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The Master Budget

Questions

1. Budgeting translates goals and objectives into the required resources, activities, and arrangements needed to accomplish those goals and objectives. The translation is extended to assign activities and allocate resources to departments and personnel who are responsible for execution of the budget.

2. The strategic plan defines the basic

purposes and goals of an organization. As such, the strategic plan identifies the key variables that will largely determine the success of the organization. Some of the major factors taken into account in formulating the strategic plan include the state of the local and global economy, trends in technology and materials, and the legislative and political climates.

3. Longer term (strategic) plans contain

insufficient detail to direct a business. Although the longer term plans provide general direction for a business, they are too vague to provide guidance on a day-to-day basis. Consequently, shorter term (tactical) plans are compiled to implement the longer term plans for a specific period. The shorter term plans can be made with greater attention given to current organizational and environmental constraints (current market, material and labor conditions). Also, the roles of specific middle- and lower- level managers can be determined in the detailed short-term plans.

4. The budget represents the cornerstone for

a company’s management planning system. Budgeting utilizes goals, objectives, and forecasts in developing plans for production, revenues, costs, cash flows, and resource procurement. Budgeting originates with strategic planning. As goals are implemented and programs developed, management needs information about various alternatives so

they can be evaluated. When a specific plan of action is determined, the budget becomes management’s master plan.

Control is really an extension of planning rather than a separate managerial function. Without formal planning, there can be little control.

5. An operating budget presents units

expected to be sold or used by a company and the price/costs associated with those units. The sales and production budgets are operating budgets. Financial budgets detail the funds to be generated or used during the budget period (cash budget and capital expenditure budget). The results from the operating budgets are the sources of input for the financial budgets. For example, sales projected in the sales budget impact the cash collections/receipts portion of the cash budget.

6. The master budget begins with a "demand

driven" estimate of sales. It is, however, possible that demand does not "exist" at the point the budget is prepared (for example, when the company is introducing a new product); thus, estimates would be made about sales. Without sales or expected sales, the company would have no need to acquire resources or remain in operation.

The production is prepared next as it follows directly from the sales budget. The production and purchases budgets are similar in that they begin with a key variable to their particular area, add ending inventory, and subtract beginning inventory. These budgets differ in that the key variable for the production area is sales, but the key variable for purchases is production. The production budget is used to schedule needed material, labor, and overhead. The purchases budget is used to determine the amount and timing

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of material input to the production process as well as provide input into the cash budget as to the amount and timing of cash disbursements for such purchases.

To predict overhead cost for a specific volume of production, costs must be separated into those that are volume dependent (variable costs), and those that are volume independent (fixed costs). The expected overhead for a given period is the sum of the projected fixed cost plus the total variable cost. The total variable cost is a function of the variable cost per unit and the expected volume of production.

Selling and administrative budgets follow and then the cash budget is prepared. Managers estimate collections from sales through historical company data on collection patterns, industry trends/patterns, and judgment. Current economic information can play an important part in estimating the collection pattern since inflation or deflation, interest rates, and employment affect both business and consumer ability to pay.

Cash collections are important in the budgeting process because of their impact on the cash budget and the availability of funds with which to make disbursements for operating and capital expenditures, and ownership distributions.

After all of these budgets are prepared, a pro forma set of financial statements is prepared to visualize the financial expected results of operations and balance sheet position.

This sequence is necessary because the information from one budget is often a primary input into another budget.

7. A firm’s production budget is influenced by

the finished goods inventory policy because that policy dictates the quantity of goods that are expected to be on hand at the end of the period. Thus, a company cannot simply make production equal to sales if some finished goods are expected. Additionally, the finished goods from one period become the

beginning inventory for the next period, which also influences the quantity of production needed. The computation for production is sales plus desired finished goods inventory minus beginning inventory.

8. Cash is a very important resource for an

organization because it is the medium of exchange for organizational inputs and outputs. A shortage of cash creates liquidity problems and may prevent the firm from acquiring inputs that are crucial to its survival. A firm can cover periods of cash shortages with loans, equity sales, or sales of assets.

9. They are similar in that they both focus on

the balance of cash and explain the change in cash balance over a period of time. However, there are substantial differences between the two. For example, the cash budget typically covers shorter time periods and has as its primary objective the identification of periods of cash shortages and cash excesses. The statement of cash flows has as its primary purpose the identification of the activities (operating, investing, and financing) that explain the change in the cash balance for a period.

10. Budgetary slack results from an

overestimation of expected expenses or an underestimation of expected revenues so that the budget will be more easily achieved. Because managerial performance is evaluated based on a comparison of actual and budgeted performance, the actual performance will appear to be more favorable if sufficient slack is impounded in the budget.

11. The budget manual provides for standards

of performance and quality control in the budgeting process. Having and using a budget manual communicates top management’s commitment to an effective budgeting process for lower-level managers.

