Cost Accounting Chapter 13

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LEARNINGOBJECTIVES
Afterreadingthischapter,youshouldbeableto:
LO131
Understandtheroleofbudgetsinoverallorganizationplans.
LO132
Understandtheimportanceofpeopleinthebudgetingprocess.
LO133
Estimatesales.
LO134
Developproductionandcostbudgets.
LO135
Estimatecashflows.
LO136
Developbudgetedfinancialstatements.
LO137
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Explainbudgetinginmerchandisingandserviceorganizations.
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Explainwhyethicalissuesariseinbudgeting.
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Explainhowtousesensitivityanalysistobudgetunderuncertainty.
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TheDecision
Lastyearwasatoughone.Theeconomydidnotrecoverasmuchaswehadhopedandtherewas
increasedcompetitionfromoverseas.Itiscrucialforourbudgettoberealistic.Wewillprobablyhaveto
askthebankforsomeadditionalfinancing.IneedyoutoansweronequestionformeHowmuchcash
willweneedtogetusthroughnextyear,sowewillbereadywhentheeconomyrecovers?Wehavea
highlevelofdebtalready,sowhileIwantyoutoberealisticinidentifyingourneeds,thereisnoroom
forextrasthatyouwouldliketohave.
TherearetwootherissuesIwantyoutoaddress.First,althoughIamconcernedaboutthecashneeds
fortheyear,Iamparticularlyconcernedaboutthefirstthreemonths.Willourcashcollectionscoverthe
disbursementsforthefirstquarter?Second,Iknowthatsalesforecastsarejustthatforecasts.Isthere
somewayyoucansummarizetheuncertaintyintheforecastsandwhatitmeansforourfinancialsnext
year?
Ijustreadanarticlethatreportedthatsmallcompaniescommonlyusebudgetsasanimportantcash
flowmanagementtool[seetheBusinessApplicationitem,UsingtheBudgettoHelpManageCash
Flow].ThatcertainlydescribesSantiagoPants!
GaryAdams,thechieffinancialofficerofSantiagoPants,leftthebudgetingtaskforcewiththis
assignment.ItwaslateOctober,andthetaskforcewasjuststartingtodevelopplansforthecomingyear.
SantiagoPantsisamanufacturerofdesignerpants.Thecompanyissmall,butithaslongtermgoalsthat
includediversifiedclothingproductsandamovetoothermarkets.
Meetingthesegoalswillnotbepossiblewiththecurrenteconomicconditions,andthecompanywill
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havetoweatherayearortwoofuncertainty.Thisdoesnotmakethebudgetingprocesseasy,butitisa
situationSantiagoPantsisusedto.Taskforcemembersorderedatakeoutlunchandgotdowntowork.
Budgetingisaprocessthatiswidelyusedandnecessary,atleastinsomeform,forsuccess,yetitisone
oftheleastpopularmanagementprocessespracticed.Budgetinghasbecomethetargetofcriticisminthe
managementpressrecentlyasbeingoutdatedandfundamentallyflawed.1
LO131
Understandtheroleofbudgetsinoverallorganizationplans.
Chapter13LO1NarratedPowerPoints
Theseareprovocativestatementsforaprocessthatiswidelypracticed.However,acloserreadingofthe
commentaryrevealsthattheproblemisnotthebudgetingprocessitself,thoughitalsocomesinforits
shareofcriticism.Theproblemstheauthorsidentifyaretheuseofbudgetsastargetsandthe
dysfunctionaleffectscausedbythatuse.
Inthischapter,wefocusontheplanningpurposeofthebudgetingprocess.Forourpurposeshere,a
budgetissimplytheplan,statedinfinancialterms,ofhowtheorganizationexpectstocarryoutits
activitiesandmeetthefinancialgoalsestablishedintheplanningprocess.Weshowhowamasterbudget
isdevelopedandhowitfitsintotheoverallplanforachievingorganizationgoals.Beforeweinvestigate
thedetailsofdevelopingamasterbudget,wediscussthewaythatstrategicplanningcanincrease
competitivenessandaffectglobaloperations.
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HowStrategicPlanningIncreasesCompetitiveness
Duringthestrategicplanningprocess,companiesoftenoutlinetheircriticalsuccessfactors,whichare
thestrengthsthatareresponsibleformakingthemsuccessful.Criticalsuccessfactorsenableacompany
tooutperformitscompetitors.Byidentifyingthesefactorsandensuringthattheyareincorporatedinto
thestrategicplan,companiesareabletomaintainanedgeovercompetitors.Inaddition,important
criticalsuccessfactorscanbeexploitedtoimprovethecompany'soverallcompetitiveness.
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BusinessApplicationUsingtheBudgettoHelpManageCashFlow
Companiesuseabudgetformanythingsincludingforecasting,reporting,performanceevaluation,andso
on.Onerecentstudycollectedsurveydatathatshows,justaswithSantiagoPants,smallfirmsrelyon
budgetstohelpmanagecashflow.
Executivesat46percentofthecompaniessurveyedviewtheirbudgetsasextremelyorveryimportant
cashflowmanagementtoolsand38percentratethemsomewhatimportant.Thebudget'scashflow
managementaspectismostimportantatcompanieswithannualrevenueslessthan$10million.
Thefollowinggraphbreaksdowntheresponses.
Source:J.Orlando,TurningBudgetingPainintoBudgetingGain,StrategicFinance,March2009,pp.
4751.
Forexample,Walmarthasreliedonseveralfactorstomaintainitscompetitiveedge,oneofwhichisto
keepitspricesconsistentlylowbyleveragingitspurchasingpower.Thecompanyknowsthatthisisa
criticalsuccessfactorandhascontinuedtoincreaseitscompetitivenessbybuildingthisfactorintoits
strategicplanningprocess.
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OverallPlan
Amasterbudgetispartofanoverallorganizationplanforthenextyearmadeupofthreecomponents:
(1)theorganizationgoals,(2)thestrategiclongrangeprofitplan,and(3)thetacticalshortrangeprofit
plan.
OrganizationGoals
Topmanagersestablishbroadobjectives,whichserveasorganizationgoalsthatcompanyemployees
worktoachieve.Thesegoalsoftenincludefinancialgoals,suchasincomegrowth,aswellasmore
generalgoalsfocusingonemployeelearning,innovation,andcommunityinvolvement.Suchbroadgoals
provideaphilosophicalstatementthatthecompanyisexpectedtofollowinitsoperations.Many
companiesincludetheirgoalstatementsinpublishedcodesofconduct,annualreportstostockholders,
andWebsites.
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StrategicLongRangeProfitPlan
Althoughastatementofgoalsisnecessarytoguideanorganization,itisimportanttodetailthespecific
stepsrequiredtoachievethem.Thesestepsareexpressedinastrategiclongrangeplan.Becausethe
longrangeplanslookintotheintermediateanddistantfuture,theyareusuallystatedinratherbroad
terms.Strategicplansdiscussthemajorcapitalinvestmentsrequiredtomaintainpresentfacilities,
increasecapacity,diversifyproductsand/orprocesses,anddevelopparticularmarkets.Forexample,in
describingitsgrowthstrategy,GeneralElectricidentifiesaGrowthasaProcessInitiative.2The
initiativerequiresconsistentexecutionin:
Technology
Commercialexcellence
Customerfocus
Globalization
Innovation
Developinggrowthleaders
Firmswithagrowthstrategythatdependsonsellingthelowestcostproduct,suchasSouthwestAirlines,
willhavedifferentstepstoachievethatstrategy.Eachstrategystatementissupportedbygeneralplans
andachievements.Theplansprovideageneralframeworkforguidingmanagement'soperatingdecisions.
MasterBudget(TacticalShortRangeProfitPlan):TyingtheStrategicPlantotheOperatingPlan
Longrangeplansareachievedinyearbyyearsteps.Theguidancetheyprovideismorespecificforthe
comingyearthanitisformoredistantyears.Theplanforthecomingyear,whichismorespecificthan
longrangeplans,iscalledthemasterbudget,alsoknownasthestaticbudget,thebudgetplan,orthe
planningbudget.Theincomestatementportionofthemasterbudgetisoftencalledtheprofitplan.The
masterbudgetindicatesthelevelofsales,production,andcostaswellasincomeandcashflows
anticipatedforthecomingyear.Inaddition,thesebudgetdataareusedtoconstructabudgetedstatement
offinancialposition(balancesheet).
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Budgetingisadynamicprocessthattiestogethergoals,plans,decisionmaking,andemployee
performanceevaluation.Themasterbudgetanditsrelationshiptootherplans,accountingreports,and
managementdecisionmakingprocessesisdiagrammedinExhibit13.1.Ontheleftsidearethe
organizationalgoalsandstrategiesthatsetthecompany'slongtermplan.Themasterbudgetisderived
fromthelongrangeplaninconsiderationofconditionsexpectedduringthecomingperiod.Suchplans
aresubjecttochangeastheeventsoftheyearunfold.Recently,airlinessuchasDeltahavepostponedthe
introductionofservicestoselectedinternationaldestinationsbecauseofglobaleconomicconditions.
Exhibit13.1OrganizationalandIndividualInteractioninDevelopingtheMasterBudget
Theconditionsanticipatedforthecomingyeararebasedinpartonmanagersneartermprojections.
Companiescangatherthisinformationfromproductionmanagers,purchasingagents(materialsprices),
theaccountingdepartment,andemployeerelations(wageagreements),amongothers.Aspartofa
benchmarkingactivity,somecompaniesgatherinformationthroughcompetitiveintelligence,speaking
totheircompetitors,customers,andsuppliers.
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HumanElementinBudgeting
LO132
Understandtheimportanceofpeopleinthebudgetingprocess.
Anumberoffactors,includingpersonalgoalsandvalues,affectmanagersexpectationsaboutthe
comingperiod.Althoughbudgetsareoftenviewedinpurelyquantitative,technicalterms,theimportance
ofthishumanfactorcannotbeoveremphasized.Theindividual'srelationshiptothebudgetis
diagrammedontherightsideofExhibit13.1.
Budgetpreparationrestsonhumanestimatesofanunknownfuture.People'sforecastsarelikelytobe
greatlyinfluencedbytheirexperienceswithvarioussegmentsofthecompany.Forexample,districtsales
managersareinanexcellentpositiontoprojectcustomerordersoverthenextseveralmonths,butmarket
researchersareusuallybetterabletoidentifylongrunmarkettrendsandmakemacroforecastsofsales.
Onechallengeofbudgetingistoidentifywhointheorganizationisbestabletoprovidethemost
accurateinformationaboutparticulartopics.
ValueofEmployeeParticipation
Theuseofinputfromlowerandmiddlemanagementemployeesisoftencalledparticipative
budgetingorgrassrootsbudgeting.Theuseoflowerandmiddlemanagersinbudgetinghasanobvious
costitistimeconsuming.Italsohassomebenefitsitenhancesemployeemotivationandacceptanceof
goalsandprovidesinformationthatenablesemployeestoassociaterewardsandpenaltieswith
performance.Italsoservesatrainingordevelopmentroleformanagers.Participativebudgetingcan
yieldinformationthatemployeesknowbutmanagersdonot.
Anumberofstudieshaveshownthatmanagersoftenprovideinaccuratedatawhenaskedtogivebudget
estimates.Theymightrequestmoremoneythantheyneedbecausetheyexpecttheirrequesttobecut.
Managerswhobelievethatthebudgetwillbeusedasanormforevaluatingtheirperformancecould
provideanestimatethatwillnotbemuchofachallengetoachieve.
