,-5000)
                 = 2.92%

5-32. (IRR)

        Spreadsheet Formula Solution

                 = Rate(nper,pmt,pv,fv,type,guess)
                 = Rate(36,5000,-125000)
                 = 2.12% per month
                 = 25.5%
                        Annual rate exceeds 18%, so accept the contract.
 10-12         Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

         CHAPTER 6

6-1. Long-term debt includes unsecured notes, notes secured with collateral, mortgages, bonds, and

6-2. Collateral is a specific asset that the lender will be able to take possession of if the borrower fails
     to make payment of amounts due. For example, if the organization has made an investment,
     buying 10,000 shares of Microsoft stock, it may offer that stock as collateral when it borrows
     money. By providing the lender with specific valuable collateral, the loan is less risky. Therefore,
     the lender is more likely to be willing to make the loan and to charge a lower interest rate.

6-5. Leasing is more flexible, can save money, can protect you from unexpected events, can provide a
     higher level of financing, and can have tax advantages. If you expect to need a piece of equipment
     for only half of its useful life, you can set the lease term for that period and will not have to get
     involved with selling it, as you would if you purchased the item. Leases may protect you from
     obsolescence. They provide 100% financing. In some cases, a for-profit organization can save
     taxes by purchasing certain items and pass some of that tax savings on to the not-for-profit
     organization in the form of lower lease payments.

6-8.     1. PMT=5,000,000*(6%/2)= 150,000

         2a. $5,000,000 – NO CALCULATION NECESSARY

         2b.                    FV=5,000,000

               PV = $5,141,393.25

6-9.           N= 20 years remaining * 2 payments per year = 40
               I = 4.6% /2 compounding periods per year = 2.3%
               Payment = $3,000,000 = 6%/2 * $100,000,000
               Future Value = $100,000,000
                   Par Value of Bond                        $100,000,000
                   Coupon Interest Rate                              6%
                   Market Interest Rate                            4.6%
                   Years remaining                                    20
                   Compounding periods/year                            2

                   I                                              2.30%
                   N                                                  40
                   Payment                                    $3,000,000
                   FV                                       $100,000,000

                   PV of interest payments                $77,909,539.62
                   PV of Principal repayment              $40,269,352.96

                   Value of the Bond                     $118,178,892.58
10-13           Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

6-12. (Bonds)

             Spreadsheet Formula Solution
             a. = PV(rate,nper,pmt,fv,type)
                = PV(6.5%,30,-300,-5000)
                = $4,673.53

             b. $4,673.53 x 10,000 = $46,735,331

6-14. (Bond)

        B. Spreadsheet Formula Solution
             = PV(rate,nper,pmt,fv,type)
             = PV(5%,20,-4000,-100000)
             = $87,537.79

6-16 (see separate Excel Spreadsheet)
10-14        Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E



  Payer      Total A/R       Current       31-60 days         61-90 days   91+ days

Medicare    5,000,000     2,500,000       1,000,000       1,500,000                   -

Medicaid    3,000,000     900,000         900,000         900,000          300,000

Insurance 4,000,000       2,000,000       2,000,000       -                           -

Self Pay    2,000,000     500,000         500,000         500,000          500,000

            14,000,000    5,900,000       4,400,000       2,900,000        800,000


Implicit Interest Lost by Paying Early = (Discount/Discount Price) x 365/(Days Sooner)

=(3,600*0.01*0.20)/(3,600*0.99*0.20) x (365/20) = 18.4% > 7% … don’t take discount


I = P x R x T = 28,000 x 7% x (3/12) = $490

$ 28,000 Principal
$ 490 Interest
$ 28, 490 Repayment


If ordering @ EOQ:

EOQ = [(2ON)/C]^.5

= [(2 * $20 * 30,000) / (.3 + (5% *$4))]^.5 = 1, 550 cans (rounded)
10-15         Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

# Orders per year = N/EOQ = 30,000/1,550 = 19.35 = 20 orders (rounded)

Carrying Cost = CQ/2 = (.5 * 1550) / 2 = $388 (rounded)

Ordering Cost = ON/Q = ($20)(30,000)/1,550 = $387 (rounded)

Product Cost = P x N = $4 x 30,000 = $120,000

Total Inventory Cost = CC + OC + PC = 388+387+120,000 = $120,775

If ordering all cans @ beginning of the year:

Carrying Cost = 30,000 x .50 = $15,000

Ordering Cost = $20 x 1 order = $20

Product Cost = P x N = $4 x 30,000 = $120,000

Total Inventory Cost = $135,020 > $120,775 (lowest possible)
10-16         Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E


8-10. Variances are calculated for three principal reasons. By understanding why results were not as
      expected, the budget process can be improved and made more accurate in future planning. Second,
      by understanding why variances are occurring, actions can be taken to avoid additional
      unfavorable variances over the coming months. The third reason for variance analysis is to
      evaluate the performance of units or departments and their managers.

8-15. This may or may not be the case. It depends largely on how revenues change as volume changes.
      Volume increases that increase revenues may be good for the organization, even though some
      expenses are rising as well. If some costs are fixed, it is possible for volume increases to cause
      revenues to increase by more than expenses increase, resulting in larger profits or smaller losses.

