LEARNING OBJECTIVES After studying Chapter 10, you should be able to: 101 Understand wy ‘organizations budget and the processes they use to create budgets. Loz Understand basic budgeting terms and the behavioral aspects of budgeting, 103 Understand the key components of a master budget in ‘manufacturing, merchandising, and service industries, Loa Prepare a master budget for a ‘manufacturing ‘company, including: a. Sales budget and aschedule of expected cash collections. ». Production budeet. Master Budgeting BUSINESS FOCUS Budgeting to Save Costs: The Advent of the Low-Cost Carrier In 2001, Mr. Tony Fernandes bought the heavily indebted AirAsia for the token sum of one ringgit (US$0.27). In 2002, he remarkably turned the com- pany from loss making into profit mak- ing. In 2009, AirAsia was one of the most successful low-cost budget carriers, reaching an annual revenue and profit after tax of RM3.18 billion (US$933 million), and RMS49 million (USS161 million), respectively. How did Mr. Tony Fernandes do i ‘An extensive amount of profit planning was involved in this success story. Low-cost carriers such as AirAsia typically earn around 45% less revenue per kilometer than the full-service airlines, and they, therefore, have to budget atleast 450% lower costs in order to make a profit. Low-cost carriers use a combination of methods to save costs. These include minimizing turnaround time to achieve high aircraft utilization, not providing free food and beverages, sticking to one single type of aircraft to save staff training and minimizing the keeping of spare parts. In addition, low-cost carriers make use of mainly Internet and call centers to sell cher tickets and prefer to land in secondary airports to save landing charges.Chapter 10, “This careful cost planning has been widely employed by many budget airlines, for ‘example, AirAsia (based in Malaysia), Tiger Airways (based in Singapore), Cebu Pacific Air (based in the Philippines), Firefly (based in Malaysia), Nok Air (based in Thailand), Lion Air (based in Indonesia), and Jetstar Pacific (based in Vietnam). m “Sonee:Teithen Francis, “AinAsia Posts 549m Ringgit Profit in 2009," Air‘Transport Intelligence ‘News, February 26,2010,Master Budgeting 'n this chapter. we describe how organizations strive to achieve their financial _godls by preparing a number of budgets that together form an integrated business plan known as the master budget. The master budget is an essential management tool that communicates management's plans throughout the organization, allocates resources, and coordinates activities. 483 The Basic Framework of Budgeting | ‘A budget is a detailed plan for acquiring and using resources over a specific time period. Individuals have budgets too—they erente budgets for personal activities. For example, individuals do budgets for their overseas holidays, weddings, and birthday parties. These ‘budgets are important to help determine the destination of the holiday and length of stay, venue for the event, the type and amount of food to be served, the number of guests to be invited, etc. Without a budget as a guide, we may end up overspending or underspending undesirably. Corporations use budgets in a similar manner, although the amount of work and the underlying details would be much greater. Budgets force us to plan and provide a ‘guide for action inthe future, In this chapter, first, we explain why companies do budgets and some of the budget- ing processes. Second, we discuss some of the budgeting terms and behavioral aspects of budgeting. Third, we look at how companies put their budgets together, Last, the pros and eons of budgeting are discussed. ‘Budgets are used for wo distinct purposes—planning and control. Planning involves developing goals and preparing various budgets to achieve those goals. Control involves, the stops taken by management to increase the likelihood that all parts ofthe organization ‘are working together to achieve the goals set dawn at the planning stage. To be effective, ‘8 good budgeting system must provide for both planning and control. Good planning ‘without effective control is a waste of time and effort. Advantages of Budgeting Organizations realize many benefits from budgeting inching: 1, Budgets communicase management's plans throughout the organization, 2, Budgets force managers to shink about and plan for the future. In the absence of the necessity to prepare & budget, many managers would spend all of their time dealing ‘with day-to-day emergencies. 4 The budgeting process provides a means of allocatine resources to those parts of the ‘organization where they can be used most effectively. 4, The budgeting process can uncover potential hortlenecks before they occur. 5. Budgets coordinate the activities of the entire organization by integrating the plans of its various parts. Budgeting helps to ensure that everyone in the organization is pulling in the same direction. 