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Exercises

12. Business loans ($3,000,000 x .065) $195,000 Consumer loans ($2,000,000 x .13) 260,000 Investments ($800,000 x .035) 28,000 Total projected revenue $483,000 13. January February March Budgeted sales 25,600 24,000 32,000 Ending inventory 12,000 16,000 19,200 Total required 37,600 40,000 51,200 Beginning inventory (7,400) (12,000) (16,000) Budgeted production 30,200 28,000 35,200 14. Quarter Total 1st 2nd 3rd 4th Sales 540,000 680,000 490,000 550,000 2,260,000 End. inv. 68,000 49,000 55,000 60,000 60,000 Total 608,000 729,000 545,000 610,000 2,320,000 Beg. inv. (54,000) (68,000) (49,000) (55,000) (54,000) Production 554,000 661,000 496,000 555,000 2,266,000 15. Sales of boots 42,960 EI of boots 5,800 Total 48,760 BI of boots (2,152) Production 46,608 46,608 x 2.5 ft. = 116,520 ft. 116,520 ft. ÷ 3 ft. per yard = 38,840 yards Yards needed for production 38,840 Ending inventory 3,000 Total 41,840 Beginning inventory (2,000) Yards to purchase 39,840 16. a., b. Sales (feet) 380,000 EI 20,000 Total 400,000 BI (24,500) Production 375,500

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Concrete Gravel Production in ft. 375,500 375,500 Lbs. per ft. x 8 x 15 Lbs. for prod. 3,004,000 5,632,500 EI 68,600 92,500 Total 3,072,600 5,725,000 BI (82,000) (65,300) Purchase (lbs) 2,990,600 5,659,700 Cost per lb. x $0.11 x $0.05 Cost $ 328,966 $ 282,985 17. a. Boxes Trays Total Production budget Units of sales 84,000 60,000 144,000 Units desired in ending inv. 1,200 450 1,650 Units needed 85,200 60,450 145,650 Units in beginning inv. (1,000) (300) (1,300) Budgeted production 84,200 60,150 144,350 b. Purchases budget - Material A Total Pounds needed for production: (84,200 x 2) + (60,150 x 1) = (168,400 + 60,150) 228,550 Desired ending inventory 2,500 Total requirements 231,050 Less beginning inventory (2,000) Pounds to be purchased 229,050 Cost per pound x $0.05 Total cost of Material A purchases $11,452.50 Purchases budget - Material B Pounds needed for production: (84,200 x 3) + (60,150 x 4) = (252,600 + 240,600) 493,200 Desired ending inventory 3,400 Total requirements 496,600 Less beginning inventory (5,000) Pounds to be purchased 491,600 Cost per pound x .08 Total cost of Material B purchases $39,328 Material purchases: Material A 229,050 lbs. $11,452.50 Material B 491,600 lbs. 39,328.00 Total 720,650 lbs. $50,780.50 Materials purchases budget – Boxes Purchase requirements for production: Material A (84,200 x 2 x $0.05) $ 8,420.00 Material B (84,200 x 3 x $0.08) 20,208.00

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Total cost of materials for box production $26,628.00

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Materials purchases budget – Trays Purchase requirements for production: Material A (60,150 x 1 x $0.05) $ 3,007.50 Material B (60,150 x 4 x $0.08) 19,248.00 Total cost of materials for tray production $22,255.50 c. Direct labor budget Required hours: Boxes (84,200 x 2) 168,400 Trays (60,150 x 0.5) 30,075 198,475 d. Overhead budget Boxes Trays Activity base (hours) 168,400 30,075 Multiply by rate x $1.60 x $1.60 Overhead applied $269,440 $48,120 $317,560 18. a. January February March Nov. sales (30% × $41,500) $12,450 Dec. sales (30% × $38,000) 11,400 Dec. sales (30% × $38,000) $11,400 Jan. sales (40% × $39,500 × 99%) 15,642 Jan. sales (30% × $39,500) 11,850 Jan. sales (30% × $39,500) $11,850 Feb. sales (40% × $44,000 × 99%) 17,424 Feb. sales (30% × $44,000) 13,200 Mar. sales (40% × $29,500 × 99%) 11,682 Total collections $39,492 $40,674 $36,732 b. Feb. sales to be collected in April (30% × $44,000) $13,200 Mar. sales to be collected in April (30% × $29,500) 8,850 Mar. sales to be collected in May (30% × $29,500) 8,850 Total A/R balance at March 31 $30,900 19. a. $607,500 Balance at October 1 (450,000) Remainder of September billings $157,500 Remainder of August billings ÷ 25% % of August billings uncollected at end of September $630,000 August billings

b. $450,000 Remainder of September billings ÷ 80% % uncollected at end of September

$562,500 September billings x 3% % estimated uncollectible $ 16,875 Total September billings expected to be uncollectible c. October collections of August billings ($630,000 × 22%) $138,600 October collections of September billings ($562,500 × 55%) 309,375

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October collections of October billings ($900,000 × 20%)

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180,000 Total October collections $627,975 20. a. $173,250 Balance at May 31 ( 135,000) Remainder of May credit sales $ 38,250 Remainder of April credit sales ÷ 15% % of April credit sales uncollected at end of May $255,000 April sales on credit ÷ 75% % of total sales made on credit $340,000 Total April sales

b. $135,000 Remainder of May credit sales ÷ 40% % of May credit sales uncollected at end of May

$337,500 May credit sales c. June collections of April credit sales $ 38,250 June collections of May credit sales ($337,500 × 25%) 84,375 June cash sales ($850,000 × 25%) 212,500 June collections of June credit sales ($850,000 × 75% × 60%) 382,500 Total June collections $717,625 d. Balance from May sales ($337,500 × 15%) $ 50,625 Balance from June sales ($637,500 × 40%) 255,000 Total June 30 A/R balance $305,625 21. Income after taxes $560,000 Accrued income tax expense (no cash involved) 41,000 Decrease in A/R (collected more than sold) 4,000 Decrease in A/P (paid for more than purchased) (3,500) Depreciation (no cash involved) 23,100 Estimated bad debts (no cash involved) 2,050 Dividends paid (20,000) Projected increase in cash $606,650 22. CGS [$2,000,000 x (1.00 - 0.40)] $1,200,000 Less decr. in inventory (sold more than bought) (33,750) Plus decr. in A/P (paid for more than bought) 40,000 Cash payments for inventory $1,206,250 Wages expense 512,500 Other cash expenses 235,250 Total cash disbursements $1,954,000

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23.