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Thus,managersusuallyviewthetechnicalstepsrequiredtoconstructacomprehensivetacticalbudget
planinthecontextoftheeffectthatpeoplehaveonthebudgetandtheeffectthatthebudgetwillhaveon
them.Ideally,thebudgetwillmotivatepeopleandfacilitatetheiractivitiessothattheorganizationcan
achieveitsgoals.
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DevelopingtheMasterBudget
Althougheachorganizationisuniqueinthewayitputstogetheritsbudget,allbudgetingprocessesshare
somecommonelements.Afterorganizationalgoals,strategies,andlongrangeplanshavebeen
developed,workbeginsonthemasterbudget,adetailedbudgetforthecomingfiscalyearwithsome
lessdetailedfiguresforsubsequentyears.Althoughbudgetingisanongoingprocessinmostcompanies,
thebulkoftheworkisusuallydoneinthesixmonthsimmediatelyprecedingthebeginningofthe
comingfiscalyear.Finalbudgetapprovalsbythechiefexecutiveandboardofdirectorsaremadeone
monthtosixweeksbeforethebeginningofthefiscalyear.
Toenvisionthemasterbudgetingprocess,picturethefinancialstatementsmostcommonlypreparedby
companies:theincomestatement,thebalancesheet,andthecashflowstatement.Thenimagine
preparingthesestatementsbeforethebeginningofthefiscalperiod.
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WheretoStart?
Wheredoyoustartwhenpreparingamasterbudget?Onewaytothinkaboutthequestionisto
understandthattheorganizationhasmorecontroloversomeaspectsofthebusiness(forexample,how
muchtoproduce)andlesscontroloverotheraspects(thedemandforitsproductsandservices,for
example).Formostorganizations,salesaremostuncertain.Therefore,beginningwithasalesforecast,
thefirmcanplantheactivitiesoverwhichithasmorecontrol.Asbetterinformationaboutsalesbecomes
available,itisreasonablyeasytoadjusttherestofthebudget.If,ontheotherhand,productionismore
uncertainthansalesbecausethefirmreliesonamaterialthatisrationedandthesupplyisuncertain,the
firmmaywanttobeginwitharawmaterialandproductionforecast.Firmsthatrelyonnaturalresources
thatarerationedorfirmsoperatingineconomiesinwhichagovernmentagencycontrolssupply(e.g.,
centrallyplannedeconomies)areexamplesofcompaniesthatstarttheprocessbypreparingaforecastof
production.
SalesForecasting
Inmostfirms,forecastingsalesisthemostdifficultaspectofbudgetingbecauseitinvolvesconsiderable
subjectivity.Toreducesubjectivityandgatherasmuchinformationaspossible,managementoftenusesa
numberofdifferentmethodstoobtainforecastsfromanumberofdifferentsources.Webeginwitha
forecastofrevenuesforthebudgetperiod.
LO133
Estimatesales.
SalesStaffSalespeopleareintheuniquepositionofbeingclosetothecustomers,andtheycouldbethe
peopleinthecompanywhopossessthebestinformationandthebestlocalknowledgeaboutcustomers
immediateandneartermneeds.AswediscussedinChapter12,salespeoplealsorealizethattheywillbe
evaluatedbased,atleastinpart,ontheiractualperformancecomparedtothebudget.Asaresult,they
haveanincentivetobiastheirsalesforecasts.
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OneofthefirstthingsthebudgetingtaskforceatSantiagoPantsdidwastoaskYuliaMakmur,the
companysalesmanager,tojointhemforanafternoontobegindevelopingthesalesforecast.Forthe
comingbudgetyear,sheexpectssalestobeabout$7.5million,althoughtheycoulddropaslowas$6
millionorrunashighas$9million.Herbonusattheendofnextyearwillbe1percentoftheexcessof
actualsalesoverthesalesbudget.Soifthebudgetis$7millionandactualsalesarealso$7million,she
willreceivenobonus.
ThetaskforceisawarethatYuliafacesconflictingincentiveswhenitcomestoprovidingasales
forecast.Ontheonehand,ifsheforecastssalesthataretoohigh,sheriskslosingherbonus.Ontheother
hand,ifsheforecastssalesthataretoolow,theapprovedbudgetmightnotincludeproductionnecessary
tomeetsales.Inthepantsbusiness,customerswillnotwaitforSantiagoPantstoincreaseproduction.
Instead,theywillbuypantsfromcompetitors.Inaddition,Yuliamighthavehersalesforcereduced,
whichwillalsohaveanegativeeffectonsales.
Thus,Yuliadecidesonaconservativebutreasonablesalesforecastof$7million,which,shebelieves,
willgiveherahighprobabilityofgettingabonusandalowriskoffailingtomeetherotherobjectives.
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Incentivecompensationplanscanbedesignedtomotivatedifferentbehaviors,eachwiththeirown
strengthsandweaknesses.If,forinstance,herbonuswereafixedpercentageofsales,shewouldhavean
incentivetomaximizesales.Thenshemightbemotivatedtomakeanoptimisticsalesforecasttojustify
obtainingalargersalesstaff.Thehighsalesforecastalsowouldbeusedtoestimatetheamountof
productioncapacityneeded,thusensuringthatadequateinventorywouldbeavailabletosatisfyanyand
allcustomerneeds.Ofcourse,themanagersandstaffwhoreceiveforecastsusuallyrecognizethe
subjectivityofthesituation.AsRexKohler,theheadofthebudgetingtaskforce,putit,We'vereceived
salesforecastsfromherforseveralyears,andtheyarealwaysabitconservative.Wedon'taskherto
reviseherestimates.Wesimplytakeherconservatismintoaccountwhenweputtogethertheoverall
salesforecast.
MarketResearchersToprovideacheckonforecastsfromlocalsalespersonnel,managementoften
turnstomarketresearchers.Thisgroupprobablydoesnothavethesameincentivesthatsalespersonnel
havetobiasthebudget.Furthermore,researchershaveadifferentperspectiveonthemarket.Theymay
knowlittleaboutcustomersimmediateneeds,buttheycanpredictlongtermtrendsinattitudesandthe
effectsofsocialandeconomicchangesonthecompany'ssales,potentialmarkets,andproducts.
DelphiTechniqueTheDelphitechniqueisanothermethodusedtoenhanceforecastingandreduce
biasinestimates.Withthismethod,membersoftheforecastinggroupprepareindividualforecastsand
submitthemanonymously.Eachgroupmemberobtainsacopyofallforecastsbutisunawareoftheir
sources.Thegroupthendiscussestheresults.Inthisway,differencesamongindividualforecastscanbe
addressedandreconciledwithoutinvolvingthepersonalityorpositionofindividualforecasters.Afterthe
differencesarediscussed,eachgroupmemberpreparesanewforecastanddistributesitanonymouslyto
theothers.Theseforecastsarethendiscussedinthesamemannerasbefore.Theprocessisrepeateduntil
theforecastsconvergeonasinglebestestimateofthecomingyear'ssaleslevel.
TrendAnalysisTrendanalysis,whichcanrangefromasimplevisualextrapolationofpointsona
graphtoahighlysophisticatedcomputerizedtimeseriesanalysis,alsocanbehelpfulinpreparingsales
forecasts.
Timeseriestechniquesuseonlypastobservationsofthedataseriestobeforecasted.Nootherdataare
included.Thismethodologyisjustifiedonthegroundsthatbecauseallfactorsthataffectthedataseries
arereflectedintheactualpastobservations,thepastdataarethebestreflectionofavailableinformation.
Thisapproachisalsorelativelyeconomicalbecauseonlyalistofpastsalesfiguresisneeded.Noother
dataaregathered.
Forecastingtechniquesbasedontrendanalysisoftenrequirelongseriesofpastdatatoderiveasuitable
solution.Generally,whenthesemodelsareusedinaccountingapplications,monthlydataarerequiredto
obtainanadequatenumberofobservations.
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EconometricModelsAnotherforecastingapproachistoenterpastsalesdataintoaregressionmodelto
obtainastatisticalestimateoffactorsaffectingsales.Forexample,thepredictedsalesforthecoming
periodcanberelatedtosuchfactorsaseconomicindicators,consumerconfidenceindexes,backorder
volume,andotherinternalandexternalfactorsthatthecompanydeemsrelevant.
Advocatesoftheseeconometricmodelscontendthattheycanincludemanyrelevantpredictors.
Manipulatingtheassumedvaluesofthepredictorsmakesitpossibletoexamineavarietyofhypothetical
conditionsandrelatethemtothesalesforecast.Thisisparticularlyusefulforperformingsensitivity
analysis,whichwediscusslaterinthischapter.
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Sophisticatedanalyticalmodelsforforecastingarenowwidelyavailable.Mostcompanieshavecomputer
softwarepackagesthatalloweconomicaluseofthesemodels.Nonetheless,itisimportanttoremember
thatnomodelremovestheuncertaintysurroundingsalesforecasts.Managementoftenhasfoundthatthe
intuitionoflocalsalespersonnelisabetterpredictorthansophisticatedanalysesandmodels.Asinany
managementdecision,costbenefittestsshouldbeusedtodeterminewhichmethodsaremost
appropriate.
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ComprehensiveIllustration
Tomakeourdiscussionofthebudgetingprocessmoreconcrete,we'lldevelopthebudgetforSantiago
Pants.Weuseamanufacturingexamplebecauseitincludesmostaspectsofafirm'soperations.The
methodswediscussalsoapplytononmanufacturingandnotforprofitorganizations.Attheendofthe
chapter,weconsidersomeoftheuniquebudgetingissuesintheseorganizations.
Afterevaluatingthesalesforecastsderivedfromvarioussources,thebudgetingtaskforceatSantiago
Pantsarrivedatthefollowingsalesbudgetforthenextbudgetyear:
ForecastingProduction
Theproductionbudgetplanstheresourcesneededtomeetcurrentsalesdemandandensurethat
inventorylevelsaresufficientforexpectedactivitylevels.Itisnecessary,therefore,todeterminethe
requiredinventorylevelforthebeginningandendofthebudgetperiod.Theproductionlevelmaybe
computedfromthebasiccostflowequation(alsoknownasthebasicinventoryformula):
LO134
Developproductionandcostbudgets.
Adaptingthatequationtoinventories,production,andsales,wehave
Rearrangingtermstosolveforrequiredproductionresultsin
Thisequationstatesthatproductionequalsthesalesdemandplusorminusaninventoryadjustment.
Productionandinventoryarestatedinequivalentfinishedunits.
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SantiagoPants'ssalesbudgetprojectssalesof160,000units.Managementestimatesthat5,000unitswill
beinthebeginninginventoryoffinishedgoodswithanestimatedcostof$120,000.Basedon
management'sanalysis,therequiredendinginventoryisestimatedtobe15,000units.Weassumefor
simplicitythatthereisnobeginningorendingworkinprocessinventory.Withthisinformation,the
budgetedlevelofproductioniscomputedasfollows:
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SeeExhibit13.2fortheproductionbudgetforSantiagoPants.Theproductionmanagerreviewsthe
productionbudgettoascertainwhetherthebudgetedlevelofproductioncanbereachedwiththecapacity
available.Ifnot,managementcanrevisethesalesforecastorconsiderwaystoincreasecapacity.Ifit
appearsthatproductioncapacitywillexceedrequirements,managementmightwanttoconsiderother
opportunitiesforusingthecapacity.