6, Budgets define goals and objectives that can serve as benchmarks for evaluating sub- sequent performance, Responsibility Accounting Most of what we say in this chapter and in the next three chapters is concerned with responsibilty accounting. The basi idea underlying responsibility accounting is that a ‘manager should be held responsible for those items—and only those items—that the ‘manager can actually control to significant extent. Each line item (Le. revenue oF ost) ‘in the budget is the responsibility of a manager who is held responsible for subsequent deviations between budgeted goals and actual results In effect, responsibility accounting personalizes accounting, information by holding individuals responsible for revenues and434 Chapter 10 NEW YORK CITY MAYOR BENEFITS FROM BUDGETS Wichael Bloomberg, the mayor of New York Cy, makes anual budget presentations to is fellow lected officials, the city counel, and the medi, Histoncally the city’s mayors had delegated these types of presentations to one oftheir budget drectos; however, Bloomberg beleves that by invest ing his me in explaining the factors influencing the city’ economy, his constituents wil in abet ter understanding of his fiscal prone, This, in tur, helps improve his negotiations wih the city ‘coun and his relaonshins wih various advocacy groups. The mayor also makes hs entre budeet avaiable olne so that New Yorkers can scrutnize budgeting detais, such asthe cost of runing ‘specific government agencies, ‘Souter uy, Th CF0 Maye naceWenk, line 25,2007, pr SAAB costs, This concept i central 10 any effective profit planning and contol system. Some- ‘ane mnt he held responsi for each cost elem ne one will he responsible andthe cost will inevitably grow out of contol ‘What happens if actual results do not measure up to the budgeted goals? The man- ager is not necessarily penalized. However, the manager should take the initiative to cor- rect any unfavorable discrepancies, should understand the source of significant favorable ‘or unfavorable discrepancies, and should be prepared to explain the reasons for diserep- ancies to higher management. The point ofan effective responsibilty accounting system isto make sure that nothing “falls through the cracks,” that the organization reats quickly and appropriately to deviations from is plans, and thatthe ganization learns from the feedback it gets by comparing budgeted goals to actual results. The point is nr to penal- jae individuals for missing targets Choosing a Budget Period Operating budgets ordinarily cover a one-year period corresponding to the company’s fiscal year. Many companies divide their budget year into four quarters. The first quarter is then subdivided into months. and monthly budgets are developed. The last three quar- ters may be carried in the budget as quarterly totals only. As the year progresses, the fig- ures for the second quarter are broken down into monthly amounis, hen the third-quarter figures are broken down, and so forth. This approach has the advantage of requiring peri- odie review and reappraisal of budget data throughout the year, ‘Continuous or perpetual budgets are sometimes used. A continuous or perpetual bud= get isa 12-month budget that rolls forward one month (or quarter) as the current month (or quarter) is completed. In other words, one month (or quarter) is added tothe end of the bud- fet as each month (oF quarter) comes to a close. This approach keeps managers focused at Teast one year ahead so that they do not become too narrowly focused on short-term results In this chapter, we will look at one-year operating budgets. However, using basi- cally the same techniques, operating budgets ean be prepared for periods that extend ‘over many years. It may be difficult to accurately forecast sales and other data much beyond a year, but even rough estimates can be invaluable in uncovering potential prob- lems and opportunities that would otherwise be overlooked. Bottom-Up versus Top-Down of Budgeting How budgets are done and the behavioral aspects of budgeting are extremely important for us to understand in order to appreciate the uses and limitations of budgets. For example, if the middle managers are asked to come up with the sales targets for next year and they know that these targets will be used to assess their performance, they are likely to set easily attainable targets so that their chances of meeting the targets areMaster Budgeting higher. However, if targets are determined by top management, the targets may be "unrealistic as top management may lack the necessary field knowledge to set realistic targets. This brings us to the two different approaches of budgeting, namely, bottom-up” and “top-down.” ‘A bottom-up budget is also known as a self-imposed budget or participative budget, This approach, as illustrated in the left-hand column of Exhibit 10-1, is a ‘budget that is prepared with the lull cooperation and, participation of managers at all levels. These budgets tend t0 have a positive impact on employee morale because the ‘employees’ views and judgments are valued by the top management, Employees are likely to be more committed to reaching the targets as these targets are set by themselves. With a self-imposed budget, it is not possible to argue that the budget is, ‘unattainable since it is a self-Formed target. A key disadvantage of thie approach is that employees tend to set easily attainable targets in order to make life easier for themaselves. Hence, too much “budgetary slack” or “budget padding” can occur with bottom-up ‘budgeting. In general, managers incorporate budgetary slack by understating budgeted sales and overstating budgeted expenses. As a result, the overall targeted net income is inderstated an ean he met more easily. Budgetary slack or budget padding can be very damaging to the organization's performance. With a slack budget, a company's performance may not be optimized as employees tend to underperform with easy targets. ‘Top management must therefore carefully review the budgeted data prepared for them. ltem-by-item comparisons with industrial figures or past-year data may help to reveal ‘budgetary slack. Therefore, this battom-up approach of budgeting is very time consuming and involves a lot of explanations, communications and negotiations between top ‘management and staf. EXHIBIT 10-1 “The Flow of Budget Data in a Bottom Up and a Top-Down Approach of Sudgeting Bottom-Up Budgeting “The initial flow ot budget data in a bottom-up budgeting