Chapter 8: Strategy and The Master Budget

Blocher, Stout, Cokins, Chen, Cost Management, 4/e 8-1 The McGraw-Hill Companies 2008
CHAPTER 8: STRATEGY AND THE MASTER BUDGET

QUESTIONS

8-1 Compel strategic planning and facilitate implementation of strategic plans. An
organizations strategy, strategic plans, and budgets are interrelated. Preparing
budgets compels reviews of an organizations strategy and its strategic plans and can
facilitate implementations of the strategic plan. Feedback from budgets often results
in improvements to an organizations strategy and strategic plan.
Serve as a basis for performance evaluation. Budgets serve as the benchmark
against which actual performance can be compared. Budgets are a better basis for
judging performance than past performance for two reasons. First, budgeted amounts
take into account expected changes and improvements in the environment. Second,
past performance is a result of past events and operations and may not be suitable to
serve as a benchmark. To the extent past performance was not effective/efficient it
does not make sense to use this as the standard against which actual performance is
compared.
Motivate managers and employees. Budgets, if internalized, serve as goals for
managers and employees and, if properly implemented, can motivate them toward
achievements of the goals.
Promote coordination and communication within the organization. Budgets compel
managers to think of interdependencies and interrelationships among subunits of the
organization. A budget is also a communication device that helps all employees and
managers understand and accept the organizations objectives and expected roles
and contributions over the coming period.
Authorization to act. The approved budget, particularly in a not-for-profit setting, gives
the manager authorization to act (make decisions, etc.).

Other benefits include serving as a basis for resource allocation, aiding cash-flow
management, and providing authorization documentation.

8-2 An organizations strategic plan describes how the organization matches its strengths
and weaknesses with the opportunities and threats in the marketplace in order to
accomplish its long-term goals (e.g., achieve sustainable competitive advantage). It is
the guideline for the firms short-term and long-term operations. A strategic plan may
extend over several budget periods (e.g., years) covered by a master budget.
A master budget is a comprehensive operational plan of action for the coming
year. It includes both operating budgets and financial budgets and culminates in a set
of forecasted (i.e., pro-forma) financial statements (cash flow, income statement, and
balance sheet). The strategic plan of a firm guides, in a general sense, the
determination of the master budgets prepared annually by the organization.
Specialized consulting companies now provide software that can be used to integrate
master budgets with strategic plans as part of a comprehensive performance
management system. (See, for example, Geac, at www.performance.geac.com.)


8-3 A master budget is a comprehensive plan of action for an organization for a future
period while a capital budget is an investment (and financing) plan for a major project
or program that has long-range effects on operations. As indicated in text Exhibit 8.3,
resources specified in the capital budget of the current period are included in the
master budget of the period.

8-4 A master budget is a comprehensive plan of action for a future period; as such, the
master budget includes both operating and financial budgets. An operating budget
consists of plans regarding revenues and resource acquisition/use across all major
operating areas of the organization (e.g., sales, production, purchasing, marketing,
research and development, and general administrative activities). The set of operating
budgets culminates in a budgeted income statement. Financial budgets relate to
sources and uses of funds for an upcoming period. The set of financial budgets
culminates in a budgeted cash flow statement and budgeted balance sheet.

8-5 Successful budgeting systems typically:

have full support by one or more key managers in the organization
become personalized budgets of the people who have the responsibility for
carrying them out; as such, they serve an important motivational function
are perceived by managers and employees as planning and coordinating tools,
not pressure devices or mechanisms designed to stifle creativity and opportunity
are not viewed as a basis for placing blame.
provide for a two-way flow of information in the budget-preparation process
include budgets that are highly achievable

8-6 The budget committee of an organization is the highest authority in the organization
for all matters related to the budget. The committee sets or approves the overall
budget goals for the organization and its major business units, directs and
coordinates budget preparation, resolves conflicts and differences that may arise
during the budget-preparation process, approves the final budget, monitors
operations as the year unfolds, and reviews operating results at the end of the period.
The budget committee also approves major revisions of the budget during the period.

8-7 No, these terms are not synonymous. The term sales forecast refers to estimated
sales volume for an upcoming period. As such, the sales forecast is generally the
starting point in preparing the sales budget for the period. The term sales budget
refers to forecasted sales dollars for an upcoming period.

Alternatively, rather than focusing on the difference between sales volume and
sales dollars, some writers distinguish between these two terms on the basis of the
level of control: we use the term sales forecast to refer to both units and dollars
because, unlike costs, these elements are affected by external (e.g., competitor
actions) as well as internal factors (e.g., product promotion expenditures).


8-8 The sales budget is often regarded as the cornerstone in the master budget because
all operating activities in a business emanate from efforts to attain the level of sales
specified in the sales budget. A firm can complete the plan for other activities of a
period only after it knows the expected sales levels for the current and the immediate
future periods. A manufacturing firm, for example, cannot complete its production
schedule for the upcoming period without knowing the number of units it must
produce for each of its products. The firm can ascertain the number of units to be
produced only after it knows both forecasted sales and the desired ending inventory.
The units to be produced, in turn, affect many other activities of the firm including
amount and kinds of materials to be purchased, number of employees to be hired,
levels of factory overhead, and selling and administrative expenses.

8-9 When sales volume is seasonal in nature, the three most significant items to
coordinate are: production volume, finished goods inventory, and sales volume.

8-10 Additional factors include:

beginning and desired ending inventories of work-in-process and finished goods
the required material inputs (in lbs., liters, etc.) for each product
beginning and desired ending inventories of direct materials
the cost of materials (per lb., liter, etc.)

8-11 The two factors that determine the amount of factory overhead for a period are
management decision and planned production volume. The former refers to
capacity-related (i.e., fixed overhead) costs while the latter refers to the planned
utilization of that capacity (i.e., variable overhead costs).

8-12 A cash budget generally includes three major components:

Cash available (i.e., beginning cash balance plus budgeted cash receipts)
Cash disbursements (other than interest expense), and
Financing activity (new financing, repayment of principal, and interest expense)

8-13 The following are some of the similarities between cash budgets and cash-flow
statements required by GAAP:

Both include sources and uses of funds
Both are prepared for a period of time
Neither includes any non-cash revenues and expenses

Among differences between these two statements are:

A cash-flow statement reports the results of past activities while a cash budget
describes effects of planned operations.
A firm needs to follow GAAP in preparing cash-flow statement while the guiding
principle for preparing a cash budget is relevance and usefulness to
management.


The major categories of cash-flow statements are operating, financing, and
investing activities. Each of these categories may include both sources and uses
of cash. The major categories of cash budgets are cash available, cash
disbursements, and financing. Both cash available and cash disbursements may
include cash from either operating or investing activities.

8-14 In comparison with manufacturing organizations, unique budget characteristics of
service organizations include:

absence of production and materials purchases budgets
emphasis on workforce planning

8-15 In contrast to business firms (i.e., for-profit entities), a not-for-profit organization:
has no single bottom-line amount such as operating income
is more likely to use its budgets as the source of authorization for its activities
limits the total amount in the budget to the expected total revenues (Federal
budgets are exceptions)

8-16 Zero-base budgeting (ZBB) is a budgeting process that requires managers to
prepare budgets each period from ground zero for all operations.

A typical budgeting process is incremental in nature. That is, budgets for the
upcoming period start from the approved budgets for the current period, with
amounts added to reflect planned changes for the upcoming period. Thus, traditional
budgets assume that most, if not all, of the current activities and functions will
continue into the coming budget period. In contrast, a zero-base budgeting process
allows no activities or functions to be included in the budget unless managers can
justify their need. Pure forms of ZBB are expensive and time-consuming. For this
reason, some companies have partial ZBB systems.

A number of companies (e.g., Xerox, Texas Instruments) and government
organizations (e.g., State of Georgia) have at one time or another used ZBB.

8-17 No. Kaizen budgeting is a budgeting approach that explicitly incorporates continuous
improvement standards/expectations in the approved budgets.

In contrast, activity-based budgeting (ABB) is a budgeting process that relies on
the costs of activities and activity-cost drivers to prepare budgets. In other words,
ABB develops master budget data using the organizations activity-based cost (ABC)
system. Thus, ABB begins by quantifying products and services to be produced for
an upcoming period. These forecasts are then used to estimate the amount of
activities, across the internal value chain, that are needed to meet forecasted output
(products or services). The budgeting process is completed by assigning estimated
resource costs to the specified activities. Both American Express and AT&T
Paradyne provide examples of actual implementation of ABB systems. See, Player,
S. & Keys, D. E. (eds.), Activity-Based Management: Arthur Andersens Lessons
from the ABM Battlefield. New York: John Wiley & Sons, 1999.


8-18 Budgetary slack, or "padding" the budget, is the practice of knowingly including a
higher amount of expenditure in the budget (or lower amount of revenue) than
managers actually believe should be the case. One reason that it is common to find
slacks in budgets is the desire of managers to use such slack as a cushion for
unpredictable/uncontrollable future events (e.g., worker attrition, machine
breakdowns/malfunctions). Another reason is the increased recognition or reward
that might accrue to those who beat their budget target. Finally, managers may
believe that the budgets they submit will be cut in the budget negotiation process.
Therefore, such managers must pad their budgets in order to secure the amount of
resources they feel they actually need.

8-19 A highly achievable budget has a target that is achievable by most managers most
of the time (e.g., 80 to 90 percent of the time). In a study by Merchant (1990), the
author finds that a budget with a highly achievable target serves well in the vast
majority of organizational situations, especially when accompanied by extra rewards
for performance exceeding the target.

Among the advantages of using a highly achievable budget target are the
following:

1. Increasing managers' commitment to achieving the budget target.
2. Maintaining managers' confidence in the budget.
3. Decreasing organizational control cost.
4. Reducing the risk that managers will engage in harmful earnings-
management practices or violate corporate ethical standards.
5. Allowing effective and efficient managers greater operating flexibility.
6. Improving predictability of earnings or operating results.
7. Enhancing the usefulness of a budget as a planning and coordinating tool.

8-20 Participative budgeting is a bottom-up approach that involves everyone in the
budget-preparation processfrom low-level workers all the way to the top managers
of the organization. The principal idea is to have employees/managers internalize
(i.e., take ownership of) the budgets that are prepared.

For participative budgeting to be effective, top management needs to be actively
involved. Furthermore, top management should institute incentives to guard against
excessive budget padding, and encourage the generation of accurate budgetary
projections. Finally, top managers may have to serve as arbiters when irreconcilable
differences occur in the budget preparation process.


BRIEF EXERCISES
8-21
Q2 Q3
Sales2007 16,000 15,000
Projected % increase for 2008 25% 25%
Estimated Sales Volume2008 20,000 18,750
x Estimated Unit Selling Price2008 $4.00 $4.00
Estimated Sales Dollars2008 $80,000 $75,000

8-22 Payment history:
% paid in month of purchase: 25%
% paid in month following month of purchase: 75%

Expected Cash Disbursements:
February: ($5,500 x 0.75) + ($6,500 x 0.25) = $5,750
March: ($6,500 x 0.75) + ($8,000 x 0.25) = $6,875

8-23 Number of units produced in Qtr. 1:

Ending inventory of DM (in lbs.) = 50,000
Target ending inventory % = 25% of following months production
requirements
Therefore, RM used for production in Qtr. 1 = 50,000/0.25 = 200,000 lbs.

Units produced in Qtr. 1 = lbs. of RM used/lbs. of RM per unit of
output = 200,000/8 = 25,000 units

DM requirements (in lbs.), Qtr. 2 = Planned production, Qtr. 2 x DM lbs./unit
= (25,000 units x 1.10) x 8 lbs./unit
= 27,500 units x 8 lbs./unit = 220,000 lbs.