Exhibit13.2ProductionBudget
Onebenefitofthebudgetingprocessisthatitfacilitatesthecoordinationofactivities.Asthesales
forecastincreases,forexample,thebudgetcommunicatestotheproductionmanagerthatmorepants
needtobeproduced.Conversely,ifproductioncapacityfalls,thesalesmanagercanavoidaccepting
ordersthecompanycannotfill,thusreducingthepossibilityofdissatisfiedcustomers.Itisfarbetterto
learnaboutdiscrepanciesbetweenthesalesforecastandproductioncapacityinadvancesothatremedial
actioncanbetaken.
ForecastingProductionCosts
Afterthesalesandproductionbudgetshavebeendevelopedandtheeffortsofthesalesandproduction
groupshavebeencoordinated,thebudgetedcostofgoodssold(productioncosts)canbeprepared.The
primaryjobofthisbudgetistoestimatethecostsofdirectmaterials,directlabor,andmanufacturing
overheadatbudgetedlevelsofproduction.
DirectMaterialsDirectmaterialspurchasesneededforthebudgetperiodarederivedfromthis
equation:
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Thebeginningandendinglevelsofmaterialsinventoryforthebudgetperiodareestimated,oftenwith
thehelpofaninventorycontrolmodel.Thematerialstobeusedinproductionarebasedonproduction
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requirements.
ProductionatSantiagoPantsforthecomingperiodwillrequiretwokindsofmaterials,cottonandfine
cotton.Cottonhasanestimatedbeginninginventoryof10,000yardsandestimatedendinginventoryof
15,000yards.Finecottonhasestimatedbeginningandendinginventoriesof1,000yards,asshown
below.
Thecostperyardisexpectedtoremainconstantduringthecomingbudgetperiod.Requiredproduction
(fromtheproductionbudget)is170,000units.
Computationoftherequiredmaterialspurchasesinunitsofeachmaterialfollows:
Indollarterms,thisamountstoestimatedpurchasesof$1,545,000forcotton(=515,000$3)and
$170,000forfinecotton(=34,000$5).
Thedirectmaterialsbudget(Exhibit13.3)showsthematerialsrequiredforproduction.
Exhibit13.3DirectMaterialsBudget
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Page498
DirectLabor
Estimatesofdirectlaborcostsoftenareobtainedfromengineeringandproductionmanagement.For
SantiagoPants,thedirectlaborcostsareestimatedat0.50hoursperunitat$22perhour(or$11per
outputunitproduced).Thus,forthebudgetyear,thebudgeteddirectlaborcostofproductionof170,000
unitsis$1,870,000(seeExhibit13.4).
Exhibit13.4DirectLaborBudget
Overhead
Unlikedirectmaterialsanddirectlabor,whichoftencanbedeterminedfromanengineer'sspecifications
foraproduct,overheadiscomposedofmanydifferenttypesofcostswithvaryingcostbehaviors.Some
overheadcostsvaryindirectproportiontoproduction(variableoverhead)somecostsvarywith
productionbutinastepfashion(forexample,supervisorylabor)andothercostsarefixedandremain
thesameunlesscapacityorlongrangepoliciesarechanged.Stillothercosts(forexample,plant
depreciation)donotnecessarilyvarywithproductionbutcanbechangedatmanagement'sdiscretion.
Budgetingoverheadrequiresanestimatebasedonproductionlevels,managementdiscretion,longrange
capacityandothercorporatepolicies,andexternalfactorssuchasincreasesinpropertytaxes.Duetothe
complexityanddiversityofoverheadcosts,severalcostestimationmethodsarefrequentlyused.To
simplifythebudgetingprocess,costsusuallyaredividedintofixedandvariablecomponents,with
discretionaryandsemifixedcoststreatedasfixedcostswithintherelevantrange.
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SeeExhibit13.5forSantiagoPants'sscheduleofbudgetedmanufacturingoverhead.Forconvenience,
afterconsultationwithdepartmentmanagement,thebudgetingtaskforceatSantiagoPantshasdivided
alloverheadintofixedandvariablecosts.Thebudgetingtaskforcenowcandeterminethebudgetedtotal
manufacturingcostsbyaddingthethreecomponents:materials,labor,andoverhead.Thistotalis
$4,250,000(seeExhibit13.6).
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Exhibit13.5ManufacturingOverheadBudget
Exhibit13.6BudgetedStatementofCostofGoodsSold
CompletingtheBudgetedCostofGoodsSold
Weneedonlyincludetheestimatedbeginningandendingworkinprocessandfinishedgoods
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inventoriestodeterminetherequirednumberofunitsproduced:170,000.Aspreviouslyindicated,no
workinprocessinventoriesexist.3Finishedgoodsinventoriesareasfollows,giventhemanagement
estimateofbeginninginventoryandtheestimated$25costofproducingpantsthisyear:
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Addingtheestimatedbeginningfinishedgoodsinventorytotheestimatedcostofgoodsmanufactured
andthendeductingtheendingfinishedgoodsinventoryyieldsacostofgoodssoldof$3,995,000
(Exhibit13.6).
Thiscompletesthesecondmajorstepinthebudgetingprocess:determiningbudgetedproduction
requirementsandthecostofgoodssold.Obviously,thispartofthebudgetingeffortcanbeextremely
complexformanufacturingcompanies.Itcanbeverydifficulttocoordinateproductionschedulesamong
numerousplants,someofwhichuseotherplantsproductsastheirdirectmaterials.Italsoisdifficultto
coordinateproductionscheduleswithsalesforecasts.Newestimatesofmaterialavailability,labor
shortages,strikes,availabilityofenergy,andproductioncapacityoftenrequirereworkingtheentire
budget.
RevisingtheInitialBudget
Atthispointinthebudgetcycle,afirstdraftbudgethasbeenprepared.Itusuallyundergoesagooddeal
ofcoordinatingandrevisingbeforeitisconsideredfinal.Forexample,projectedproductionfigures
couldcallforrevisedestimatesofdirectmaterialspurchasesanddirectlaborcosts.Bottleneckscouldbe
discoveredinproductionthatwillhamperthecompany'sabilitytodeliveraparticularproductandthus
affectthesalesforecast.Therevisionprocesscanberepeatedseveraltimesuntilacoordinated,feasible
masterbudgetevolves.Nopartofthebudgetisformallyadopteduntiltheboardofdirectorsfinally
approvesthemasterbudget.
SelfStudyQuestion
1. Theselfstudyquestionsinthischapterprovideacomprehensivebudgetingproblembasedondata
fromtheSantiagoPantsexampleinthechapter.RefertothedataforSantiagoPantsinthechapter
example.Assumethatthesalesforecastwasdecreasedto150,000unitswithnochangeinprice.
Managersrevisedtheirestimateofpropertytaxesto$51,500(reducedfrom$60,000)basedona
recentpropertytaxlawchange.Thenewtargetendinginventoriesfollow:
Prepareabudgetedmanufacturingoverheadstatementandabudgetedcostofgoodssoldstatement
withthesenewdata.(Assumefirstin,firstout.)
Thesolutiontothisquestionisattheendofthechapteronpages527528.
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MarketingandAdministrativeBudget
Creatingbudgetsformarketingandadministrativecostsisverydifficultbecausemanagershave
discretionabouthowmuchmoneytheyspendandthetimingoftheseexpenditures.
Itisalsooftendifficulttoestablishthelinkbetweenthecostsandthebenefitsforthecompany.For
example,acompanyhiredanewmarketingexecutivewhowasfamousforhiscostcuttingskills.The
executiveorderedanimmediate50percentcutinthecompany'sadvertisingbudget,afreezeonhiring,
anda50percentcutinthetravelbudget.Costsdidfall,butwithlittleimmediateimpactonsales.Ayear
later,lookingfornewchallenges,theexecutivemovedtoanothercompany.Soonafterward,the
executive'sformeremployersnoticedthatsalesweredownbecausethecompanyhadlostmarketshareto
someaggressivecompetitors.Werethemarketingexecutive'scostcuttingactionsreallyinthecompany's
bestinterests?Tothisday,nobodycangiveadocumentedanswertothatquestionbecauseitisdifficult
toproveacausallinkbetweenthecostcuttingandthesubsequentdecreaseinsales.
Page501
Inanothercase,acompany'spresidentwastheonlyonewhousedthecorporatejet,andheuseditonly
rarely.Sotheinternalauditstaffrecommendedsellingit.Thecompanypresidentrejectedtheidea,
saying,OneofthereasonsIputupwiththepressuresandresponsibilitiesofthisjobisbecauseIenjoy
someofitsperquisites,includingthecorporatejet.Somecoststhatappearunnecessary,especially
perquisites,arereallypartofthetotalcompensationpackage,whichislikelydeterminedbythelabor
marketforuniqueskills.
Thebudgetingobjectivehereistoestimatetheamountofmarketingandadministrativecostsrequiredto
operatethecompanyatitsprojectedlevelofsalesandproductionandtoachievelongtermcompany
goals.Forexample,thebudgetedsalesfigurescanbebasedonanewproductpromotioncampaign.If
productionandsalesareprojectedtoincrease,anincreaseinsupportservicesdataprocessing,
accounting,personnel,andsoforthlikelywillbeneededtooperatethecompanyatthehigherprojected
levels.
Aneasywaytodealwiththeproblemistostartwithapreviousperiod'sactualorbudgetedamountsand
makeadjustmentsforinflation,changesinoperations,andsimilarchangesbetweenperiods.Thismethod
hasbeencriticizedandcanbeviewedasbeingverysimplistic,butithasoneadvantage:Itisrelatively
easyandinexpensive.Asalways,thebenefitsofimprovingbudgetingmethodsmustjustifytheir
increasedcosts.
AtSantiagoPants,eachmanagementlevelsubmitsabudgetrequestformarketingandadministrative
coststothenexthigherlevel,whichreviewsitandapprovesit,usuallyaftermakingsomeadjustments.
Thebudgetispassedupthroughtheranksuntilitreachestopmanagement.Thescheduleofmarketing
andadministrativecostsisdividedintovariableandfixedcomponents(seeExhibit13.7).Inthiscase,
variablemarketingcostsarethosethatvarywithsales(notproduction).Fixedmarketingcostsare
usuallythosethatcanbechangedatmanagement'sdiscretionforexample,advertising.
Exhibit13.7MarketingandAdministrativeCostsBudget
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Page502
PullingItTogetherintotheIncomeStatement
AccordingtoRexKohler,headofthebudgetingtaskforceatSantiagoPants,Atthispoint,wereableto
puttogethertheentirebudgetedincomestatementfortheperiod(Exhibit13.8)sowecandetermineour
projectedoperatingprofits.Bymakingwhateveradjustmentsarerequiredtosatisfygenerallyaccepted
accountingprinciplesforexternalreporting,wecanprojectnetincomeafterincometaxesandearnings
pershare.Ifwedon'tliketheresults,wegobacktothebudgetedincomestatementand,startingatthe
top,gothrougheachsteptoseeifwecanincreasesalesrevenuesorcutcosts.Weusuallyfindsome
plantoverhead,marketing,oradministrativecoststhatcanbecutorpostponedwithoutdoingtoomuch
damagetothecompany'soperations.
Exhibit13.8BudgetedIncomeStatement
TheboardofdirectorsatSantiagoPantsapprovedthesales,production,andmarketingand
administrativebudgetsandthebudgetedincomestatementassubmitted.Notethatthebudgetedincome
statementalsoincludesestimatedfederalandotherincometaxes,whichthetaxstaffprovided.Wewill
notdetailthetaxestimationprocessbecauseitisahighlytechnicalareaseparatefromcostaccounting.
