Chap007_1

Chapter 07 - Planning for Profit and Cost Control

Answers to Questions

1. Budgets are useful for large companies with complex activities as well as small companies. Budgets act as a vehicle for communication by formalizing management’s plans in a document that communicates company objectives. The benefits associated with this kind of planning apply to all sizes of companies operating at all levels of complexity.

2. The budget represents the companywide plans stated in financial terms as to how to coordinate operating activities to accomplish goals and objectives. Accordingly, its success depends upon the combined effort of all of the parties involved. A committee that includes representatives from all pertinent departments is necessary to formulate the master budget.

3. The three levels of planning are as follows:(1) Strategic planning – the long-run planning activities that address

issues such as overall company goals and objectives.(2) Capital budgeting – the intermediate financial planning activities of

the entire company that concern investments, product selection, and desired profitability.

(3) Operations budgeting – the short-run financial planning for the company’s different departments that culminates in the formation of a master budget.

4. The span of time is the primary factor that distinguishes the three levels of planning from each other. Strategic planning involves long-range decisions; capital budgeting is associated with intermediate-range plans; and operational budgeting is concerned with short-range plans.

5. The perpetual budget has the advantage of keeping management involved in the budget process. Too often budgets are prepared and forgotten. The perpetual budget forces management to maintain a constant focus on the company’s goals and objectives.

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6. The primary advantages associated with budgeting are as follows:Planning – formalizes management’s plans in a document that

communicates company objectives.Coordination – forces departments to coordinate their activities in a

manner that ensures the attainment of the objectives of the whole company.

Performance measurement – represents specific, quantitative standards that can be used to evaluate performance.

Corrective action – acts as an early warning system that promotes corrective action.

7. Budgeted amounts represent management’s expectations regarding how the firm as a whole and individual departments within the firm should perform. By comparing actual performance with the expected performance (the budgeted amounts), managers can be effectively evaluated.

8. Mr. Shilov’s failure with budgets seems to stem from his misunderstanding of the human element. He states that “he made budgets.” Experience shows that, in general, employees are more willing to accept budget standards if they participate in the budgeting process. Further, Mr. Shilov appears to have used the budget as a tool for punishment – a basis for reprimanding employees. As a result, employees would resent the budget and would be unmotivated to accomplish budget standards.

9. A master budget consists of a series of detailed schedules and budgets that describe the overall financial plans for the forthcoming accounting period.

10. The sales forecast normally functions as the starting point for the development of the master budget. Clearly, production and other related activities depend upon the level of sales.

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11. The desired level of ending inventory must be added to projected sales in order to determine the amount of goods that are needed during the period. The beginning inventory is subtracted from the amount of goods needed in order to determine the amount of goods to be produced. Managing inventory is important because an inventory shortage can result in customer dissatisfaction and loss of sales. Conversely, excess inventory ties up capital investment, creates unnecessary storage cost, and is subject to obsolescence or spoilage. Finding the balance between too much and too little inventory is essential to the profitability of a company.

12. The cash budget is composed of three major components:

(1) Cash receipts – expected cash inflows from sales, sale of investments, and borrowing activities, etc.

(2) Cash payments – expected cash outflows for inventory purchases, selling and administrative expenses, and purchases of investments, etc.

(3) Financing activities – expected borrowing and repayment activities.

13. Determining the amount of the cash balance to include on the budgeted balance sheet is an insignificant reason for preparing a cash budget. The real purpose of preparing a cash budget is to enable a company to effectively manage its financing and investing activities. If the company can foresee a cash surplus then investment opportunities can be investigated to earn interest or debt can be repaid to reduce interest. If the company anticipates a cash shortage, appropriate sources of financing can be investigated to avoid possible bankruptcy. When dealing with large amounts of money, investing, borrowing, and repayment activities that involve interest can be critical to profitability.

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14. The pro forma income statement provides information about the expected profitability of the company. The completion of this statement is dependent on the departmental operating budgets. For example, the sales budget provides information about projected sales revenues, the purchases budget provides information as to projected cost of goods sold, the selling and administrative expenses budget provides information about projected operating expenses, and the cash budget provides information as to expected interest revenue and expense.

15. The cash budget, like the pro forma statement of cash flows, provides information as to expected cash receipts and cash payments, but in addition it shows how a firm plans to effectively manage its cash through financing and investing activities.

Exercise 7-1A

Ms. Huffman appears to be a person with an attitude problem. She does not understand how to involve her colleagues in the budgeting process. She degrades their input and uses the budget as a tool for criticism. In so doing, Ms. Huffman has failed to gain the support of upper-level management. The attitudes of upper-level management will have a significant impact on the effectiveness of the budget. Subordinates develop a keen awareness of management's expectations. If upper-level managers degrade, make fun of, or ignore the budget, subordinates will rapidly follow suit. If budgets are used to humiliate or embarrass subordinates, they will resent the treatment and the budgeting process that enables it. To be effective, upper-level management must accept and portray the budget as a sincere effort to express realistic goals that employees will be expected to accomplish. The proper atmosphere is essential to budgeting success. Once a negative pattern has been established, it is difficult to change. Perhaps the most effective solution in this case is to replace Ms. Huffman.

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Exercise 7-2A

a.Sales Budget

January February MarchCash sales $ 40,000 $ 44,000 $ 48,400Sales on account 100,000 110,000 121,000Total budgeted sales $140,000 $154,000 $169,400

b. The amount of sales revenue appearing on the 1st quarter income statement is the sum of the monthly amounts ($140,000 + $154,000 + $169,400 = $463,400).

Exercise 7-3A

a.

Schedule of Cash Receipts July August SeptemberCurrent cash sales $ 70,000 $ 75,000 $ 80,000 Plus collections from accounts receivable 300,000 90,000 108,000 Total budgeted collections $370,000 $165,000 $188,000

b. The current month’s sales on account will be collected in the following month. Accordingly, the amount of accounts receivable at the end of September is equal to September’s sales on account ($129,600).

Exercise 7-4Aa.

1st Quarter 2nd Quarter 3rd Quarter 4th QuarterEast Div. $100,000 $104,000 $108,160 $112,486West Div. 300,000 306,000 312,120 318,362South Div. 200,000 212,000 224,720 238,203Total $600,000 $622,000 $645,000 $669,051

b.1st Quarter 2nd Quarter 3rd Quarter 4th Quarter

Total $600,000 $622,000 $645,000 $669,051

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Exercise 7-5A

a. Sales for January are expected to be $392,000 ( $560,000 x 0.70)

Beginning accounts receivable balance $ 96,400January sales on account 392,000Available for collection 488,400Less: Ending accounts receivable balance (73,600)Cash collected $414,800

b. It is reasonable to assume that sales will decline in January. Customers tend to buy merchandise in December for Christmas gifts and to cut back on buying in January immediately after Christmas.

Exercise 7-6A

Sales would likely be highest in late January or early February because of Valentine’s Day sales. October may also produce higher sales due to buying for Halloween. Other holiday seasons are also likely to boost sales. Accordingly, sales would be high in April for Easter, and November and December for Christmas and Hanukah. Months that would be lower would be May and June. Summer months may pick up due to children being out of school and in the malls. Similarly, sales would be expected to drop off in August and September when school reopens.

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Exercise 7-7A

a.

Inventory Purchases BudgetJanuary February March

Budgeted cost of goods sold $50,000 $ 54,000 $60,000Plus: Desired ending inventory 5,400 6,000 7,500Total inventory needed 55,400 60,000 67,500Less: Beginning inventory 5,000 5,400 6,000Required purchases (on account) $50,400 $ 54,600 $61,500

Exercise 7-7A (continued)

b. The amount of cost of goods sold appearing on the first quarter pro forma income statement is the sum of the monthly amounts ($50,000 + $54,000 + $60,000 = $164,000).

c. Since the quarter ends on March 31, the ending inventory for March is also the ending inventory for the quarter, $7,500.