system is from lower levels of management to higher levels of management. Each person with responsibilty {or cost or revenue will prepare his or her own budget estimates and submit them to the next higher level of management, Thoce estimates aro reviewod and con- solidated as they move upward in the organization. ‘Top-Down Budgeting “Top marayernent seis all the key targets for the entire ‘company, These key targets are then moved downward for the middle and lower-level management to come up with other detailed budgeted figures. Under this ‘approach, middle and lower-level management are tasked to compiate the hudget plan toward meeting the key targets set by the top management. cc Sere486 ‘chapter 10, Another possible way to minimize budgetary slack is to have the budgets set at the top. A top-down budgeting, as iMustraved in the right-hand column of Exhibit 10-1, 18 prepared by the top management and imposed on the lower layers of the organization ‘Top-down budgets clearly express the performance goals and expectations of top man- agement, but these budgets can be unrealistic because input from the lower-level staff is not obtained. A key advantage of these top-down budgets is that it requires less time 10 prepare as fewer discussions or negotiations are required. However, lower-level employees are unlikely to be committed to reach these targets as they can argue that, they did not set the major targets. Which system is a better system may depend on where the knowledge lies. For ‘example, if the ground-level sales people know better about the market demand, they should then be asked to come up with the budgeted sales figures. On the other hand, if the top management has access to market data, they may be in a better position to do. the projection. In practice, a mixture of both approaches may be used, For example, the initial targets may be set by the top management, the views of managers are then obtained and any necessary adjustments to the targets made by the top management. Also, the definition of bottom-up or top-down is not so clear-eut, For example, a com- any may appear to have a system of bottom-up approach of budgeting, but as the proposed budgets are reviewed and edited up the chain of command, the final budgeted figures may be very different from what was bbe more of a top-down approach, ae BUSINESS TOP-DOWN AND BOTTOM-UP BUDGETING © ——————————— ee inally proposed. In a sense, this would te curent budotiy Yeo don] oes exe an eo ett acoso Drosera ff Zorobaseall 2% omer IM 1 om 20% 0% cy Perceriage cl espodents According to research survey funded by PricewaterhouseCoopers (PwC) of 220 large comoa- ‘es with annual revenues greater than S2 biion, the majority of respondents spit evenly, 38% 2c, between topdavm and bottomup budgeting. While a top-down approach can help mitigate budgetary slack, @bottamup approach is often required in order to gather cial ground level infor. ‘mation which top management does not have direct access to, More Important, the bottom up ‘approach can motivate staf to work harder to achieve their awn targets whereas the figures from,Master Budgeting the top-down approach are imposed on them and this lack ownership and motivational eects. Based on PwC's experience wit is clients, it suggests that “a balanced approach incorporating, both topdown and bottomup approaches isthe optimal path It encourages upront target discus- sions and negotiations which streamine the numberof planning iterations. ‘ouree: CFO Retearch “Financial Planing! Rearing he Vain of Rigating ao Frente" 11) Rate duced wh permission Budget Lapsing Budget lapsing is avery popular method used by government agents, universitis, non profi ongcnizations, and organzations/visions that rely om allocated funds. der bad ft lapsing, any unused budget aftr the financial year-end bas lapsed cannot be carried forward tothe following year. As a result, te following year's budget may be cut becase ofthe underexpenditue in the previous year Budget lasing is used by organizations that would ike to ensue that the appropriate level of resources is flied in each period. Without budget lpsing, risk-averse managers may sometimes accumulate funds unnecessarily justo prepare for highly unforeseeable evens. For example, managers may cut back on training und this eu may lado sub- ‘ptimal result such as substandard goods and services being made and provided. Ttcan be argued that budget lapsing provides a good opportunity for organizations to have a clean cut-off of expenditure and to reallocate any unused resources for other appropiate requiemens, However, ican also cause a lo of undesired behavior effets. One of te major drawbacks of budget lpsing is that it reates incentives for manager o wastfully spend thoi entre barge fore the end ofthe year regardless ofthe actual needs in order to avoid tuadget cts, For example, managers may organize expensive overseas af retreats just before the end of the year, buy lot of tatoncry tems which canbe expense of. ‘Budget lapsing therefore has its purposes and drawbacks, In order to enjoy the benefits ofthe system while avoiding wasteful expenditure, a system of reviewing the expenditures near end of the year can be implemented, and any unusual expenditure is investigated, This may provide the necessary disincentive for managers to wasteil spending caused by budget lapsing. Incremental versus Zero-Based Budgets Most organizations plan the year's budgct by referring to the previous your's figures. Adjustments are then made t0 the budget to account for the expected changes such as nnew prices for the next year. While this method, also known as the incremental ‘budget approach, is practical and fast, any inefficiency in the previous