SelfStudyQuestion
2. RefertoSelfStudyQuestion1.RecallthatSantiagoPantshasasalesforecastof150,000unitsand
newtargetendinginventoriesasfollows:
Inaddition,youlearnthatincometaxexpenseis$500,000.Variablemarketingcostschange
proportionatelywithvolumethatis,theamountnowis(150,000160,000)oftheamountinthetext
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example.
Prepareabudgetedscheduleofmarketingandadministrativecostsandabudgetedincomestatement.
Thesolutiontothisquestionisattheendofthechapteronpages528529.
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Page503
KeyRelationships:TheSalesCycle
Assemblingthemasterbudgetdemonstratessomekeyrelationsamongsales,accountsreceivable,and
cashflowsinthesalescycle.Advantagesofunderstandingtheserelationsincludetheabilitytosolvefor
unknownamountsandtoauditthemasterbudgettoensurethatthebasicaccountingequationhasbeen
correctlyapplied.
AtSantiagoPants,forexample,therelationsamongbudgetedsales,accountsreceivable,andcash
receiptsareasfollows(salesareassumedtobeonaccount):
Note:BBandEBrefertobeginningandendingbalances.Thesebalancesforaccountsreceivableappear
inlaterexhibits.Wepresentthemheretohelpyouseehowcash,sales,andaccountsreceivableare
interrelated.
Ifanamountinthesalescycleisunknown,thebasicaccountingequationcanbeusedtofindit.For
example,supposethatalloftheamountsintheprecedingdiagramareknownexceptendingcashbalance
andsales.Usingthebasiccostflowequation,
wefindsalesfromtheAccountsReceivableaccount:
WecanfindtheendingcashbalancefromtheCashaccount:
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UsingCashFlowBudgetstoEstimateCashNeeds
Althoughthebudgetedincomestatementisanimportanttoolforplanningoperations,acompanyalso
requirescashtooperate.Cashbudgetingisimportanttoensurecompanysolvency,maximizeinterest
earnedoncashbalances,anddeterminewhetherthecompanyisgeneratingenoughcashforpresentand
futureoperations.
LO135
Estimatecashflows.
Preparingacashbudgetrequiresthatallrevenues,costs,andothertransactionsbeexaminedintermsof
theireffectsoncash.Thebudgetedcashreceiptsarecomputedfromthecollectionsfromaccounts
receivable,cashsales,saleofassets,borrowing,issuingstock,andothercashgeneratingactivities.
Disbursementsarecomputedbycountingthecashrequiredtopayformaterialspurchases,manufacturing
andotheroperations,federalincometaxes,andstockholderdividends.Inaddition,thecash
disbursementsnecessarytorepaydebtandacquirenewassetsalsomustbeincorporatedintothecash
budget.
SeeExhibit13.9forthecashbudgetforSantiagoPants.Thesourceofeachitemisindicated.
Exhibit13.9CashBudget
Page504
MultiperiodCashFlows
AlthoughthecashbudgetforSantiagoPantsshowsasurplusfortheendoftheyear,wecannotbesure
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thatthecompanywillnotrunoutofcashduringtheyear.Forthatreason,cashflowsoftenareanalyzed
inmoredetailthanshownintheSantiagoPantsexamplesofar.Assumethatthefollowingisconsistent
withtheexperienceofSantiagoPantsconcerningitsmonthlycollectionexperienceforsalesoncredit:
ThismeansthatifJanuary'screditsalesare$500,000,expectedcollectionsare$100,000inJanuaryand
$375,000inFebruary$10,000isnotexpectedtobecollectedbecausethecustomerspaidearlyenough
togetadiscountand$15,000isnotexpectedtobecollectedbecausetheseaccountswillbewrittenoff
asbaddebts.SeeExhibit13.10foramultiperiodscheduleofcashcollectionsforthethreemonthsofthe
quarterendingMarch31forSantiagoPants.Assumethatthebeginningaccountsreceivablebalanceon
January1isexpectedtobe$540,000(netofdiscountsandbaddebts),allofwhichisanticipatedtobe
collectedduringJanuary.Theexpectedsalesforthethreemonthsfollow:
Exhibit13.10MultiperiodScheduleofCashReceipts
Page505
Thesameapproachisusedforcashdisbursements.SeethecashdisbursementsinExhibit13.11for
SantiagoPants,whichpaysfor50percentofitspurchasesinthemonthofpurchaseand48percentinthe
followingmonth,andtakesa2percentdiscountforpayingontime.Followingisalistofpurchasesfor
thethreemonthsJanuarythroughMarch:
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Exhibit13.11MultiperiodScheduleofCashDisbursements
Page506
Inaddition,allothercashpaymentsareexpectedtobe$250,000permonth.SantiagoPantshadaccounts
payableof$256,000onJanuary1,allofwhichitpaidinJanuary.
BusinessApplicationTheCurseofGrowth
AquicklookatthebudgetedincomestatementandcashpositionofSantiagoPantsrevealsaseemingly
contradictoryphenomenon.Basedonincome,SantiagoPantsisprojectedtodoquitewellthisyear:
$1.15millioninincomeonsalesof$7.2million,a16percentreturnonsales.Lookingatcash,however,
thefirmisindangerofnotbeingabletopayitsdebts.
Thisisacommonproblem,especiallyamongnewfirmsthatexperiencehighgrowthbecauseofthe
successoftheirproductinthemarket.Theproblemisthatcashisrequiredtopurchaseinventorypriorto
thesalebutisnotcollecteduntilafterthesale.Inagrowingfirm,thedollarpurchasesofnewinventory
(oroftheresourcestoproducenewinventory)arehigherthanthedollarcollectionsofpriorsales.
Lookingonlyatprojectedincomestatementsgivesamisleadingviewoftheoperations.
SelfStudyQuestion
3. ThisquestionisbasedonthepreviousSelfStudyQuestionsinthischapterandontheSantiago
Pantsexampleinthetext.PrepareacashbudgetgiventherevisedfiguresforSantiagoPants
providedinSelfStudyQuestions1and2.Assume,however,thatcashcollectionswilldecreaseby
thesameamountasthedecreaseinsalesexceptthattheendingaccountsreceivablelevelwill
decreasebyanother$20,000.Lowerpaymentsforpurchasesofmaterialsequaltothereductionin
purchaseswillberequired,butendingaccountspayablealsowilldecreaseby$2,000.Paymentsfor
incometaxeswilldecreaseto$300,000.
Thesolutiontothisquestionisattheendofthechapteronpage529.
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PlanningfortheAssetsandLiabilitiesontheBudgetedBalanceSheets
Budgetedbalancesheets,orstatementsoffinancialposition,combineanestimateoffinancialposition
atthebeginningofthebudgetperiodwiththeestimatedresultsofoperationsfortheperiod(fromthe
incomestatements)andestimatedchangesinassetsandliabilities.Thelatterresultfrommanagement's
decisionsaboutoptimallevelsofcapitalinvestmentinlongtermassets(thecapitalbudget),investment
inworkingcapital,andfinancingdecisions.Decisionmakingintheseareasis,forthemostpart,the
treasurer'sfunction.Weassumethatthesedecisionshavebeenmadeandincorporatetheirresultsinthe
budgetedbalancesheets.SeeExhibit13.12forSantiagoPants'sbudgetedbalancesheetsatthebeginning
andendofthebudgetyear.
LO136
Developbudgetedfinancialstatements.
Page507
Exhibit13.12BudgetedBalanceSheet
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Page506
BigPicture:HowItAllFitsTogether
WehavecompletedthedevelopmentofacomprehensivebudgetforSantiagoPants.SeeExhibit13.13
foramodelofthebudgetingprocess.Althoughwehavesimplifiedthepresentation,youcanstillseethat
assemblingamasterbudgetisacomplexprocessrequiringcarefulcoordinationofmanydifferent
organizationsegments.
Exhibit13.13AssemblingtheMasterBudgetforaManufacturingFirm
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Page508
BudgetinginRetailandWholesaleOrganizations
Weusedamanufacturingexample,SantiagoPants,toillustratetheconstructionofthemasterbudget
becauseitallowedustoincludetheeffectsofinventoriesandinventorybalancesonthebudgeting
process.Althoughamanufacturingoperationprovidesagoodcomprehensiveexample,budgetingisused
extensivelyinotherenvironmentsaswell,andwenowconsidersomeoftheuniquefeaturesofbudgeting
inthesesettings.
LO137
Explainbudgetinginmerchandisingandserviceorganizations.
Asinmanufacturing,thesalesbudgetinretailandwholesale(oftencalledmerchandising)organizations
drivestherestofthebudgetedincomestatement.Amerchandiserdoesnothaveaproductionbudgetbut
insteadhasamerchandisepurchasesbudget,whichismuchlikethedirectmaterialspurchasesbudgetin
manufacturing.Forexample,managersatCastroAudio&Video,Inc.,preparedthefollowingpurchases
budgetforaparticularhomeentertainmentsystem:
SeeExhibit13.14forthemerchandisepurchasesbudgetforCastro.
Exhibit13.14PurchasesBudget
Asyoucansee,thisbudgetrequiresextensivecoordinationbetweenthemanagersresponsibleforsales
andthoseinchargeofbuying.Becauseofthecriticalimportanceoftimingandseasonalityin
merchandising,specialattentionisusuallygiventoshorttermbudgets(forexample,spring,summer,and
holidayseasonbudgets).Thebudgethelpsformalizeanongoingprocessofcoordinatingbuyingand
selling.Thiscoordinationiscriticaltothesuccessofmerchandisingenterprises.
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Page509
BudgetinginServiceOrganizations
Akeydifferenceinthemasterbudgetofaserviceenterpriseistheabsenceofproductormaterials
inventories.Consequently,neitheraproductionbudget(preparedinmanufacturingfirmbudgets)nora
merchandisepurchasesbudget(preparedinmerchandisingfirmbudgets)isneeded.Instead,service
businessesneedtocarefullycoordinatesales(thatis,servicesrendered)withthenecessarylabor.
Managersmustensurethatpersonnelwiththerightskillsareavailableattherighttimes.
ThebudgetforDeltaConsultingServices,aconsultingfirmhopingtolandtheSantiagoPantsaccount,is
developedaroundthethreemajorservicesoffered:strategy,operations,andinformationsystems.
Revenueprojectionsarebasedonestimatesofthenumberandtypesofclientsthefirmplanstoservicein
thebudgetyearandtheamountofservicesrequested.Theforecastsstemprimarilyfromservices
providedinpreviousyearswithadjustmentsfornewclients,newservicestoexistingclients,lossof
clients,andchangesintherateschargedforservices.
BusinessApplicationBudgetIstheLawinGovernment
Wehaveemphasizedtheplanningpurposeofbudgetinginthischapter.However,ingovernmental
organizations,thebudgetservesasanexpressionofthelegislature's(voters)desiresandassuchitisa
legallybindingspendingauthorization.Thiscanoftenleadtounintendedconflictsbetweenmakinggood
decisionsandcomplyingwiththebudget.
Forexample,adepartment'sbudgetistypicallymadeupoffundsfordifferentpurposes(e.g.,capital
procurementbuyingmachinesandoperatingandmaintenanceactivities).Supposeadepartment
needstobuyacomputer.IfthedepartmentisshortofO&Mfundsandhasexcesscapitalprocurement
funds,ithasanincentivetobuythecomputerratherthanleaseit,regardlessofwhataleaseversusbuy
analysissuggests.