Exercise 7-8A

a.

Schedule of Cash Payments for Inventory PurchasesApril May June

Payment for current accounts payable $90,000 $108,000 $118,800 Payment for previous accounts payable 8,000 10,000 12,000 Total budgeted payments for inventory $98,000 $118,000 $130,800

b. Since 90% of the current purchases on account are paid in cash during the month of purchase, 10% will remain payable at the end of the month, $13,200 ($132,000 x 0.10).

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Exercise 7-9A

a. Budgeted cost goods sold for July is $315,000 ($300,000 x 1.05)

Ending inventory balance $ 29,000Budgeted cost of goods sold 315,000Total inventory needed 344,000Less: Beginning inventory balance (28,000)Budgeted purchases $316,000

b.June’s payables balance paid in July $ 35,000Cash paid for July purchases ($316,000 x 0.70) 221,200Projected cash payments for July $256,200

Exercise 7-10A

a.

Schedule of Cash Payments for S&A ExpensesOct. Nov. Dec.

Equipment lease expense $6,000 $ 6,000 $ 6,000 Prior month's salary expense, 100% 0 6,100 6,600 Cleaning supplies 2,800 2,730 3,066 Insurance premium 7,200 0 0Rent 1,700 1,700 1,700 Miscellaneous expenses 700 700 700 Total payments for S&A expenses $18,400 $17,230 $18,066 Depreciation is a noncash charge.

b. Since salaries expense is paid in the month following the month it is incurred, the amount payable at the end of December will be the amount of salary expense incurred in December, $7,000.

c. Since the insurance premium is prepaid for 6 months on October 1, the amount of prepaid insurance at the end of December will be $3,600 [$7,200 – ($1,200 x 3)].

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Exercise 7-11A

a. An inventory purchases budget prepared with the sales manager's estimate:

1st Quarter 2nd Quarter 3rd Quarter 4th QuarterSales $380,000 $310,000 $280,000 $480,000Cost of goods sold $228,000 $186,000 $168,000 $288,000Plus: Desired ending inventory 18,600 16,800 28,800 30,000Total inventory needed 246,600 202,800 196,800 318,000Less: Beginning inventory 29,000 18,600 16,800 28,800Required purchases $217,600 $184,200 $180,000 $289,200

b. An inventory purchases budget prepared with the marketing consultant's estimate:

1st Quarter 2nd Quarter 3rd Quarter 4th QuarterSales $520,000 $460,000 $410,000 $650,000Cost of goods sold $312,000 $276,000 $246,000 390,000Plus: Desired ending inventory 27,600 24,600 39,000 30,000Total inventory needed 339,600 300,600 285,000 420,000Less: Beginning inventory 29,000 27,600 24,600 39,000Required purchases $310,600 $273,000 $260,400 $381,000

Exercise 7-12A

a. Budgeted payments for January: Sales commissions $25,000 Rent 16,000 Miscellaneous 2,000

Total* $43,000

*The amount of utilities is not included because the cash payment will be made in February. The amount of depreciation is not included because the depreciation does not require a cash payment. Recall that cash is paid at the time of purchase rather than when the depreciation is recognized.

b. The full $5,000 balance for the utilities charge will remain payable at the end of January.

c. The problem implies that the monthly charge for depreciation is $4,000. Accordingly, the amount of depreciation to be recognized on an annual income statement would be $48,000 ($4,000 x 12).

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Exercise 7-13A

a.

Cash Budget July August SeptemberSection 1: Cash receipts

Beginning cash balance $ 42,500 $ 14,000 $ 14,000 Add cash receipts 180,000 200,000 240,600

Total cash available (a) 222,500 214,000 254,600 Sections 2: Cash Payments

For inventory purchases 165,526 140,230 174,152 For S&A expenses 54,500 60,560 61,432 For interest exp at 2% per month 0 2311 2512

Total budgeted disbursements (b) 220,026 201,021 235,835 Sections 3: Financing Activities

Cash surplus (shortage) (a – b=c) 2,474 12,979 18,765Borrowing (repayment) (d–c) 11,526 1,021 (4,765)

Ending cash balance (d) $ 14,000 $ 14,000 $ 14,000

111,526 x 2% = 231 (rounded)2(11,526+1,021) x 2% = 251 (rounded). Note that $4,765 is repaid at the end of month in addition to interest that still has to be paid in September.

b. Cash flow from operating activities is equal to total (i.e., sum of the monthly

amounts) cash receipts from customers minus the total (i.e., sum of the monthly amounts) of cash payments for inventory, S&A expense, and interest [i.e., $620,600 – ($220,026 + $201,021 + $235,835) = ($36,282) net cash outflow.]

c. Cash flow from financing activities is the amount borrowed less repayments (i.e., $11,526 + $1,021 – $4,765 = $7,782 net cash inflow.)

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Exercise 7-14A

a.Cash Collections Collections from May’s receivables balance $ 60,000 Collections from June’s credit sales ($600,000 x .80) 480,000 Cash sales from June 150,000 Total cash receipts $690,000Desired cash balance 30,000Cash disbursements 700,000

Total cash needs 730,000Cash shortage (amount needed to be borrowed) $40,000

b. The interest expense for June is $0 because the loan is taken at the end of June.

c. The interest expense for July is $300 ($40,000 x 9% ÷ 12).

Exercise 7-15A

a. Pro forma income statement prepared with Mr. Wing’s estimate:

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter TotalSales revenue $187,000 $220,000 $231,000 $286,000 $924,000Cost of goods sold 112,200 132,000 138,600 171,600 554,400Gross profit 74,800 88,000 92,400 114,400 369,600S. & Adm. expenses 18,700 22,000 23,100 28,600 92,400Net income $ 56,100 $ 66,000 $ 69,300 $ 85,800 $277,200

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b. Pro forma income statement prepared with Ms. Sullivan's estimate:

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter TotalSales revenue $178,500 $210,000 $220,500 $273,000 $882,000Cost of goods sold 107,100 126,000 132,300 163,800 529,200Gross Profit 71,400 84,000 88,200 109,200 352,800S & A expenses 17,850 21,000 22,050 27,300 88,200Net income $ 53,550 $ 63,000 $ 66,150 $ 81,900 $264,600

c. Forecasting is not likely to be 100% accurate. Therefore, different executive officers within the same company may have different estimates about the future. In addition to legitimate differences caused by honest opinions, self-interest may also contribute to differences. For example, Glenda Sullivan may want to establish low budgetary figures for sales because these figures will become the standards for the evaluation of Sarah's future performance. With low standards, she would have a better chance of reaching the standards.

Problem 7-16A

a.

Sales Budget January February March Total Sales on account $200,000 $220,000 $242,000 $662,000

b. Sales revenue for the quarter is equal to the sum of the monthly amounts ($200,000 + $220,000 + $242,000 = $662,000).

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c.Schedule of Cash Receipts January February MarchReceipts from January sales $140,000 Receipts from January sales $ 40,000 Receipts from January sales $ 20,000 Receipts from February sales 154,000 Receipts from February sales 44,000 Receipts from March sales 169,400 Total $140,000 $194,000 $233,400

d.

Schedule of Cash Receipts January February March April MayReceipts from January sales $140,000 Receipts from January sales $ 40,000 Receipts from January sales $ 20,000 Receipts from February sales 154,000 Receipts from February sales 44,000 Receipts from February sales $22,000 Receipts from March sales 169,400 Receipts from March sales 48,400 Receipts from March sales $24,200Total $140,000 $194,000 $233,400 $70,400 $24,200

The accounts receivable as of March 31, 2012 is equal to the amount due to be collected in April and May from the first quarter sales, $94,600 ($70,400 + $24,200).

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Problem 7-17A

a.