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April May June Total Beginning cash balance $ 3,700 $ 3,600 $ 3,600 $ 3,700 Cash receipts 8,200 10,100 16,900 35,200 Total cash available $11,900 $13,700 $20,500 $38,900 Cash disbursements: Payments on account $ 1,300 $ 3,900 $ 5,700 $10,900 Wage expenses 5,000 6,100 6,200 17,300 Overhead costs 4,000 4,600 4,400 13,000 Total disbursements $10,300 $14,600 $16,300 $41,200 Cash excess (inadequacy) $ 1,600 $ (900) $ 4,200 $ (2,300) Minimum cash balance (3,500) (3,500) (3,500) (3,500) Cash available (needed) $ (1,900) $ (4,400) $ 700 $ (5,800) Financing: Borrowings (repayments) $ 2,000 $ 4,500 $ (500) $ 6,000 Sell (acquire) investments 0 0 0 0 Receive (pay) interest 0 0 (10) (10) Ending cash balance $ 3,600 $ 3,600 $ 3,690 $ 3,690 24. a. CGS = $5,000,000 + (0.40 × $20,000,000) = $13,000,000 b. CGS [$900,000 x (1 - 0.35)] $585,000 Increase in Inventory 40,000 Decrease in Accounts Payable 34,000 Total cash payment for inventories $659,000 25. New sales in units = 50,000 x 1.20 = 60,000 New DM cost per unit = [($200,000 ÷ 50,000) x 1.10] = $4.40 New DL cost per unit = [($100,000 ÷ 50,000) x 1.10] = $2.20 Overhead rate = $50,000 ÷ $100,000 = 50% of DL cost Variable selling expenses = $50,000 - $12,000 = $38,000 $38,000 ÷ $500,000 = 7.6% of sales Desired NI = 10% of Sales Sales – CGS – Selling Exp. – Admin. Exp. = Net Income Sales – DM – DL – OH – SE – AE = NI

Sales – ($4.40 x 60,000) – ($2.20 x 60,000) – [0.5($2.20 x 60,000) - $12,000 – (0.076 x Sales) - $60,000 = (0.10 x Sales)

Sales - $264,000 - $132,000 - $66,000 - $12,000 - (0.076 x Sales) - $60,000 = (0.10 x Sales)

Sales - $534,000 - (0.076 x Sales) = (0.10 x Sales) Sales - (0.076 x Sales) - (0.10 x Sales) = $534,000 .824 Sales = $534,000 Sales = $648,058 (rounded) Selling price per unit = $648,058 ÷ 60,000 = $10.80 (rounded)

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Sales (60,000 x $10.80) $648,000 Cost of Goods Sold Direct Material $264,000 Direct Labor 132,000 Overhead 66,000 (462,000) Gross profit $186,000 Expenses Selling* ($12,000 + $49,248) $ 61,248 Administrative 60,000 (121,248) Net income before taxes $ 64,752

* Variable Selling Expenses = (0.076 × $648,000) = $49,248 Proof: $64,752 ÷ $648,000 = 9.99% (off due to rounding) 26. a. Beginning balance $ 750,000 July credit sales 900,000 Cash collections in July (660,000) Write-offs in July (27,000) Ending balance $ 963,000 b. Cash collections, $660,000 c. Credit sales, $900,000, and the provision for uncollectible accounts,

$20,000. (CPA adapted) 27. Global Co.

Pro Forma Income Statement For the Month Ended May 31, 2006

Sales $400,000 Cost of goods sold ($400,000 ÷ 1.60) (250,000) Gross margin $150,000 Selling and administrative expenses $55,000 Depreciation expense 8,000 Bad debts expense ($400,000 × 0.025%) 10,000 (73,000) Net income $ 77,000

(CPA adapted) 28. a. Sales (120,000 x $25) $3,000,000 Variable costs (.75 x $3,000,000) (2,250,000) Fixed costs (400,000) Net income $ 350,000 b. Sales (120,000 x $25) $3,000,000 Variable costs (.65 x $2,250,000) (1,462,500)

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Fixed costs* (750,000) Net income $ 787,500 *Depreciation is included in fixed costs c. Assuming all costs related to the machine have been considered in the

analysis, the machine should be acquired because income will increase significantly.

29. The spend-it-or-lose-it attitude is induced by the incentives in the budget and

evaluation cycle. It is much likelier that a manager will be called to task for overspending rather than underspending the budget. This induces the manager to build slack into the budget. Partly because of the slack in the budget, managers may find themselves in an "underspent" position near the end of the fiscal year. If the manager ends the year with a big budget surplus, the slack built into the budget would be revealed. Naturally, the manager would be fearful of revealing the budgetary slack because a consequence would be that a smaller budget would be awarded in ensuing years.