Thebudgetingprocessforagovernmentunitsuchasacityisimportantbecauseitcommunicates
citizensgoalsbyidentifyingtheprogramstobefundedandsetslimitsonthespendingforany
particularactivity.
Source:Basedontheauthors'research.
Page510
Oncetheamountofservices(expressedinlaborhours)isforecast,thefirmdevelopsitsbudgetfor
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personnel.Staffingtomeetclientneedsisaveryimportantpartofthebudgetingprocess.NormAgnew,
afounderofthefirm,explains,Budgetingiscriticalinaservicebusinesslikeours.Virtuallyallofour
costsarepeople.Ifwehirebasedonexpectedbusiness,wecannoteasilyadjustourstaffingifsome
projectsdonotmaterialize.Therefore,wealwaysfaceatradeoffbetweennothavingthestafftodothe
workorhavingcostlystaffwhoareunderemployed.
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EthicalProblemsinBudgeting
Budgetingcreatesseriousethicalissuesformanypeople.Managersandemployeesprovidemuchofthe
informationforthebudgettheirperformancetheniscomparedtothebudgettheyhelpeddevelop.For
example,asamanager,supposethatyoubelievethatalthoughitispossibletoachievea10percent
increaseinyourdepartment'ssales,a2percentincreaseisalmostcertain.Ifyoutelluppermanagement
thata10percentincreaseisanappropriatebudgetbutyoufallshortofit,youwillloseopportunitiesfor
meritpayincreasesandapromotion.Managementcouldassumethatyoufellshortof10percentnot
becauseofmarketcircumstancesbeyondyourcontrolbutbecauseyoudidnotperformwellinmaking
sales.Ontheotherhand,ifyoureportthatonlya2percentincreaseispossible,thecompanywillnot
provideenoughproductioncapacitytofillthesalesordersifthe10percentincreasecomesthrough.
Shouldyoudowhatisinyourbestinterestorgiveyourbestestimateofreality?
LO138
Explainwhyethicalissuesariseinbudgeting.
Partoftheproblem,aswewilldiscussinChapter14,istheformofthemeritpayschedulethatcreates
strongincentivesasactualperformanceapproachestheperformancetarget.AswenotedinChapter12,
thecompanymustrecognizethetradeoffbetweenencouragingunbiasedreportingbylocalmanagers
andusingthisinformationinperformanceevaluationandrewardsystems.Whiletheconflictscannotbe
avoidedinadecentralizedfirm,managerswhoareawareofthepotentialproblemsthatthisconflict
createsareinapositiontotakestepstomitigatetheconsequences.
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BudgetingunderUncertainty
Amajorbenefitofformalplanningmodelsisthattheyallowyoutoexploremanyalternativesand
optionsintheplanningprocess.Althoughitisbeyondthescopeofthisbooktogointothedetailsof
formalcorporateplanningmodels,webelievethatyoucanseehowtointegratethebudgetplanwith
formalplanningmodelsthatsetforthmathematicalrelationshipsamonganorganization'soperatingand
financialactivities.
LO139
Explainhowtousesensitivityanalysistobudgetunderuncertainty.
Forexample,acentralelementofenterprisewideriskmanagementisevaluatingthefirm'sexposureto
eventsthatwouldmateriallyaffectthefirm'sfinancialprospects.Recognizingthis,managersoften
performsensitivityanalysisontheirprojections.Thisanalysisconsistsofhypotheticalquestionssuchas
these:Whatiflaborcostsare10percenthigher(orlower)thanprojected?Whatifnewhealthandsafety
regulationsthatincreaseourcostsofoperationsarepassed?Whatifourmajorsupplierofdirect
materialsgoesbankrupt?Byaskingandansweringsuchquestionsduringtheplanningphase,
managementcandeterminetheriskofvariousphasesofitsoperationsanddevelopcontingencyplans.
AspartofthebudgetplanatSantiagoPants,forexample,localmanagerswereaskedtoprovidethree
forecastsofsellingpriceandsellingquantity:theirbestestimate,anoptimisticestimate(definedasan
estimatesohighthatthereisonlya10percentorlesschancethatconditionswillbebetterthanthe
optimisticestimate),andapessimisticestimate(definedasanestimatesolowthatthereisonlya10
percentorlesschancethatconditionswillbeworsethanthepessimisticestimate).Theoptimisticand
pessimisticforecastswerenotasdetailedasthebestestimates,buttheydidhighlightsomepotential
problemsandrisks.Thisexerciseledtoninepossiblescenariosdefinedbysellingpriceandsales
quantity.
Page511
Spreadsheetsareextremelyhelpfulinpreparingbudgets,whichrequireconsiderablesensitivity,orwhat
if,thinking.Spreadsheetshelplinkthevariouswhatifscenariostochangesinfinancialvariablesandto
financialconsequences.
Forexample,thesimplespreadsheetinExhibit13.15showstheninescenariosreflectingtheestimated
salespricesandsalesquantitiesjustdescribed.Eachscenarioisassociatedwithestimatedchangesincost
ofgoodssoldandinmarketingandadministrativecosts.(Row9presentsthebudgetusedinthetext
ignoringinventoriesassumethattheotherscenarioswereworkedoutbymanagementandpresentedto
us.)Notethattheamountshownforoperatingprofitsvariesconsiderablybetweentheworstscenarioin
row4andthebestscenarioinrow14.ThisanalysisalertsmanagementthatSantiagoPantswillearnless
thanhalftheexpectedprofitsundertheworstscenario.Giventhecompany'sprecariouscashposition,
thisanalysiswillmotivatemanagersatSantiagoPantstodevelopcontingencyplansforobtainingcashto
meetoperatingexpensesintheeventthatthemorepessimisticscenariosarerealized.
Exhibit13.15SpreadsheetAnalysisofAlternativeBudgetingScenarios
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Theseareonlyafewofthenumerousscenariosthatmanagementcoulddevelop.Furthermore,managers
coulddevelopalternativescenariosforanyofthebudgetsthatwehavediscussed.Largecompanies
usuallydevelopcomplexfinancialmodelstodealwiththenumerousinteractionsofthebudgetandthese
modelsinvolveconsiderablymorethanjustthesensitivityanalysisillustratedinExhibit13.15.
Forexample,adecisionsupportsystemmodelhasbeendevelopedtohelpmanagersassessthetradeoffs
ofdifferentbusinessapproaches.Mostbudgetingactivitiesinvolvedecisionshavingmorethanone
strategicobjective.Acompanycouldhavetwoobjectives,tomaximizeincomeandminimizelabor
overtime.Asthenumberofobjectivesincreasesandtheybegintoconflict,thedecisionmakingprocess
becomesmorecomplex.Aninteractive,multipleobjective,programmingmodelallowsmanagerstodeal
withoftenconflictingobjectivesbyusingastraightforwardsetofequationsandconstraints.Theresultis
asolutionthatmaximizeseachobjective.
TheDebrief
GaryAdams,theCFOatSantiagoPants,scrollsthroughthespreadsheetsthatthebudgetingtaskforce
hasjustemailedhim.Afterafirstlook,hecommentsontheirefforts.
Iknowthatbudgetingisnotafavoriteactivityformostofthepeopleonthetaskforce,butitisa
necessaryone.Lookingthroughthisbudget,Ihavemoreconfidenceinourfinancialhealthnextyear.I
feelbetterwiththefirstquartercashcollectionanddisbursementschedules,especiallywhenIlookatthe
monthtomonthnumbers.Thespreadsheetwiththeoperatingresultsshownforgivenassumptionson
salesquantityandsalespricealsoletsmeknowhowmuchuncertaintywearefacing.Itmaybetruethat
noonelikesbudgetsorthepeoplewhorequestthem,butIdonotknowhowwewouldplanfornextyear
withoutthem.
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Page512
SUMMARY
Thischapterhasdiscussedandillustratedthebudgetprocess.Thebudgetispartoftheoverallplanfor
achievinganorganization'sobjectives.Themasterbudgetisusuallyaoneyearplanthatencompasses
budgetedsalesandproduction,thebudgetedincomestatement,thebalancesheet,andthecashflow
statement,aswellassupportingschedules.
Thefollowingsummarizeskeyideastiedtothechapter'slearningobjectives.
LO131Understandtheroleofbudgetsinoverallorganizationplans.Budgets,whichareusedas
ablueprintforoperations,helpcompaniesdeterminethemeansforachievingtheirgoalsby
outliningprojectedsales,productioncosts,andmarketingandadministrativecosts.
LO132Understandtheimportanceofpeopleinthebudgetingprocess.Budgetsarebasedon
people'sestimates,whichareaffectedbytheirowngoals,values,andabilities.Managersshould
considerthesesoftfactorswhencollectinginformationforbudgets.
LO133Estimatesales.Thekeytothebudgetisagoodsalesforecastbecausemanyotherpartsof
thebudgetdependonthesalesforecast.Thesalesforecastusuallyisderivedfrommultiplesources
ofdata,includingdataprovidedbysalespersonnel,marketresearchers,andstatisticalanalyses.
LO134Developproductionandcostbudgets.Aftersalesforecastshavebeendeveloped,the
numberofunitstobeproducedisestimated.Thisprocessderivesthecostofgoodssold.An
estimateofmarketingandadministrativecostsalsoismadebasedonthepreviousperiod'sactual
andbudgetedamountsadjustedforseveralfactors,includinginflationandchangesinoperations.
LO135Estimatecashflows.Preparingacashbudgetrequiresthatallrevenues,costs,andother
transactionsbeexaminedintermsoftheireffectsoncash.
LO136Developbudgetedfinancialstatements.Budgetedsales,productioncosts,andmarketing
andadministrativecostsarecombinedtoformthebudgetedincomestatement.Tocompletethe
budgetedfinancialstatements,projectedcashflowsandabalancesheetareprepared.
LO137Explainbudgetinginmerchandisingandserviceorganizations.Retailandwholesale
organizationbudgetsaresimilartomanufacturingbudgetsexceptthattheyhavenoproduction
budget.Serviceorganizationsaresimilarexceptthattheyhavenoinventories.Thebudgetisnot
onlyaplanningtoolbutalsoalegalauthorizationforexpenditureingovernmental(nonprofit)
units.
LO138Explainwhyethicalissuesariseinbudgeting.Conflictsofinterestoftenarisewhen
employeesareaskedforinputtohelpestablishabudget.Incentivesexistforemployeestoprovide
targetsthatarerelativelyeasytoachieve.Conversely,companiestypicallyhopetoestablish
challenginggoalsandrewardemployeesformeetingthechallenge.Asaresult,employeesdonot
alwaysprovideaccurateinformationforthebudgetingprocess.Inaddition,ifbudgettargetsare
difficulttomeet,employeescouldturntofraudulentfinancialreporting.
LO139Explainhowtousesensitivityanalysistobudgetunderuncertainty.Uncertaintyisan
importantpartofpreparingbudgetsandplans.Inadditiontomanyformalmodels,managersuse
sensitivityanalysestobetterunderstandtherangeofoutcomeslikelytooccur.Spreadsheet
softwarehasmadesensitivityanalysismucheasiertoperform.
http://textflow.mheducation.com/parser.php?secload=13.f&fake&print
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KEYTERMS
budget,489
budgetedbalancesheets,506
cashbudget,503
criticalsuccessfactors,489
Delphitechnique,494
econometricmodels,495
masterbudget,490
organizationgoals,490
participativebudgeting,492
productionbudget,495
profitplan,491
strategiclongrangeplan,491
trendanalysis,494
REVIEWQUESTIONS
131.Whichhasmoredetail,thebudgetforthecomingperiodoralongrangeforecast?Why?