Inventory Purchases Budget April May JuneBudgeted cost of goods sold $60,000 $70,000 $80,000 Plus desired ending inventory 7,000 8,000 8,600 Inventory needed 67,000 78,000 88,600 Less beginning inventory 3,600 7,000 8,000 Required purchases (on account) $63,400 $71,000 $80,600

b. Since the quarter ends on June 30, the ending inventory for June is also the ending inventory for the quarter (i.e., $8,600).

c.

Schedule of Cash Payments April May JunePayment of current accounts payable $38,040 $42,600 $48,360 Payment of previous accounts payable 14,800 25,360 28,400 Total budgeted payments for inventory $52,840 $67,960 $76,760

d. Since 60% of the current purchases on account are paid in cash during the month of purchase, 40% will remain payable at the end of the month (i.e., $80,600 x .40 = $32,240).

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Problem 7-18A

This is a typical problem for what-if analysis. Students can use a computerized spreadsheet to try different possible scenarios.

a.The budgeted net income for the next year: $340,000x115%= $391,000Assume x = Desired salesSales – Cost of goods sold – S&A = NIX – 0.7 X – ($60,000 + .10 X) = $391,000.20 X – $60,000 = $391,000X = $2,255,000

Alternatively, you can use the contribution margin ratio to determine sales.

Contribution margin ratio = Sales (100%) – Variable costs (80%) = 20% (Net income + Fixed cost) ÷ CM ratio = ($391,000+$60,000) ÷ 20% = $2,255,000

Pro Forma Income StatementSales revenue $2,255,000Cost of goods sold 1,578,500Gross profit 676,500Selling & admin. expenses 285,500*Net income $ 391,000

*($2,255,000 x 10% + $60,000) = $285,500

% increase required: ($2,255,000 – $2,000,000) ÷ $2,000,000 = 12.75%

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Problem 7-18A (continued)

b.

Budgeted cost of goods sold with a 2% cut: $1,400,000 x 98% = $1,372,000Budgeted gross profit: $2,000,000 – $1,372,000= $628,000

The budgeted level of selling and administrative expenses: $628,000– $391,000 = $237,000

Pro Forma Income StatementSales revenue $2,000,000Cost of goods sold 1,372,000Gross profit 628,000Selling & admin. expenses 237,000*Net income $ 391,000

*The figure means that management has to cut the selling and administrative expenses by $23,000 ($237,000 – $260,000) in order to reach the president’s goal.

c.

Projected sales revenue to increase by 15%: $2,000,000 x 115%= $2,300,000

Projected cost of goods sold: $2,300,000 x 70% = $1,610,000

Pro Forma Income StatementSales revenue $2,300,000Cost of goods sold 1,610,000Gross profit 690,000Selling & admin. expenses 340,000Net income $ 350,000

Since the projected net income under the given scenario will be only $350,000, which is short of the original $391,000, the company cannot reach its goal.

Problem 7-19A

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a.

Schedule of Cash Payments for S&A ExpensesJuly August September

Salary expense $18,000 $18,000 $18,000 Prior month's sales commissions, 100% 0 1,700 1,700 Supplies expense 360 390 420Prior month's utilities, 100% 0 1,100 1,100 Rent 6,600 6,600 6,600 Miscellaneous 690 690 690 Total payments for S&A expenses $25,650 $28,480 $28,510 Depreciation is a noncash charge.

b. Since utilities are paid in the month following the month they are incurred, the amount payable at the end of September will be the amount of utilities expense incurred in September which is $1,100.

c. Since sales commissions are paid in the month following the month they are incurred, the amount payable at the end of September will be the amount of sales commissions expense incurred in September which is $1,700.

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Problem 7-20A

Cash Budget January February MarchBeginning cash balance $ 8,000 $ 5,600 $ 5,000 Add cash receipts 100,000 106,000 126,000 Cash available (a) 108,000 111,600 131,000 Less cash payments For inventory purchases 90,000 72,000 85,000 For S&A expenses 31,000 32,000 27,000 Interest exp at 1% per month 4001 5902 5703

Total budgeted payments (b) 121,400 104,590 112,570 Payments minus receipts Surplus (Shortage) (a – b) (13,400) 7,010 18,430Financing Activity Borrowing (repayment) (c) 19,000 (2,010) (13,430)Ending cash balance (a – b + c) $ 5,600 $ 5,000 $ 5,000

1($40,000) x 1% = $400 2($40,000 + $19,000) x 1% = $5903($40,000 + $19,000 – $2,010) x 1% = $570 (rounded).

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Problem 7-21A

a.

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter TotalPeaches $231,000 $252,000 $315,000 $252,000 $1,050,000Oranges 440,000 495,000 627,000 418,000 1,980,000Total $671,000 $747,000 $942,000 $670,000 $3,030,000

b. Budgeted cost of goods sold: $3,030,000 x 60% = $1,818,000

Budgeted Annual Income StatementSales revenue $3,030,000Cost of goods sold 1,818,000Gross profit 1,212,000Selling & admin. expenses 700,000Net income $512,000

c. Inventory purchases budget for peaches

1st Quarter 2nd Quarter 3rd Quarter 4th QuarterSales $231,000 $252,000 $315,000 $252,000Cost of goods sold $138,600 $151,200 $189,000 $151,200Plus: desired ending inventory 30,240 37,800 30,240 34,000Inventory needed 168,840 189,000 219,240 185,200Less: beginning inventory 27,720 30,240 37,800 30,240Required purchases $ 141,120 $158,760 $181,440 $154,960

Inventory purchases budget for oranges

1st Quarter 2nd Quarter 3rd Quarter 4th QuarterSales $440,000 $495,000 $627,000 $418,000Cost of goods sold $264,000 $297,000 $376,200 $250,800Plus: desired ending inventory 59,400 75,240 50,160 56,000Inventory needed 323,400 372,240 426,360 306,800Less: beginning inventory 52,800 59,400 75,240 50,160Required purchases $270,600 $312,840 $351,120 $256,640

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Problem 7-22A (Note: All computations are rounded to the nearest whole dollar.)

a. & b.

Sales Budget Pro FormaOct. Nov. Dec. Data

Cash sales $ 48,000 $ 60,000 $ 75,000 Sales on account 72,000 90,000 112,500 $112,500(a) Total budgeted sales $120,000 $150,000 $187,500 457,500(b)

Schedule of Cash Receipts Oct. Nov. Dec.Current cash sales $48,000 $ 60,000 $ 75,000 Plus collections from A/R 0 72,000 90,000 Total collections $48,000 $132,000 $165,000 $345,000 (c)(a) Ending accounts receivable balance appearing on balance sheet.(b) Sales revenue appearing on income statement (sum of monthly amounts).(c) Cash receipts from customers on statement of cash flows (sum of monthly amounts).

c. and d.

Inventory Purchases BudgetPro Forma

Oct. Nov. Dec. DataBudgeted cost of goods sold $72,000 $ 90,000 $112,500 $274,500(a) Plus: Desired ending inventory 9,000 11,250 12,000 12,000(b) Inventory needed 81,000 101,250 124,500 Less: Beginning inventory 0 9,000 11,250 Required purchases (on account) $81,000 $ 92,250 $113,250 33,975(c)

Schedule of Cash Payments Budget for Inventory PurchasesPmt. of current month's accts. pay. $56,700 $64,575 $ 79,275 Pmt. for prior month's accts. pay. 0 24,300 27,675 Total budgeted pmts. for inventory $56,700 $88,875 $106,950 $252,525(d)

(a) Cost of goods sold appearing on pro forma income statement (sum of monthly amounts).(b) Ending inventory balance appearing on pro forma balance sheet.(c) Ending accounts payable balance appearing on pro forma balance sheet ($113,250 -$79,275).(d) Cash payments for inventory purchases (sum of monthly amounts).

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e. and f.