8-17. Using the flexible budget technique, the variance for any line item can be subdivided into three
      pieces: a volume variance, a price variance, and a quantity variance. The volume variance is
      defined as the portion of the variance in any line item that is caused by the fact that the output level
      differed from the budgeted expectation. The price, or rate, variance is the portion of the total
      variance for any line item that is caused by spending more per unit of some input resource than had
      been anticipated. The quantity, or use, variance is the portion of the overall variance for a
      particular line item that results from using more of a resource than was expected for a given output
      level. These three variances together equal the traditional variance for a line item.

8-19. The more we aggregate information, the greater the chance that we will misinterpret what has
      happened. An entire organization may spend nearly the same amount for a given month as it
      expected. In total, there is nearly no variance. However, that does not mean that there are no
      problems that need to be investigated. Some departments might have large favorable variances and
      other departments might have large unfavorable variances. Within just one department, two line
      items might have offsetting variances, both of which should be investigated. Even within one line
      item, there may be offsetting price, quantity, and volume variances that warrant attention.

8-22. No. Variances can result from uncontrollable, random events. If a variance is very small, it is often
      not worth the manager’s time to investigate. However, it requires skill and experience to know
      when a variance is large enough to indicate the possibility of problems that require management

8-25.   The total variance is $90,000 – (400 * 4 * $55) or $88,000 = 2,000 U
        The variance is unfavorable because the expense was higher than they had anticipated
10-17           Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

8-27. (Expense Variances)

Calculate the volume, quantity, and rate variances, and provide some possible explanations for each.

Original Budget:                  Budgeted Volume x Budgeted Quantity x Budgeted Rate
Flex Budget:                      Actual Volume x Budgeted Quantity x Budgeted Rate
                                 125 x 10 x $20           = $25,000
                               - 150 x 10 x $20           = - $30,000
                                 Volume Variance          = $ (5,000) U

Flex Budget:                      Actual Volume x Budgeted Quantity x Budgeted Rate
VQA Budget:                       Actual Volume x Actual Quantity x Budgeted Rate
                                 150 x 10 x $20           = $30,000
                               - 150 x 8 x $20            = - $24,000
                                  Quantity Variance       = $ 6,000 F

VQA Budget:                       Actual Volume x Actual Quantity x Budgeted Rate
Actual:                           Actual Volume x Actual Quantity x Actual Rate
                                 150 x 8 x $20            = $24,000
                               - 150 x 8 x $25            = - $30,000
                                  Price Variance          = $ (6,000) U

        Investigation of why there were 20% more trials is required. The $5,000 Unfavorable Volume
        Variance might reflect an increased amount of crime, or simply greater efficiency of the Courts in
        providing a speedy trial. The Judge is correct in arguing that more cases tend to raise costs, other
        things being equal. However, everything else did not stay the same. The trials have become
        shorter resulting in a Favorable Quantity Variance of $6,000. Shorter trials require less labor
        hours. This could reflect greater efficiency, or simply a mix of cases that tend to be shorter. If it is
        the result of efficiency, that improvement should be noted and rewarded to encourage its
        continuation. In any case, the shorter trials more than made up for the increased number of trials.
        The Unfavorable Rate Variance caused spending of $6,000 over the expected level. One might
        argue that the additional volume of cases required overtime, accounting for the higher wage.
        However, because the trials were shorter we actually used only 2,400 labor hours as compared to
        the 2,500 budgeted. The variance could be due to a new union contract, or perhaps we hired
        stenographers with more experience who earn a higher wage. Perhaps there was a payroll error,
        and the stenographers were paid at the wrong hourly wage. In any event, investigation of this rate
        variance is clearly warranted.

8-29. (Revenue Variances)
                      Budget                Actual         Variance
10-18           Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

                        300  $3,000 400  $2,700
        Revenue           $900,000    $1,080,000           180,000 F

        Price variance—average sale price per car
        Volume variance—number of cars donated

Original Budget:         Budgeted Volume x Budgeted Mix x Budgeted Price
                         Cars:        300 x 100% x $3,000       =        $ 900,000

Flex Budget:             Actual Volume x Budgeted Mix x Budgeted Price
                         Cars:        400 x 100% x $3,000        =                   $1,200,000

Original Budget:                                                                    $ 900,000
Flex Budget:                                                                       - 1,200,000
                         Volume Variance                                   =        $ 300,000 F

VMA Budget:              Actual Volume x Actual Mix x Budgeted Price
                         Cars:        400 x 100% x $3,000         =                  $1,200,000

Flex Budget:                                                                        $1,200,000
VMA Budget:                                                                        - 1,200,000
                         Mix Variance                                      =        $        0U

Since there is only one type of product, the mix variance must be zero.

Actual:                  Actual Volume x Actual Mix x Actual Price
                         Cars:        400 x 100% x $2,700          =                 $1,080,000

VMA Budget:                                                                         $1,200,000
Actual:                                                                            - 1,080,000
                         Price Variance                                    =        $ 120,000 U
10-19          Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E


9-1. Assets are anything of value that the organization owns. Liabilities are obligations owed to
     outsiders. Owner’s equity represents the share of the organization’s assets owned by its owners.