Both superior and subordinate managers have an ethical obligation to overcome the spend-it-or-lose-it attitude. Honest communication between upper and lower managers is the fastest approach to curing this attitude. Further, upper managers have an obligation to provide incentives to lower managers that do not encourage the spend-it-or-lose-it attitude.

30. Continuous budgeting means that a budget that covers the coming 12 months

of operations is constantly maintained. As one month expires, another month is added to the budget. The advantage of the continuous budget is that a constant planning horizon of 12 months is maintained. If only annual budgets are prepared, the budget covers a fixed period, typically one year. Because budgeting is an ongoing activity, budgeting skills are maintained throughout the year and the time crunch that typically accompanies annual budgeting is avoided. One further benefit is that a continuous budget may be more flexible in that revisions can be made as conditions warrant. The main disadvantage of the continuous budget is the time dedicated to planning activities. Continuous budgeting is more time intensive because planning activities are always under way.

31. Each student will have a different answer. No solution provided. 32. a. Competitors’ actions are extremely important to business planning

because those actions will probably affect whether the planning company will succeed in its planned activities. Competitors may decide to offer new products, making other products obsolete; competitors may decide to enter or expand their markets, creating a market decline for other companies; competitors may lower prices, forcing others offering the same or similar products do also lower product prices or increase advertising that would explain higher prices to consumers.

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b. Competitors’ actions may affect internal planning activities because of the

implications of those actions on sales and related production figures. Also, actions such as “no-interest” installment promotions may impact sales and collection patterns. Changes in products may require changes in production technology or labor needs.

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c. Other internal factors that will affect the budgeting process are marketing promotions that are being planning, capital budgeting purchases and payments, stock or bond issuances, new management strategies (such as market entrances or departures), expansion or contraction of the company’s sales force, and technological changes that could affect training needs.

Other external factors that will affect the budgeting process are interest rate changes, war or threats of war, expansion or contraction of oil (or other raw material) supplies, and changes in minimum wage laws.

Problems

33. Production Budget - 2006 Jan.-June July-Dec. Total Sales budget 580,000 720,000 1,300,000 Ending inventory 36,000 60,000 60,000 Beginning inventory (25,000) (36,000) (25,000) Production 591,000 744,000 1,335,000 Material A Purchases Budget - 2006 Jan.-June July-Dec. Total Production 591,000 744,000 1,335,000 Number of pounds x 4 x 4 x 4 Production budget 2,364,000 2,976,000 5,340,000 Ending inventory 135,000 142,000 142,000 Beginning inventory (120,000) (135,000) (120,000) Purchases 2,379,000 2,983,000 5,362,000 Times cost per lb. x $1.25 x $1.25 x $1.25 Total cost $2,973,750 $3,728,750 $6,702,500 Material B Purchases Budget - 2006 Jan.-June July-Dec. Total Production 591,000 744,000 1,335,000 Number of gallons x 3 x 3 x 3 Production budget 1,773,000 2,232,000 4,005,000 Ending inventory 35,000 38,000 38,000 Beginning inventory (45,000) (35,000) (45,000) Purchases 1,763,000 2,235,000 3,998,000 Times cost per gal. x $0.80 x $0.80 x $0.80 Total cost $1,410,400 $1,788,000 $3,198,400

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34. a. Sales budget 300,000 Ending inventory (375,000 × 0.05) 18,750 Beginning inventory (12,300) Production Budget 306,450 cans b. Tea Purchases Budget (pounds); Production budget [306,450 x (14 ÷ 16)] 268,143.75 Ending inventory [18,750 x (14 ÷ 16)] 16,406.25 Beginning inventory (750.00) Purchases 283,800.00 c. Sugar Purchases Budget (pounds) Production budget [306,450 x (2 ÷ 16)] 38,306.25 Ending inventory [18,750 x (2 ÷ 16)] 2,343.75 Beginning inventory (200.00) Purchases 40,450.00 d. ($3.50 × 283,800) + ($0.40 × 40,450) = $993,300 + $16,180 = $1,009,480 e. ($1,009,480 × 0.30) × 0.98 = $296,787.12 35. a. January February March Total Sales 3,200 2,600 3,700 9,500 Ending inventory 650 925 900 900 Beginning inventory (800) (650) (925) (800) Production 3,050 2,875 3,675 9,600 b. (Felt) January February March Total Production (yds.) 2,287.50 2,156.25 2,756.25 7,200.00 End. inv. 431.25 551.25 540.00 540.00 Beg. inv. (457.50) (431.25) (551.25) (457.50) Purchases 2,261.25 2,276.25 2,745.00 7,282.50 Cost per yd. x $5.00 x $5.00 x $5.00 x $5.00 $ of purchases $11,306.25 $11,381.25 $13,725.00 $36,412.50 (Ribbon) January February March Total Production (in.) 61,000 57,500 73,500 192,000 End. Inv. 11,500 14,700 14,400 14,400 Beg. Inv. (12,200) (11,500) (14,700) (12,200) Purchases 60,300 60,700 73,200 194,200 Cost per inch x $0.15 x $0.15 x $0.15 x $0.15 $ of purchases $ 9,045.00 $ 9,105.00 $10,980.00 $29,130.00 Total purchases $20,351.25 $20,486.25 $24,705.00 $65,542.50