Selling and Administrative Expense BudgetPro Forma

Oct. Nov. Dec. DataSalary expense $18,000 $18,000 $18,000 Sales commissions, 5% of sales 6,000 7,500 9,375 $ 9,375(a) Supplies expense, 2% of sales 2,400 3,000 3,750 Utilities 1,400 1,400 1,400 1,400(b) Depreciation on store fixtures 4,000 4,000 4,000 12,000(c) Rent 4,800 4,800 4,800 Miscellaneous 1,200 1,200 1,200 Total S&A expenses $37,800 $39,900 $42,525 120,225(d)

Schedule of Cash Payments for S&A ExpensesSalary expense $18,000 $18,000 $18,000 Prior month's sales comm., 100% 0 6,000 7,500 Supplies expense 2,400 3,000 3,750 Prior month's utilities, 100% 0 1,400 1,400 Depreciation on store fixtures 0 0 0Rent 4,800 4,800 4,800 Miscellaneous 1,200 1,200 1,200 Total payments for S&A expenses $26,400 $34,400 $36,650 $97,450 (e)Depreciation is a noncash charge.(a) Ending sales commissions payable account balance shown on pro forma balance sheet.(b) Ending utilities payable account balance shown on pro forma balance sheet.(c) Accumulated depreciation appears on the pro forma balance sheet (sum of monthly amounts).(d) S&A expense appearing on pro forma income statement (sum of monthly amounts).(e) Total cash payments for S&A expenses on pro forma statement of cash flows (sum of monthly

amounts).

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g.

Cash BudgetPro Forma

Oct. Nov. Dec. DataBeginning cash balance $ 0 $ 12,900 $ 12,000 Add cash receipts 48,000 132,000 165,000 $345,000(a) Cash available (w) 48,000 144,900 177,000 Less payments For inventory purchases 56,700 88,875 106,950 252,525(b) For S&A expenses 26,400 34,400 36,650 97,450(c) Purchase of store fixtures 164,000 0 0 164,000(d) Interest expense* 0 2,120 2,045 4,165 (f)Total budgeted payments (x) 247,100 125,395 145,645 Payments minus receipts Surplus (shortage) (w – x) (199,100) 19,505 31,355Financing activity Borrowing (repayment) (y) 212,000 (7,505) (19,355) 185,140(e) Ending cash balance (w – x+ y) $ 12,900 $ 12,000 $ 12,000 12,000(g)

*October ($0 x 0.01); November ( $212,000 x 0.01); December [( $212,000 – $7,505) x 0.01](a) Operating activities section of pro forma Statement of Cash Flows (sum of monthly amounts). (b) Operating activities section of pro forma Statement of Cash Flows (sum of monthly amounts).(c) Operating activities section of pro forma Statement of Cash Flows (sum of monthly amounts).(d) Investing activities section of pro forma Statement of Cash Flows. The investment in store fixtures also

appears on the pro forma balance sheet.(e) Financing activities section of pro forma Statement of Cash Flows (sum of monthly amounts). (f) Operating activities section of pro forma Statement of Cash Flows (sum of monthly amounts). (g) The ending cash balance appears on the pro forma balance sheet and as the last item on the pro forma

statement of cash flows.

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h.

Patel CompanyPro Forma Income Statement

For the Quarter Ended December 31, 2012Sales revenue $457,500 Cost of goods sold (274,500)Gross margin 183,000 S&A expenses (120,225)Operating income 62,775 Interest expense (4,165)Net income $ 58,610

i.

Patel CompanyPro Forma Balance Sheet

December 31, 2012Assets Cash $ 12,000 Accounts receivable 112,500 Inventory 12,000 Store fixtures $164,000 Accumulated depreciation (12,000) Book value of fixtures 152,000 Total assets $288,500

Liabilities Accounts payable $ 33,975 Utilities payable 1,400 Sales commissions payable 9,375 Line of credit liability 185,140 Equity Retained earnings 58,610 Total liabilities and equity $288,500

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j.

Patel CompanyPro Forma Statement of Cash Flows

For the Quarter Ended December 31, 2012

Cash flows from operating activities Cash receipts from customers $ 345,000 Cash payments for inventory (252,525) Cash payments for S&A expenses (97,450) Cash payments for interest expense (4,165)Net cash flows from operating activities $ (9,140)

Cash flows from investing activities Cash payment for store fixtures (164,000)

Cash flow from financing activities Net Inflow from line of credit 185,140 Net increase in cash 12,000 Plus: Beginning cash balance 0 Ending cash balance $ 12,000

Problem 7-23A

a. Pro forma income statement assuming 5% growth:

BudgetSales revenue $4,200,000Cost of goods sold 2,625,000Gross profit 1,575,000Selling & administrative expenses 945,000Net income $ 630,000

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b. Pro forma income statement with 10% growth:

Actual ResultSales revenue $4,400,000Cost of goods sold 2,750,000Gross profit 1,650,000Selling & administrative expenses 990,000Net income $ 660,000

Excess of actual net income over budget: $660,000 – $630,000 = $30,000

Bonus: $30,000 x 15% = $4,500

c. Pro forma income statement assuming 15% growth:

BudgetSales revenue $4,600,000Cost of goods sold 2,875,000Gross profit 1,725,000Selling & administrative expenses 1,035,000Net income $ 690,000

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d. Zero

e. The process of participative budgeting is recommended. This process requires two-way communication between the president and divisional vice presidents. Any disagreement about the budget assumptions should be fully discussed and pros and cons well considered. If the president believes that the divisional budget is unrealistic, he should tell the vice president directly and explain the reasons. Participative budgeting is more than just a budget proposal from a subordinate and a review and final decision by the superior. The process described in the problem is nothing but gamesmanship.

Exercise 7-1B

The primary deficiencies in Mullins’ budgeting process are the absence of leadership and top management participation and the failure of the controller and department managers to coordinate their efforts. As a result of these flaws, department managers proposed budgets that would satisfy their individual needs at the expense of the company’s best interests.

Ms. Morgar should have established general corporate goals early in the budgeting process. She needn’t dictate company goals based on her personal ambitions; rather, she could have created a high-level committee to evaluate the company’s long-term competitive position in the market and to advise her regarding possible alternative future company goals. Once top management establishes company goals, individual departments should propose department-level goals and budgets to support the company’s general goals.

Mr. Judson should have coordinated the budgeting process among the different departments to ensure that they would propose individual budgets in support of the company’s overall goals.

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Exercise 7-2B

a.

Revenues Budget July August SeptemberFood sales $40,000 $42,000 $44,100 Beverage and liquor sales 24,000 25,200 26,460 Total budgeted revenues $64,000 $67,200 $70,560

b. The total revenue Gardner’s will report on the 3rd quarter pro forma income statement is the sum of the monthly amounts, $64,000 + $67,200 + $70,560 = $201,760.

Exercise 7-3B

a.

Schedule of Cash Receipts April May JuneCurrent cash sales $120,000 $140,000 $150,000 Plus: Collections from accounts receivable 310,000 480,000 568,000 Total budgeted collections $430,000 $620,000 $718,000

b. Since the current month’s sales on account will be collected in the following month, the amount of accounts receivable at the end of June is equal to June’s credit sales of $500,000.

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Exercise 7-4B

a.

This Quarter 1st Quarter 2nd Quarter 3rd Quarter 4th QuarterMoore $160,000 $166,400 $173,056 $179,978 $187,177Pickrell 200,000 202,000 204,020 206,060 208,121Rice 320,000 329,600 339,488 349,673 360,163Total $680,000 $698,000 $716,564 $735,711 $755,461

b.

Budgeted 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter AnnualIncome $698,000 $716,564 $735,712 $755,461 $2,905,736

Exercise 7-5B

a. The expected cash collections in July are 50% of that month’s expected sales revenues. The computation follows:

$300,000 x 50% = $150,000

b. The expected cash collections in August are the sum of 50% of July’s expected revenues and 50% of August’s expected revenues. The computation follows:

$300,000 x 50% + $280,000 x 50% = $290,000

Exercise 7-6B

Sales would likely be high in February because of Valentine’s Day sales, in May because of Mother’s Day sales, in June because of Father’s Day sales, and in December because of Christmas sales. Sales should be relatively stable in other months since birthdays and other personal events occur in a normal distribution pattern.