132.Whatisthepurposeofthecashbudgetifthebudgetedincomestatementwillindicate
whetherthefirmexpectstobeprofitable?
Page513
133.Describefourmethodsusedtoestimatesalesforbudgetingpurposes.
134.Whatroledoesthemasterbudgetplayintheplanningandbudgetingexercise?
135.Whatproblemsmightariseifafirmreliessolelyonmanagementestimatesinpreparingthe
masterbudget?
136.Whatisthecoordinatingroleofbudgeting?
CRITICALANALYSISANDDISCUSSIONQUESTIONS
137.Preparingabudgetisawasteoftime.Thestrategicplaniswhatweworktoaccomplish.
Howwouldyourespondtothiscomment?
138.IntheBusinessApplicationfeature,UsingtheBudgettoHelpManageCashFlow,smaller
firmsweremorelikelytofindthebudgetextremelyorveryimportantthanlargerfirms.Why
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mightthisbethecase?
139.Whataretheadvantagesanddisadvantagesofstartingthebudgetingprocessearlyintheyear
versuslaterintheyearpriortothebudgetyear?
1310.Wouldthebudgetingplansforacompanythatusesajustintime(JIT)inventorysystembe
differentthanthoseforacompanythatdoesnot?Why?
1311.Governmentagenciesarelimitedinspendingbybudgetcategories,notjustbyanoverall
spendinglimit.Whatpurposedoesthisserve?Whatproblemsdoesitcreate?
1312.Whatisthedifferencebetweentheplanningandthecontrolfunctionsofthebudget?What
problemsdothesedifferencescreate?
1313.Whenmightthemasterbudgetstartwithaforecastofsomethingotherthansalesfor
example,production?Why?
1314.Insomeorganizations(firms,universities,governmentagencies),spendingappearsto
increaseastheendofthebudgetingperiodapproaches,eveniftherearenoseasonaldifferences.
Whatmightcausethis?
1315.Ourcashbudgetshowsasurplusforthequarter,sowedonothavetothinkabout
arranginganybankfinancing.Commentonthisstatement.
1316.Yourbossasksforyourestimateonthecostsofamajorprojectforwhichyouhave
responsibility.Yourfuturewiththecompanydependsonyourperformancerelativetothisbudget.
Yourbestguessis,forexample,$1,000,000.Whatwillyousay?Why?
EXERCISES
AllapplicableExercisesareincludedinConnectAccounting
1317.EstimateSalesRevenues
(LO133)
SVIisalargesecuritiesdealer.Lastyear,thecompanymade600,000tradeswithanaveragecommission
of$20.Becauseofthegeneraleconomicclimate,SVIexpectstradevolumetodeclineby15percent.In
addition,employeesatalocalmanufacturingplanthavehistoricallyconstituted10percentofSVI's
volume.Theplantjustclosedandallemployeeshaveclosedtheiraccounts.
Offsettingthesefactorsistheobservationthattheaveragecommissionpertradeislikelytoincreaseby
15percentbecausetradesareexpectedtobelargerinthecomingyear.
Required
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EstimateSVI'scommissionrevenuesforthecomingyear.
(LO133)
EZCredit,Inc.,has$80millioninconsumerloanswithanaverageinterestrateof13.5percent.The
bankalsohas$64millioninhomeequityloanswithanaverageinterestrateof9percent.Finally,the
companyowns$6millionincorporatesecuritieswithanaveragerateof6percent.
EZCreditestimatesthatnextyearitsconsumerloanportfoliowillriseto$84millionandtheinterestrate
willfallto12percent.Itshomeequityloanswillfallto$60millionwithanaverageinterestrateof8
percent,anditscorporatesecuritiesportfoliowillincreaseto$16millionwithanaveragerateof7
percent.
Required
EstimateEZCredit'srevenuesforthecomingyear.
(LO133)
StarliteCompanymanufacturesofficeproducts.Lastyear,itsold45,000electricstaplersfor$10per
unit.Thecompanyestimatesthatthisvolumerepresentsa30percentshareofthecurrentelectricstapler
market.Themarketisexpectedtoincreaseby10percentnextyear.Marketingspecialistshave
determinedthatasaresultofnewcompetition,thecompany'smarketsharewillfallto25percent(ofthis
largermarket).Duetochangesinprices,thenewpricefortheelectricstaplerswillbe$11perunit.This
newpriceisexpectedtobeinlinewiththecompetitionandhavenoeffectonthevolumeestimates.
Page514
Required
EstimateStarlite'ssalesrevenuesfromelectricstaplersforthecomingyear.
1320.EstimateProductionLevels
(LO134)
HoffmannCorporationhasjustmadeitssalesforecastsanditsmarketingdepartmentestimatesthatthe
companywillsell72,000unitsduringthecomingyear.Inthepast,managementhasmaintained
inventoriesoffinishedgoodsatapproximatelyonemonth'ssales.Theinventoryatthestartofthebudget
periodis3,900units.Salesoccurevenlythroughouttheyear.
Required
Estimatetheproductionlevelrequiredforthecomingyeartomeettheseobjectives.
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1321.EstimateSalesLevelsUsingProductionBudgets
(LO134)
Sanlax,Inc.,makesportableappliancesanddevelopsplansusinganannualbudgetingcycle.Fornext
year,theproductionbudgetis400,000units.Inventoriesareexpectedtoincreaseby20,000units.
Required
Whatisthesalesbudgetforthecomingyear?
1322.EstimateInventoryLevelsUsingProductionBudgets
(LO134)
HarborEnterprises,Inc.(HE)manufactureselectricalcomponents.TheinventorypolicyatHEistohold
inventoryequalto150%oftheaveragemonthlysalesforitsmainproduct.Salesforthefollowingyear
areexpectedtobe600,000units.Basedontheinventorypolicy,thebudgetcallsfortheproductionof
610,000units.
Required
Whatisthebeginninginventoryofthecomponent?
1323.EstimateProductionLevels:CapacityConstraints
(LO134)
HamiltonCorp.manufacturesacomponentusedinapopulargamingconsole.Demandhasbeenstrong
andtheexecutivestaffatHamiltonisplanningfornextyear.OnOctober1,theycallyouintoa
budgetingmeetingwhereproductionplansarebeingreviewed.Youlearnthattheinventorypolicyat
Hamiltonistoholdtwomonthsworthofsales(toavoidissueswithtransportationdisruptions).The
salesbudgetfornextyearis900,000units,spreadevenlyovertheyear.Expectedinventoryattheendof
thisyearis75,000units.Thecapacityoftheplantis950,000unitsannually.
Required
1. Whatproductionlevelnextyearwillberequiredtomeetthetargets?
2. Arethereanyissuesthatyoubelieveyoushouldbringtotheattentionoftheexecutivestaff?
3. Doyouhaveanysuggestionsfortheresolutionoftheseissues?
1324.EstimateProductionandMaterialsRequirements
(LO134)
TheCasingsPlantofWyomingMachinesmakesplasticsshellsforthecompany'scalculators.(Each
calculatorrequiresoneshell.)Foreachofthenexttwoyears,Wyomingexpectstosell160,000
calculators.ThebeginningfinishedgoodsinventoryofshellsattheCasingsPlantis20,000units.
However,thetargetendingfinishedgoodsinventoryforeachyearis5,000units.
Eachunit(shell)requires6ouncesofplastic.Atthebeginningoftheyear,60,000ouncesofplasticarein
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inventory.Managementhassetatargettohaveplasticonhandequaltotwomonthssalesrequirements.
Salesandproductiontakeplaceevenlythroughouttheyear.
Required
1. Computethetotaltargetedproductionofthefinishedproductforthecomingyear.
2. Computetherequiredamountofplastictobepurchasedforthecomingyear.
1325.EstimatePurchasesandCashDisbursements
(LO135)
WestileCompanybuysplainceramictilesandprintsdifferentdesignsonthemforsouvenirandgift
stores.ItbuysthetilesfromasmallcompanyinEurope,soatalltimesitkeepsonhandastockequalto
thetilesneededforthreemonthssales.Thetilescost$2eachandmustbepaidforincash.Thecompany
has56,000tilesinstock.Salesestimates,basedoncontractsreceived,areasfollowsforthenextsix
months:
Page515
Required
1. Estimatepurchases(inunits)forJanuary,February,andMarch.
2. EstimatecashrequiredtomakepurchasesinJanuary,February,andMarch.
1326.EstimatePurchasesandCashDisbursements
(LO134,5)
WhiteProductswishestopurchasegoodsinonemonthforsaleinthenext.OnMarch31,thecompany
has8,000portablemusicplayersinstock,althoughsalesforthenextmonth(April)areestimatedtototal
8,600players.Totalsalesofplayersareexpectedtobe7,000inMayand7,400inJune.
Portablemusicplayersarepurchasedatawholesalepriceof$45.Thesupplierhasafinancing
arrangementbywhichWhiteProductspays60percentofthepurchasepriceinthemonthwhenthe
playersaredeliveredand40percentinthefollowingmonth.Whitepurchased10,000playersinMarch.
Required
1. Estimatepurchases(inunits)forAprilandMay.
2. EstimatethecashrequiredtomakepurchasesinAprilandMay.
1327.EstimateCashDisbursements
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(LO135)
AshlandCorporation,amerchandisingfirm,ispreparingitscashbudgetforOctober.Thefollowing
informationisavailableconcerningitsinventories:
Required
WhataretheestimatedcashdisbursementsinOctober?
1328.EstimateCashCollections
(LO135)
DuluthCompanyispreparingitscashbudgetforDecember.Thefollowinginformationisavailable
concerningitsaccountsreceivable:
Required
WhatistheestimatedamountofcashreceiptsfromaccountsreceivablecollectionsinDecember?
(CPAadapted)
Page516
1329.EstimateCashCollections
(LO135)
NassauProductsispreparingacashbudgetforApril.Thefollowinginformationonaccountsreceivable
collectionsisavailablefrompastcollectionexperience:
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Theremaining2percentisnotcollectedandiswrittenoffasbaddebts.Creditsalestodateare:
Required
WhataretheestimatedcashreceiptsfromaccountsreceivablecollectionsinApril?
(CPAadapted)
1330.EstimateCashReceipts
(LO135)
Scare2BU(S2BU)specializesincostumesforalloccasions.Theaveragepriceofeachofitscostumes
is$240.Foreachoccasion,S2BUreceivesa20percentdeposittwomonthsbeforetheoccasion,50
percentthemonthbefore,andtheremainderonthedaythecostumeisdelivered.Basedoninformationat
hand,managersatS2BUexpecttomakecostumesforthefollowingnumberofoccasionsduringthe
comingmonths:
Required
1. WhataretheexpectedrevenuesforS2BUforeachmonth,AprilthroughSeptember?Revenuesare
recordedinthemonthoftheoccasion.
2. Whataretheexpectedcashreceiptsforeachmonth,AprilthroughJuly?
1331.EstimateCashReceipts
(LO135)
VarmitBGoneisapestcontrolservicethatoperatesinasuburbanneighborhood.Thecompany
attemptstomakeservicecallsatleastonceamonthtoallhomesthatsubscribetoitsservice.Itmakes
morefrequentcallsduringthesummer.Thenumberofsubscribersalsovarieswiththeseason.The
numberofsubscribersandtheaveragenumberofcallstoeachsubscriberforthemonthsofinterest
follow:
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Theaveragepricechargedforaservicecallis$80.Oftheservicecalls,30percentarepaidinthemonth
theserviceisrendered,60percentinthemonthaftertheserviceisrendered,and8percentinthesecond
monthafter.Theremaining2percentisuncollectible.