9-5. GAAP, or Generally Accepted Accounting Principles, are a set of rules and conventions. They are
     established by the Financial Accounting Standards Board (FASB) and the Governmental
     Accounting Standards Board (GASB). The CPA’s audit examines the financial statements and the
     underlying financial records of an organization. Based on their examination, they issue a letter that
     gives their opinion as to whether the financial statements are free of material (substantial)
     misstatements and whether they conform to Generally Accepted Accounting Principles (GAAP).
     GAAP help create some degree of uniformity.

9-11. CPAs try to find and eliminate all material errors. However, it is virtually impossible to find every
      error. Material errors are those that might affect a decision made by a user of the financial report.

9-12. GAAP require organizations to report their financial position and results of operations on an
      accrual basis. This means that revenues are recorded in the year that the organization provides
      goods or services and becomes legally entitled to payment. Expenses are recorded in the year that
      assets have been consumed in the process of providing goods and services. This contrasts sharply
      with the cash basis of accounting, which would record revenue when cash is received and expense
      when cash is paid. The rationale for using accrual accounting is that it provides a better measure of
      how well the organization has done for the year. The cash basis can be quite misleading because
      there may be a poor matching of revenue and expense in any one year. This can lead to
      substantially over or understated measures of income.

9-13. The primary requirement for classification as a current asset is management’s expectation or
      intention to convert the asset to cash or use it up within a year. Thus, an investment in Microsoft
      stock would be a current asset only if we expect to sell it in the coming year. Otherwise the stock
      would be treated as a long-term asset.

9-26. (Transactions Analysis)

        Date        Assets (A)          =         Liabilities (L)         + Net Assets (NA)
        1.            Cash                        Note Payable
                    + $50,000           =           + $50,000             +       No change

        2.             Cash
                    – $50,000           =           No change             +       No change
10-20        Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

                  + $50,000

        3.          Cash
                 + $500,000           =           No change             +       No change

             Pledges Receivable
                 – $500,000

        4.           Cash             =           No change             +       No change
                  – $10,000

             Brochures Inventory
                 + $10,000

        5.      No transaction

        6.           Cash                      Grants Payable
                  – $700,000          =         – $700,000              +       No change
10-21              Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

                                           Journal Entries
                                                     Dr.                     Cr.
        1.        Cash                             $50,000
                     Notes Payable                                     $50,000

        2.        Furniture                            $50,000
                     Cash                                              $50,000

        3.        Cash                                $500,000
                     Pledges Receivable                               $500,000

        4.        Brochures Inventory                  $10,000
                     Cash                                              $10,000

        5.        No transaction is recorded.

        6.        Grants Payable                      $700,000
                     Cash                                             $700,000

9-27. (Transactions Analysis Worksheet)
                                             Assets                            =                       Liabilities and Net Assets
                                                                                         Liabilities                       Net Assets
                                 Pledges    Brochures                                                                     Tempo-     Perma-
                                 Receiv-     Inven-      Invest-                    Grants        Notes         Unre-      rarily     nently
                      Cash        Able        tory       ments     Furniture        Payable     Payable        Stricted  restricted restricted
Beginning          $ 270,000    $500,000       $ 1,000 $830,000     $     0        $700,000     $      0        $101,000   $700,000 $100,000
Transaction # 1       50,000                                                                     50,000
Transaction # 2      (50,000)                                       50,000
Transaction # 3      500,000 (500,000)
Transaction # 4      (10,000)                   10,000
Transaction # 5
Transaction # 6     (700,000)                                                      (700,000)
Ending Balance     $ 60,000     $     0        $11,000 $830,000    $50,000          $     0     $50,000         $101,000     $700,000   $100,000
10-22           Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

9-28     (Balance Sheet)
                  Statement of Financial Position
                  as of the End of the Fiscal Year
           Current assets
               Cash                                     $ 60,000
               Brochures Inventory                        11,000
               Total current assets                     $ 71,000
           Long-term assets
               Investments                              $830,000
               Furniture                                  50,000
               Total long-term assets                   $880,000
        Total Assets                                    $951,000

        Liabilities & Net Assets
           Long-term liabilities
                Notes payable                           $ 50,000
                Total long-term liabilities             $ 50,000
           Total Liabilities                            $ 50,000

        Net assets
           Unrestricted                               $ 101,000
           Temporarily restricted                       700,000
           Permanently restricted                       100,000
           Total net assets                            $901,000

        Liabilities and Net Assets                      $951,000
10-23         Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E


10-3. Revenues and expenses can only be recorded if certain conditions are met. Revenues are
      recorded if they have been earned and realized. The first requirement, being earned, is met only
      if the organization has provided goods or services to the customer. If a legal transfer has
      occurred, raising a legal right to collect payment, then the revenues have been earned. To be
      realized we must be able to objectively measure the amount of money owed, and there must be a
      reasonable likelihood of eventual collection.
          Support recognition is allowed even though the gift has not been received, and even though
      no goods or services have actually been provided. In fact, pledges are enforceable contracts. We
      record pledges as support if there is a specific amount and a reasonable likelihood of collection.