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Exercise 7-7B

a.

Inventory Purchases BudgetJanuary February March

Budgeted cost of goods sold $80,000 $56,000 $60,000 Plus desired ending inventory 8,960 9,600 10,080 Inventory needed 88,960 65,600 70,080 Less beginning inventory 12,000 8,960 9,600 Required purchases (on account) $76,960 $56,640 $60,480

b. The amount of cost of goods sold reported on the first quarter income statement is the sum of the monthly amounts, $80,000 + $56,000 + $60,000 = $196,000.

c. Since the quarter ends on March 31, the ending inventory for March is also the ending inventory for the quarter, $10,080.

Exercise 7-8B

a.

Schedule of Cash Payments for Inventory PurchasesOct. Nov. Dec.

Payment for current accounts payable $28,000 $21,000 $25,200 Payment for previous accounts payable 9,000 12,000 9,000 Total budgeted payments for inventory $37,000 $33,000 $34,200

b. Since 70% of current accounts payable are paid in cash in the month of purchase, 30% will remain payable at the end of any month,$10,800 ($36,000 x .30) at the end of December.

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Exercise 7-9B

a. Budgeted cost goods sold for February is $328,000 ($320,000 x 1.025).

Desired February ending inventory balance $ 30,000Budgeted cost of goods sold 328,000Inventory needed in February 358,000Less: beginning inventory balance (January) (25,000)Budgeted February purchases $333,000

b.

January’s payables balance paid in February $ 30,000Cash paid for February purchases ($333,000 x 0.60) 199,800Projected cash payments for February $229,800

Exercise 7-10B

a.

Schedule of Cash Payments for Selling and Administrative ExpensesJanuary February March

Equipment depreciation* $ 0 $ 0 $ 0 Prior month's salary expense, 100% 0 3,400 3,200 Cleaning supplies 1,000 940 1,100 Insurance premium 7,200 0 0Equipment maintenance expense 500 500 500Leases expense 1,600 1,600 1,600 Miscellaneous expenses 400 400 400 Total payments for S&A expenses $10,700 $6,840 $6,800 *Depreciation is a noncash charge.

b. Since salary expense is paid in the month following the month it is incurred, the amount payable at the end of March will be the amount of salary expense incurred in March, $3,600.

c. Since the annual insurance premium is prepaid on January 1, the amount of prepaid insurance at the end of March will be $5,400 [$7,200 – ($600 x 3)].

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Exercise 7-11B

a. An inventory purchases budget prepared with Rachel’s estimate:

1st Quarter 2nd Quarter 3rd Quarter 4th QuarterSales $360,000 $400,000 $300,000 $420,000Cost of goods sold $216,000 $240,000 $180,000 $252,000Plus: ending inventory 36,000 27,000 37,800 35,000Inventory needed 252,000 267,000 217,800 287,000Less: beginning inventory 25,000 36,000 27,000 37,800Required purchases $227,000 $231,000 $190,800 $249,200

b. An inventory purchases budget prepared with David's estimate:

1st Quarter 2nd Quarter 3rd Quarter 4th QuarterSales $300,000 $320,000 $340,000 $480,000Cost of goods sold $180,000 $192,000 $204,000 $288,000Plus: ending inventory 28,800 30,600 43,200 35,000Inventory needed 208,800 222,600 247,200 323,000Less: beginning inventory 25,000 28,800 30,600 43,200Required purchases $183,800 $193,800 $216,600 $279,800

Exercise 7-12B

a. Budgeted payments for January: Office lease $4,000 Utilities 1,900

Office supplies 2,400 Miscellaneous 1,000

Total* $9,300

*The referral fees are not included because cash payment for them will be made in February. The depreciation is not included because depreciation does not require a cash payment. Cash for depreciable assets is paid when the assets are purchased rather than when depreciation is recognized.

b. The full $5,000 balance for the referral fees will remain payable at the end of January.

c. Since the office lease is $4,000 each month, the annual lease expense will be $48,000 ($4,000 x 12).

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Exercise 7-13B

a.

Cash Budget July August SeptemberBeginning cash balance $ 16,000 $ 4,000 $ 4,000 Add cash receipts 180,000 192,000 208,000 Cash available (a) 196,000 196,000 212,000 Less disbursements For inventory purchases 158,000 153,000 171,000 For S&A expenses 37,000 36,000 39,000 Interest expenses at 1% per month 0 301 0 Total budgeted disbursements (b) 195,000 189,030 210,000 Cash surplus (shortage) (a – b) 1,000 6,970 2,000Financing activity Borrowing (repayment) (c) 3,000 (2,970) 2,000Ending cash balance (a – b + c) $ 4,000 $ 4,000 $ 4,000

1$3,000 x 1% = $302($3,000 – $2,970) x 1% = $0 (rounded)

b. Net cash flows from operating activities equals total (sum of the monthly amounts) cash receipts from customers minus total (sum of the monthly amounts) cash payments for inventory, S&A expenses, and interest. The computation follows:

($180,000 + $192,000 + $208,000) – ($195,000 + $189,030 + $210,000) = $580,000 – $594,030= $(14,030) net cash outflow

c. Net cash flows from financing activities is the amount borrowed less repayments. The computation follows:

$3,000 – $2,970 + $2,000 = $2,030 net cash inflow

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Exercise 7-14B

a.Cash Collections Collections from June 30 receivables balance $ 50,000 Collections from July’s credit sales ($320,000 x 0.75) 240,000 July cash sales 70,000 Total cash receipts in July $360,000Desired cash balance 15,000Cash disbursements in July 380,000

Total July cash needs 395,000Cash shortage (amount to borrow) $ 35,000

b. There will be no interest reported on the July pro forma income statement because the money was borrowed on the last date of the month.

c. Estimated interest expense for August is $350 [$35,000 x (12% 12)].

Exercise 7-15B

a. Pro forma income statement prepared with Mr. McFerrin’s estimate:

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter TotalSales revenue $252,000 $210,000 $226,800 $329,700 $1,018,500Cost of goods sold 126,000 105,000 113,400 164,850 509,250Gross margin 126,000 105,000 113,400 164,850 509,250S&A expenses 31,500 26,250 28,350 41,213* 127,313Net income $ 94,500 $ 78,750 $ 85,050 $123,637 $ 381,937

*rounded

b. Pro forma income statement prepared with Ms. Dester’s estimate:

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter TotalSales revenue $259,200 $216,000 $233,280 $339,120 $1,047,600Cost of goods sold 129,600 108,000 116,640 169,560 523,800Gross margin 129,600 108,000 116,640 169,560 523,800S&A expenses 32,400 27,000 29,160 42,390 130,950Net income $ 97,200 $ 81,000 $ 87,480 $127,170 $ 392,850

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Exercise 7-15B (continued)

c. Forecasting is not likely to be 100% accurate. It is based on inexact factors such as judgment and economic predictions. Different executive officers in the same company will probably have different future expectations. In addition to legitimate differences of opinion, self-interest may also contribute to disagreement. For example, Millard McFerrin, who deals with customers’ credit problems and uncollectible accounts, may want stricter criteria for granting customer credit, which would naturally result in lower sales growth. On the other hand, Dorothy Dester, who deals with market potential and sales commissions, may want looser criteria for customer credit, which would result in greater sales growth.

Problem 7-16B

a.Sales Budget January February TotalSales on account $540,000 $594,000 $1,134,000

b. Sales revenue for January and February is equal to the sum of the monthly amounts ($540,000 + $594,000 = $1,134,000).

c.Schedule of Cash Receipts January FebruaryReceipts from December sales $ 90,000Receipts from January sales 432,000 Receipts from January sales $108,000 Receipts from February sales 475,200 Receipts from February salesTotal $522,000 $583,200

d. The accounts receivable as of February 28, 2012 is equal to the amount due to be collected in March, $118,800 ($594,000 x 20%).