year’s figures may be carried forward, For example, if wages and salaries were budgeted based on the previous year’s plus a percentage of pay adjustment. the budget would potentially be allowing an overstaffing situation to continue from the previous year. Zero-based budgets, in contrast, are prepared based on the assumption that the ‘company has just started operations. Therefore, resources required have to be justified from scratch. For example, when budgeting staff cost for a restaurant, the manager using the zero-based budgeting approach would ignore the existing staff level and expenses. Instead, he would examine factors such as the opening hours, number of tables, and expected patron numbers to work out the number of staff required at each position and level, and the resultant associate costs. The zero-based method's figures ‘would then be compared with the previous year’s figures to check if they are reasonable, In practice, organizations use a mixture of both incremental and zero based budgets. Most of the relatively less significant items can he based on the ineremental method. This 487488 Chapter 10 is consistent with the cost and benefit concept. It is more cost effective to estimate these smal items using the less time-consuming incremental method. The comparatively more time-consuming zero-based method should be used for the more significant items such as, ‘wages and salaries in the service industry. The reason for this is that the high cost of ‘geting very accurate information for small items is not justifiable by the benefit as small items’ impact on budget is relatively small. Budget accuracies for significant items, ‘compared to smaller items, are therefore much more evtial for the overall budgeted profit. ZERO-BASED BUDGETING IN THE UNITED STATES ‘Over the past tree decaces, state lawmakers have been using the same tradtional budgeting ‘method, which assumes an existing baseline, with incremental changes made to it Oklahoma's, ‘Sate Representative, Joe Dorman, says that the curent budgeting system is too restrictive and lacks transparency. He proposes the adoption of a zero-based budgeting process so that Legisla- ‘ure Members can have a better understanding of haw and where state funds are being utlized. Dorman is fling for intorim studies to examine the possibify of implementing the zero based bud _zeting approach. tis idea is generally supported by other lawmakers. However, the implementation ‘ofthis method of budgeting is expected to be a long process and unkely to happen soon! ‘Source: M. Sent Care, -2eo-Based Budgeting in Ola, Possible but Not Likely Soo,” The Journal Record, ay 14,2013. Top Management Attitude in Budgeting ‘The success of a budget program also depends on the degree to which top management accepts the budget program as a vital part of the company’s activities and the way in which top management uses budgeted data, Ifa budget program is to be successful, it must have the complete acceptance and support of the people who occupy key management positions. If lower or middle ‘managers sense that op management is lukewarm about budgeting, or if they sense that management siniply tolerates budgeting as a nevessary evil, thew Ueit own attitudes will reflect a similar lack of enthusiasm. Budgeting is hard work, and if top management is not enthusiastic about and committed to the budget program, then itis unlikely that anyone else in the organization will be either, Inadministering the budget program, its particularly important that top management not use the budget to pressure or blame employees. Using budgets in such negative ways will breed hostility, tension, and mistrust rather than cooperation and productivity. ‘Unfortunately, the budget is too often used as a pressure device and excessive emphasis is placed on “meeting the budget” under all circumstances. Rather than being used as a ‘weapon, the budget should be used as a positive instrument to assist in establishing goals, measuring operating results, and isolating areas that need attention For an effective budget, top-management attitude toward the preparation and use of the budget is extremely important. The purpose of the budget is to motivate people and to coordinate efforts. This purpose would be undermined if the budget was used in a rigid and inflexible manner to control people. Stretch Budgets and Rewards How challenging should budget targets be? Some experts argue that budget targets should be very challenging and should require managers to stretch to meet goals, Even the mostMaster Budgeting capable managers may have to scramble to meet such a “stretch budget” and they may not always succeed. In practice, most companies set their budget targets at a “challenging but attainable” level. A challenging but attainable budget may be very difficult to achieve, but it can almost always be met by competent managers exerting reasonable effort. Bonuses based on meeting and exceeding budgets are often a key element of ‘management compensation. Typically, no bonus is paid unless the budget is met. The ‘bonus often increases when the budget target 1s exceeded, but the bonuis is usually capped ‘out at some level, For obvious reasons, managers who have such a bonus plan or whose performance is evaluated based on meeting budget targets usually prefer to be evaluated ‘based on challenging but attainable budgets rather than on stretch budgets. Moreover, challenging but attainable budgets may help build a manager's confidence and generate ‘greater conwnitment (9 the Iuxlget. And finally, challenging but attainable budgets may result in less undesirable behavior atthe end of budgetary periods by managers who are intent on earning their bonuses, Examples of