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c. Month of Payment

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January February March Total Month of purchase: December $ 3,800.00 $ 3,800.00 January 15,955.38 $ 4,070.25 20,025.63 February 16,061.22 $ 4,097.25 20,158.47 March 19,368.72 19,368.72 Totals $19,755.38 $20,131.47 $23,465.97 $63,352.82 d. January February March Total Factory overhead: $5,200 + $1.25(unit) $ 9,012.50 $ 8,793.75 $ 9,793.75 $27,600.00 Non-factory overhead: $2,800 + 10% (rev.) 8,560.00 7,480.00 9,460.00 25,500.00 Totals $17,572.50 $16,273.75 $19,253.75 $53,100.00 e. January February March Total Beg. Balance $18,760.00 $12,312.12 $12,346.90 $ 18,760.00 Collections 58,080.00 48,960.00 62,640.00 169,680.00 Cash available $76,840.00 $61,272.12 $74,986.90 $188,440.00 Cash needed: Purchases $19,755.38 $20,131.47 $23,465.97 $ 63,352.82 Overhead 17,572.50 16,273.75 19,253.75 53,100.00 DL ($4 per hat) 12,200.00 11,500.00 14,700.00 38,400.00 Taxes 5,000.00 0.00 0.00 5,000.00 Bonuses 15,000.00 0.00 0.00 15,000.00 Total $69,527.88 $47,905.22 $57,419.72 $174,852.82 Cash excess $ 7,312.12 $13,366.90 $17,567.18 $ 13,587.18 Min. Balance 12,000.00 12,000.00 12,000.00 12,000.00 Cash (needed) avail. $ (4,687.88) $ 1,366.90 $ 5,567.18 $ 1,587.18 Financing: Borrow (repay) 5,000.00 (1,000.00) (4,000.00) 0.00 Sell (invest) (1,000.00) (1,000.00) Receive (pay) interest 0.00 (20.00) (120.00) (140.00) Ending cash balance $12,312.12 $12,346.90 $12,447.18 $ 12,447.18 36. a. $1,200,000 ÷ 0.60 = $2,000,000 b. ($2,000,000 × 0.70) - ($1,200,000 - $75,000) = $275,000 c. Total expenses = 85% of sales Total variable costs = 70% of sales Total fixed costs = 85% - 70% = 15% Fixed costs = 0.15 x $2,000,000 = $300,000 Fixed S&A expenses = $300,000 - $75,000 = $225,000

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d. Cash receipts: $2,000,000 × 0.55 = $1,100,000

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Total expenses: $2,000,000 × 0.85 = $1,700,000 Depreciation (37,500) Pending expenses $1,662,500 Percent paid in cash x 0.65 Cash disbursement $1,080,625

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37. a. January sales: ($34,560 + $1,440) ÷ 0.50 = $72,000

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Collections = (72,000 x 0.48) + ($120,000 x 0.50) = $34,560 + $60,000 = = $94,560

b. Beginning inventory $ 52,400 Purchases ($120,000 x 0.65 x 0.60) + ($130,000 x 0.65 x 0.30) 72,150 Cost of Goods Sold ($120,000 × 0.65) (78,000) Ending inventory $ 46,550 c. First determine expected earnings for February: Sales $120,000 CGS (78,000) Gross margin $ 42,000 Operating expenses (21,500) Net income $ 20,500 Beginning balance, RE $ 39,760 Expected net income 20,500 Ending balance $ 60,260 d. Beginning balance $ 12,000 Cash collections 94,560 Cash available $106,560 Cash disbursements: Accounts Payable $70,200 Other ($21,500 - $4,000) 17,500 (87,700) Cash available $ 18,860

Since there is $18,860 of cash available and the minimum cash balance is $8,000, there is $10,860 available for investment.

38. a. Billed Collected 6/10 7/10 $600,000 × 0.8 × 0.5 × 0.18 6/20 7/20 $800,000 × 0.8 × 0.5 × 0.18 7/10 7/20 $800,000 × 0.8 × 0.5 × 0.80 × 0.98 7/20 7/30 $700,000 × 0.8 × 0.5 × 0.80 × 0.98 6/10 $ 43,200 6/20 57,600 7/10 250,880 7/20 219,520 $571,200 b. Billed Collected 8/20 9/20 $800,000 × 0.8 × 0.5 × 0.18 9/10 9/20 $800,000 × 0.8 × 0.5 × 0.80 × 0.98 8/20 $ 57,600 9/10 250,880

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$308,480 c. ($600,000 × 0.70) × 0.25 = $105,000 d. ($800,000 × 0.70 × 0.75) + ($700,000 × 0.70 × 0.25) = $420,000 + $122,500 = $542,500 e. July purchases: ($700,000 × 0.70 × 0.75) + ($800,000 × 0.70 × 0.25) = $367,500 + $140,000 = $507,500 August purchases: ($800,000 X 0.70 × 0.75) + ($600,000 × 0.70 × 0.25) = $420,000 + $105,000 = $525,000 August payments: ($507,500 + $525,000) × 0.50 = $516,250

(CMA adapted) 39. Freeman Manufacturing

Cash Budget For Years Ending March 31, 2007 and 2008

2007 2008 Beginning cash bal. $ 0 $ 75,000 Collections-Schedule A 825,000 1,065,000 Total $ 825,000 $1,140,000 Disbursements: Direct Material - Schedule B $ 220,000 $ 249,167 Direct Labor* 300,000 375,000 Variable overhead** 100,000 125,000 Fixed costs 130,000 130,000 Total (750,000) (879,167) Cash available $ 75,000 $ 260,833 Cash received from sale of A/R & inventories 90,000 (2) 0 Total cash available $ 165,000 $ 260,833 Payments to creditors (90,000) (2) (260,833) Ending cash balance (1) $ 75,000 $ 0 *At $30 per unit produced. **At $10 per unit produced. (1) This amount could be used to pay general creditors or carried forward to the beginning of next year.