Problem 7-17B

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a.

Inventory Purchases Budget Oct. Nov. Dec.Budgeted cost of goods sold $450,000 $562,500 $675,000 Plus desired ending inventory 112,500 135,000 120,000* Inventory needed 562,500 697,500 795,000 Less beginning inventory 90,000 112,500 135,000 Required purchases (on account) $472,500 $585,000 $660,000

*$800,000 x .75 x .20 = 120,000

b. Since the quarter ends on December 31, the ending inventory for December is also the ending inventory for the quarter (i.e., $120,000).

c.

Schedule of Cash Payments Oct. Nov. Dec.Payment of current accounts payable $330,750 $409,500 $462,000 Payment of previous accounts payable 90,000 141,750 175,500Total budgeted payments for inventory $420,750 $551,250 $637,500

d. Since the quarter ends on December 31, the ending accounts payable balance for December is the balance in accounts payable that will appear on the end of quarter pro forma balance sheet. 70% of the current purchases on account are paid in cash during the month of purchase, therefore, 30% will remain payable at the end of the month (i.e., $660,000 x .30 = $198,000).

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Problem 7-18B

This is a typical problem for what-if analysis. Students can use a computerized spreadsheet to try different possible scenarios.

Budgeted net income for the next year: $60,000 x 120%= $72,000Budgeted cost of goods sold for the next year: $350,000 ÷ $500,000 = 70% of salesBudgeted selling and administrative expenses for the next year:

$68,000 +10% of sales.

a. The budgeted sales that meet the goal: If sales = XSales – Cost of goods sold – S&A expenses = NI1X – .70X – ($68,000 + .10X) = $72,000.20X – $68,000 = $72,000.20X = $140,000X = $700,000($700,000 – $500,000) ÷ $500,000 = 40% increase in sales

Pro Forma Income StatementSales revenue $700,000Cost of goods sold 490,000Gross profit 210,000Selling & admin. expenses 138,000*Net income $ 72,000

*($700,000 x 10% + $68,000) = $138,000

b.

Budgeted cost of goods sold with a 3% cut: $350,000 x 97% = $339,500

Budgeted gross profit: $500,000 – $339,500= $160,500The budgeted level of selling and administrative expenses:

If X = S&A expensesGross Profit – X = $72,000$160,500 – X = $72,000X = $88,500

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Problem 7-18B (continued)

Pro Forma Income StatementSales revenue $500,000Cost of goods sold 339,500Gross profit 160,500Selling & admin. expenses 88,500*Net income $ 72,000

*The figure means that management has to cut the selling and administrative expenses by $1,500 in order to reach Mr. Morris’ goal.

c.

Projected sales revenue to increase by 25%: $500,000 x 125%= $625,000

Projected cost of goods sold: $625,000 x 70% = $437,500

Pro Forma Income StatementSales revenue $625,000Cost of goods sold 437,500Gross profit 187,500Selling & admin. expenses 150,000Net income $ 37,500

Since the projected net income under the given scenario will be only $37,500, which is far short of the original $60,000 and the desired $72,000, the company cannot reach its goal.

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Problem 7-19Ba.

Schedule of Cash Payments for S&A ExpensesJanuary February March

Salary expense $ 9,000 $ 9,000 $ 9,000 Prior month's sales commissions 0 600 640 Prior month's advertising expense 0 500 500Prior month's telephone expense 0 1,000 1,080 Rent 10,000 10,000 10,000 Miscellaneous 800 800 800 Total payments for S&A expenses $19,800 $21,900 $22,020 Depreciation is a noncash charge.

b. Since telephone expense is paid in the month following the month it is incurred, the amount payable at the end of March will be the amount of telephone expense incurred in March, $1,100.

c. Since sales commissions are paid in the month following the month they are incurred, the amount payable at the end of February will be the amount of sales commissions expense incurred in February, $640.

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Problem 7-20B

Cash Budget April May JuneBeginning cash balance $ 36,000 $ 60,000 $ 60,090 Add cash receipts 320,000 470,000 624,000Cash available (a) 356,000 530,000 684,090Less cash payments For inventory purchases 410,000 420,000 464,000 For S&A expenses 80,000 106,000 132,000 Interest exp at 1% per month 01 2,9102 3,7953

Total budgeted payments (b) 490,000 528,910 599,795Payments minus receipts Surplus (shortage) (a–b) (134,000) 1,090 84,295Financing Activity Borrowing (repayment) (c) 194,000 59,000 (24,295)

Ending cash balance (a – b + c) $ 60,000 $ 60,090 $ 60,000

1$0 x 1.5% = $02194,000 x 1.5% = $2,910 3($194,000 + $59,000) x 1.5% = $3,795

Problem 7-21B

When necessary, all computations are rounded to the nearest dollar.a.

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter TotalComputer $550,000 $605,000 $682,000 $ 803,000 $2,640,000Calculator 260,000 286,000 301,600 338,000 1,185,600Total $810,000 $891,000 $983,600 $1,141,000 $3,825,600

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b. Budgeted cost of goods sold: $3,825,600 x 75% = $2,869,200

Budgeted Annual Income StatementSales revenue $3,825,600Cost of goods sold 2,869,200Gross profit 956,400Selling & admin. expenses 500,000Net income $ 456,400

c. Inventory purchases budget for palm-size computers:


Inventory purchases budget for programmable calculators:


7-40


Problem 7-22B (Note: All computations are rounded to the nearest whole dollar.)

a. & b.

Sales BudgetPro Forma

January February March DataCash sales $ 75,000 $ 82,500 $ 90,750 Sales on account 175,000 192,500 211,750 $211,750(a) Total budgeted sales $250,000 $275,000 $302,500 827,500(b)

Schedule of Cash Receipts Pro FormaJanuary February March Data

Current cash sales $ 75,000 $ 82,500 $ 90,750 Plus: Collections from accts. rec. 0 175,000 192,500 Total collections $75,000 $257,500 $283,250 $615,750 (c)(a) Ending accounts receivable balance appearing on balance sheet.(b) Sales revenue appearing on income statement (sum of monthly amounts).(c) Cash receipts from customers on statement of cash flows (sum of monthly amounts).

c. and d.

Inventory Purchases BudgetPro Forma

Jan. Feb. Mar. DataBudgeted cost of goods sold $125,000 $137,500 $151,250 $413,750(a) Plus desired ending inventory 27,500 30,250 33,000 33,000(b) Inventory needed 152,500 167,750 184,250Less beginning inventory 0 27,500 30,250Required purchases (on Acct.) $152,500 $140,250 $154,000 61,600(c)

Schedule of Cash Payments Budget for Inventory Purchases Pro FormaJanuary February March Data

Pmt of current month's A/P $91,500 $ 84,150 $ 92,400 Pmt for prior month's A/P 0 61,000 56,100Total budgeted pmts. for invent. $91,500 $145,150 $148,500 $385,150(d)

(a) Cost of goods sold appearing on pro forma income statement (sum of monthly amounts).(b) Ending inventory balance appearing on pro forma balance sheet.(c) Ending accounts payable balance appearing on pro forma balance sheet ($154,000 x 0 .40).(d) Cash payments for inventory purchases on statement of cash flows (sum of monthly amounts).