8-24 Scheduled Production, Quarter 2:

Units required to meet estimated sales, Qtr. 2 = 12,000 units
Units required to meet targeted ending inventory:
15,000 units x 10% = 1,500 units
Total units needed 13,500 units
Less: Beginning inventory, Qtr.2 (12,000 units x 10%) = 1,200 units
Scheduled production, Quarter 2 = 12,300 units

8-25 Current level of monthly operating costs = $10,000:

Estimated operating costs, January = $10,000 x 0.99
1
= $9,900
Estimated operating costs, June = $10,000 x 0.99
6
= $9,415
Estimated operating costs, December = $10,000 x 0.99
12
= $8,864


8-26 Collection of Credit SalesNovember:

30% of Credit Sales made in October = 0.30 x $30,000 = $9,000
70% of Credit Sales made in November = 0.70 x $24,000 = $16,800
Total Estimated Collections--November = $25,800

Collection of Credit SalesDecember:

30% of Credit Sales made in November = 0.30 x $24,000 = $7,200
70% of Credit Sales made in December = 0.70 x $20,000 = $14,000
Total Estimated Collections--December = $21,200

8-27 Collection of Credit SalesDecember:

From credit sales made in November = 0.20 x $90,000 = $18,000
From credit sales made in December:
= (0.75 x $100,000) x 0.98 = $73,500
Total Estimated CollectionsDecember = $91,500

8-28 Estimated interest expenseApril = borrowing in April x (annual rate/12)
= [($30,000 - $18,000) + $1,000] x (0.12/12)
= $13,000 x 0.01 = $130.00

Note that, strictly speaking, to maintain a minimum cash balance of $30,000, the
company would have to borrow an extra $1,000 to be able to cover the interest
payment (eom) and still have at least $30,000 of cash.

Estimated financing transactionsMay:
Interest expense (paid eom): $13,000 x 0.01 = $130
Principal repayment:
Beginning-of-month cash balance
= $18,000 + ($13,000 - $130) = $30,870
Plus: net cash flow in May, prior to financing = $22,000
Cash balance prior to financing transactions = $52,870
Less: interest expense (eom) for May ($130)
Less: minimum cash balance requirement = ($30,000)
Cash available for principal repayment = $22,740
Rounded down to nearest $1,000 = $22,000
Total financing transactionsMay = $22,130

8-29 DM purchases, December = (DM issued to production +
ending DM inventory) - beginning DM inventory

= ($150,000 + $39,500) - $37,000 = $152,500


8-30 Total estimated marketing expenses, 4
th
quarter:

Variable costs = $0.05/unit x (4,000 units x 1.10)
= $0.05/unit x 4,400 units = $220
Fixed costs:
Salaries = $10,000
Depreciation = $5,000
Insurance = $2,000 $17,000
Total estimated marketing expenses, 4
th
quarter $17,220
Less: non-cash charges:
Depreciation expense $5,000
Estimated cash payments for marketing expenses $12,220


EXERCISES

8-31 What-If Analysis (20 Minutes)

1. The term what if analysis is one example of the more general term sensitivity
analysis and is used to explore the effects (e.g., on a decision or a budget for an
upcoming period) of different marketing, production, or selling strategies (e.g., the
effect on revenues of lowering product selling prices, the profit-effect of using a
different sales-promotion plan). That is, a what-if analysis examines how a result
will change if the original (base-line) data are not achieved or, as in the present case,
if an underlying assumption (viz., rate of bad-debts expense) changes.

2.

3. Managers today work in a world of uncertainty. One way to cope with uncertainty in
the master budgeting process is to model the underlying relationships associated
with the various budgets that are prepared and then to perform sensitivity analysis.
One form of sensitivity analysis is the what-if analysis described above. For Tyson
Company, this type of analysis can help the firm decide whether it might need to
implement a more restrictive credit-granting policy and, if so, how much it might be
willing to spend in this regard.


8-32 Behavioral Considerations (15 Minutes)

There are at least two issues here. One is the failure to take advantage of all the
cash discount included in the sales term. (In this regard, see Exercise 8-37.) The
other is the constant occurrence of rush orders, last-minute changes, and other
operating emergencies that require the purchasing department to do last minute
purchases.

Janet needs to ensure that the Accounting Department records all purchases at
the net price whenever a purchase is made with cash discounts included in the sales
terms. Any additional amount that the firm has to pay because of the failure to make
the payment within the payment terms should be charged to the finance department
as a loss and not treated as an adjustment to the cost of purchase.

The firm needs to be very clear in its operating procedures about the minimum
amount of time required for purchases. Any additional acquisition cost because of
rush orders, last-minute changes, or operating emergencies should be borne by the
department making the request.


8-33 Budgetary Slack and Zero-Based Budgeting (ZBB) (20 minutes)

1. Budgetary slack is a planned difference between budgeted revenue and expected
revenue, and/or budgeted expenditures and expected expenditures. Budgetary slack
describes the tendency of managers to under-estimate revenues and over-estimate
expenditures during the budgetary process in order to build in allowances
(cushions) for unexpected declines in revenue and/or unforeseen expenses.
Budgetary slack occurs because of conflicts between the personal interests of a
manager and the interests of the organization. These conflicts include pressure from
top management to achieve budgets and the desire on the part of the manager to
look favorable in the eyes of top management.

2. a. From the point of view of the business unit manager, budgetary slack provides:

performance that will look better in the eyes of their superiors
a coping mechanism regarding uncertainty
a way to obtain what is needed since initially submitted budgets tend to be cut
during the budget-negotiation process

However, the use of budgetary slack limits the objective evaluation of a business
unit and, therefore, limits the objective evaluation of the performance of the unit
manager. It also becomes more difficult for the business unit manager to evaluate
the performance of subordinates and to use the budget as a control mechanism
over subordinate performance.

b. From the perspective of corporate management, the use of budgetary slack
increases the probability that budgets will be achieved. This increased probability
facilitates the overall corporate budgeting process. Corporate management may
also allow budgetary slack as a form of reward to managers for previous good
performance.

However, from the point of view of the business unit management, the use of
budgetary slack increases the likelihood of inefficient allocation of scarce
resources, and decreases the ability to identify potential weaknesses or trouble
spots in operating activities.


8-33 (Continued)

3. a. Zero-based budgeting (ZBB) is a budgeting technique that evaluates all proposed
operating and administrative expenditures as though they were being initiated for
the first time. Each manager must evaluate the proposed expenditure for each
activity to be undertaken during the upcoming budget period, investigate
alternative means of conducting each activity, and rank expenditures in order of
perceived importance.

b. Atlantis Laboratories could benefit from ZBB as each of the business unit
managers would be required to identify and justify all proposed expenditures for
the upcoming year. This increased evaluation of expenditures would make it
difficult to include budgetary slack in the budget for the upcoming year and likely
uncover opportunities of cost savings and operational improvements.

c. The biggest disadvantage of ZBB is the significant amount of time and cost
involved in its implementation. In addition, the concept of zero-based budgeting
may be difficult for management to learn and accept. Atlantis must be sure that
the benefits of ZBB outweigh the associated costs.


8-34 Budgeted Cash Disbursements (25 minutes)

1. Budgeted cash payments for merchandise purchases:

a. February:
25% x $100,000 = $25,000
75% x $120,000 = $90,000 $115,000

b. March:
25% x $120,000 = $30,000
75% x $110,000 = $82,500 $112,500

2. Budgeted cash payments for merchandise purchases:

a. February:
25% x $100,000 x 0.98 = $24,500
75% x $120,000 x 0.98 = $88,200 $112,700

b. March:
25% x $120,000 x 0.98 = $29,400
75% x $110,000 x 0.98 = $80,850 $110,250

3. The financial cost of not taking advantage of the early-payment discount can be
approximated by the following formula:

Opportunity cost (%) = [discount %/(1 - discount %)] x [365/no. of extra
days allowed if discount is not taken]

= [0.02/(1 - 0.02)] x [365/20] = 0.020408 x 18.25 = 37.25%

Basically, if you choose not to take the early-payment discount, you are giving up a
2% discount (on the net amount) in return for an extra 20 days in which to pay.
There are 18.25 (365/20) 20-day periods in a year. Note that in the first term of this
formula we divide the 2% discount rate by 98% (1 - 2%) because, in effect, you are
paying 2% to delay for 20 days paying 98% of the total bill. So, the percentage rate
you are paying in this case is really 2.0408% of the net bill (the bill without financing
cost). Regardless of the technicalities here, students should understand that the
opportunity cost of not taking advantage of the early-payment (cash) discount can
be very significant, as is the case here. For this reason, firms record purchases at
net cost and any discounts lost as interest expense.


8-35 Budgeted Cash Receipts and Disbursements (20 minutes)

1. Budgeted Cash Receipts:

November:
($100,000 x 0.95) x 0.35 x 0.80 x 0.98 = $26,068
($100,000 x 0.95) x 0.35 x 0.20 = $6,650
($150,000 x 0.95) x 0.65 x 0.80 x 0.98 = $72,618
($150,000 x 0.95) x 0.65 x 0.20 = $18,525 $123,861

December:
($150,000 x 0.95) x 0.35 x 0.80 x 0.98 = $39,102
($150,000 x 0.95) x 0.35 x 0.20 = $9,975
($ 90,000 x 0.95) x 0.65 x 0.80 x 0.98 = $43,571
($ 90,000 x 0.95) x 0.65 x 0.20 = $11,115 $103,763

2. Budgeted Cash Disbursements:

November:
($170,000 x 0.75) x 0.25 = $31,875
($270,000 x 0.75) x 0.75 = $151,875 $183,750

December:
($200,000 x 0.75) x 0.25 = $37,500
($170,000 x 0.75) x 0.75 = $95,625 $133,125


8-36 Production and materials purchases budgets (20 minutes)

Production Budget:
2nd Quarter 3rd Quarter
Budgeted sales 38,000 34,000
Desired ending inventory (10%) + 3,400 + 4,800
Total units needed 41,400 38,800
Beginning inventory 3,800 3,400
Total units to produce 37,600 35,400

Budgeted Purchases of Direct Materials for the Second quarter:

2nd Quarter 3rd Quarter
Budgeted production 37,600 35,400
Direct materials per unit x 3 x 3
Direct materials needed in production 112,800 106,200
Desired ending inventory of direct materials
(20% of 106,200) + 21,240
Total direct materials needed 134,040
Beginning inventory of DM (20% of 112,800) 22,560
Budgeted purchases of direct materials (lbs.) 111,480


8-37 Purchase Discounts on Credit Purchases (20 minutes)

The financial cost of not taking advantage of the early-payment discount for
purchases made on credit can be approximated by the following formula (we use the
term approximate here to denote the fact that the estimate below does not assume
compounding of interest and as such provides a conservative estimate):

Opportunity cost (%) = [discount %/(1 - discount %)] x [365/no. of
extra days allowed if discount is not taken]

1. In the case of 2/10, n/30, the approximate economic cost of not taking
advantage of the early-payment discount is:

= [0.02/(1 - 0.02)] x [365/20] = 0.020408 x 18.25 = 37.25%

Basically, if you choose not to take the early-payment discount, you are giving
up a 2% discount (on the net amount) in return for an extra 20 days in which to
pay. There are 18.25 (365/20) 20-day periods in a year. Note that in the first
term of this formula we divide the 2% discount rate by 98% (1 - 2%) because, in
effect, you are paying 2% to delay for 20 days paying 98% of the total bill. So,
the percentage rate you are paying in this case is really 2.0408% of the net bill
(the bill without financing cost).

2. In the case of 1/10, n/30, the opportunity cost of not taking advantage of the
early-payment cash discount is:

= [0.01/(1 - 0.01)] x [365/20] = 0.010101 x 18.25 = 18.43%

3. Given the significant opportunity cost of not taking advantage of early-payment
cash discounts, good accounting practice would be to record purchases at their
net-of-discount amount and then to record as interest expense or purchase
discounts lost any cash discounts not taken advantage of.