such undesirable behaviors are presented in several of the In Business boxes in this chapter. ‘THE DARK SIDE OF TYING BONUSES TO MEETING TARGETS |Athough there are some merits behind offering bonuses to managers for meeting targets set in the budget, there may be some negative repercussions from distributing bonuses based on meet- ing targets. One potential downtal of cistibuting bonuses only when managers ht ther targets that managers may resort to unethical means to obtain results. For example, inthe 1970s, when managers over at Ford needed to hit their sales targets, despite being aware ofthe fact thatthe Ford Pinto was not entirely safe for usage, they decided to proceed with mass production to ‘Barner more sales revenue. As a result, many drivers of the Ford Pinto were involved in car acci- ‘dents that resulted in griovous injuries or deaths, causing the company to incur mascive legal ‘ees and other costs. Hence, thorough consideration is vital before companies decide to make bonus distribution contingent on meeting certain targets. Source: Max H.Bazerman and Arn E. Tenn, “ial Breakdowns,” Harvard Business Review, Aoi 2011. The Budget Committee A standing budget committee is usually responsible for overall policy relating to the budget ‘program and for coordinating the preparation of the budget itself This committee may consist, of the president; vice presidents in charge of various functions such as sales, production, and ‘purchasing; and the controller, Difficulties and disputes relating tothe budget are resolved by the budget committe. In addition, the budget committe approves the final budget. Disputes can (and do) erupt over budget matters. Because budgets allocate resources, the budgeting process determines to u large extent which departments get ore resources und which get less. Also, the budget sets te beuclunarks used (0 evalu- ate managers and their departments. Therefore, it should not be surprising that managers take the budgeting process very seriously and invest considerable energy and emotion in ‘ensuring that their interests, and those of their departments, are protected. Because of this, the budgeting process can easily degenerate into an interoffice brawl in which the ultimate goal of working together toward common goals is Forgotten. ‘Running a successful budgeting program that avoids interoffice battles requires con- siderable interpersonal skills in addition to purely technical skills, But even the best interpersonal skills will fail if, as discussed earlier, top management uses the budget process to inappropriately pressure employees or to assign blame.490 Chapter 10 | Technical Aspects of Budget Preparation | ‘The remainder of the chapter deals with the technical aspects of budget preparation. AS mentioned earlier, the behavioral aspects of budgeting directly affect the budgeted figures. While understanding the computations of various figures, we must not lose sight of how the figures can be affected by human factors BRAZIL'S WORLD CUP 2014 BUDGET NIGHTMARE 1h 2007, Braz on the rights to host he egy anticipated 2014 FFAWurkl Cup. Hume, constuction of the venues promised by Brazlian officials is severely behind schedule and the country which produces superb players has difficulty keeping its stadium construction costs within budget. The texpected cost of building and refurbishing 12 stadiums has increased by 1 bllon Brazian reas ($435 hilo. According to the government’ Werld Cup webst, the budget for refubishng and constructing ‘the stadiums was 3.3 bill ad 7.03 billion Brazen reas in 2010 and 2011, rspertivy. The current ‘estimated budget stands at 8 bilion Brazicn eas, tremendous 50% inerease from the 2010 budget. “The lock of tigt budget management tas led o social unrest as Brazilian taxpayers protest ayant the baloning extravagant spending on fancfu stadiums, despte havng poor pub heaticare and ‘education systems. Furthermore, ts foreseen that some ofthese stadiums wil be urderutized in he future, siior tothe Being Obmipic Beds Nest Hence, such hefty budeets have raised doubts on ‘whether hosing a wrid cass event il actualy benefit Brazi's economy. ‘Source: Jonthan Wats, “xl Prepares fr Wd Cup ag Crit ants over Cost” The Guaan, ne 9, 2013. The Master Budget: An Overview “The master budget consists‘of a number of separate but interdependent budgets that for- ‘mally ay out the company’s sales, production, and financial goals. The master budget culmi- hates in a cash budget, a budgeted income statement, and a budgeted balance sheet. Bxhibit 10-2 provides an overview of the various parts of the master budget and how they are ‘elated, Companies in different industries adapt this master budget based on their particular needs For a manufacturer, the first step in the budgeting process is the preparation of the sales budget, which is a detailed schedule showing the expected sales for the budget period. An accurate sales budget is the key t0 the entire uxlgeting process as all other ‘budgets, such as the production budget and the income statement budget, depen on the sales budget. The sales budget is compiled by taking into account, for example, past sales levels, general economic trends, competitors’ actions, and pricing strategies. Once the sales budget is produced, a manufacturer will form the production budget based on the sales budget and the required finished goods inventory, as a finished goods inventory is necessary to cater for any unexpected change in demand. Thereafter, the production | budget is utilized to determine the budgets for direct materials, direct labor, and manu- facturing overiieads. A budget for selling and administrative expenses will then be pre- pared. Finally, a budgeted cash statement, income