Page517
Required
WhatareVarmitBGone'sexpectedcashreceiptsforMay,June,July,andAugust?
1332.PrepareBudgetedFinancialStatements
(LO136)
RefertothedatainExercise1331.VarmitBGoneestimatesthatthenumberofsubscribersin
Septembershouldfall10percentbelowAugustlevels,andthenumberofservicecallspersubscriber
shoulddecreasebyanestimated20percent.Thefollowinginformationisavailableforcostsincurredin
August.Allcostsexceptdepreciationarepaidincash.
Variableserviceandmarketingcostschangewithvolume.Fixeddepreciationwillremainthesame,but
fixedadministrativecostswillincreaseby5percentbeginningSeptember1.Maintenanceandrepairare
providedbycontract,whichcallsfora1percentincreaseinSeptember.
Required
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PrepareabudgetedincomestatementforSeptember.
(LO136)
Rhodes,Inc.,isafastgrowingstartupfirmthatmanufacturesbicycles.Thefollowingincomestatement
isavailableforJuly:
Salesvolumeisexpectedtoincreaseby20percentinAugust,butthesalespriceisexpectedtofall10
percent.Variablemanufacturingcostsareexpectedtoincreaseby3percentperunitinAugust.In
additiontothesecostchanges,variablemanufacturingcostsalsowillchangewithsalesvolume.
Marketingandadministrativecashcostsareexpectedtoincreaseby10percent.
Rhodesoperatesonacashbasisandmaintainsnoinventories.Depreciationisfixedandshouldremain
unchangedoverthenextthreeyears.
Required
PrepareabudgetedincomestatementforAugust.
(LO136)
CarrerasCafisaSpanishrestaurantinacollegetown.Theownerexpectsthatthenumberofmeals
servedinJunewillbe40percentbelowthoseservedinMay,becausesomanystudentsleaveforthe
summer.InMay,therestaurantserved4,200mealsatanaveragepriceof$15.00.Inthesummer(June
throughAugust),theaveragepriceofamealtypicallyincreasesby25percentandtheaveragefoodcost
ofamealincreasesby10percent.Othercostsaretypicallyunchangedduringthesummer.Thefollowing
costinformationisavailableforMay.
Page518
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Required
PrepareabudgetedincomestatementforJune.
1335.BudgetinginaServiceOrganization
(LO137)
BKConsultingisamanagementconsultingfirm.Otherthantheseniorleadership(whomanagethefirm,
butdonotactivelyconsult),themanagersandstaffarebilledtoclientsonanhourlybasis.Theworkload
variesquiteabitfrommonthtomonthrequiringcarefulplanning.
Managersarebilledtoclientsatarateof$800perhourandstaffatarateof$400perhour.Managersare
paid$200perhourworked(includingnonbillabletime)andstaffarepaid$100perhour.Thecurrent
plancallsformanagerstobill800hoursinMayand500hoursinJune.Staffareexpectedtobill4,800
hoursinMayand3,000hoursinJune.Managerswillworkatotalof1,600hoursinbothmonthsand
staffwillworkatotalof6,400hoursinbothmonths.
Othermonthlycosts(allfixed)are$500,000SG&A,$200,000indepreciation,and$300,000in
marketing.
Required
PrepareabudgetedincomestatementforBKConsultingforMayandJune(separately).
1336.IncentivesandSalesForecasts:EthicalIssues
(LO132,3,8)
ThecontrollerofNorthwestHardwarehasjustreceivedtwoforecastsforsalesintheMontanaDistrict
forthecomingyear.Basedonaneconometricanalysisofconsumerspendingandeconomictrends,a
marketingresearchfirmestimatessalesof$1millionfornextyear.LloydSutter,thedistrictsales
manager,estimatessalesof$900,000.Thecontrollerseeksyouradviceontheestimatethatshouldbe
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usedindevelopingnextyear'sbudget.
Required
1. Whataretwopossibleexplanationsforthedifferencebetweenthemarketingfirm'sestimateand
Lloyd's?
2. Supposethatinsteadof$900,000,Lloydestimates$1.1millioninsales.Whataretwopossible
explanationsforthedifferencebetweenthemarketingfirm'sestimateandLloyd's?
3. DoanyoftheseexplanationssuggestunethicalbehaviorbyLloyd?
1337.BudgetRevisions:EthicalIssues
(LO138)
ElizabethJablonskiisthedirectorofResearchandDevelopmentforGalaxyElectronics.Lastweek,she
submittedthefollowingfundingrequestaspartoftheannualbudgetprocess.
Page519
Theaircraftguidancesystemisaprojectthecompanyhaspubliclyannouncedandismarketingstrongly
tomanufacturers.TheminiatureDVDprojecthasreceivedlittlesupportinthecompanybutisoneof
Elizabeth'sfavorites.Thechieffinancialofficerrequestsallgroupstorevisetheirbudgetsbecauseof
lowerthanexpectedsalesforthecompany.Departmentheadshavebeenaskedtosubmitnewbudgets
thatare10percentbelowtheiroriginalsubmissions.
Knowingthecompany'scommitmenttotheaircraftguidancesystem,Elizabethsubmitsthefollowing
revisionnotingthatitis10percentlowerasrequested.
Required
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1. WhatdoyouthinkElizabethistryingtoaccomplishwiththerevisedrequest?Isthisethical?
2. IsElizabethlikelytobesuccessfulinachievingthegoalyouidentifiedinrequirement(a)?
1338.SensitivityAnalysis
(LO139)
Sanjana'sSweetShoppeoperatesontheboardwalkofaNewEnglandcoastaltown.Thestoreonlyopens
forthesummerseasonandthebusinessisheavilydependentontheweatherandtheeconomyinaddition
tonewcompetition.SanjanaSweet,theowner,preparesabudgeteachyearafterreadinglongterm
weatherforecastsandestimatesofsummertourism.Thebudgetisafirststepinplanningwhethershe
willneedanyloansandwhethersheneedstoconsideradjustmentstostorestaffing.Basedonexpertise
andexperience,shedevelopsthefollowing:
Sanjanaassumes,forsimplicity,thatthegrossmarginandtheestimatednumberofcustomersare
independent.Thus,shehasninepossiblescenarios.Inadditiontothecostoftheproductssold,Sanjana
estimatesstaffingcoststobe$25,000plus$2foreverycustomerinexcessof20,000.Themarketingand
administrativecostsareestimatedtobe$10,000plus3percentofthegrossmargin.
Required
UseaspreadsheettoprepareananalysisofthepossibleoperatingincomeforSanjanasimilartothatin
Exhibit13.15.Whatistherangeofoperatingincomes?
1339.SensitivityAnalysis
(LO139)
BayAreaLimosoperatestransportationservicestoBayCityairport.Thepriceofserviceisfixedataflat
rateforeachtripandmostcostsofprovidingtheservicearefixedforeachtrip.BettySmith,theowner,
forecastsincomebyestimatingtwofactorsthatfluctuatewiththeeconomy:thefuelcostassociatedwith
thetripandthenumberofcustomerswhowouldtaketrips.Lookingatnextyear,Bettydevelopsthe
followingestimatesofcontributionmargin(pricelessvariablecosts,includingfuel)fortheestimated
numberofcustomers.Forsimplicity,sheassumesthatthefuelcosts(thereforethecontributionmargin
perride)andthenumberofcustomersareindependent.
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Page520
Inadditiontothecostsofaride,Bettyestimatesthatotherservicecostsare$45,000plus$5foreach
customer(ride)inexcessof4,500rides.Annualadministrativeandmarketingcostsareestimatedtobe
$20,000plus10percentofthecontributionmargin.
Required
UseaspreadsheettoprepareananalysisofthepossibleoperatingincomeforBayAreaLimossimilarto
thatinExhibit13.5.Whatistherangeofpossibleoperatingincomes?
PROBLEMS
AllapplicableProblemsareincludedinConnectAccounting
(LO136)
mhhe.com/lanen4e
Thefollowinginformationisavailableforyear1forDancerComponents:
Alldepreciationchargesarefixedandareexpectedtoremainthesameforyear2.Salesvolumeis
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expectedtoincreaseby18percent,butpricesareexpectedtofallby5percent.Materialcostsperunitare
expectedtodecreaseby8percent.Otherunitvariablemanufacturingcostsareexpectedtodecreaseby2
percentperunit.Fixedmanufacturingcostsareexpectedtoincreaseby5percent.
Variablemarketingcostswillchangewithvolume.Administrativecashcostsareexpectedtoincreaseby
10percent.Inventoriesarekeptatzero.Danceroperatesonacashbasis.
Required
Prepareabudgetedincomestatementforyear2.
1341.EstimateCashfromOperations
(LO135)
RefertothedatainProblem1340.Estimatethecashfromoperationsexpectedinyear2.
(LO134,6)
mhhe.com/lanen4e
CameronPartshasthefollowingdatafromyear1operations,whicharetobeusedfordevelopingyear2
budgetestimates:
Page521
Alldepreciationchargesarefixed.Oldmanufacturingequipmentwithanannualdepreciationchargeof
$14,550willbereplacedinyear2withnewequipmentthatwillincuranannualdepreciationchargeof
$21,000.Salesvolumeandpricesareexpectedtoincreaseby12percentand6percent,respectively.On
aperunitbasis,expectationsarethatmaterialscostswillincreaseby10percentandvariable
manufacturingcostswilldecreaseby4percent.Fixedmanufacturingcostsareexpectedtodecreaseby7
percent.
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Variablemarketingcostswillchangewithvolume.Administrativecashcostsareexpectedtoincreaseby
8percent.Inventoriesarekeptatzero.Cameronoperatesonacashbasis.
Required
Prepareabudgetedincomestatementforyear2.
1343.EstimateCashfromOperations
(LO135)
RefertothedatainProblem1342.Estimatethecashfromoperationsexpectedinyear2.
1344.PrepareaProductionBudget
(LO134)
mhhe.com/lanen4e
Chander,Inc.,manufacturesclothshoppingbags.Thecontrollerispreparingabudgetforthecoming
yearandasksforyourassistance.Thefollowingcostsandotherdataapplytobagproduction:
Youlearnthatequipmentcostsandbuildingoccupancyarefixedandarebasedonanormalproduction
of300,000unitsperyear.Otheroverheadcostsarevariable.Plantcapacityissufficienttoproduce
375,000unitsperyear.
Laborcostsperhourarenotexpectedtochangeduringtheyear.However,thecottonsupplierhas
informedChanderthatitwillimposea20percentpriceincreaseatthestartofthecomingbudgetperiod.
Noothercostsareexpectedtochange.
Duringthecomingbudgetperiod,Chanderexpectstosell270,000bags.Finishedgoodsinventoryis
targetedtoincreasefromthecurrentbalanceof60,000unitsto105,000unitstoprepareforanexpected
salesincreasetheyearafternext.Productionwilloccurevenlythroughouttheyear.Inventorylevelsfor
cottonandcanvasareexpectedtoremainunchangedthroughouttheyear.Thereisnoworkinprocess
inventory.
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Required
Prepareaproductionbudgetandestimatethematerials,labor,andoverheadcostsforthecomingyear.
1345.PrepareaProductionBudget
(LO134)
LotusFixtures,Inc.(LFI),manufacturessteelfittings.Eachfittingrequiresbothsteelandanalloythat
allowsthefittingtobeusedunderextremeconditions.Thefollowingdataapplytotheproductionofthe
fittings:
Page522
Theplantandequipmentdepreciationandmiscellaneouscostsarefixedandarebasedonproductionof
500,000unitsannually.Allothercostsarevariable.Plantcapacityis600,000unitsannually.Allother
overheadcostsarevariable.