8-38 Production and materials budgets--process costing (20 minutes)

1. Budgeted Production (XPL30):
Units
Budgeted sales 480,000
Budgeted finished goods ending inventory (June 30, 2008) + 50,000
Total number of units needed 530,000
Less: Budgeted finished goods beginning inventory 80,000
Budgeted production (units) 450,000

2. Units of XPL30 to Start into Production:

Budgeted production (from (1) above) 450,000
Budgeted WIP ending inventory (June 30, 2008) + 20,000
Total number of units needed 470,000
Less: Budgeted WIP beginning inventory (July 1, 2007) 10,000
Total units of XPL30 to start into production 460,000

3. Raw Materials Purchases Budget:

Units of XPL30 to start into production (from (2) above) 460,000
Units of raw materials needed per unit of XPL30 x 2
Total raw materials needed for production 920,000
Budgeted raw materials ending inventory (June 30, 2008) + 50,000
Total number of units of raw materials needed 970,000
Budgeted raw materials beginning inventory (July 1, 2007) 40,000
Total units of raw materials that must be purchased 930,000

4. While the timing of the addition of materials would affect the calculation for number of
equivalent units produced, number of equivalent units in the ending WIP inventory, and
the raw materials cost per equivalent unit, it will have no impact on the budgeted
purchases of materials for the period.


8-39 Cash Budget--Financing Effects (20 minutes)

Hartz & Co.
Cash Budget
For November and December, 2007

November December

Cash balance, beginning $75,000 $99,000
Plus: Cash receipts $525,000 $450,000
Total cash available (A) $600,000 $549,000

Cash disbursements, prior to financing (B) $450,500 $550,000
Plus: Minimum cash balance (given) $50,000 $50,000
Total cash needed (C) $500,500 $600,000

Excess (deficiency of) cash, before
financing (D) = (A) - (B) $99,500 ($51,000)

Financing:
Short-term borrowing -0- $51,000
Repayments (loan principal) ($50,000) -0-
Interest (@12%) ($500) ($510)
Total Effects of Financing = (E) ($50,500) $50,490

Ending cash balance = (A) - (B) + (E) $99,000 $49,490


8-40 Cash budget (10-15 minutes)

Cash Available
Cash balance, beginning $ 10,000
Cash collections from customers + 150,000
Total cash available $160,000

Cash Disbursements
Direct materials purchases $ 25,000
Operating expenses $50,000
Less: Depreciation expenses - 20,000 30,000
Payroll 75,000
Income taxes 6,000
Machinery purchase + 30,000
Total cash disbursements prior to financing $166,000

Financing:
Cash excess (shortage) before financing ($ 6,000)
Minimum cash balance desired - 20,000
Financing need $26,000


8-41 Cash budget (15 minutes)

Cash Available:
Cash balance, beginning (given) $ 6,000
Cash collections from customers (given) + 175,000
Total cash available $181,000

Budgeted Cash Disbursements, 2007:
Payroll $160,000
Other operating expenses $18,000
Less: Property taxes (see below) - 3,000
Less: Depreciation expense - 5,000
Cash operating expenses 10,000
Property taxes:
2
nd
half of 2006 (0.50 x $2,500) $1,250
1
st
half of 2007 (0.50 x $3,000) 1,500 2,750
Payment for office equipment + 6,000
Total cash disbursements, prior to financing $178,750

Financing:
Cash balance before financing $2,250

No, the cash budget shows that Bill will not be able to meet the minimum cash
balance requirement of $6,000. As such, borrowing (or some other source of
financing) must occur in order to meet the minimum cash requirement.


8-42 Cash Budgeting: Not-for-Profit Context (30 minutes)

1. Endowment fund: a gift (contribution) whose principal must be maintained but whose
income may be expended. (You might use the example of an endowed
professorship as an example.)

2.
Cash Budget for Tri-County Social Service Agency
2007
(in thousands)
Quarters
I II III IV Year
Cash Balance, beginning $11 $8 $8 $8 $11
Receipts:
Grants $80 $70 $75 $75 $300
Contracts $20 $20 $20 $20 $80
Mental Health Income $20 $25 $30 $30 $105
Charitable donations $250 $350 $200 $400 $1,200
Total Cash Available $381 $473 $333 $533 $1,696
Less: Disbursements:
Salaries and Benefits $335 $342 $342 $346 $1,365
Office expenses $70 $65 $71 $50 $256
Equipment purchases & maintenance $2 $4 $6 $5 $17
Specific assistance $20 $15 $18 $20 $73
Total disbursements $427 $426 $437 $421 $1,711
Excess (deficiency) of cash available
over disbursements ($46) $47 ($104) $112 ($15)
Financing:
Borrow from endowment fund $54 $0 $112 $0 $166
Repayments $0 ($39) $0 ($104) ($143)
Total financing effects $54 ($39) $112 ($104) $23
Cash Balance, ending $8 $8 $8 $8 $8

3. $23,000.

4. It is probable that both donations and requests for services are unevenly distributed over
the year. The agency may want to increase requests for donations and seek additional
grants.

5. No. Assuming there is careful fiscal management, borrowing only occurs when necessary.


8-43 Collection of Accounts Receivable (15-20 minutes)

1. Month Total % to be Collected Budgeted Cash
of Sale Credit Sales in October Collection In October
October $90,000 70% $ 63,000
September 80,000 15% 12,000
August 70,000 10% 7,000
July 60,000 4% 2,400
Estimated Total Cash Collections in October $84,400

2. Amount Budgeted collection
Month of Credit % Collected in in the 4
th
quarter from
of Sale Sales Oct. Nov. Dec. sales in the 4
th
Quarter
October $ 90,000 70% $ 63,000
15% 13,500
10% 9,000
November 100,000 70% 70,000
15% 15,000
December 85,000 70% 59,500
Total budgeted cash collections in the 4
th
quarter
from credit sales made in the 4
th
quarter $230,000


8-44 Accounts Receivable Collections and Sensitivity Analysis (45 minutes)

Original Assumptions/Data:
Actual credit sales for March $120,000
Actual credit sales for April $150,000
Estimated credit sales for May $200,000
Estimated collections in month of sale 25%
Estimated collections in first month following month of sale 60%
Estimated collections in the second month after month of sale 10%
Estimated provision for bad debts in month of sale 5%

1. Estimated cash receipts from collections in May:
Collection from sales in March (0.10 x $120,000) $12,000
Collection from sales in April (0.60 x $150,000) $90,000
Collection from sales in May (0.25 x $200,000) $50,000
Total estimated cash collections in May $152,000

2. Gross accounts receivable, May 31
st
:
From credit sales made in April (0.15 x $150,000) $22,500
From credit sales made in May (0.75 x $200,000) $150,000
Estimated gross accounts receivable, May 31
st
$172,500

3. Net accounts receivable, May 31
st
:
Gross accounts receivable, May 31
st
$172,500
Less: Allowance for uncollectible accounts:
From credit sales made in April $7,500
From credit sales made in May $10,000
Net accounts receivable, May 31
st
$155,000

4. Revised data/assumptions:
Estimated provision for bad debts in month of sale 5%


8-44 (Continued)

a. Estimated cash receipts from collections in May:
Collection from sales in March (0.10 x $120,000) $12,000
Collection from sales in April (0.25 x $150,000) $37,500
Collection from sales in May (0.60 x $200,000) $120,000
Total cash collections in May $169,500

b. Gross accounts receivable, May 31st:
From credit sales made in April (0.15 x $150,000) $22,500
From credit sales made in May (0.40 x $200,000) $80,000
Gross accounts receivable, May 31st $102,500

Note to Instructor: An Excel spreadsheet solution file is embedded in this document.
You can open the spreadsheet object that follows by doing the following:

1. Right click anywhere in the worksheet area below.
2. Select worksheet object and then select Open.
3. To return to the Word document, select File and then Close and return
to... while you are in the spreadsheet mode. The screen should then return
you to the Word document.

5. The principal benefit is the accelerated receipt of cash, which the company can
potentially employ to pay down debt, reduce borrowing, invest, etc. Principal costs
would relate to whatever programs are needed to secure the accelerated collection
of cash. These costs could include personal, travel, mailings, telephone, incentive
programs, and costs related to customer relations.

Input Data


8-45 Budgeting: Not-for-Profit Sector (25 minutes)

1. Stewardship is defined by Merriam-Webster Online Dictionary as the conducting,
supervising, or managing of something; especially: the careful and responsible
management of something entrusted to one's care.

The Socially Responsible Investment Guidelines cited states: Although it is a moral
and legal fiduciary responsibility of the trustees to ensure an adequate return on
investment for the support of the work of the church, their stewardship embraces
broader moral concerns. Also, the principles of stewardship lists two fundamental
and interdependent principles: The Conference should exercise responsible financial
stewardship over its economic resources. and The Conference should exercise
ethical and social stewardship in its investment policy.

The latter states: Socially responsible investment involves investment strategies
based on Catholic moral principles. These strategies are based on the moral
demands posed by the virtues of prudence and justice. They recognize the reality that
socially beneficial activities and socially undesirable or even immoral activities are
often inextricably linked in the products produced and the policies followed by
individual corporations. Given the realities of mergers, buyouts and conglomeration, it
is increasingly likely that investments will be in companies whose policies or products
make the holding of their stock a "mixed investment" from a moral and social point of
view. Nevertheless, by prudently applying traditional Catholic moral teaching, and
employing traditional principles on cooperation and toleration, as well as the duty to
avoid scandal, the Conference can reflect moral and social teaching in investments.

2. These two major principles work together to encourage the Conference to identify
investment opportunities that meet both our financial needs and our social criteria.
These principles are carried out through strategies that seek: 1) to avoid participation
in harmful activities, 2) to use the Conference's role as stockholder for social
stewardship, and 3) to promote the common good.

3. No. (Reasons should vary.)

4. Yes.


8-46 Budgeting Cash Receipts: Cash Discounts Allowed on Receivables (30
Minutes)
1. Breakdown of Cash/
Sales Data Amount Bank Credit-Card Sales
June $60,000 Cash sales 40%
July $80,000 Credit cards 60%
August $90,000
September $96,000 Bank charges 3%
October $88,000
Credit sales: Collection of Credit Sales
Current month 20%
Sales Breakdown and Terms 1st month 50%
Cash and bank credit card sales 25% 2nd month 15%
Credit sales 75% 3rd month 12%
Terms 1/eom, n/45 Late charge/mo. 2%

Sales % % Cash
September Total % Paid Collected Receipts
Cash sales $96,000 25% 40% $ 9,600
Bank credit card sales $96,000 25% 60% 97% $13,968
Collections of A/R:
September credit sales $96,000 75% 20% 99% $14,256
August credit sales $90,000 75% 50% $33,750
July credit sales $80,000 75% 15% $ 9,000
June credit sales $60,000 75% 12% 102% $ 5,508
Total Cash Receipts, September $86,082

2. Appropriate accounting treatment for:

a) Bank service (collection) fees: these can be considered an offset to gross sales and
thus can be reflected as a deduction in determining net sales (see text Exhibit
8.15). Alternatively, these amounts can be considered selling expenses and, as
such, be treated as an operating expense, (i.e., an element of Selling and
Administrative Expenses on the Income Statement).

b) Cash discounts allowed on collection of receivables: these can be considered a
selling expense and, as such, would be included within the Selling and
Administrative expense category on the Income Statement.


8-47 Cash Discounts; Spreadsheet application (45 Minutes)


2. Select worksheet object, then select Open
3. To return to the Word document, select File and then Close and return to...
while you are in the spreadsheet mode. The screen should then return you to
the Word document below.