(2) ($600,000 × 60%) - ($50,000 + $40,000) = $360,000 – $90,000 = $270,000 - $260,833 = $9,167 still owed to creditors

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Schedule A (Collections from Customers): 2007 2008 Sales $900,000 $1,080,000 Beg. A/R 0 75,000 Total $900,000 $1,155,000 End. A/R (1/12) (75,000) (90,000) Collections $825,000 $1,065,000 Schedule B (Disbursements for Direct Material): 2007 2008 Unit sales 10,000 12,000 Required ending inventory 2,000 (3) 2,500 (4) Total needed 12,000 14,500 Beginning inventory 0 (2,000) Total units produced 12,000 12,500 Times DM cost per unit x $20 x $20 Total purchases $240,000 $250,000 Delayed payment (1/12) (20,000) (20,833) Paid previous balance 0 20,000 Disbursements $220,000 $249,167 (3) 12,000 units × 2/12 = 2,000 (4) 15,000 units × 2/12 = 2,500

(CMA adapted)

Chapter 8

40. a., b. (Supporting calculations for these requirements are keyed to the

amounts and follow the cash budgets.)

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CME, INC.

Cash Budgets (Dollars in thousands)

For Year Ending For Month Ending December 31, 2006 January 31, 2006 Cash balance, Jan.1 $ 750 $ 750 Cash receipts: Program revenue 12,000 1,440 (3) Membership income 10,000 (1) 0 Total cash available $22,750 $2,190 Cash outflows: Seminar Instruction fees $ 8,400(2) $ 0 Facilities 5,600 672 (4) Promotion 1,000 100 (5) Total $15,000 $ 772 Salaries 960 80 (6) Benefits, staff 240 18 (7) Office lease 240 20 (8) Gen. admin. 1,500 125 Gen. promotion 600 50 (9) Research grants 3,000 500 Cap. Expenditures 510 102 (10) Total (22,050) (1,667) Ending cash balance $ 700 $ 523 Supporting calculations: (1) 100,000 members × $100 = $10,000,000 (2) $12,000,000 × 70% = $8,400,000 (3) $12,000,000 × 12% = $1,440,000 (4) $5,600,000 × 12% = $672,000 (5) $1,000,000/10 = $100,000 (6) $960,000/12 = $80,000 (7) ($240,000 - $24,000)/12 = $18,000 (8) $240,000/12 = $20,000 (9) $600,000/12 = $50,000 (10) $510,000/5 = $102,000

c. The most important operating problem faced by CME, Inc. is the short-term liquidity. During the first six months expenditures ($14.5 million) are forecasted to be slightly more than double the revenue ($7.2 million). This will necessitate short-term borrowing during the second and third quarters of the year. The second most important problem is that the cash expenditures are

Chapter 8

forecasted to exceed revenue by $50,000 and this could be further compounded by interest for short-term borrowing, which apparently has not been forecasted. The fees do not fully support the seminars. The total of the facility costs and the faculty costs exceed the seminar revenue.

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198

(CMA adapted) 41. a. Fixed prod. cost [($2,000,000 × 1.08) × 0.80] $1,728,000 Estimated production ÷ 300,000 Estimated fixed production cost per unit $ 5.76 Variable production cost ($50 × 1.15) 57.50 Total production cost per unit $63.26 b. Selling price = $63.26 x 1.25 = $79.08 c. Sales ($79.08 x 300,000) $23,724,000 CGS ($63.26 × 300,000) (18,978,000) Gross margin $ 4,746,000 S&A [($2,000,000 × 1.08) - $1,728,000] (432,000) Income before taxes $ 4,314,000 d. Y = unit SP that gives pre-tax income of 25% of sales 300,000Y - $18,978,000 - $432,000 = 0.25(300,000Y) 300,000Y - $19,410,000 = 75,000Y 225,000Y = $19,410,000 Y = $86.27 42. a. Sales Budget: Mixers: $ 90 × 60,000 = $ 5,400,000 Breadmakers: $140 × 40,000 = 5,600,000 Total budgeted sales $11,000,000 b. Mixers Breadmakers Budgeted sales 60,000 40,000 Ending inventory 20,000 5,000 Beginning inventory (15,000) (4,000) Budgeted production 65,000 41,000 c. Purchasing Budgets: Motors Beaters Fuses Mixer production 65,000 130,000 130,000 Breadmaker production 41,000 164,000 123,000 Ending inventory 3,600 24,000 7,500 Beginning inventory (2,000) (21,000) (6,000) Units to be purchased 107,600 297,000 254,500 Times price per unit x $18 x $1.75 x $2.40 Budgeted purchases $1,936,800 $519,750 $610,800