10-8. No. The primary goal of depreciation is not determining the current value of the asset to place on
      the balance sheet. Depreciation strives to allocate the cost of the asset over the asset’s useful life.
      In accord with the matching principle of GAAP, the goal of depreciation is to assign expense for
      use of the asset into the periods that the asset is used up, generating revenue. Depreciation is
      based on assigning the cost incurred when we acquired the asset, rather than on some measure of
      replacement cost if we were to buy the asset now.

10-9. At best, estimates are subjective guesses. We can try to base them on historical experience, but
      they still introduce the possibility of errors into the financial statements. Another problem is that
      estimates open the door to manipulating results. If we want to look poor to encourage donations,
      we might be tempted to overstate bad debt expense or to underestimate the salvage value of a
      piece of equipment. Both of those actions would tend to lower current net income, making us
      look poorer now. Estimates increase the chances that the financial statements will not be free of
      material misstatements.

10-11. The statement shows Cash Flows from Operating Activities, Cash Flows from Investing
       Activities, and Cash Flows from Financing Activities. Cash from operating activities helps us
       understand the organization’s ability to continue operations over time. If this number is positive,
       then the routine operations are self-sustaining. Cash from investing activities allows us to
       determine if the organization is spending cash to either acquire productive assets or investments
       in stocks and bonds. Alternatively, we might learn that the organization is selling its fixed assets
       to raise cash. That would send a warning signal of potential problems. Cash from financing
       activities shows sources of cash such as loans and issuance of stock. If the organization is taking
       out long-term loans to finance cash losses from current operations, that would also send a
       warning signal.

10-12. The balance sheet, activity statement, and cash flow statement are interconnected. The
       information from each relies to some extent on information from the others. Suppose that we use
10-24               Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

             up inventory as we provide services during the year. Our asset—inventory—goes down on the
             balance sheet. Our expense related to supply use increases on the activity statements. Just the
             reverse happens with revenues. When we charge clients for our services, accounts receivable
             rise, increasing assets and the balance sheet. Revenues also rise, affecting the activity statement.
             The net of the revenues and expenses helps account for the change in net assets on the balance
             sheet from the beginning to the end of the year.
                  The cash flow statement has linkages to both the activity statement and balance sheet. The
             first line on the cash flow statement is the change in net assets, taken from the activity statement.
             The ending balance of the cash flow statement is the cash balance, which appears at the
             beginning of the balance sheet.
                  The balance sheet provides information on the current assets and current liabilities (working
             capital). The change in each working capital account has an impact on the organization’s cash
             balances. These changes primarily show in the adjustments that are made in the cash from
             operations section of the cash flow statement. Changes in fixed assets and investments on the
             balance sheet are reflected in the cash from investing activities section of the cash flow
             statement. Similarly, financing activities will appear on the cash flow statement, but also are
             reflected in changes in long-term liability values on the balance sheet.

10-14.          (Transactions Analysis)
     1.         Jan. 2.    No journal entry. There has been no exchange by either party.

        2.      Jan. 14

                           Assets (A)            =          Liabilities (L)          +       Net Assets (NA)
                           + $100,000            =            No change              +           No change

                        Pledges receivable
                           – $100,000

                 Date                                                           Dr.                 Cr.
                 1/14            Cash                                         $100,000
                                     Pledges receivable                                           $100,000
                                 Collection of pledges

        3.      Feb 19

                           Assets (A)            =         Liabilities (L)           +       Net Assets (NA)
                           Inventory                      Accounts payable
                           + $35,000             =           + $15,000               +           No change

                            – $20,000
10-25          Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

             Date                                                          Dr.                 Cr.
             2/19           Inventory                                    $35,000
                                Cash                                                         $20,000
                                Accounts payable                                             $15,000

                            Purchase gift shop inventory

        4.   May 15

                       Assets (A)            =         Liabilities (L)             +    Net Assets (NA)
                       + $30,000             =             No change               +        No change

                       – $30,000

             Date                                                          Dr.                 Cr.
             5/15           Deposit                                      $30,000
                               Cash                                                          $30,000

                            Deposit on ordered equipment

        5.   July 12

                       Assets (A)            =         Liabilities (L)             +    Net Assets (NA)
                       + $80,000             =             No change               +        No change

                       – $30,000

                       – $50,000

             Date                                                          Dr.                 Cr.
             7/12           Equipment                                    $80,000
                                Deposit                                                      $30,000
                                Cash                                                         $50,000

                            Received equipment

        6.   Dec. 28

                       Assets (A)            =         Liabilities (L)             +    Net Assets (NA)
10-26             Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

                           Cash                                                               Admission revenue
                         + $74,000               =                                      +        + $74,000

              Date                                                              Dr.                   Cr.
              11/1              Cash                                          $74,000
                                    Admission revenue                                                $74,000

                                Admission revenues for the year.

        Please note that in real life admission revenues would be collected throughout the year, and recorded on an ongoing
        basis, rather than all at once at the end. That is true with many of these transactions. This summarized approach is
        used for simplification purposes only.