2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
B C D E F G
Sales Data Amount Breakdown of Cash/Bank Credit-Card Sales
June $60,000 Cash sales 40%
July $80,000 Bank credit-card sales 60%
August $90,000 Bank processing fee 3%
September $96,000 Collection of Credit Sales:
October $88,000 Current month 20%
Sales Terms 1st month 50%
Cash and bank credit-card sales 25% 2nd month 15%
Credit sales 75% 3rd month 12%
Discount term 1% Late charge/mo. 2%
Sales Pay. Coll. Cash
Total % % % Receipts
Cash Receipts for September
Cash sales $96,000 25% 40% 9,600 $
Bank credit-card sales $96,000 25% 60% 97% 13,968 $
Collection of accounts receivable:
September credit sales $96,000 75% 20% 99% 14,256 $
August credit sales $90,000 75% 50% 33,750 $
July credit sales $80,000 75% 15% 9,000 $
June credit sales $60,000 75% 12% 102% 5,508 $
Total Cash Receipts 86,082 $
Cash Receipts for October
Cash sales $88,000 25% 40% 8,800 $
Credit cards sales $88,000 25% 60% 97% 12,804 $
Collections of account receivables
October credit sales $88,000 75% 20% 99% 13,068 $
September credit sales $96,000 75% 50% 36,000 $
August credit sales $90,000 75% 15% 10,125 $
July credit sales $80,000 75% 12% 102% 7,344 $
Total Cash Receipts 88,141 $


8-48 Activity-Based Budgeting (ABB) (20 Minutes)

1. Budgeted Cost
Activity Volume Driver Rate Total Cost
Storage 400,000 $0.4925 $ 197,000
Requisition Handling 30,000 $12.50 $ 375,000
Pick Packing 800,000 $ 1.50 $1,200,000
Data Entry 800,000 $ 0.80 $ 640,000
30,000 $ 1.20 $ 36,000
Desktop Delivery 12,000 $30.00 $ 360,000
Total Budgeted Cost for the Division $2,808,000
2. Average number of cartons/delivery
= 1,170,000 cartons 11,700 deliveries = 100 cartons/delivery
Total number of cartons budgeted for delivery in January 2007:
12,000 deliveries x 100 cartons/delivery = 1,200,000 cartons
Cost per carton delivered = $2,808,000 1,200,000 = $2.34
Therefore, the total budgeted cost for the division remains the same at
$2,808,000.
3. Expected saving in costsJanuary 2007:
Requisition Handling $ 375,000
Data Entry: number of lines 640,000
Data Entry: number of requisitions 36,000
Expected Cost Savings, January 2007 = $1,051,000

If the firm uses a single cost-rate system based on the number of cartons
delivered, the firm will not be able to estimate the savings without special
efforts to gather additional information.


8-49 Activity-Based Budgeting with Kaizen (40 Minutes)

1. Unit-Level: Pick packing, Data entryLines
Batch-Level: Requisition handling, Data entryRequisitions,
Desktop delivery

2. Cost driver rates:

Cost-Reduction Cost-Driver Rates
Activity Rate (per month) January February March
Requisition Handling 98% $12.50 $12.250 $12.0050
Pick Packing 99% $ 1.50 $ 1.485 $ 1.4702
Data EntryLines 99% $ 0.80 $ 0.792 $ 0.7841
Data EntryRequisitions 98% $ 1.20 $ 1.176 $ 1.1525
Desktop Delivery 98% $30.00 $29.400 $28.8120

Budgeted Costs:
Activity
Activity Volume February March
Requisition Handling 30,000 $ 367,500 $ 360,150
Pick Packing 800,000 $1,188,000 $1,176,120
Data EntryLines 800,000 $ 633,600 $ 627,264
Data EntryRequisitions 30,000 $ 35,280 $ 34,574
Desktop Delivery 12,000 $ 352,800 $ 345,744
Divisional Totals $2,577,180 $2,543,852

3. Factors that may influence the success of a continuous improvement (Kaizen)
program include:

Reasonable or achievable cost reductions.
Awareness of all employees on the expected (scheduled) cost
improvements over at least the immediate future periods.
Acceptance by both management and employees.
Commitment of both management and employees on the strategic
importance of the success of the continuous improvement program.
Close link between the scheduled improvements and performance
evaluations and rewards.
Cost reductions possible from small, incremental improvements, not from
large discontinuous changes in factors such as operating processes, capital
equipment, supplier networks, or customer interactions.


8-49 (Continued)

4. Primary criticisms of Kaizen (continuous improvement) budgets include the
following:

The budgeting process tends to place enormous pressure on employees to
reduce all costs, which can lead to employee burnout.
The use of Kaizen budgets tends to motivate small, incremental rather than
major/significant process improvements.
If the Kaizen targets are confined to the manufacturing function (including
product and process design engineering), frictions can arise if
manufacturing believes that other parts of the organization (e.g., marketing)
are not subjected to the same budgetary pressure.


8-50 Cash budget (30 minutes)

1. Total credit sales in November $240,000
Percentage collectible x _ 95%
Total amount collectible from credit sales in November $228,000
Percentage collected in the month following month of sales x 40%
Budgeted collections in December from Nov. credit sales $ 91,200

2. Cash sales in January $ 60,000
Collections from credit sales in January:
Total collectible from credit sales
$180,000 x 95% = $171,000
Percentage to be collected in January x 60% $102,600
Collections from credit sales in December:
Total collectible from credit sales
$360,000 x 95% = $342,000
Percentage to be collected in January x 40% 136,800
Budgeted total cash receipts in January $299,400

3. Total inventory purchases in November:
For November sales: $320,000 x 0.3 X 0.6 = $ 57,600
For December sales: $460,000 x 0.7 X 0.6 = 193,200 $250,800
Percentage of Nov. purchases to be paid in December x 75%
Payment in December for purchases in November $188,100
Budgeted purchases in December:
For December sales: $460,000 x 0.3 X 0.6 = $ 82,800
For January sales: $240,000 x 0.7 X 0.6 = 100,800 $183,600
Percentage of Dec. purchases to be paid in December x 25%
Payment in December for purchases in December $45,900
Budgeted payment in December for inventory purchases $234,000


8-51 Budgeting for a Service Firm (60-75 minutes)

Total hours for the budgeted activities:
Total Hourly
Revenue Rate Total
(Given) (Given) Hours
Business return $1,000,000 $250 4,000
Complex individual return $1,200,000 $100 12,000
Simple individual return $1,640,000 $50 32,800
$3,840,000

Staff requirements for the budgeted activities:
Senior
Total Hours Partner Manager Consultant
Required Each Total Each Total Each Total Each Total
Business return 4,000 0.30 1,200 0.20 800 0.50 2,000 0.00 0
Complex individual return 12,000 0.05 600 0.15 1,800 0.40 4,800 0.40 4,800
Simple individual return 32,800 0.00 0 0.00 0 0.20 6,560 0.80 26,240
Total Hours 48,800 1,800 2,600 13,360 31,040
Hours per week 50 45 40 40
# of weeks needed 36 58 334 776
# of weeks per employee per year 40 45 45 48
# of employees needed 1 2 8 16
Excess (deficiency) hours 1,040 (320)

Note: Because Consultants can be hired on a part-time basis, we round the calculation DOWN for this class of labor. The
other three labor classes are given (i.e., do not have to be planned for based on data in the problem).


8-51 (Continued)

SOLUTION:

1. Since, according to the present staffing plan and anticipated workload needs, there is an
excess of senior consultant hours, the budgeted cost for overtime hours worked by
senior consultants would be $0.

2. Number of full-time consultants needed for the year:

Total number of consultant-weeks needed for the year = 776
Number of weeks per full-time consultant per year = 48
Number of full-time consultants needed per year = 16

3. The manager's total compensation, assuming that the revenues from preparing tax
returns remains the same:

Annual Salaries:
Per partner = $250,000
Per manager = $90,000
Per senior consultant = $90,000
Per support staff = $40,000

Consultant's pay (assumed paid on an hourly basis):
Earnings per year = $60,000
Hrs. worked/year = 1,920
Hourly pay rate = $31.25

Staffing Plan:
Partners = 1
Managers = 1
Senior consultants = 8
Full-time Consultants = 16
Support staff = 5

Number of part-time (PT) hours, consultants = 320


8-51 (Continued)

AccuTax, Inc.
Budget Operating Income
Year ended August 31, 2007

Revenue $3,840,000 Payroll expenses:

Partner $250,000
Manager $90,000
Senior consultantsbase pay $720,000
Senior consultantspay for overtime hours $0
Consultants:
Full-time $960,000
Part-time $10,000 $970,000
Support staff $200,000 $2,230,000
General and administrative expenses $373,000
Operating income before bonus to manager $1,237,000
Less: manager's bonus $73,700
Operating income before taxes $1,163,300

Total compensation for the manager:
Salary (given) $90,000
Bonus (0.10 x [$1,237,000 - $500,000]) $73,700
Total $163,700


2. Select Worksheet Object, then Open.
while you are in the spreadsheet mode.

Total hours for the budgeted activities:
Total Hourly
Revenue Rate Total
(Given) (Given) Hours


8-52 Budgetary Pressure and Ethics (20-25 minutes)
1. The use of alternative accounting methods to manipulate reported earnings is
professionally unethical because it violates the Standards contained in the IMAs
Statement of Ethical Professional Practice (see: www.imanet.org). The Competence
standard is violated because of failure to perform duties in accordance with relevant
accounting (technical) standards. It can probably be argued that the competence
standard is also violated because the accountant is not providing information that is
accurate. The Integrity standard is violated because the underlying activity would
discredit the profession. The Credibility standard is violated because of failure to
communicate information fairly and objectively.

2. Yes, costs related to revenue should be expensed in the period in which the revenue
is recognized (matching principle). Perishable supplies are purchased for use in the
current period, will not provide benefits in future periods, and should therefore be
matched against revenue recognized in the current period. In short, the accounting
treatment for supplies was not in accordance with generally accepted accounting
principles (GAAP). Note that similar issues, but on an extremely large basis,
occurred at WorldCom and at Global Crossing. In the case of the latter, the company
was engaging simultaneously in contracts to buy and to sell bandwidth, treating the
former as capitalized expenses and the latter as revenue for the current accounting
period.

3. The actions of Gary Woods were appropriate. Upon discovering how supplies were
being accounted for, Wood brought the matter to the attention of his immediate
superior, Gonzales. Upon learning of the arrangement with P&R, Wood told
Gonzales that the action was improper; he then requested that the accounts be
corrected and the arrangement discontinued. Wood clarified the situation with a
qualified and objective peer (advisor) before disclosing Gonzaless arrangement with
P&R to Belcos division manager, Tom LinGonzaless immediate superior. Contact
with levels above the immediate superior should be initiated only with the superiors
knowledge, assuming the superior is not involved. In this case, however, the superior
is involved. According to the IMAs statement regarding Resolution of Ethical
Conduct, Wood acted appropriately by approaching Lin without Gonzaless
knowledge and by having a confidential discussion with an impartial advisor.


PROBLEMS

8-53 Small business budgets (30 minutes)

1. Key features that need to be considered in developing a profit plan for a small
business include:

Estimation of key factors such as revenues (sales demand, sales price) and
expenses for the budget period.
Systematic evaluation of all available resources (materials, labor, technology) and
their utilization rates.
Coordination of related functions or elements, such as scheduling production to
meet sales forecasts or providing sufficient capacity to meet sales demand.
Critical evaluations of non-operational sources and uses of cash. Nonoperational
items may pose a more serious threat to small businesses than to large businesses.
Greater control over monthly cash flows and short-term financing than may be
necessary in large enterprises.
Greater needs for continuous budgeting than for large organizations, because of the
higher risks associated with economic, competitive, and financial factors for small
businesses.

2. The management accountant must exercise care to ensure that the small business
manager does not suffer from information overload (i.e., strive for simplicity and
parsimony). A profit-management system should be established that captures sufficient
data on a timely basis to allow a reasonable level of operational control and evaluation
without becoming too costly or too sophisticated for the business.

Many large enterprises may continue operations simply by inertia. With small
businesses, a strategic plan linked to the master budget is critical, especially in the
early stage of a products life cycle. The concepts of activity-based management
(ABM), total quality management (TQM), logistics management, life-cycle and target
costing, and constraints- management (e.g., Theory of Constraints) are essential for the
long-run survival and growth of small businesses.

3. The management accountant can insist upon, and assist in the preparation of,
continuous cash budgets. These cash-flow reports should identify the major operational
and nonoperational sources and uses of cash, and point out the periods of potential
cash shortages or surpluses. This will facilitate planning for short-term lines-of-credit
financing and short-term investments.

A profit-management system should be created, utilizing the principles of activity-based
costing (ABC) and cost-variance reporting including activity-based standard costing and
activity-based cost variances. Segmented income statements comparing budgeted to
actual results with profit-variance summaries should be an integral component of the
high-quality profit-management system.