Thefollowingareforecastforyear2.Contractnegotiationswiththeunionareexpectedtoleadtoan
increaseinhourlydirectlaborcostsof10percent,mostlyintheformofadditionalbenefits.Commodity
prices,includingsteel,areexpectedtodeclineby20percentduetotheeconomicslowdown.Alloyprices
areexpectedtoremainconstant.Plantandequipmentdepreciationcostsareexpectedtoincreaseby5
percent.Allotherunitoverheadcostsareexpectedtoremainconstant.
LFIexpectstosell420,000unitsinyear2.Thecurrentinventoryoffittingsis40,000unitsand
managementwouldliketoseeareductionofinventoryof20,000unitsbytheendoftheyear2.Steeland
alloyinventorieswillnotchange.Salesareapproximatelyuniformovertheyear.
Required
Prepareaproductionbudgetandestimatethematerials,labor,andoverheadcostsforyear2.
1346.SalesExpenseBudget
(LO134)
CapstoneCorporationhasjustreceiveditssalesexpensereportforJanuary,whichfollows.
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Youhavebeenaskedtodevelopbudgetedcostsforthecomingyear.Becausethismonthistypical,you
decidetoprepareanestimatedbudgetforatypicalmonthinthecomingyearandyouuncoverthe
followingadditionaldata:
Salesvolumeisexpectedtoincreaseby10percent.
Salespricesareexpectedtoincreaseby5percent.
Commissionsarebasedonapercentageofsalesrevenue.
Salesstaffsalarieswillincrease4percentnextyearregardlessofsalesvolume.
Buildingrentisbasedonafiveyearleasethatexpiresinthreeyears.
Telephoneandmailingexpensesarescheduledtoincreaseby8percentevenwithnochangein
salesvolume.However,thesecostsarevariablewiththenumberofunitssold,asarepackaging
anddeliverycosts.
Utilitiescostsarescheduledtoincreaseby15percentregardlessofsalesvolume.
Depreciationincludesfurnitureandfixturesusedbythesalesstaff.Thecompanyhasjustacquired
anadditional$17,100infurniturethatwillbereceivedatthestartofnextyearandwillbe
depreciatedovera10yearlifeusingthestraightlinemethod.
Marketingconsultantexpenseswereforaspecialadvertisingcampaignthatrunsfromtimetotime.
Duringthecomingyear,thesecostsareexpectedtoaverage$31,500permonth.
Required
Prepareabudgetforsalesexpensesforatypicalmonthinthecomingyear.
Page523
1347.BudgetedPurchasesandCashFlows
(LO134,5,6)
Delhi,Inc.,seeksyourassistanceindevelopingcashandotherbudgetinformationforAugust,
September,andOctober.AtJuly31,thecompanyhadcashof$22,000,accountsreceivableof
$1,748,000,inventoriesof$1,237,600,andaccountspayableof$532,220.Thebudgetistobebasedon
thefollowingassumptions.
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Eachmonth'ssalesarebilledonthelastdayofthemonth.
Customersarealloweda3percentdiscountifpaymentismadewithin10daysafterthebilling
date.Receivablesarerecordedintheaccountsattheirgrossamounts(notnetofdiscounts).
Thebillingsarecollectedasfollows:60percentwithinthediscountperiod,25percentbytheend
ofthemonth,and9percentbytheendofthefollowingmonth.Sixpercentisuncollectible.
Purchasedataareasfollows.
Ofallpurchasesofmerchandiseandselling,general,andadministrativeexpenses,54percentis
paidinthemonthpurchasedandtheremainderinthefollowingmonth.
Thenumberofunitsineachmonth'sendinginventoryequals130percentofthenextmonth'sunits
ofsales.
Thecostofeachunitofinventoryis$20.
Selling,general,andadministrativeexpenses,ofwhich$8,000isdepreciation,equal15percentof
thecurrentmonth'ssales.
Actualandprojectedsalesfollow:
Required
Computethefollowing:
1. BudgetedpurchasesindollarsforAugust.
2. BudgetedpurchasesindollarsforSeptember.
3. BudgetedcashcollectionsduringAugust.
4. BudgetedcashdisbursementsduringSeptember.
5. ThebudgetednumberofunitsofinventorytobepurchasedduringOctober.
(CPAadapted)
1348.ComprehensiveBudgetPlan
(LO134,5,6)
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Brighton,Inc.,manufactureskitchentiles.Thecompanyrecentlyexpanded,andthecontrollerbelieves
thatitwillneedtoborrowcashtocontinueoperations.Itbegannegotiatingforaonemonthbankloanof
$500,000startingMay1.Thebankwouldchargeinterestattherateof1percentpermonthandrequire
thecompanytorepayinterestandprincipalonMay31.Inconsideringtheloan,thebankrequesteda
projectedincomestatementandcashbudgetforMay.
Thefollowinginformationisavailable:
Thecompanybudgetedsalesat600,000unitspermonthinApril,June,andJulyandat450,000
unitsinMay.Thesellingpriceis$4perunit.
TheinventoryoffinishedgoodsonApril1was120,000units.Thefinishedgoodsinventoryatthe
endofeachmonthequals20percentofsalesanticipatedforthefollowingmonth.Thereisnowork
inprocess.
TheinventoryofrawmaterialsonApril1was57,000pounds.Attheendofeachmonth,theraw
materialsinventoryequalsnolessthan40percentofproductionrequirementsforthefollowing
month.Thecompanypurchasesmaterialsinquantitiesof62,500poundspershipment.
Page524
Sellingexpensesare10percentofgrosssales.Administrativeexpenses,whichinclude
depreciationof$2,500permonthonofficefurnitureandfixtures,total$165,000permonth.
Themanufacturingbudgetfortiles,basedonnormalproductionof500,000unitspermonth,
follows:
Required
1. Prepareschedulescomputinginventorybudgetsbymonthsfor
1. ProductioninunitsforApril,May,andJune.
2. RawmaterialspurchasesinpoundsforAprilandMay.
2. PrepareaprojectedincomestatementforMay.Costofgoodssoldshouldequalthevariable
manufacturingcostperunittimesthenumberofunitssoldplusthetotalfixedmanufacturingcost
budgetedfortheperiod.Assumecashdiscountsof1percentandbaddebtexpenseof0.5percent.
(CPAadapted)
1349.ComprehensiveBudgetPlan
(LO134,5,6)
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mhhe.com/lanen4e
PantherCorporationappearedtobeexperiencingagoodyear.Salesinthefirstquarterwereonethird
aheadoflastyear,andthesalesdepartmentpredictedthatthisratewouldcontinuethroughouttheentire
year.ThecontrolleraskedJanetNomura,asummeraccountingintern,toprepareadraftforecastforthe
yearandtoanalyzethedifferencesfromlastyear'sresults.Shebasedtheforecastonactualresults
obtainedinthefirstquarterplustheexpectedcostsofproductiontobecompletedintheremainderofthe
year.Sheworkedwithvariousdepartmentheads(production,sales,andsoon)togetthenecessary
information.Theresultsoftheseeffortsfollow:
Page525
Adjustmentsforthechangeininventoryandforincometaxeshavenotbeenmade.Thescheduled
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productionforthisyearis450,000units,andplannedsalesvolumeis400,000units.Salesand
productionvolumewas300,000unitslastyear.ThecompanyusesafullabsorptioncostingandFIFO
inventorysystemandissubjecttoa40percentincometaxrate.Theactualincomestatementforlastyear
follows:
Required
Preparedabudgetedincomestatementandbalancesheet.
(CMAadapted)
INTEGRATIVECASE
1350.PrepareCashBudgetforServiceOrganization
(LO134,5,6,7)
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TheboardofdirectorsoftheCortezBeachYachtClub(CBYC)isdevelopingplanstoacquiremore
equipmentforlessonsandrentalsandtoexpandclubfacilities.Theboardplanstopurchaseabout
$50,000ofnewequipmenteachyearandwantstobeginafundtopurchasea$600,000pieceofproperty
forclubexpansion.
Page526
Theclubmanagerisconcernedabouttheclub'scapabilitytopurchaseequipmentandexpandits
facilities.Oneclubmemberhasagreedtohelppreparethefollowingfinancialstatementsandhelpthe
managerascertainwhethertheplansarerealistic.Additionalinformationfollowsthefinancial
statements.
AdditionalInformation
1. OtherfinancialinformationasofOctober31,Year9:
1. Cashincheckingaccount,$14,000.
2. Pettycash,$600.
3. Outstandingmortgagebalance,$720,000.
4. AccountspayableforsuppliesandutilitiesunpaidasofOctober31,Year9,andduein
NovemberYear9,$5,000.
2. Theclubpurchased$50,000worthofsailingequipmentduringthecurrentfiscalyear(ending
October31,Year9).Cashof$20,000waspaidondelivery,withthebalancedueonOctober1,
whichhadnotbeenpaidasofOctober31,Year9.
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3. Theclubbeganoperationsinyear3inrentalquarters.InOctoberYear5,itpurchaseditscurrent
property(landandbuilding)for$1,200,000,paying$240,000downandagreeingtopay$60,000
plus6percentinterestannuallyonthepreviouslyunpaidloanbalanceeachNovember1,starting
November1,Year6.
4. Membershiprose3percentduringyear9,approximatelythesameannualrateofincreasetheclub
hasexperiencedsinceitopenedandthatisexpectedtocontinueinthefuture.
5. Membershipfeeswereincreasedby15percentinyear9.Theboardhastentativeplanstoincrease
themby10percentinyear10.
6. Lessonandclassfeeshavenotbeenincreasedforthreeyears.Thenumberofclassesandlessons
hasgrownsignificantlyeachyearthepercentagegrowthexperiencedinyear9isexpectedtobe
repeatedinyear10.
7. Miscellaneousrevenuesareexpectedtogrowinyear10(overyear9)atthesamepercentageas
experiencedinyear9(overyear8).
8. Lessonandclassemployeeswagesandbenefitswillincreaseto$604,650.Thewagesandbenefits
ofregularemployeesandthemanagerwillincrease15percent.Equipmentdepreciationand
supplies,utilities,andmiscellaneousexpensesareexpectedtoincrease25percent.
Page527
Required
1. Constructacashbudgetforyear10forCortezBeachYachtClub.
2. Identifyanyoperatingproblem(s)thatthisbudgetdisclosesforCBYC.Explainyouranswer.
3. Isthemanager'sconcernthattheboard'sgoalsareunrealisticjustified?Explainyouranswer.
(CMAadapted)
SOLUTIONSTOSELFSTUDYQUESTIONS
1. Budgetedproductionis:
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2.
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3.
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Footnotes
1MichaelJensen,CorporateBudgetingIsBrokenLet'sFixIt,HarvardBusinessReview79(no.10):
95andJeremyHopeandRobinFraser,BeyondBudgeting(Watertown,MA:HarvardBusinessSchool
Press,2003).
2http://www.ge.com/as2007/ltr_highperf.jsp.
3Ifthecompanyhasbeginningandendingworkinprocessinventories,unitsareusuallyexpressedas
equivalentfinishedunitsandtreatedthewaywehavetreatedfinishedgoodsinventories.Inmost
companies,estimatesofworkinprocessinventoriesareomittedfromthebudgetbecausetheyhavea
minimalimpactonthebudget.
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