        7.    Dec. 28

                         Assets (A)              =         Liabilities (L)              +      Net Assets (NA)
                            Cash                           Wages payable                        Wage expense
                         – $68,000               =           – $2,000                   –          $73,000

                                                           Wages payable
                                                             + $7,000

        Alternatively one could combine the $2,000 reduction in the Wages Payable from last year with the $7,000 increase in
        wages payable this year, and just show Wages Payable going up by $5,000.

              Date                                                              Dr.                   Cr.
              12/28             Wage expense                                  $73,000
                                   Wages payable                                                    $ 5,000
                                   Cash                                                              68,000

                                Record wage expense and payment

        8.    December 30

                         Assets (A)              =          Liabilities (L)             +      Net Assets (NA)
                           Cash                                                                 Sales revenue
                         + $56,000               =                                      +         + $53,000

                     Accounts receivable
                         – $6,000

                     Accounts receivable
                         + $3,000
10-27     Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

                 Assets (A)             =         Liabilities (L)             +    Net Assets (NA)
                 Inventory                                                        Cost of goods sold
                 – $32,000              =                                     –        $32,000

        Date                                                          Dr.                 Cr.
        12/1           Cash                                         $56,000
                       Cost of goods sold                            32,000
                           Accounts receivable                                          $ 3,000
                           Sales revenue                                                 53,000
                           Inventory                                                     32,000

                       Record gift shop sales
10-28           Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

        9.    December 31

                      Assets (A)                =        Liabilities (L)           +        Net Assets (NA)
                         Cash                   =        Notes payable                      Interest expense
                      – $134,000                          – $127,000               –             $7,000

              Date                                                                 Dr.                 Cr.
              12/31          Interest expense                                 $     7,000
                             Notes payable                                        127,000
                                  Cash                                                              $134,000

                             Payment on note and interest expense

        10.   December 31

                       Assets (A)               =        Liabilities (L)           +        Net Assets (NA)
                 Building & equip., net         =                                  –        Deprec. expense
                       – $60,000                                                                $60,000

              Date                                                               Dr.                   Cr.
              12/31          Depreciation expense                              $60,000
                                Building & equipment, net                                            $60,000

                             Record depreciation expense

        11.   December 31

                     Assets (A)                 =        Liabilities (L)           +        Net Assets (NA)
                Accounts receivable, net        =                                  –        Bad debt expense
                      – $1,000                                                                   $1,000

              Date                                                                  Dr.                   Cr.
              12/31          Bad debt expense                                      $1,000
                                 Accounts receivable, net                                                $1,000

                             Record estimated uncollectible receivables

                      Assets (A)                =        Liabilities (L)           +        Net Assets (NA)
                   Allowance for                =                                  –        Bad debt expense
                Uncollectible Accounts
                       – $1,000                                                                 $1,000

              Date                                                                  Dr.                   Cr.
              12/31          Bad debt expense                                      $1,000
                                 Allowance for Uncollectible Accounts                                    $1,000
10-8           Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E
10 -15. (Transactions Analysis Worksheet)

   (000’s omitted)                            Assets                            =                              Liabilities and Net Assets
                                                                                                                                     Net Assets
                                     Accounts                      Equip-                                                                     Tempo-     Perma-
                           Pledges    Receiv-                      ment,            Accounts Wages Notes                                       rarily    nently
                     Cash Receivable able, Net Inventory Deposits   net             Payable Payable Payable Unrestricted                     Restricted Restricted
   Beginning          $80      $320        $ 6         $    0     $ 0   $550            $2       $2    $250            $ 372                      $30     $300

   Transaction #1
   Transaction #2      100     (100)
   Transaction #3     (20)                                  35                          15
   Transaction #4     (30)                                         30
   Transaction #5     (50)                                       (30)      80
   Transaction #6       74                                                                                                74 Admission
   Transaction #7     (68)                                                                        5                     (73) Wage expense
   Transaction #8       56                  (3)                                                                           53 Sales revenue
    #8, continued                                      (32)                                                             (32) Cost of goods
   Transaction #9    (134)                                                                             (127)             (7) Interest
   Transaction #10                                                       (60)                                           (60) Depreciation
   Transaction #11    ___       ___         (1)            ___   ____   ____           ___      ___     ___              (1) Bad debt             ____    ____
   Ending Balance      $8      $220        $ 2              $3     $0   $570    =      $17       $7    $123            $326                       $30     $300
   Trial Balance

       Alternatively the ―Accounts Receivable, Net‖ column could be split into two columns, one for ―Accounts Receivable‖ which
       would have the beginning balance and transaction 8, and one for ―Allowance for Uncollectible Accounts‖ which would have
       transaction 11. The Accounts Receivable ending balance would be $3. The Allowance for Uncollectible Acccounts would
       have an ending balance of ($1). On the balance sheet they would reported as a combined Accounts Receivable, Net amount
       of $2.
10-9             Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

10-16. (Financial Statements)

                  American Natural History Center
                         Activity Statement
              for the Year Ending December 31, Year 2
       Revenues and support
          Admission revenue                         $74,000
          Sales or Gift Shop revenue                 53,000
       Total revenues and support                 $127,000

          Cost of goods sold                                      $ 32,000
          Wage expense                                              73,000
          Interest expense                                           7,000
          Bad debts                                                  1,000
          Depreciation                                              60,000
       Total expenses                                             $173,000