8-54 Ethics in Budgeting/Budgetary Slack (40 minutes)

1. a. The reasons that Marge Atkins and Pete Granger use budgetary slack include the
following:

These employees are hedging against the unexpected (i.e., they use slack to
deal with or reduce uncertainty and risk).
Budgetary slack allows employees to look good, (i.e., to exceed expectations
and/or show consistent performance). This is particularly important when
performance is evaluated on the basis of actual versus budgeted results.
Employees who are able to blend personal and organizational goals through
budgetary slack and show good performance generally are rewarded with higher
salaries, promotions, and bonuses.
By padding the budget, the manager is more likely to get what he/she actually
needs in terms of resources for the upcoming period.

b. The use of budgetary slack can adversely affect Atkins and Granger by:

limiting the usefulness of the budget to motivate their employees to top
performance
affecting their ability to identify trouble spots and take appropriate corrective
action
reducing their credibility in the eyes of management
reducing the ability of top management to effectively allocate resources to
organizational subunits on the basis of actual economic performance. For
example, the use of budgetary slack may affect management decision-making,
as the budgets will show lower contribution margins (lower sales, higher
expenses). Decisions regarding the profitability of product lines, staffing levels,
incentives, etc. could have an adverse effect on Atkins's and Granger's
departments.

2. The use of budgetary slack, particularly if it has a detrimental effect on the company,
may be unethical. In assessing the situation, the IMAs Statement of Ethical
Professional Practice can be consulted (www.imanet.org). This statement notes that a
commitment to ethical professional practice includes: overarching principles
(expressions of core values) and a set of standards intended to guide actual conduct
and practice.


8-54 (Continued)

The IMAs overarching PRINCIPLES include: Honesty, Fairness, Objectivity, and
Responsibility. The list of STANDARDS includes the following: Competence,
Confidentiality, Integrity, and Credibility. The following Standards could be referenced in
conjunction with the use of budgetary slack, as described above:

Competence: Provide decision support information and recommendations that are
accurate, clear, concise, and timely.
Integrity: Refrain from engaging in any conduct that would prejudice carrying out
duties ethically.
Credibility: Communicate information fairly and objectively; disclose all relevant
information that could reasonably be expected to influence an intended users
understanding of the reports, analyses, or recommendations.

Though not asked for in the original CMA exam problem, you might want to discuss
with students how, in practice, they would deal with ethical dilemmas. In its Resolution
of Ethical Conflict statement the IMA provides the following guidance:

1. Discuss the issue with your immediate supervisor except when it appears that the
supervisor is involved. In that case, present the issue to the next level. If you
cannot achieve a satisfactory resolution, submit the issue to the next
management level. If your immediate superior is the chief executive officer or
equivalent, the acceptable reviewing authority may be a group such as the audit
committee, executive committee, board of directors, board of trustees, or owners.
Contact with levels above the immediate superior should be initiated only with
your superiors knowledge, assuming he or she is not involved. Communication of
such problems to authorities or individuals not employed or engaged by the
organization is not considered appropriate, unless you believe there is a clear
violation of the law.

2. Clarify relevant ethical issues by initiating a confidential discussion with an IMA
Ethics Counselor or other impartial advisor to obtain a better understanding of
possible courses of action.

3. Consult your own attorney as to legal obligations and rights concerning the
ethical conflict.


8-55 Master Budget (40-45 minutes)

1. The benefits that can be derived from implementing a master budgeting system include
the following:

The preparation of budgets forces management to plan ahead and to establish
goals and objectives that can be quantified.
Budgeting compels departmental managers to make plans that are in congruence
with the plans of other departments as well as the objectives of the entire firm.
The budgeting process promotes internal communication and coordination of
subunit activities.
Budgets provide directions for day-to-day operations, clarify duties to be performed,
and assign responsibility for these duties.
Budgets provide a framework for measuring financial performance.
A properly implemented budgeting system can motivate employees and managers
to higher levels of performance, particularly if goals and outputs are linked through
appropriate incentives.
Budgets allow managers to anticipate problem areas (e.g., cash short-falls) and
opportunities (e.g., short-term investment of excess cash).


8-55 (Continued)

2. a & b: The basic intent here is to demonstrate the interrelationships that exist among
budgets contained in the organizations master budget.

Subsequent
Schedule/Statement Budget Schedule/Statement
Sales Budget Production Budget
Selling Expense Budget
Budgeted Income Statement

Ending Inventory Budget (units) Production Budget

Production Budget (units) Direct Materials Purchases Budget
Direct Materials Usage Budget
Direct Labor Budget
Factory Overhead Budget

Direct Materials Budget Cost of Goods Manufactured Budget
Direct Labor Budget Cost of Goods Manufactured Budget
Factory Overhead Budget Cost of Goods Manufactured Budget
Cost of Goods Manufactured Cost of Goods Sold Budget
Budget

Cost of Goods Sold Budget Budgeted Income Statement
Budgeted Balance Sheet

Selling Expense Budget Budgeted Income Statement
Research & Development Budget Budgeted Income Statement
Budgeted Income Statement Budgeted Balance Sheet

Capital Expenditures Budget Cash Budget
Cash Receipts Budget Cash Budget
Cash Disbursements Budget Cash Budget

Cash Budget Budgeted Balance Sheet


8-56 Comprehensive Profit Plan (90 minutes)

1. Sales Budget

Spring Manufacturing Company
Sales Budget
2007

C12 D57 Total
Sales (in units) 12,000 9,000 21,000
x Selling Price Per Unit $150 $220
Total Sales Revenue $1,800,000 $1,980,000 $3,780,000

2. Production Budget

Production Budget
2007
C12 D57
Budgeted Sales (in units) 12,000 9,000
+ Desired finished goods ending inventory 300 200

Beginning finished goods inventory 400 150

Budgeted Production (in units) 11,900 9,050


8-56 (Continued-1)

3. Direct Materials Purchases Budget

Direct Materials Purchases Budget (units and dollars)
2007

C12 D57 Total
Raw Material (RM) 1:
Budgeted Production 11,900 9,050
Pounds per Unit x 10 x 8
RM 1 needed for production 119,000 72,400 191,400
Plus: Desired Ending Inventory (lbs.) 4,000
Total RM 1 needed (lbs.) 195,400
Less: Beginning inventory (lbs.) 3,000
Required purchases of RM 1 (lbs.) 192,400
Cost per pound $2.00
Budgeted purchases, RM 1 $384,800

RM 2 needed for production 0 36,200 36,200

Raw Material 3:


8-56 (Continued-2)

4. Direct Manufacturing Labor Budget

Direct Labor Budget
2007

C12 D57 Total
Direct labor hours per unit x 2 x 3
Total direct labor hours needed 23,800 27,150 50,950
Hourly wage rate $25.00
Budgeted direct labor costs $1,273,750

5. Factory Overhead Budget

2007

Variable Factory Overhead:
Indirect materials $10,000
Miscellaneous supplies and tools 5,000
Indirect labor 40,000
Payroll taxes and fringe benefits 250,000
Maintenance costs 10,080
Heat, light, and power 11,000 $326,080

Fixed Factory Overhead:
Supervision $120,000
Heat, light, and power 43,420
Total Cash Fixed Factory Overhead $183,420
Depreciation 71,330 $254,750
Total Budgeted Factory Overhead $580,830


8-56 (Continued-3)

6. Budgeted Cost of Goods Sold

Ending Finished Goods Inventory and Budgeted CGS
2007

C12 D57 Total
Sales volume 12,000 9,000 21,000
Cost per unit (Schedule 1 and 2) $93.80 $135.70
Cost of goods sold $1,125,600 $1,221,300 $2,346,900

Finished goods ending inventory 300 200
Budgeted ending inventories $28,140 $27,140 $55,280

Schedule 1: Cost per Unit--Product C12:
Inputs Cost
Cost Element Unit Input Cost Quantity Per Unit
RM-1 $2.00 10 $20.00
RM-3 $0.50 2 $1.00
Direct labor $25.00 2 $50.00
Variable factory OH ($326,080/50,950) $6.40 2 $12.80
Fixed factory OH ($254,750/50,950) $5.00 2 $10.00
Manufacturing cost per unit $93.80

Schedule 2: Cost per Unit--Product D57:
Inputs Cost
RM-1 $2.00 8 $16.00
RM-2 $2.50 4 $10.00
RM-3 $0.50 1 $0.50
Direct labor $25.00 3 $75.00
Fixed factory OH ($254,750/50,950) $5.00 3 $15.00


8-56 (Continued-4)

7. Budgeted selling and administrative expenses:

Selling and Administrative Expense Budget
2007

Selling Expenses:
Advertising $60,000
Sales salaries 200,000
Travel and entertainment 60,000
Administrative expenses:
Offices salaries $60,000
Executive salaries 250,000
Supplies 4,000
Total selling and administrative expenses $645,000

8. Budgeted Income Statement:

Budget Income Statement
For the Year 2007

C12 D57 Total
Sales (part 1) $1,800,000 $1,980,000 $3,780,000
Cost of goods sold (part 6) 1,125,600 1,221,300 2,346,900
Gross profit $674,400 $758,700 $1,433,100
Selling and administrative expenses (part 7) $645,000
Pre-tax operating income $788,100
Income taxes (@40%) $315,240
After-tax operating income $472,860


8-56 (Continued-5)


while you are in the spreadsheet mode.

8-56 Spring Manufacturing Company
1. Sales Budget
Sales Budget
C12 D57 Total
2007


8-57 Spring Manufacturing CompanyComprehensive Profit Plan (90 Minutes, but
much less if used in conjunction with 8-56 and completed with an Excel
spreadsheet)

1. Sales Budget

Sales Budget
2007

C12 D57 Total
Sales (in units) 12,000 18,000 30,000
Total revenue $1,920,000 $3,240,000 $5,160,000


Production Budget
2007

C12 D57
Plus: Desired finished goods ending inventory 300 200
Less: Beginning finished goods inventory 400 150


8-57 (Continued-1)

3. Direct Materials Purchases Budget (units and dollars)

2007
C12 D57 Total


Raw Material 3:


8-57 (Continued-2)


Direct Labor Budget
2007

C12 D57 Total
Direct labor hours (DLH) per unit x 2 x 3



Variable OH per DLH (from Prob. 8-56): $6.40

2007

Variable Factory Overhead ($6.40/DLH x 77,950) $498,880
Fixed Factory Overhead:
Total Budgeted Factory Overhead $753,630

Variable OH rate per DLH $6.40
Fixed OH rate per DLH ($254,750/77,950 DLHs) $3.26812


8-57 (Continued-3)

6. Budgeted CGS and Ending Finished Goods Inventory Budget

2007

C12 D57 Total
Sales volume 12,000 18,000 30,000


Schedule 1: Cost per UnitProduct C12:
Inputs Cost
RM-1 $2.00 10 $20.00
RM-3 $0.50 2 $1.00
Direct labor $25.00 2 $50.00
Fixed factory OH ($254,750/77,950) $3.26812 2 $6.53624

Schedule 2: Cost per UnitProduct D57:
Inputs Cost
RM-1 $2.00 8 $16.00
RM-2 $2.50 4 $10.00
RM-3 $0.50 1 $0.50
Direct labor $25.00 3 $75.00
Fixed factory OH ($254,750/77,950) $3.26812 3 $9.80436


8-57 (Continued-4)

7. Selling and Administrative Expense Budget

2007

Selling Expenses:
Advertising $60,000
Supplies 4,000

8. Budgeted Income Statement

For the Year 2007

C12 D57 Total
Sales (part 1) $1,920,000 $3,240,000 $5,160,000
Gross profit $835,965 $890,921 $1,726,886
Pre-tax operating income $1,081,886
Income taxes (@40%) $432,754


8-57 (Continued-5)

Answers:

1. The projected increase in after-tax operating income =

$649,132 $472,860 = $176,272

2. While the changes are projected to increase after-tax operating income, the company
should examine the decision more closely. Although the company increases its after-tax
operating income by 37% ($176,272/$472,860), it requires a doubling of units of D57 to
achieve this. In fact, a 100% increase in units sold of D57 increases the gross profit of
D57 from $758,700 to $890,921, an increase of $132,221, while the total change in
gross profit is $293,786 (from $1,433,100 to $1,726,886). The 100% increase in D57
accounts for only 45% ($132,221 $293,786) of the increase in gross profit; C12
contributes 55% of the increase.