statement, and balance sheet are ‘compiled For a merchandiser, the first step is also the preparation of the sales budget. After the sales budget is done, a merchandiser will produce a budget for the merchandise purchases. The sales budget and the inventory required are utilized to compile the bud- fot for merchandise purchases, Production, direct materials, direct Tabor, andMaster Budgeting 491 EXHIBIT 10-2 The Master Budget Interrlationships ‘manufacturing overhead budgets are not applicable for a merchandiser. As with a man- ufacturer, other budgets, including selling and administrative expenses, cash, income statement, and balance shect, are prepared by the merchandiser. A service provide, like a manufacturer or « merchandiser, will also prepare a sales budget firs. The sales budget gives details ofthe services tobe provided and the related income. Based on the sales budget other budgets are then prepared. A not-for proft organization budget has many similarities with other organizations. “The major difecence is Ut this wnganization uoxnally does wot charge fr its goods ad services, and funding is obtained from government bodies or donors. Therefore, ther is no sales budget fora not-for-profit organization. Instead, it wil havea budget for revenve or funding. From this budget, the organization will plan for its activities accordingly by ‘producing a budget for activites and expenses Tn summary, the fest step of budgeting for every business isto budget forthe reve- rue, whether itis a sales budget for providing goods or services ora funding budget. Although operational budgets are adapted according to the industries, they are very simi- Jarand typically comprise budgets for income statement, cash and balance sheet. We will next desctibe the detailed budgeted information for a manufacturer.492 Chapter 10 | Preparing the Master Budget for a Manufacturing Company ‘Tom Will is the majority stockholder and chief executive officer of Hampton Freeze, Inc., a ‘company he started in 2010. The company makes premium popsicles using only natural ingre- 2 one trweSuee etre net oo | teeta lies Samkows cong Sones 108 | fede lait ame Ure Ste ee rt a | $F 5 Gnmitiene — ttetem an a | | 10 Wow Feesbook United States ‘Software 8 Internet 14 Source: Bood & Co., 2013 Global novation 1000 Stud. The Cash Budget As illustrated in Exhibit 10-2, the cash budget combines much of the data developed in the preceding steps. Its a good idea to review Exhibit 10-2 to get the big picture firmly in your mind before moving on. CONCENTRATING ON THE CASH FLOW Vestas Wind Systems AS, a Danish turbine maker, managed to reduce its loss from €963 milion (USS1,319 milion) in 2012 to a smaler loss of €82 millon (US$112 milion) in 2013 despite decin. ing revenue from €7.2 bilion (USS 9.9 bilion) to €6.1bilion (US$8.3 bilo). The improvement was ‘due to its focus on cash flow management and forecast according to its new chief executive Anders Runevad. The company had been losing maney for three years since 2011 as demand for its wind turbines had suffered amid lower government subsidies and cheaper competitors. Cash flow vas \weak spot for Vestas, therefore the company executed deep cost reductions including thousands of job cuts and asset sales to stabilize cash reserves, maintaining expected free each fnu hetween ‘€500 milion and €700 milion. This approach was well received by the market. The share price of Yestas increased drastically from Danish Krone (OKK) 50 per share on May 1, 2013 to DKK150 per ‘share on Nov 1, 2013 and progressed to DKK235 per share on Apri 4, 2014. Sources: Clemens Bomscort, "Vestas Boosts Tomarnd Hopes,° The Wal Steet Jour wsicom, Nov 6, 2013 (itp /onie ws. comvoows/atiets/S810001424052702303309500570181572833755770) and Pisiness- week com investment research on Vestas Wind System AS ft: //mvesting businessweekconvreseachy stocks nancasinancils espicker= WS:DCkadstaset=castFlowSperod=ABcurrency=nate) Api 7, 2014 Te504 Chapter 10 ‘The cash budget is composed of four major sections: ‘The receipts section, ‘The disbursements section. ‘The cash excess or deficiency section. ‘The financing section aeRe ‘The receipts section lists all of the cash inflows, except from financing, expected during the budget period, Generally, the major source of receipts is from sales. ‘The disbursements section summarizes all cash payments that are planned for the ‘budget period. These payments include raw materials purchases, direct labor payments, ‘manufacturing overhead costs, and so on, as contained in their respective budgets. In addition, other cash disbursements such as equipment purchases and dividends are listed. ‘The eash excess or deticiency section is computed as follows: Gash balance, beginning . ‘Add receipts Tolal cash available. Loss disbursements e 2 Excess (deficiency) of cash available over disbursements, If'a cash deficiency exists during any budget period, the company will need to borrow funds. If there isa cash excess during any budget period, funds borrowed in previous periods can be repaid or the excess funds can be invested, ‘The financing section details the borrowings and repayments projected to take place during the budget period. It also lists interest payments that will be due on money borrowed. ‘The cash balances at both the beginning and end of the year may be adequate even though a serious cash deficit occurs at some point during the year. Consequently, the ‘cash budget should be broken down into time periods that are short enough to capture major fluctuations in cash balances. While a monthly cash budget is most common, some organizations budget cash on a weekly or even daily basis. Tarry Gian has prepared a quarterly cash budget for Hampton Freeze that can be further refined as necessary. This budget appears in Schedule 8. The cash budget builds on the earlier schedules and on additional data that are provided below: 1, The beginning cash balance is $42,500. 