       Increase/(Decrease) in net assets                         ($46,000)

                                                American Natural History Center
                                                  Statement of Financial Position
                                              as of December 31, Year 2 and Year 1
                                   Assets                                             Liabilities & Net Assets
                                              Year 2          Year 1                                 Year 2          Year 1
       Current assets                                                   Liabilities
           Cash                               $   8,000   $    80,000   Current liabilities
           Accounts receivable, net                                         Accounts payable      $   17,000     $     2,000
                of estimated uncollectibles
                of $1,000 in Year 2               2,000       6,000          Wages payable              7,000          2,000
           Pledges receivable                   220,000     320,000
           Inventory                              3,000           0
       Total current assets                   $ 233,000   $ 406,000     Total current liab.        $ 24,000      $      4,000

       Long-term assets                                                 Long-term liabilities
          Fixed assets                                                      Notes payable         $ 123,000 $ 250,000
          Buildings and                                                 Total long-term liab.     $ 123,000 $ 250,000
               Equipment, net                 $ 570,000   $ 550,000
                                                                        Total liabilities         $ 147,000 $ 254,000
       Total long-term assets                 $ 570,000   $ 550,000     Net assets
                                                                            Unrestricted           $ 326,000     $ 372,000
                                                                            Temp. restricted          30,000        30,000
                                                                            Perm. restricted         300,000       300,000
                                                                        Total net assets           $ 656,000     $ 702,000
       Total assets                           $ 803,000   $ 956,000     Total equities             $ 803,000     $ 956,000
10-10           Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

                American Natural History Center
                     Statement of Cash Flows
            for the Year Ending December 31, Year 2
        Cash flows from operating activities
           Decrease in unrestricted net assets                      $ (46,000)
           Add expenses not requiring cash:
               Depreciation                                             60,000
           Other adjustments:
               Add the decrease in receivables                          4,000
               Add the decrease in pledges receivable                100,000
               Add the increase in wages payable                        5,000
               Add the increase in accounts payable                    15,000
               Subtract the increase in inventory                     (3,000)
                  Net cash from operating activities               $ 135,000

        Cash flows from investing activities
           Purchase of equipment                                   $ (80,000)
                  Net cash from investing activities               $ (80,000)

        Cash flows from financing activities
           Repayments of notes                                     $ (127,000)
                  Net cash from financing activities               $ (127,000)

        Net increase/(decrease) in cash                            $ (72,000)
        Cash, beginning of year                                        80,000
        Cash, end of year                                          $    8,000

10-17. (LIFO/FIFO Inventory)

                                                 Consumption                          Balance left
                                              FIFO        LIFO                    FIFO          LIFO
        Beginning bal. 1,000 @ $17            1,000        400                      0            600
        Purchase Jan. 2 300 @ 21                200        300                     100             0
        Purchase July 1 500 @ 23                           500                     500             0

                                                                                Inventory        Inventory
                                            Expense     Expense                   Value            Value
                                           1,000  $17 400  $17                                 600  $17
                                          + 200  $21 + 300  $21                100  $21
                                                       + 500  $23               500  $23
                                            $21,200      $24,600                  $13,600         $10,200
10-11        Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

 Note: Under LIFO 500 doses purchased on July 1 are assumed to have been used, even
 though only 400 doses were consumed after that date. This seems counter-intuitive. The key
 is that LIFO is a cost flow assumption used only to calculate inventory-related expense and
 ending inventory balances. It does not identify the specific inventory units that were actually
10-12          Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E


11-4. Although an activity statement includes revenues and expenses as an income statement
      would, it is more comprehensive, showing all changes in net assets. It uses terms such as
      Change in Net Assets or Change in Equity, rather than net income. Thus the Activity
      Statement includes the information that for-profits show in the Income Statement as well
      as information that would be contained in a for-profit organization’s Statement of
      Changes in Owner’s Equity. An income statement per se reflects revenues and expenses,
      gains and losses. There are other things that can affect stockholders’ equity or net assets,
      such as dividends, issuance of stock, or restricted donations. When items similar to these
      exist, they appear on an activity statement, but often do not appear on an income

11-6. As ―used in nonprofit accounting, a fund is an accounting entity with a self-balancing set
      of accounts for recording assets, liabilities, the fund balance, and changes in the fund
      balance. Separate accounts are maintained for each fund to ensure that the limitations and
      restrictions on the use of resources are observed. Though the fund concept involves
      separate accounting records, it does not entail the physical segregation of resources. Fund
      accounting is basically a mechanism to assist in exercising control over the purpose of
      particular resources and amounts of those resources available for use.‖1

11-7. A variety of different funds are used in organizations, depending on the specific types of

restrictions faced by the organization. Funds are divided into two main categories—unrestricted

and restricted. Virtually all not-for-profit organizations have a current unrestricted or general

fund. The main categories of restricted funds are donor restricted versus board restricted. Donor-

restricted funds are funds that exist to comply with various requirements donors have placed at

the time of donation. These might include building replacement funds, building expansion funds,

endowment funds, custodian funds, and strike funds among other restricted funds. Board-

restricted funds are those that are established to track the use of resources that the board has

decided to devote to a specific purpose. If board-restricted resources are needed for other

purposes, the board can remove the restriction, and the resources can be transferred to an

unrestricted fund.