Further, the price increase in C12 has no effect on the units sold. This may be an
indication that C12 may have a higher potential than the firm perceived.


3. To return to the Word document, select File and then Close and
return to... while you are in the spreadsheet mode.

1. Budgeted Sales (units):
C12 = 12,000
D57 = 18,000
Budgeted Selling Prices/Unit:
C12 = $160
D57 = $180


8-58 Comprehensive Profit Plan with Kaizen (90 minutes, but much less if
assigned in conjunction with 8-56 and completed with an Excel
spreadsheet)

1. Sales Budget

Sales Budget
2007

C12 D57 Total
Sales (in units) 12,000 9,000 21,000
Total revenue $1,800,000 $1,980,000 $3,780,000


Production Budget
2007

C12 D57
Plus: Desired finished goods ending inventory 300 200
Total units needed
12,300 9,200
Less: Beginning finished goods inventory 400 150


8-58 (Continued-1)

3. Direct Materials Purchases Budget (units and dollars)

2007

C12 D57 Total

Pounds per Unit x 0 x 3.6

Raw Material 3:
Pounds per Unit x 1.8 x 0.8


8-58 (Continued-2)


Direct Labor Budget
2007

C12 D57 Total
Direct labor hours per unit x 1.5 x 2


2007

Original Variable OH Budget:
Indirect materials $10,000
Miscellaneous supplies and tools 5,000
Indirect labor 40,000
Payroll taxes and fringe benefits 250,000
Total Variable Factory Overhead $326,080

Reduction Rate for Variable OH Costs 10.00%

Original Fixed OH, Excluding Depreciation:
Depreciation 71,330
Total Original Fixed OH $254,750

Reduction Rate for Cash Fixed OH Costs = 5.00%


8-58 (Continued-3)

Budgeted Variable OH:
($326,080 x (1 - 0.10)) = $293,472
Budgeted Fixed OH:
Cash Charges = ($183,420 x (1 - 0.05)) = $174,249
Depreciation (same as last year) = $71,330
Total Budgeted Fixed OH = $245,579

6. Budgeted CGS and Ending Finished Goods Inventory Budget

2007

C12 D57 Total
Sales volume 12,000 9,000 21,000


Schedule 1: Cost per UnitProduct C12:
Inputs Cost
RM-1 $2.00 9 $18.00
RM-3 $0.50 1.8 $0.90
Direct labor $30.00 1.5 $45.00
Variable factory OH ($293,472/35,950) $8.16334 1.5 $12.24501
Fixed factory OH ($245,579/35,950) $6.83113 1.5 $10.24669


8-58 (Continued-4)

Schedule 2: Cost per UnitProduct D57:
Inputs Cost
RM-1 $2.00 7 $14.00
RM-2 $2.50 3.6 $9.00
RM-3 $0.50 0.8 $0.40
Direct labor $30.00 2 $60.00
Fixed factory OH ($245,579/35,950) $6.83113 2 $13.66225

7. Selling and Administrative Expense Budget

2007
Selling Expenses:
Advertising $60,000
Supplies 4,000


8-58 (Continued-5)

8. Budgeted Income Statement

For the Year 2007

C12 D57 Total
Sales (part 1) $1,800,000 $1,980,000 $3,780,000
Gross profit $763,300 $959,500 $1,722,800
Pre-tax operating income $1,077,800
Income taxes (@40%) $431,120

Answers:

1. The budgeted after-tax operating income with Kaizen is $646,680.

2. The immediate benefit is an increase of $173,820 in operating income, or 37% from
$472,860.

The firm is also likely benefit in the long-run from the reductions in materials, labor
hours, and factory overhead required in production. Decreases in consumption of
manufacturing elements reduce wear and tear of equipment and other facilities and
lessens the need for additional capital investments/replacements.

You can open this spreadsheet object that follows by doing the following:

3. To return to the Word document, select File and then Close and return to... while
you are in the spreadsheet mode.

1. Budgeted Sales (units):


8-59 Retailer Budget (45-50 minutes)

1. Budgeted merchandise purchases

D. Tomlinson Retail
Budgeted Merchandise Purchases
May and June

May June July
Sales (in units) 11,900 11,400 12,000
Cost per unit x $20 x $20 x $20
Cost of Goods Sold (CGS) $238,000 $228,000 $240,000
Ending inventory (130% of
next month's CGS) + 296,400 + 312,000
Total needed $534,400 $540,000
Beginning inventory (130% of
this month's CGS) 309,400 296,400
Budgeted Merchandise Purchases $225,000 $243,600

2. Budgeted cash disbursements

S, G, & A expenses: May June
Sales revenue $357,000 $342,000
S, G, & A expense ratio x 0.15 x 0.15
Total S, G, & A expense $ 53,550 $ 51,300
Less: Depreciation 2,000 2,000
Out-of-pocket S, G & A expense $ 51,550 $ 49,300

D. Tomlinson Retail
Budgeted Cash Disbursements for June

May June
Merchandise purchases $ 225,000 $ 243,600
Out-of-Pocket S, G, & A expenses + 51,550 + 49,300
Total payables $276,550 $292,900
Payment for the current months payables (54%) $158,166
Owed from last month (46%) + 127,213
Budgeted cash outflow for payables $285,379


8-59 (Continued)

3. Budgeted cash collections

D. Tomlinson Retail
Cash Collections
May

From last month's (April) credit sales

Within the discount period ($363,000) x 60% x 97% = $211,266
After the discount period $363,000 x 25% = 90,750

From credit sales two months ago (i.e., March)

Collection of credit sales made in March $354,000 x 9% = 31,860

Total cash collections $333,876

4. Gross and Net Balance of Accounts Receivable (AR) as of May 31

March April May Total
Sales $354,000 $363,000 $357,000
Remaining AR % 6% 15% 100%
AR Balance (Gross) $21,240 $54,450 $357,000 $432,690
Bad-debt allowance* $21,240 $21,780 $21,420 64,440
AR Balance (Net) $368,250

* @ 6% of gross sales dollars


8-60 Sales budget and pro-forma financial statements (75 minutes)

1.
Original Budget Data

Sales (units):

Beginning inventory of finished goods (9/1/2007) 9,300
Estimated production for the 2007-8 fiscal year 162,000
Units available for sale 171,300
Planned ending finished goods inventory (8/31/2008) 3,300
Projected unit sales, 2007-8 fiscal year 168,000

Selling price/unit:

a. & b. Revised sales volume--units and dollars:
Sales in units in the original budget (see above) 168,000
Increase in units of production (170,000 - 162,000)* + 8,000
Revised total salesunits 176,000
Selling price per unit (see above) x $ 186
Revised projected dollar-volume of net sales $32,736,000

*With no change in the ending finished goods inventory (3,300 units) the increase in
production is a result of the expected increase in sales.

$186 =
168,000
0 $31,248,00
=

Sales Unit Projected
Sales of Dollars Projected
= Price/Unit Selling


8-60 (Continued-1)

2.
Molid Company
Pro-Forma Statement of Cost of Goods Sold (Revised)
For the Year Ending August 31, 2008

Direct materials:
Materials inventory, 9/1/07 $ 1,360,000
Materials purchases
1
15,576,000
Materials available for use $16,936,000
Materials inventory, 8/31/08
2
1,709,400
Direct Materials used $15,226,600
Direct labor
3
1,215,200
Factory overhead:
Indirect material
4
$ 1,522,660
General factory overhead
5
3,320,000 4,842,660
Cost of goods manufactured $21,284,460
Plus: Finished goods inventory, 9/1/07 (given) 1,169,000
Cost of goods available for sale $22,453,460
Less: Finished goods inventory, 8/31/08
6
413,169
Cost of goods sold $ 22,040,291

1
Supporting Calculations (units represent equivalent units of output):
37,500 units @ $88.00* = $ 3,300,000
45,000 units** @ $88.00 = 3,960,000
90,000 units @ $92.40***= 8,316,000
$15,576,000


8-60 (Continued-2)

*$3,300,000/37,500 units = $88.00

**Desired ending inventory of materials 18,500
Materials needed for production this year + 170,000
Total materials needed 188,500
Beginning inventory 16,000
Total materials purchases for the year 172,500
Less: Materials purchased in the 1
st
quarter 37,500
Materials yet to be purchased during the year 135,000
Number of remaining quarters 3
Materials to be purchased in each remaining quarter 45,000

***$88.00 x 1.05 = $92.40

2
18,500 units @ $92.40 = $1,709,400

3
Direct labor cost

4
Indirect material:$15,226,600 x 0.10 = $1,522,660

5
General factory overhead:
Variable: $1,620,000 x (170,000units/162,000units) = $1,700,000
Fixed $3,240,000 x 1/2 = 1,620,000
Total $3,320,000

6
Average manufacturing cost/unit, 2007-8:
$21,284,460 /170,000 units = $125.2027
Ending finished goods inventory (units) x 3,300
Cost of ending finished goods inventory (FIFO basis) $ 413,169
$1,215,200
25,200 = .08 x
units 170,000
units 45,000
x $1,190,000
$1,190,000 =
units 162,000
units 170,000
x $1,134,000


8-60 (Continued-3)

3.
a. Savings in working capital from eliminating ending inventory:

Finished goods $ 413,169
Direct materials $92.40 x (18,500 100) = 1,700,160
Total savings $2,113,329

The firm can reduce the need for working capital by $2,113,329. The final net savings
depends on the cost of capital of the firm. At 10%, the company saves financing costs
of over $200,000 per year. The firm can save more than $211,333 per year if the cost
of capital exceeds 10%. Note that this estimate refers to financing (cost-of-capital-
related) costs, not operating costs.

b. Yes. Under the assumption that the companys cost of capital is 10%, the economic
savings would represent about 4% of its current pre-tax operating income figure, as
shown below. Note that these savings put the company in an improved economic
position, although the formal accounting statements might not reflect this. As such, this
gives the instructor the opportunity to discuss with students the notion of Economic
Value Added (EVA) as alternative financial performance indicator to conventional
accounting income statements.

Molid Company
Pro-Forma Statement Income Statement
For the Year Ending August 31, 2008

Net sales (part 1b above) $32,736,000
Cost of goods sold (part 2 above) 22,040,291
Gross profit $10,695,709
Operating expenses (givensee text):
Marketing $3,200,000
General and administrative 2,200,000 5,400,000
Income from operations before income taxes $ 5,295,709

$211,333/$5,295,709 = 4%

c. In addition to financial terms, the firm needs to consider carefully, among other items:
adequacy of the firm's equipment to support the new system
proficiency of the firm's accounting information system to handle the new system
support of vendors
acceptance of factory managers and production workers


8-61 Budgeting for a Merchandising Firm (50-60 minutes)

1. Budgeted cash collectionsDecember:
From Novembers sales = net A/R, November 30
th
= $ 76,000
From Decembers sales = $220,000 x 60% x 99% = 130,680
Budgeted cash collections--December $206,680

2. Net accounts receivableDecember 31
st
:
Budgeted sales in December (given) $220,000
Allowance for doubtful accounts $220,000 x 2% = 4,400
Net A/R from sales in December $215,600
Collections of December sales in December $220,000 x 60% = 132,000
Net Accounts ReceivableDecember 31
st
$ 83,600

3. Budgeted pre-tax operating incomeDecember:
Total sales $220,000
Gross margin ratio x 25%
Gross margin $ 55,000
Operating expenses:
Monthly cash operating expenses $22,600
Bad-debts expense $220,000 x 2% = 4,400
Depreciation expense $216,000/12 = 18,000 45,000
Pre-tax operating income $10,000

4. Budgeted InventoryDecember 31
st
:

Inventory, December 31
st
= ($200,000 x 0.75) x 80% = $120,000

5. Budgeted PurchasesDecember:

st
(given) = $132,000
Plus: Purchases during December (plug figure) = 153,000
Cost of goods available for sale $285,000
Less: Cost of goods sold $220,000 x 75% = 165,000
st
(part 4 above) = $120,000


8-61 (Continued)

6. Budgeted Accounts PayableDecember 31
st
:

Accounts Payable, December 1
st
(given) $162,000
Plus: Budgeted Purchases, December (part 5 above) $153,000
Total Accounts Payable during December $315,000
Less: Payments in December (entire beginning balance) $162,000
Budgeted Accounts Payable, December 31
st
$153,000

Alternatively, the end-of-December Accounts Payable Balance = Purchases
made in December = answer to Part 5 above.