2, Management plans to spend $130,000 during the year on equipment purchases: $50,000 in the first quarter; $40,000 in the second quarter, $20,000 in the third quarter; and $20,000 in the fourth quarter. 3. The board of directors has approved cash dividends of $8,000 per quarter. Management would like to have a cash balance of at least $30,000 at the begin- ning of each quarter for contingencies. 5. Hampton Freeze has an agreement with a local bank that allows the company to borrow in increments of $10,000 at the beginning of each quarter, up to a total loan balance of $250,000. The interest rate on these loans is 1% pet month and for simplicity we will assume that interest is not compounded. The company would, as far as it 8 able, repay the Toan plus accumulated interest atthe end of the year. ‘The cash budget is prepared one quarter at a time, starting with the first quarter, Larry began the cash budget by entering the beginning balance of cash for the first 2 The format fr the statement of cash flows, whichis diseused in a later chapter, may also be used for the cash budget.Master Budgeting SCHEDULE 8 pieces eer ete Fess axon ho 2OG-Jo--- @s-HH Me™ -O. +2 pr UR RES 8 x, Ae RR B-AS. a ET ‘Hampton Freeze, Ine. ‘Cash Budget For the Year Ending December 31, 2012 ‘quarter of $42,500—a number that is given above. Receipts—in this case, just the $230,000 in cash collections from customers—are added to the beginning balance to autive at the (otal cash: available of $272,500. Because the total disbursements are $366,500 and the total cash available is only $272,500, there is a shortfall of $94,000. Because management would like to have a beginning cash balance of at least $30,000 for the second quarter, the company will need to borrow at least $124,000. Required Borrowings at the Beginning of the First Quarter, Desired ending cash balance... el Plus deficioney of cash availabe over disbursements ‘Minimum required borrowings Recall that the bank requires that loans be made in increments of $10,000. Because Hampton Freeze needs to borrow at least $124,000, it will have to borrow $130,000, ‘The second quarter of the cash budget is handled similarly. Note that the ending ‘cash balance for the first quarter is brought forward as the beginning cash balance for the second quarter. Also note that additional borrowing is required in the second quarter because of the continued cash shortfall.Chapter 10 Required Borrowings at the Beginning of the Second Quarter Desired ending cash balance... .. 3 ‘$30,000 Plus deficiency of cash available over disbursements ‘Minimum required borrowings .......+- Again, recall that the bank requires that loans be made in increments of $10,000. [Because Hampton Freeze needs to borrow at least $66,100 at the beginning of the second ‘quarter, the company will have to borrow $70,000 from the bank. In the third quarter, the cash flow situation improves dramatically and the excess of ‘cash available over disbursements is $165,650. Therefore, the company will end the quar- ter with ample cash and no further borrowing is necessary. At the end of the fourth quarter, the loan and accumulated interest must be repaid. ‘The accumulated interest can be computed as follows: Interest on $ 130,000 borrowed al the beginning of the first quarter: {$190,000 x 0.01 per month x 12months".... Interest on $70,000 borrowed at the beginning of the second quarter: {$70,000 x 0.01 per month * 9 months". re - _ 6300 ‘Total interest accrued to the end of the fourth quarter $21,900 $15,600 “Simple, rather than compounded, interest is assumed for simplicity. Note that the loan repayment of $200,000 ($130,000 + $70,000) appears in the financing seotion for the fourth quarter along with the interest payment of $21,900 computed above. ‘As with the production and raw materials budgets, the amounts under the Year ‘column in the eash budget are not always the sum of the amounts for the four quarters In particular, the beginning cash balance for the year isthe same as the beginning cash balance for the first quarter and the ending cash balance for the year isthe same as the ending cash balance forthe fourth quarter. Also note the beginning cash balance in any quarter is the same as the ending cash balance forthe previous quarter. CASH CRISIS AT A START-UP COMPANY ‘Good Home Co., headquartered in New York City, sells home cleaning and laundry products through merchandisers such as Restoration Hardware and Nordstrom. In 2001, the company’s sales were $2.1 milion. Then in September 2002, the company’s founder Christine Dimmick appeared on the cable shopping network QVC and in 2 few hours she sold more than $300,000 ‘wath of meichancise.owever, euphoria turned to panic when Christine realized that she needed $200,000 in short term fnancing to fil those oder. When attempts to renegotiate payment terms with suppers failed, Christine realized that she needed to hire afnance protessionl. Jerry Charlup, who was hired as Good Home's parttime CFO, spent $6,000 to create a cash low fore casting System using Excel. As Good Home's annual sales have grown to $4 millon, Charl say the new foverasting system is giving the company "afr clare ix on how much operating ceptl itmeeds at any given time.” Source: Susan Hansen, “The Rent Town CFO Program,” ne. Magazine, February 2004, pp. 28-29.Master Budgeting 507 The Budgeted Income Statement ‘A budgeted income statement can be prepared from the data developed in Schedules 1-8, The budgeted income statement