    Vincent M. O’Reilly, Murray B. Hirsch, Philip L. Defliese, and Henry R. Jaenicke, Montgomery’s Auditing,
    11th. (New York: John Wiley and Sons, 1990), 791.
10-13           Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

11-8. Three types of events can occur that concern more than one fund in an organization. One

is a loan, where one fund borrows money from another. A second is the sale of services, where

one fund consumes services provided by another fund. The third type of event is a transfer,

where one fund gives resources to another.

                Loans between funds are treated the same as a loan from a bank. The borrowing

fund has a liability on its balance sheet, reflecting the need to repay the loan, and the lending

fund has a receivable. These are called ―Due to‖ and ―Due from.‖

                When one fund purchases services from another, the event is recorded by both

funds just as if the organizations were totally separate.

                A transfer between funds is a permanent movement of resources from one fund to

another. The assets and fund balance or net assets of one fund are reduced, and for another fund

they are increased. Some transfers are done at the discretion of management. Other transfers may

be mandatory.

11-11. Under FAS 124, investments in equity securities that have readily determinable fair

values and all debt securities are reported at their fair value in the statement of financial position

(balance sheet). Gains and losses, both realized and unrealized, on investments are shown in the

activity statement. If a security has been sold during the year, the gain or loss has been realized

and the security will not appear on the balance sheet at the end of the period, because the

organization no longer owns it.

11-14. 1.    c. permanently restricted
       2.    a. unrestricted
10-14         Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

11-15. (Net Assets)
        a. Unrestricted
        b. Temporarily restricted
        c. Unrestricted if there is a reasonable expectation of eventual collection
        d. Permanently restricted
        e. Unrestricted
        f. Temporarily restricted

11-17. 1. Unrestricted, temporarily restricted, permanently restricted
       2. Unrestricted may be used for any reasonable operating purposes, temporarily
          restricted may not be used except for certain purposes or at a certain point in time,
          permanently restricted net assets may not be expensed – only their earnings may be
       3. Unrestricted – sale of items from a gift shop, Temporarily restricted – a grant that
          may only be used for a specific research project; permanently restricted – an
          endowment gift that may be invested and the interest used for a particular purpose.
10-15         Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E


14-2. The first paragraph of the audit letter points out that although the auditor can provide an
      expert opinion, management holds primary responsibility for the contents of the financial
      statements. In some organizations, the auditors, in practice, provide a substantial amount
      of help in compiling the financial statements. It is important for managers to bear in mind
      that if there are later problems with the information contained in the financial statements,
      it is the organization’s management, rather than the auditors, who bear the primary
      responsibility for their content.

14-5. Financial statements, in themselves, do not provide a complete picture of the
      organization’s finances. Financial statements are limited in their ability to convey
      information. For example, fixed assets are recorded based on their historical cost,
      adjusted for depreciation. Therefore, the balance sheet does not convey the value of the
      fixed assets. Inventory may be valued on the financial statements based on a LIFO (last-
      in, first-out), FIFO (first-in, first-out), or weighted average cost assumption. There may
      be commitments to make lease payments or there may be outstanding lawsuits. There are
      many types of information that do not fit neatly into the financial statements, but are
      needed for the financial statements taken as a whole to provide the user with a fair
      representation of the organization’s finances.
          Given the wide range of possible ways to report information, it is vital to examine the
      notes in order to gain an understanding of which choices were made and the likely impact
      of those choices. A good understanding of financial position and results requires more
      information than the financial statements themselves can convey. For example, ―what
      contingent liabilities are there and are they material in amount? How old are the
      organization’s buildings and equipment?‖

14-6. Ratios are used because the comparison between two numbers generates information that
       is more useful than either or both of the numbers separately. Ratios can be grouped in a
       variety of different ways. The chapter grouped them into the following six principal types:
       (1) common size (2) liquidity (3) asset turnover (4) leverage (5) coverage, and (6)
            A common size ratio compares all the numbers on a financial statement to one key
     number. For example, each asset on the balance sheet is compared to total assets. One of
     the difficult aspects of comparing different organizations is that they may be substantially
     different in size. A common size ratio attempts to make the numbers on the financial
     statement more comparable by stating them terms of a key number such as total assets or
     total revenue.
            Liquidity ratios focus on whether the organization has enough cash and other liquid
     resources to meet its obligations in the near term. At the same time, we can use liquidity
     ratios to assess whether the organization is wastefully maintaining too much liquidity. If
     liquidity is excessive, long-term investments with high relevance to the organization’s
     mission and perhaps high profit potential may be lost.
            A set of ratios called asset turnover ratios (sometimes called efficiency ratios) can
     help assure that resources are being used efficiently. The ratios in this category are related
10-16           Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

        to timely collection of receivables, appropriateness of inventory levels, and appropriate
        amounts of fixed assets and total assets.
              Leverage refers to the extent to which an organization supports its activities by using
        debt. The greater the debt, the riskier the organization becomes. In contrast to the liquidity
        ratios, which seek to assess short-term risk, the leverage ratios provide insight into the
        ability of the organization to meet its long-term obligations.
              Some would argue that coverage ratios are even more critical. They examine the
        organization’s capacity to make debt service payments (interest and/or principal) as they
        come due.
              Virtually all organizations need to earn a profit to be financially healthy—to be able
        to replace equipment, acquire new technologies, and expand services and to be able to meet
        the challenges of the future. At the same time, it might be inappropriate for many not-for-
        profit organizations to make an excessive profit. Profitability ratios can help the manager
        and outside users assess whether the organization is making an adequate, but not excessive,

14-10. (Financial Analysis)

Part A.