8-62 Budgets for a Service Firm (50 Minutes)

1. The annual cash budget is presented on the next page.

2. Operating problems that Triple-F Health Club could experience include:

The cash contribution from lessons and classes will decrease because the projected
wage increase for lesson and class employees is significantly greater than the
projected increases in revenues (i.e., in additional volume). Last year, the cash
generated from these operations was $39,000 ($234,000 $195,000). The 2009
projection is only $12,675 ($304,200 $291,525).
Operating expenses are increasing faster than revenues from membership fees.
Last year (2008), cash generated from regular operations was $91,000 [($355,000 +
$2,000) ($461,000 $195,000)]. The 2009 projection is only $92,482 [($402,215
+ $2,667) ($603,925 $291,525)]. The increase in cash from regular operations
is projected to be about 4%, whereas these revenues are projected to increase
13%.
Triple-F Health Club seems to have a cash-management problem. The club does
not generate enough cash from operations to meet its obligations. It may not be
able to meet expenditures for day-to-day operations if the trend continues. To avoid
cash crises, the club should prepare monthly cash budgets to help cash
management.
Non-operational payments are projected to use up virtually all of the cash generated
from operations. Given the recent declines in mortgage interest rates, management
should consider refinancing this debt to reduce this cash drain.

3. Jane Crowe's concern with regard to the Board's expansion goals is justified. The 2009
budget projections show only a minimal increase in the cash balance (i.e., an increase
of only $2,757). The total cash available is well short of the $60,000 annual additional
cash needed for the land purchase. If the Board desires to purchase the adjoining
property, it is going to have to consider increases in fees, refinancing existing debt, or
other methods of financing the acquisition (such as additional mortgage debt or
membership bonds).


8-62 (continued)

TRIPLE-F HEALTH CLUB
Cash Budget
For the Year Ending October 31, 2009

Price
2008 Growth Increase 2009
Operating Cash Inflows:
Annual membership fees $355,000 3.0% 10.0% $402,215
Lesson and class fees 234,000 30.0% 304,200
Miscellaneous 2,000 33.33% 2,667
Total Operating Cash Inflows $591,000 $709,082

Operating Cash Outflows:
Managers salary and benefits $36,000 15.0% $41,400
Employee wages and benefits:
Regular employees 190,000 15.0% 218,500
Lesson and class employees 195,000 30.0% 15.0% 291,525
Towels and supplies 16,000 25.0% 20,000
Utilities (heat and lights) 22,000 25.0% 27,500
Miscellaneous 2,000 25.0% 2,500
Payoff of outstanding A/P N/A given 2,500
Total Operating Cash Outflows $461,000 $603,925

Net Operating Cash Flow $130,000 $105,157

Non-Operating Cash Outflows:
Payoff of equipment payable given $15,000
Mortgage principal given 30,000
Mortgage interest 32,400
1
Planned equipment purchases given 25,000
Total Non-Operating Cash Outflow $102,400

Net Cash Flow $2,757
Beginning Cash Balance (given) 7,300
Budgeted Ending Cash Balance $10,057
_______________
1
$360,000 x 0.09 = $32,400 ($360,000 = principal balance at beginning of the year)


8-63 Budgeting for Marketing Expenses; Strategy (45-50 minutes)

1. The following screen shots are from the Excel spreadsheet created for this problem. It
shows that the original monthly budgeted marketing expense is $338,000 and that the
revised (budgeted) amount is $372,628, an overall increase of 10.24%.


8-63 (Continued)

2. In order to achieve the monthly targeted cost of $350,000, the rate of telephone and
mailing costs cannot increase at all (as is the case in the proposed budget); in fact, the
results of the goal seek analysis indicates that such rates must be decreased by
approximately 43%, as shown below:

These results are generated by completing the following dialog box that appears after
activating the goal-seek command from the Tools menu in Excel:


8-63 (Continued)

3. As indicated in the text, budgets can be used both for control and for planning
purposes. The relative importance of each can be linked either to the competitive
strategy the business is pursuing or to the product life-cycle. In the present case (start-
up company, competing on the basis of a product-differentiation strategy), the relative
emphasis of the marketing budget is likely more for planning than control. That is, the
information contained in this budget can assist the company in determining its financing
needs. However, it probably should not be used for controlling (i.e., cutting) expenses
in situations where the underlying expenditures are determinants of competitive
success. Further, many types of so-called discretionary costs (such as marketing) are
fixed (or at least sticky) and therefore difficult to cut in the short run. As such, the
primary benefit of the budget in such cases is to better plan for, rather than control, the
underlying expenses.

Note to Instructor: The Excel spreadsheet solution referred to above is embedded in
this document. You can open the spreadsheet object by doing the following:

3. To return to the Word document, select File and then Close and return to... while
you are in the spreadsheet mode.

8-63 Budgeting for Marketing Expenses; Strategy
Initial Data
Cost Amount
Sales Commissions $120,000


8-64 Strategy, product life-cycle, and cash flow (25-30 minutes)

1. The development stage is generally characterized by large cash outflows and little or no
cash inflows. Expenditures for research and development, plant and equipment,
retooling, distribution, and promotion are required. During this stage, a project or
company normally generates losses and may require an infusion of outside capital.

During the growth stage, sales and revenues rise rapidly. Significant cash inflows are
generally present; however, these may be offset in part or completely by cash outflows
to build production capacity and for growing inventories and receivables. During this
stage, manufacturing efficiencies will improve contribution margins as volume
increases.

During the maturity stage, net cash inflows are generally at an optimum. Production
capacity is in place and inventories and receivables should approach a steady state.
However, by this stage, competitors generally have entered the market resulting in
higher promotional costs to maintain market share. As a consequence, margins may
begin to decline.

During the decline stage, both sales volume and profits fall. Increased price competition
and the increased availability of alternative products will reduce margins. The declining
volume will generally increase the unit cost at the manufacturing level. Sometimes,
significant cash inflows can be generated from the liquidation of inventories and other
product-related assets.

2. The maturity stage, the period of optimum net cash inflows, is missing from Burke
Company's product cycle. The company must be able to generate or raise sufficient
cash to support R & D, capital investment, and promotional costs during the
development stages and depend on the growth stage for significant cash inflows. This
will require rapid improvement in manufacturing efficiencies and careful investment in
production facilities and inventories. In addition, inventory control is extremely important
in order to minimize cash investment and reduce potential obsolescence.

3. The techniques that Devin Ward should consider to cope with Burke Company's cash-
management problems include:
careful, timely cash-flow projections and monitoring, matching the cash receipts
from products in the growth stage with the expenditures for products in the
development stage.
establishing good banking relationships and flexible lines of credit to facilitate short-
term borrowing needs.
aggressive accounts-receivable management.
tight control of materials purchasing and inventory management.
improved cost controls.
timely decisions on inventory liquidation as product life cycles near collapse.


8-65 Continuous budgeting (25-30 minutes)

1.a. The increase in sales could have the following effects on production:
Production capacity may have to be reallocated to the three models based upon
the composition of the sales increase.
Some parts, in addition to the molded doors, may have to be purchased from
outside suppliers.
Depending upon the ability to purchase parts from outside suppliers and long-
term sales projections, additional capacity may be required.

1.b. The increase in sales could have the following effects on finance and accounting:
Short-term financing may be needed to finance increased receivable levels and
for the replacement of depleted inventories.
Long-term financing may be needed to expand production capacity.
Budgeting may have to be revised because sales volume is probably beyond the
relevant range assumed for the current budget.

1.c. The increase in sales could have the following effects on marketing:
The need to advertise will probably decrease.
Investigation into the credit-worthiness of potential credit customers may need
to become more thorough and the number of investigations will probably
increase.
Collection efforts may have to be increased unless credit-granting is tightened.
Customers may have to accept extended shipping dates or may receive units on
some rational basis of output allocation.

1.d. The increase in sales could have the following effects on personnel:
Increased stress levels because of the increased volume.
Need to schedule additional shifts or overtime, which the employees may deem
unnecessary or not beneficial.
Need to hire additional workers to meet the increase in demand.

2.a. A continuous (rolling) budget is the preparation of a new twelve-month budget as
each period (e.g., month, quarter) is completed. At the end of each period, the
budget amounts for the period just completed are deleted, the amounts for the
remaining periods of the old budget are revised as necessary, and budgeted
amounts for the new period are added. Thus, a twelve-month budget is rolled
forward as each period is completed.

2.b. The preparation of a continuous budget would force WestWood's management to
engage in planning on an almost continuous basis. Shorter planning cycles increase
the chances that management will anticipate and give attention to problem situations
earlier than would otherwise be the case. Thus, planning would be enhanced in all of
the functional areas and there would not be any periods when a budget did not exist.


8-66 Cash Budget (45-50 minutes)

Quarters
I II III IV Year
Cash balance, beginning $30,000 $38,000 $30,520 $30,770 $30,000
Plus: Cash receipts:
Collections from customers 425,000 437,000 479,480 460,000 1,801,480
Equipment disposal 0 0 0 5,000 5,000
Total cash available = (A) $455,000 $475,000 $510,000 $495,770 $1,836,480

Cash disbursements:
Raw material purchases $200,000 $220,000 $250,000 $270,000 $940,000
Payroll 117,000 120,000 115,000 122,000 474,000
S, G, & A expenses 60,000 62,000 58,000 64,000 244,000
Equipment purchase 20,000 30,000 30,000 0 80,000
Bond interest (@9%) 0 11,250 0 11,250 22,500
Bond sinking fund payment 0 20,000 0 0 20,000
Income taxes 20,000 21,000 25,000 18,000 84,000
Total cash disbursements, prior to financing = (B) $417,000 $484,250 $478,000 $485,250 $1,864,500
Plus: Minimum cash balance $30,000 $30,000 $30,000 $30,000 $30,000
Total cash needed = (C) $447,000 $514,250 $508,000 $515,250 $1,894,500

Excess cash (cash deficiency), prior to financing
(D) = (A) - (C) $8,000 ($39,250) $2,000 ($19,480) $(58,020)

Financing:
Short-term borrowing $0 $41,000 $0 $22,000 $63,000
Repayment (principal) $0 $0 $0 $0 $0
Interest (@12%) $0 ($1,230) ($1,230) ($1,890) ($4,350)
Total Effects of Financing = (E) $0 $39,770 ($1,230) $20,110 $58,650

Ending cash balance = (A) - (B) + (E) $38,000 $30,520 $30,770 $30,630 $30,630


8-67 Comprehensive Budget (90 minutes)

1. Schedule A: Budgeted Monthly Cash Receipts

Item June July August Sept.
Cash sales (80% x sales) $60,000 $64,000 $65,600 $72,000
Credit sales (20% x sales) 15,000 16,000 16,400 18,000
Total sales $75,000 $80,000 $82,000 $90,000
Receipts:
Cash sales $64,000 $65,600 $72,000
Collections on accounts (last months
credit sales) 15,000 16,000 16,400
Total cash collections $79,000 $81,600 $88,400

Schedule B: Budgeted Monthly Cash Disbursements for Purchases

Item July August Sept. 3rd Qtr.
Purchases (@ gross cost) $49,200 $54,000 $60,000 $163,200
Cash discount (1% of gross cost) 492 540 600 1,632
Net purchases $48,708 $53,460 $59,400 $161,568