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199

d. Direct Labor Budget: Mixers: $8 × 2 × 65,000 $1,040,000 Doughmakers: $10 × 3 × 41,000 1,230,000 Budgeted labor cost $2,270,000

e. Mixer = $18.00 + (2 x $1.75) + (2 x $2.40) + (2 x $8.00) + (2 x $5.00) = = $18.00 + $3.50 + $4.80 + $16.00 + $10.00 = $52.30 Breadmaker = $18.00 + (4 x $1.75) + (3 x $2.40) + (3 x $10.00) + (3 x $5.00) = = $18.00 + $7.00 + $7.20 + $30.00 + $15.00 = $77.20

(CPA adapted) 43. Sales Budget: Jan. Feb. March April 8,000 10,000 15,000 12,000 x $12 x $12 x $12 x $12 $96,000 $120,000 $180,000 $144,000 Accounts Receivable collections (70%, 20%, 10%): January February March Total November $ 7,000 $ 7,000 December 13,000 $ 6,500 19,500 January 67,200 19,200 $ 9,600 96,000 February 0 84,000 24,000 108,000 March 0 0 126,000 126,000 Total $87,200 $109,700 $159,600 $356,500 Accts. Rec. ending balance = $26,500 + $396,000 - $356,500 = $66,000 Production Budget: January February March Total April Sales 8,000 10,000 15,000 33,000 12,000 Ending inv. 500 750 600 600 550 Beginning inv. (400) (500) (750) (400) (600) Production 8,100 10,250 14,850 33,200 11,950 Purchases Budget: January February March Total April Production 8,100 10,250 14,850 33,200 11,950 Gallons x 1.2 x 1.2 x 1.2 x 1.2 x 1.2 Production needs 9,720 12,300 17,820 39,840 14,340 Ending inv. 615 891 717 717 Beginning inv. (1,000) (615) (891) (1,000) Purchases 9,335 12,576 17,646 39,557

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January February March Total Purchases 9,335 12,576 17,646 39,557 Cost per gallon x $0.80 x $0.80 x $0.80 x $0.80 Cost $ 7,468 $10,061 $14,117 $31,646 Payment of Accounts Payable (60%, 40%): January February March Total December $2,148 $ 2,148 January 4,481 $2,987 7,468 February 6,037 $ 4,024 10,061 March 8,470 8,470 Total $6,629 $9,024 $12,494 $28,147 A/P ending balance = $2,148 + $31,646 - $28,147 = $5,647 Direct Labor Budget:

January February March Total Production 8,100 10,250 14,850 33,200 DLH per unit x 0.5 x 0.5 x 0.5 x 0.5 Total DLHs 4,050 5,125 7,425 16,600 DL rate x $6 x $6 x $6 x $6 DL cost $24,300 $30,750 $44,550 $99,600 Variable OH Budget: January February March Total Production 8,100 10,250 14,850 33,200 MH per unit x 5 x 5 x 5 x 5 Total MHs 40,500 51,250 74,250 166,000 VOH rate x $0.06 x $0.06 x $0.06 x $0.06 VOH cost $ 2,430 $ 3,075 $ 4,455 $ 9,960 Fixed OH Budget January February March Total Comments Salaries $ 6,500 $ 6,500 $ 6,500 $19,500 (cash) Utilities 1,000 1,000 1,000 3,000 (cash) Insurance 200 200 200 600 (decr.in ppd. ins.) Depreciation 2,300 2,300 2,550 7,150 (incr. in acc. dep) FOH cost $10,000 $10,000 $10,250 $30,250

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201

Other Payments, Collections, and Cost Adjustments: January February March Total Comments Dividends $10,000 $10,000 (cash) Equipment $ 7,200 7,200 (cash; incr. in equip.; will cause $250 incr.

in depr. exp. and acc. depr.)

Int. expense 250 $ 147 397 (cash) Int.received 140 140 (cash) S&A costs $25,800 $25,800 $25,800 $77,400 (cash)

Color Blaze Cash Budget

For the First Quarter of 2006 January February March Total Beg. bal. $ 5,080 $ 5,071 $ 5,075 $ 5,080 Collections 87,200 109,700 159,600 356,500 Cash available $ 92,280 $114,771 $164,675 $361,580 Disbursements: Purchases $ 6,629 $ 9,024 $ 12,494 $ 28,147 DL 24,300 30,750 44,550 99,600 VOH 2,430 3,075 4,455 9,960 FOH 7,500 7,500 7,500 22,500 S&A 25,800 25,800 25,800 77,400 Equip. 7,200 7,200 Total $ 66,659 $ 76,149 $101,999 $244,807 Cash excess $ 25,621 $ 38,622 $ 62,677 $116,773 Min. bal. (5,000) (5,000) (5,000) (5,000) Cash avail. $ 20,621 $ 33,622 $ 57,676 $111,773 Financing: Repay $(10,300) $(14,700) $ (25,000) Investment (18,700) $(57,800) (76,500) Pay div. (10,000) (10,000) Receive (pay) Interest (250) (147) 140 (257) Total $(20,550) $(33,547) $(57,660) $(111,757) Ending balance $ 5,071 $ 5,075 $ 5,016 $ 5,016