Statements of Financial Position
Common Size Ratios
                                                    December 30, 2007                  December 30, 2006
                                                     %           $                      %            $
CASH AND CASH EQUIVALENTS                            14.35%          1,909,606            9.38%         1,044,193
RECEIVABLE                                            0.46%              61,244           0.47%             52,582
CAMPAIGNS’ PLEDGES RECEIVABLE                         2.81%            373,788            3.22%            358,632
PREPAID EXPENSES AND OTHER                            0.12%              16,244           0.23%             25,367
INVESTMENTS                                          82.26%        10,944,924           86.70%          9,653,039

TOTAL                                              100.00%         13,305,806          100.00%         11,133,813

 Accounts payable — DAV                               1.52%            201,721            1.54%            171,550
 Accounts payable — other                             0.01%                 910           0.01%               1,017
 Annuity payment liability                           28.99%          3,857,262          33.04%          3,679,148
     Total liabilities                               30.51%          4,059,893          34.59%          3,851,715

UNRESTRICTED NET ASSETS                              69.49%          9,245,913          65.41%          7,282,098
10-17   Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

TOTAL                                      100.00%         13,305,806          100.00%         11,133,813
10-18          Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

Statements ofActivities
Common Size Ratios
                                                   December 30, 2007                  December 30, 2006
                                                    %           $                      %            $
 Contributions                                      59.96%          4,771,172           7.44%          2,654,400

  Contributions of charitable gift annuities         3.03%            241,245           0.50%             178,626
  Bequests                                          27.38%          2,178,924         90.98%          32,436,803
 Investment income — net                             9.63%            766,580           1.08%             384,670

 Total support and revenue                        100.00%           7,957,921        100.00%          35,654,499

 Program services                                   76.07%          6,053,675         97.48%          34,754,236
 Management and general                              1.08%              85,933          0.21%              75,499
 Fundraising                                         2.25%            179,277           0.47%             168,316

 Total expenses                                     79.40%          6,318,885         98.16%          34,998,051

APPRECIATION OF INVESTMENTS                         20.60%          1,639,036           1.84%             656,448

APPRECIATION OF INVESTMENTS                          4.08%            324,779           1.20%             428,159

CHANGE IN NET ASSETS                                24.68%          1,963,815           3.04%          1,084,607

NET ASSETS — Beginning of year                      91.51%          7,282,098         17.38%           6,197,491

NET ASSETS — End of year                          116.19%           9,245,913         20.42%           7,282,098
10-19             Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

                                                                                      2007                    2006
 Part B
                          Current Assets                                      $2,360,882            $1,480,774
 Current Ratio           -----------------------                             ------------------     ----------------
                         Current Liabilities                                  $4,059,893            $3,851,715

                                                                         =             0.58                   0.38

 Part C
                         Cash + Short-term Investments                        $1,909,606            $1,044,193
 Days Cash               -----------------------------------------           ------------------     ---------------
 Hand                    (Operating Expense - Deprec.)/365                        $17,312                $95,885

                                                                         =          110.31                   10.89

 Part D
                           Total Debt                                         $4,059,893             $3,851,715
 Debt Ratio               -----------------                                   ---------------        ---------------
                          Total Assets                                       $13,305,806            $11,133,813

                                                                         =             0.31                   0.35
                                                                             or                    Or
                                                                                   30.51%                 34.59%

 Part E
                             Total Debt                                       $4,059,893             $3,851,715
 Debt to Equity          ----------------------                               ---------------        ---------------
                         Total Net Assets                                     $9,245,913             $7,282,098

                                                                     =                 0.44                   0.53
                                                                             or                    Or
                                                                                   43.91%                 52.89%

 Part F
                           Increase in Net Assets                             $1,963,815             $1,084,607
 Total margin            -----------------------------------                  ---------------        ---------------
                         Total Operating Revenues                             $7,957,921            $35,654,499

                                                                     =                 0.25                   0.03
                                                                             or                    Or
                                                                                   24.68%                   3.04%
10-20        Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

 Part G
                     Program Service Expense                    $6,053,675                     $34,754,236
 Program Services    -----------------------------------        ---------------                 ---------------
                              Total Expense                     $6,318,885                     $34,998,051

                                                           =             0.96                            0.99
                                                               or                             or
                                                                    95.80%                           99.30%
10-21              Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 3E

               Ratio analysis is a field that was developed primarily to serve for-profit organizations. Managers in public service organizations should be pro-
        active in developing additional useful ratios. For example, the not-for-profit industry in recent years has started to actively report the program services

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