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e. and f.Selling and Administrative Expense Budget

Pro FormaJanuary February March Data

Salary expense $25,000 $25,000 $25,000 Sales commissions, 8% sales 20,000 22,000 24,200 $24,200(a) Supplies expense, 4% sales 10,000 11,000 12,100Utilities 1,800 1,800 1,800 1,800(b) Depreciation on store fixtures 5,000 5,000 5,000 15,000(c) Rent 7,200 7,200 7,200Miscellaneous 2,000 2,000 2,000 Total S&A expenses $71,000 $74,000 $77,300 222,300(d)

Schedule of Cash Payments for S&A ExpensesSalary expense $25,000 $25,000 $25,000 Prior month's sales comm., 100% 0 20,000 22,000Supplies expense 10,000 11,000 12,100100% prior month's utilities, 100% 0 1,800 1,800 Depreciation on store fixtures 0 0 0Rent 7,200 7,200 7,200Miscellaneous 2,000 2,000 2,000 Total payments for S&A expenses $44,200 $67,000 $70,100 $181,300(e)

Depreciation is a noncash charge.(a) Ending sales commissions payable account balance shown on pro forma balance sheet.(b) Ending utilities payable account balance shown on pro forma balance sheet.(c) Accumulated depreciation appears on the pro forma balance sheet (sum of monthly amounts).(d) Total S&A expenses appearing on pro forma income statement (sum of monthly amounts).(e) Total cash payments for S&A expenses on pro forma statement of cash flows (sum of monthly amounts).

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g.Cash Budget

Pro FormaJanuary February March Data

Beginning cash balance $ 0 $ 50,300 $ 50,000 Add cash receipts 75,000 257,500 283,250 $615,750(a) Cash available (w) 75,000 307,800 333,250 Less payments For inventory purchases 91,500 145,150 148,500 385,150(b) For S&A expenses 44,200 67,000 70,100 181,300(c) Purchase of store fixtures 350,000 0 0 350,000(d) Interest expense* 0 6,915 6,334 13,249(f)Total budgeted payments (x) 485,700 219,065 224,934Payments minus receipts Surplus (shortage) (w – x) (410,700) 88,735 108,316Financing activity Borrowing (repayment) (y) 461,000 (38,735) (58,316) 363,949(e) Ending cash balance (w – x + y) $ 50,300 $ 50,000 $50,000 50,000(g)

*January ($0 x 0.015); February ($461,000 x 0.015); March [($461,000 – $38,735) x 0.015](a) Operating activities section of pro forma statement of cash flows (sum of monthly amounts). (b) Operating activities section of pro forma statement of cash flows (sum of monthly amounts).(c) Operating activities section of pro forma statement of cash flows (sum of monthly amounts).(d) Investing activities section of pro forma statement of cash flows. The investment in store fixtures also

appears on the pro forma balance sheet.(e) Financing activities section of pro forma statement of cash flows (sum of monthly amounts). (f) Operating activities section of pro forma statement of cash flows (sum of monthly amounts). (g) The ending cash balance appears on the pro forma balance sheet and as the last item on the statement

of cash flows.

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h.

McGriff Gifts CorporationPro Forma Income Statement

For the Quarter Ended March 31, 2011Sales revenue $827,500 Cost of goods sold (413,750)Gross margin 413,750S&A expenses (222,300)Operating income 191,450Interest expense (13,249)Net income $178,201

i.

McGriff Gifts CorporationPro Forma Balance Sheet

March 31, 2011Assets Cash $ 50,000 Accounts receivable 211,750 Inventory 33,000 Store fixtures $350,000 Accumulated depreciation (15,000) Book Value of fixtures 335,000 Total assets $629,750

Liabilities Accounts payable $ 61,600 Sales commissions payable 24,200 Utilities payable 1,800 Line of credit liability 363,949Equity Retained earnings 178,201Total liabilities and equity $629,750

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j.

McGriff Gifts CorporationPro Forma Statement of Cash Flows

For the Quarter Ended March 31, 2011

Cash flows from operating activities Cash receipts from customers $615,750 Cash payments for inventory (385,150) Cash payments for S&A expenses (181,300) Cash payments for interest expense (13,249)Net cash flows from operating activities $ 36,051

Cash flows from investing activities Cash payment for store fixtures (350,000)

Cash flows from financing activities Net inflow from line-of-credit 363,949Net increase in cash 50,000Plus beginning cash balance 0 Ending cash balance $ 50,000

Problem 7-23B

a. Pro forma income statement assuming 4% growth:

BudgetSales revenue $8,320,000Cost of goods sold 4,992,000Gross profit 3,328,000Selling & administrative expenses 1,331,200Net income $1,996,800

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b. Pro forma income statement assuming 8% rate:

BudgetSales revenue $8,640,000Cost of goods sold 5,184,000Gross profit 3,456,000Selling & administrative expenses 1,382,400Net income $2,073,600

c. Excess of actual net income over budget:

$2,073,600 – $1,996,800 = $76,800

Bonus: $76,800 x 10% = $7,680

d. The process of participative budgeting is recommended. This process requires two-way communication between the president and divisional directors. Any disagreement on budget assumptions should be fully discussed and pros and cons well considered. If the president believes that the divisional budget is unrealistic, he/she should tell the vice president directly and explain the reasons. Participative budgeting is more than just a submission of a budget proposal from a subordinate and a review and final decision by the superior. The process described in the problem is nothing but gamesmanship.

It would be unethical if Ms. Rollin proposes only a 4% growth rate because it not only reflects a dishonest estimate but also results in Ms. Rollin’s personal gain at the expense of her employer. On the other hand, the company's plan to use the excess of actual income over budget as the basis for bonuses is an invitation for unethical behavior.

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ATC 7-1a.

BudgetedFinancial Statements

Income Statement Amounts Computations Sales revenue $240,000 12 x $20,000Cost of goods sold (192,000) 12 x $16,000Depreciation expense (2,000) ($15,000 – $5,000) ÷ 5Other expense (5,000) $20,000 – $15,000Operating income 41,000 Interest expense (900) $15,000 x .06 Net income $40,100

Statement of Cash FlowsOperating Activities: Inflows from sales $240,000 12 x $20,000 Outflows for: Purchase of food, etc. (192,000) 12 x $16,000 Other initial expenses (5,000) $20,000 – $15,000 Interest payments (900) $15,000 x .06Net Operating Activities 42,100

Investing Activities: Outflow for purchase of trailer cart (15,000) given

Financing Activities” Inflows from: Contribution by owners 5,000 given Loan from parents 15,000 givenNet NCF Financing Activities 20,000 Net Change in Cash 47,100 Plus beginning cash 0 Ending cash balance $47,100

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ATC 7-1 (continued)

BudgetedFinancial Statements

(continued)Balance Sheet Amounts Computations Cash $47,100 from SCFTrailer cart 15,000 givenAcc. depreciation (2,000) ($15,000 – $5,000) ÷ 5 Total assets $60,100

Note payable $15,000 given

Contributed capital 5,000 givenRetained earning 40,100 from Inc. StatementTotal liabilities & Equity $60,100

b. The budget financial statements above assume sales for each month of the year will be approximately equal to sales for September and October. Most likely, sales will be lower during periods between semesters, during the colder months, and during the summer session. On the plus side, some of the initial expenses of $5,000 may not have to be incurred every year.

Also, the presentation above assumes the owners do not take any money out of the business. Obviously, they would need to use some of the earnings from the business to pay their living expenses.

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ATC 7-2

a. Group Tasks

Task 1

Pro FormaOctober November December Data

Cash sales $ 40,000 $ 44,000 $ 48,400 Sales on account 140,000 154,000 169,400 $169,400 Accounts Rec.Total budgeted sales $180,000 $198,000 $217,800 595,800 Sales Rev.