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202

Color Blaze

Budgeted Income Statement For the First Quarter of 2006

Sales $396,000 Cost of Goods Sold Beginning inventory - FG $ 2,104 Cost of goods manufactured 171,682 Cost of goods avail. for sale $173,786 Ending inv.- FG (600 × $5.26) (3,156) (170,630) Gross margin $225,370 Selling & administrative expenses (77,400) Operating income $147,970 Other income and expenses Interest expense $ (396) Interest revenue 140 (256) Net income $147,714

Color Blaze Budgeted Schedule of Cost of Goods Manufactured

For the First Quarter of 2006

Beginning work in process $ 0 Raw material used: Beginning raw materials $ 800 Purchases 31,646 Available for use $32,446 Ending inventory (717 × $.80) (574) Cost of raw materials used $31,872 Direct labor 99,600 Variable factory overhead 9,960 Fixed factory overhead 30,250 171,682 Total mfg. costs in process $171,682 Ending work in process 0 Cost of goods manufactured $171,682

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203

Color Blaze Budgeted Balance Sheet

March 31, 2006

Assets Cash $ 5,016 Accounts receivable 66,000 Raw material inventory 574 Finished goods inventory 3,156 Prepaid insurance 600 Investments 76,500 Building and machinery $309,000 Accumulated depreciation (27,150) 281,850 Total Assets $ 433,696

Liabilities and Stockholders’ Equity Liabilities: Accounts payable $ 5,647 Note payable - equipment 1,800 $ 7,447 Stockholders' Equity: Common stock $100,000 Paid-in capital 50,000 Retained earnings 276,249 426,249 Total Liabilities & Equity $ 433,696 44. a. Y = gross billings to meet required return objective Y - $425,000 - 0.20Y = $700,000 + $240,780 0.80Y = $1,365,780 Y = $1,707,225 Budget: Gross billings $1,707,225 Variable expenses Overhead $256,084 Client service 85,361 (341,445) Contribution margin $1,365,780 Fixed costs Salaries $300,000 Overhead 125,000 (425,000) Net operating earnings $ 940,780 b. A number of actions are possible depending largely on the operating

climate of the firm. Many of the actions that could be taken can fit within one of the three groupings that follow:

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1. Increase the staffing level. A larger staff is a reasonable alternative

only if there is an expectation that billings can be increased well above he budgeted level if the firm was allowed to grow.

2. Reduce the budgeted billings level and try to maintain the budgeted level of earnings by cutting costs. In selecting activities to cut, the firm would try to identify those activities that are not value adding.

3. Try to selectively cut down the size of the business by dropping

those clients that contribute the least to the bottom line. This action requires the firm to have knowledge about the relative profitability of the various services it offers and the relative amounts of profits generated by various classes of clients (large, small, industry group, tax service, audit, etc.).

45. a. The Lopez Agency

Revised Operating Budget Fourth Quarter 2006

Revenues: Consulting fees: Management consulting $468,000 EDP consulting 478,125 Total consulting revenue $946,125 Other revenue 10,000 Total revenue $956,125 Expenses: Consulting salary expense $510,650 Travel and related expense 57,875 General and admin. expense 93,000 Depreciation expense 40,000 Corporate allocation 75,000 Total expenses (776,525) Operating income $179,600 Supporting computations: Schedule of Projected Revenues for Fourth Quarter 2006 Mgmt Consulting EDP Consulting Third Quarter Revenues $315,000 $421,875 Divided by billing rate ÷ $90 ÷ $75 Billable hours 3,500 5,625 Divided by # of consultants ÷ 10 ÷ 15 Hours per consultant 350 375 Fourth Quarter Planned increase + 50 + 50 Billable hrs per consultant 400 425 # of consultants x 13 x 15

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205

Billable hrs. 5,200 6,375 Billing rate x $90 x $75 Projected revenue $468,000 $478,125

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Schedules of Projected Salaries, Travel, General and Administrative, and Allocated Corporate Expenses Mgmt Consulting EDP Consulting Compensation: Existing consultants: Annual salary $ 50,000 ($50,000 × 92%) $ 46,000 Quarterly salary $ 12,500 $ 11,500 Planned increase (10%) 1,250 1,150 Total $ 13,750 $ 12,650 # of consultants x 10 x 15 Total $137,500 $189,750 New consultants (3) at old salary (3 × $12,500) 37,500 0 Total $175,000 $189,750 Benefits (40%) 70,000 75,900 Total $245,000 $265,650

Total compensation = $245,000 + $265,650 = $510,650 Travel expense: Management consultants (400 hrs. x 13) 5,200 EDP consultants (425 hrs. x 15) 6,375 Total hours 11,575 Rate per hour* x $5 Total travel expense $57,875

*3rd quarter travel expense divided by hours = rate per hour ($45,625 ÷ 9,125 = $5). General and administrative ($100,000 × 93%) $93,000 Corporate allocation ($50,000 × 150%) $75,000

b. An organization would prepare a revised forecast when the assumptions

underlying the original forecast are no longer valid. The assumptions may involve factors outside or inside the company. Changes in assumptions involving external factors may include changes in demand for the company's products or services, changes in the cost of various inputs to the company, or changes in the economic or political environment in which the company operates. Changes in assumptions involving internal factors may include changes in company goals or objectives by management or stockholders.

c. Although management of Chalmette Industries can do this using an

“ability-to-bear” basis, the increase can be demoralizing to Lopez Agency personnel unless the increased activity can be shown to have caused an increase in corporate expenses.

(CMA adapted)