Schedule C: Budgeted Monthly Cash Disbursements for Operating Costs

Salaries and wages $12,000 $12,100 $12,500 $36,600
Rent & Property Taxes 1,000 1,000 1,000 3,000
Other cash operating costs 1,600 1,640 1,800 5,040
Total $14,600 $14,740 $15,300 $44,640

Schedule D: Budgeted Cash Disbursements Prior to Financing

Cash operating costs $14,600 $14,740 $15,300 $44,640
Net purchases 48,708 53,460 59,400 161,568
Equipment -0- 63,500 -0- 63,500
Total $63,308 $131,700 $74,700 $269,708


8-67 (Continued-1)

Schedule E: Cash Budget

Cash balance, beginning $25,000 $40,692 $39,967 $25,000
Total cash receipts 79,000 81,600 88,400 249,000
Cash disbursements prior to financing 63,308 131,700 74,700 269,708
Cash balance before financing $40,692 ($9,408) $53,667 $4,292
Financing:
Borrowing required $0 $50,000 $0 $50,000
Interest payment $0 $625 $625 $1,250
Borrowing repaid $0 $0 $20,000 $20,000
Net effect of financing $0 $49,375 ($20,625) $28,750
Cash balance, ending $40,692 $39,967 $33,042 $33,042

Minimum cash balance required $30,000 $30,000 $30,000 $30,000
Check for minimum balance OK OK OK OK

2.
Gold Sporting Equipment
Budgeted Income Statement
For the Third Quarter, 2007

Sales $252,000
Cost of Goods Sold (sales x (1 - 0.40) x (1 - 0.01)) $149,688
Gross Profit $102,312
Operating Expenses:
Salaries & wages $36,600
Rent & property taxes $3,000
Depreciation $2,400
Other operating expenses $5,040 $47,040
Operating Income $55,272
Other Income/Expenses:
Interest Expense $1,250
Pre-tax Income $54,022
Income Taxes (@25%) $13,506
Net Income $40,516


8-67 (Continued-3)

Gold Sporting Equipment
Budgeted Balance Sheet
June 30
th
and September 30
th
, 2007

June 30
th
September 30
th

Assets
Cash $25,000 $33,042
Accounts Receivable (A/R) $15,000 $18,000
1
Merchandise Inventory $47,520 $59,400
2
Building and equipment (net) $200,000 $324,600
3
Total Assets $287,520 $435,042

Liabilities and Stockholders Equity
Short-term payable (new equipment purchase) $0 $63,500
Short-term bank loan payable $0 $30,000
Income Tax Payable $0 $13,506
Total Liabilities $0 $107,006
Stockholders' Equity $287,520 $328,037
Total Liabilities & Stockholders Equity $287,520 $435,042

Notes:

1
Credit sales made in September, to be collected in October

2
Net merchandise purchases made in September (to meet expected sales in
October)

3
Beg. Balance (net) + New Equipment Purchased Depreciation Expense =
$200,000 + $127,000 $2,400


to... while you are in the spreadsheet mode.

8-67 Comprehensive budget, strategy
Data Input
Account balances, June 30th Recent and forecasted sales
Cash $25,000 June (actual)


8-67 (Continued-4)

3. Gold needs to borrow to finance part of the payment for the new equipment during the
third quarter. In addition, fluctuations in business may require the firm to seek short-
term loans. Payrolls, materials, and supplies have to be paid before collections from
customers. In anticipation of rising sales in the coming season, Gold may experience a
peak demand for cash to pay for the increased purchases of materials, payrolls, and
supplies while collections from customers may be at the lowest point of the year as the
firm comes out of a low-activity season.

A short-term financing arrangement is the best way to meet seasonal cash needs. A
short-term loan can be repaid as soon as activities in cash collections increase and
payrolls and purchases of materials and supplies decrease as the firm enters into a
slow season. Although the firm may have to pay a higher cost for short-term borrowing,
the total financing cost likely would be lower than if the firm raised sufficient funds
through either issuing long-term bonds or capital stock to meet peak demands for cash.
A bond requires interest payments whether or not the firm uses the funds raised from
the bond in operations. Additional capital stock is not without cost. Management needs
to earn a desired return on equity to satisfy investors.

Furthermore, studies have shown that management is prone to be careless in spending
when abundant funds are available.

4. The scenarios described involved many simplified assumptions in order to make the
problem managable. Among possible complicating factors are:

No bad debts are considered.
Customers always make payment as prescribed in sales terms.
Within a given month cash inflows are in time to meet cash outflows. It is
conceivable that the bulk of cash inflows occur toward the end of the month while
payments need to go out at the beginning of the month.
Cash customers do not use bank credit cards for the purchases.


8-68 Cash Budgeting; Sensitivity Analysis (50 Minutes)

1. Estimated Cash Receipts, April 2007:
April Cash Receipts:
April cash sales (25.0% x $425,000) = $106,250
April credit-card sales ($425,000 x 55% x 97%) = $226,738
Collection of accounts receivable:
From April Sales (20% x $425,000 x 25%) = $21,250
From March Sales ($400,000 x 20% x 45%) = $36,000
From February Sales ($550,000 x 20% x 27%) = $29,700
Total $419,938

2. Purchase Order for Hardware, executed January 25th (to be paid April 10th):

a) Number of units to be ordered:
Estimated Unit Sales, March = 90
Plus: Desired End. Inv., March (30% x 100) = 30
Total Needs (in Units) = 120
Less: Beg. Inv., March (30% x 90) = 27
Required Purchases (in Units) = 93

b) Cost of purchases:
Selling price per unit (e.g., $300,000/100 units) = $3,000
Estimated cost per unit (@65% of selling price) = $1,950
Total cost of purchases (93 units x $1,950/unit) = $181,350

Note that the cash outflow associated with these purchases will be 4/10/2007 (75
days after executing the purchase order).


8-68 (Continued-1)

3. Sensitivity Analysis: Three Senarios for March Sales and the CGS%

Estimated
SalesMarch CGS %
Optimistic Estimate = 100 60%
Base-line Estimate = 90 65%
Pessimistic Estimate = 80 70%

March Cash
Sales Payment
Scenario (units) CGS % April 10th
1 100 60% $180,000
2 100 65% $195,000
3 100 70% $210,000
4 90 60% $167,400
5 90 65% $181,350
6 90 70% $195,300
7 80 60% $154,800
8 80 65% $167,700
9 80 70% $180,600
Maximum = $210,000
Minimum = $154,800
Range = $55,200

4. Monthly cash budgets are prepared by companies such as CompCity, Inc., in order to
plan for their cash needs This means identifying when both excess cash and cash
shortages may occur. A company needs to know when cash shortages will occur so that
prior arrangements can be made with lending institutions in order to have cash available
for borrowing when the company needs it. At the same time, a company should be
aware of when there is excess cash available for investment or repaying loans so that
planned usage of the excess can be made.


8-68 (Continued-2)

Sensitivity analysis, one type of which is illustrated in part (3) above, can be used to
help managers deal with uncertainties in the budgeting process. Sensitivity analysis
enables managers to examine how a budget would change in response to changes in
one or more underlying assumptions (such as sales volume level and CGS %). As such,
the process enables managers to monitor key assumptions and to make timely
adjustments to plans. In practice, management might view the base-line outcome as the
expected value prediction. It might define, subjectively, optimistic and pessimistic
values as those having a small probability, (e.g., 10% or less).

Note to Instructor: An Excel spreadsheet solution file for this assignment is
embedded below. You can open the spreadsheet object that follows by doing
the following:

to... while you are in the spreadsheet mode.

8-68 Cash Budgeting; Sensitivity Analysis
Inputs
Hardware Hardware Software/Support Total
Sales (Units) Revenue Services Revenue Revenue
January 120 $360,000 $140,000 $500,000
February 130 $390,000 $160,000 $550,000


Check Figures: Chapter 8
8-31 Base case (5%) for March: $5,500
8-32 No check figure
8-34 1(a) = $115,000; 2(b) = $110,250; 3 = 37.25%
8-35 1 (Nov.) = $123,861; 2 (Nov.) = $183,750
8-36 Production, Qtr. 2 = 37,600 units; Purchases, Qtr. 2 = 111,480 lbs.
8-37 1 = 37.25%; 2 = 18.43%
8-38 1 = 450,000; 2 = 460,000; 3 = 930,000
8-39 Ending cash balances: $99,500 (Nov.); $50,490 (Dec.)
8-40 $26,000
8-41 Cash balance before financing = $2,250
8-42 2. Qtr. I: Total cash available = $381; Salaries & benefits = $335; Total financing
effects = $54.
8-43 1 = $84,400; 2 = $230.000
8-44 1 = $152,000; 2 = $172,500; 3 = $155,000; 4(a) = $169,500, 4(b) = $102,500
8-46 1. $86,082
8-47 Total cash receipts: September = $86,082; October = $88,141
8-48 1. $2,808,000; 2. cost/carton delivered = $2.34; 3 = $1,051,000 (expected cost
savings, January 2007)
8-49 2. Budgeted cost-driver rates, Data entryRequisitions: $1.20 (Jan.), $1.176 (Feb.),
and $1.1525 (March)
8-50 1 = $91,200; 2 = $299,400; 3 = $234,000
8-51 1 = $0 (no budgeted overhead for senior consultants); 2 = 16; 3 = $163,700 (total
compensation)
8-56 1 = $1,800,000 (C12); 2 = 11,900 (C12); 3 = $384,800 (budgeted purchases, RM1);
4 = $1,273,750; 5 = $580,830 (total budgeted overhead); 6 = $2,346,900 (CGS),
$55,280 (Ending Inventory); 7 = $645,000; 8 = $472,860 (after-tax income).


4 = $1,948,750; 5 = $753,630 (total budgeted overhead); 6 = $3,433,113 (CGS),
$50,002 (Ending Inventory); 7 = $645,000; 8 = $649,132 (after-tax income)
4 = $1,078,500; 5 = $293,472 (budgeted variable overhead), $245,579 (budgeted
fixed overhead); 6 = $2,057,200 (CGS), $45,596 (Ending Inventory); 7 = $645,000; 8
= $646,680 (after-tax income)
8-59 1 = $225,000 (May); 2 = $285,379; 3 = $333,876; 4 = $368,250 (net accounts
receivable)
8-60 1a = 176,000 units; 1b = $32,736,000; 2 = $22,040,291 (CGS); 3 = reduced
investment in working capital = $2,113,329
8-61 1 = $206,680; 2 = $83,600; 3 = $10,000; 4 = $120,000; 5 = 153,000 units; 6 =
$153,000
8-62 1. Total operating cash inflows, 2009 = $709,082; Total operating cash outflows:
$461,000 (2008), $603,925 (2009); Budgeted ending cash balance, 2009 = $10,057.
8-63 1 = $372,628; 2: cost-reduction rate = 43%
8-66 Qtr. 1: Cash available = $455,000; bond sinking-fund payment = $0; Excess cash,
prior to financing transactions = $8,000; total effects of financing = $0.
Qtr. IV: Beginning cash balance = $30,770; payroll = $122,000; total cash needs =
$515,250; total effect of financing = $20,110; ending cash balance = $30,630
8-67 1. Cash receipts: $79,000 (July); Cash Disbursements for Purchases: $59,400
(Sept.); Cash Disbursements for Operating Costs: $14,600 (July); Ending Cash
Balance: $40,692 (July), $39,967 (August), $33,042 (Sept.).
2. Net Income = $40,516; Sept. 30
th
Balances: Total Assets = $435,042; Total
Liabilities = $107, 006.
8-68 1 = $419,938; 2a = 93 units; 2b = $181,350; 3: Budgeted cash payment on April 10
th

when March Sales = 100 units and CGS % = 60%, is $180,000.

Chapter 8: Strategy and The Master Budget

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Blocher, Stout, Cokins, Chen, Cost Management, 4/e 8-1 The McGraw-Hill Companies 2008

CHAPTER 8: STRATEGY AND THE MASTER BUDGET

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