Schedule of Cash Receipts October November December

Cash sales $ 40,000 $ 44,000 $ 48,400 Collections from accounts receivable 60,000 140,000 154,000 Total cash collections $100,000 $184,000 $202,400

Task 2

Pro FormaOct. Nov. Dec. Data

Budgeted cost of goods sold $72,000 $79,200 $87,120 $238,320 Cost of Goods SoldPlus: Desired ending inventory 14,400 15,840 17,424 17,424 Ending InventoryInventory needed 86,400 95,040 104,544 Less: Beginning inventory 40,000 14,400 15,840Required purchases (on account) $46,400 $80,640 $88,704 22,176 Accounts Payable

Schedule of Cash Payments Budget for Inventory PurchasesOctober November December

Pmt of current month's accts. pay. $34,800 $60,480 $66,528 Pmt for prior month's accts. pay. 72,000 11,600 20,160 Total budgeted pmts. for inventory $106,800 $72,080 $86,688

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ATC 7-2 (continued)

Task 3Pro Forma

Oct. Nov. Dec. DataSales commissions $ 7,200 $ 7,920 $ 8,712 $ 8,712 Commissions pay.Supplies expense 1,800 1,980 2,178 Utilities 2,200 2,200 2,200 2,200 Utility payableDepreciation on store equipment 1,600 1,600 1,600 4,800 Accum. dep.Salary expense 34,000 34,000 34,000 Rent 6,000 6,000 6,000 Miscellaneous 1,000 1,000 1,000 Total S&A expenses $53,800 $54,700 $55,690 $164,190 S&A Exp.

b. Financial Statements

Income StatementSales revenue $595,800 Cost of goods sold (238,320)Gross margin 357,480 Operating expenses (164,190)Operating income 193,290 Interest expense (2,530)Net income $190,760

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ATC 7-2 (continued)

Balance SheetAssets Cash $ 9,760 Accounts receivable 169,400 Inventory 17,424 Store equipment $200,000 Accumulated depreciation store equipment (81,600) Book value of store equipment 118,400 Total assets $314,984

Liabilities Accounts payable $ 22,176 Utilities payable 2,200 Sales commissions payable 8,712 Line of credit 23,936 Equity Common stock 50,000 Retained earnings 207,960 Total liabilities and equity $314,984

c. Havel will need to borrow money in October.

Cash Budget for October

Beginning cash balance $ 16,000 Add: Cash receipts 100,000 (1)Cash available 116,000 Less: Payments For inventory purchases 106,800 (2) For S&A expenses 42,800 (3)Total budgeted payments 149,600

Payments minus receipts = shortage $ 33,600

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ATC 7-2 (continued)

(1) $40,000 cash sales + $60,000 collection on September accounts receivable.(2) $34,800 payment for Oct. Inventory + $72,000 payment on September

accounts payable.(3) $53,800 October S&A expenses – $7,200 sales commissions – $2,200

utilities expense – $1,600 depreciation = $42,800

ATC 7-3

a. There was a budgeted surplus in 6 years and a deficit in the 51 years from 1960 to 2010: 1960, 1969, 1998, 1999, 2000, 2001. Thus, a deficit was reported in 45 years.

b. 2009 had a deficit of 12.9 % of GDP2010 had a deficit of 8.5 % of GDP1983 had a deficit of 6.0 % of GDP.2000 had a surplus of 2.4 % of GDP.

c. For 2009: Deficit $1,841,188Revenues $2,156,654

= 85.4%

d. The departments whose budgets changed the most from the Clinton years to the Bush years were:

Health and Human Services 2.3 increaseDefense—Military 2.2 increase

Other Independent Agencies (On-budget) 0.9 increaseTreasury 3.9 decreaseSocial Security Administration (Off-budget) 1.9 decrease

See the table below for complete data.

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ATC 7-3 (continued)

Comparison of Average Budget Percentages by Department for 1994 - 2001 (Clinton Years) to 2002 – 2009 (Bush Years)

Average Averagefor for

Clinton BushYears Years Difference

Legislative Branch 0.2 0.2 0.0The Judiciary 0.2 0.2 0.0Agriculture 3.7 3.2 -0.5Commerce 0.3 0.3 0.0Defense—Military 16.2 18.4 2.2Education 1.9 2.5 0.6Energy 1.0 0.8 -0.2Health and Human Services 20.9 23.2 2.3Homeland Security 0.7 1.5 0.8Housing and Urban Development 1.8 1.7 -0.1Interior 0.4 0.4 -0.1Justice 0.8 1.0 0.2Labor 2.1 2.4 0.3State 0.4 0.5 0.1Transportation 2.3 2.4 0.0Treasury 22.4 18.5 -3.9Veterans Affairs 2.5 2.6 0.1Corps of Engineers 0.2 0.2 0.0Other Defense—Civil Programs 1.9 1.7 -0.2Environmental Protection Agency 0.4 0.3 -0.1Executive Office of the President 0.2 0.2General Services Administration 0.1 -0.1International Assistance Programs 0.6 0.5 -0.1National Aeronautics and Space Administration 0.9 0.6 -0.2National Science Foundation 0.2 0.2 0.0Office of Personnel Management 2.7 2.3 -0.4Small Business Administration 0.1 0.1 0.0Social Security Administration (On-budget) 2.2 2.1 -0.1Social Security Administration (Off-budget) 22.1 20.3 -1.8Other Independent Agencies (On-budget) 0.3 1.1 0.8Other Independent Agencies (Off-budget) 0.1 0.0 -0.1Allowances 0.1 0.1Undistributed offsetting receipts -9.4 -9.1 0.3(On-budget) -6.2 -5.0 1.2(Off-budget) -3.2 -4.1 -1.1

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ATC 7-4

HON could use a technique known as perpetual or continuous budgeting. This technique utilizes a twelve-month budgeting period. However, at the completion of the current month, a new month is added to the end of the budget period. The result is a continuous twelve-month budget. The advantage of the perpetual budget is that it keeps management involved in the budget process. The traditional approach often leads to a frenzied stop-and-go mentality. The annual budget is prepared in a year-end rush, and the assumptions underlying its formation are forgotten shortly thereafter. Changing conditions are not likely to be discussed until the next year-end review cycle. The perpetual budget overcomes these shortcomings by keeping management involved with the budget. Each month a new monthly budget is prepared to replace the budget of the ending month. Management is thereby forced into a constant twelve-month think-ahead process.

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ATC 7-5

a. Mr. Cleaver’s behavior could be construed to be in violation of the objectivity standards. The failure to disclose the lack of need for computers to the Board of Education would violate (1) the standard to communicate information fairly and objectively and (2) the standard to disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. However, Mr. Cleaver could have disclosed all information fairly to the board. He is correct in his assessment that neither he nor Ms. Simmons has the right to establish policy. Also, it should be noted that Mr. Cleaver may not be a member of the Institute of Management Accountants and is therefore not bound by the organization’s code of ethics.

b. Sarbanes-Oxley Act requires management of public companies to report accurately the financial statements to external users such as investors and creditors. This case does not involve external reporting, and, consequently, the law is not applicable. However, with recent school board scandals abound in the past ten years, many principles of Sarbanes-Oxley have been adopted by school districts.

c. As its name implies, participative budgeting encourages participation by subordinates as well as upper level managers in the budget process. Information flows from the bottom up as well as from the top down during the preparation of the budget. Accordingly, the Board of Education members would be in a position to gain insight as to the true needs of the schools and would thereby be more likely to allocate funds where they would produce the greatest benefit.

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ATC 7-6

Screen capture of cell values:

7-56


ATC 7-6 (continued)

Screen capture of cell formulas:

7-57


ATC 7-7

Screen capture of cell values:

7-58


ATC 7-7

Screen capture of cell formulas:

7-59


ATC 7-7

Screen capture of cell formulas (continued):

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7-61

Chapter 7 Comprehensive Problem

Growth Rate of Sales 0.01Sales Budget

Jan Feb MarCash sales $10,000 $10,100 $10,201Sales on account 50,000 50,500 51,005Total budgeted sales $60,000 $60,600 $61,206

Schedule of Cash ReceiptsJan Feb Mar

Current cash sales $10,000 10,100 10,201

Plus: Collections from accts. rec. 48,000 50,000 50,500Total budgeted collections $58,000 60,100 60,701




Current cash sales $10,000 $10,200 $10,404Plus: Collections from accts. rec. 48,000 50,000 51,000Total budgeted collections $58,000 $60,200 $61,404




Current cash sales $10,000 $10,400 $10,816Plus: Collections from accts. rec. 48,000 50,000 52,000Total budgeted collections $58,000 $60,400 $62,816

Chap007_1

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