is one of the key schedules in the budget process. It shows the company’s planned profit and serves as a benchmark against which subsequent com- pany performance can be measured. ‘Schedule 9 contains the budgeted income statement for Hampton Freeze SCHEDULE 9 OSES SRY SBB-F oo @z-a wm - opr ules elo %, BDA Hampton Freeze, Inc. Budgeted Income Statement Ending December 31, 2012 ‘Schedules - 4__| $2,000,000 Cost of goods sold 16 ‘Gross margin ip Seling and administrative expenses (576,000 Net operating income 124,000 24,900 $102,100 "100,000 cases sold x $19 per case = $1,300,000. The Budgeted Balance Sheet ‘The budgeted balance sheet is developed using the data from the balance sheet from the beginning of the budget period and data contained in the various schedules. Hampton Froeze’s budgeted balance sheet is presented in Schedule 10. Some of the data on the ‘budgeted balance sheet have been taken from the company’s latest end-of-year balance sheet for 2011 which appears on page 509,Chapter 10 SCHEDULE 10 Osheaa 6ay seas er moon 2 "R-BIrUR SSH ex, Ba RA ~* Hampton Freeze, ine. Budgeted Balance Sheet December 31, 2012 Curent assets: ape fied ‘Cash $_41400 | @) Accounts receivable [420,000 | (b) Raw materials inventory 4,500 | (c) Finished goods inventory 39,000 | (a) (Totalcurentasscts | Plant and equipment: Land £20,000 Buildings and equipment | ‘Accumulated depreciation (s02000) @) [Plant andequpment.net —=~=~*~*~S~S*S*«SCS OOD 17 Total assets __ Ezs00 =z Liabilities and Stockholders’ Equity Current iabilties: [ | ‘Accounts payable (raw materials | Stockholders’ cquity ‘Common stock, no par Retained earings Total stockholders’ equity 695,000 ‘Total labillies and stockholders’ equity $722,900 $27,900 th) Explanation of December 31, 2012, balance sheet figures: (@) The ending cash balance, as projected by the cash budget in Schedule 8 (©) Thirty pereant of furin-quarier sales, from Sehadiula + ($400,000 > 30% = $120,000) (©) From Schedule 3, the ending raw materials inventory will be 22,500 pounds. This material costs $0.20 per pound. Therefore, the ending inventory in dolars will be £22,500 pounds x $0.20 per pound = $4,500, (@) From Schedule 6. (e) From the December 31, 2011, balance sheet (no change). (The December 31, 2011, balance shest indicated a balance of $700,000. During £2042, $130,000 of adaitional equipment will be purchased (see Schedule 8), bringing the December 31, 2012, balance to $830,000. (@ The December 31, 2011, balance sheet indicated a balance of $292,000. During 2012, $100,000 of depreciation will be taken ($60,000 on Schedule 5 and $40,000 ‘on Schedule 7), bringing the December 31, 2012, balance to $392,000, (0) One-half of the fourth-quarter raw materials purchases, from Schedule 3. (From the December 31, 2011, balance sheet (no change). @ December 31, 2011, balance ......... $449,900 ‘Add net income, from Schedule 9... 102,100 552,000 Deduct dividends paid, from Schodulo 8... . 32,000 December 31, 2012, balance ‘$520,000Master Budgeting Hampton Freeze, Inc. Balance Sheet, f December 31, 2011 Assets Current assets: Cash... i $ 42,500 | ‘Accounts receivable 190,000 Faw materials inventory (21,000 pounds) “4200 | Finished goods inventory (2,000 cases) . ++ 26,000 | ‘otal current assets. Plant and equipment: Buildings and equipment. ‘Accumulated depreciation. Plant and equipment, net . Total assets, Liabilities and Stockholders’ Equity | (Current abies: | ‘Accounts payable (raw materials) ......... Stockholders’ equity: ‘Common stock, no par Retained earnings. Total stockholders’ equity . ‘Total labiltiag and stockholders’ aquity After completing the master budget, Larry Giano took the documents to Tom Wills, chief executive officer of Hampton Freeze, for his review. Larry: Here's the budget. Overall, the net income is excellent, and the net eash flow for the entire yea is postive Yes, but I see on this cash budget that we have the same problem with negative cash flows in the first and second quarters that we had lst year Larry: That's rue. 1 don't see any way around that problem. However, there is no doubt {in my mind that if you take this budget to the bank today, they'll approve an open line of credit that will allow you to borrow enough to make it through the first two quar- ters without any problem ‘Tom: Are you sure? They didn’t seem very happy to See me last year when T came in for ‘an emergency loan. Larry: Did you repay the loan on time? Tom: Sure. Larry: | don't see any problem. You won't be asking for an emergency loan this time. ‘The bank will have plenty of warning. And with this budget, you have a solid plan that shows when and how you are going to pay off the loan. Trust me, they'll go tort. To 509510 Chapter 10 ‘This section illustrates the essential aspects of budgeting for a theme park (a hypothetical ‘one). Wonder World is a theme park that has some mechanical rides, an aquarium, and a dolphin pool. On average, about one mittion visitors, including locals and tourists. are attracted to the theme park annually. Wonder World is a very profitable company. ‘Wonder World has three main sources of revenue, namely, ticketing, food and bever- ‘ages, and the souvenir shop. Major expenses are salaries, rent, cost of sales for selling food and beverages, and souvenir items. ‘Wonder World has a number of departments: Finance and Administration, Opera~ tions, Marketing, Souvenir Shop, Food and Beverages, and Maintenance. Each of the ‘department heads provides input of his or her area of responsibility for the company’s annual budget. ‘The first step of budgeting for Wonder World is to budget forthe projected visitorshi Eee) figure Ths the most cial stop for producing the badge! for Woner World s Vso ship is the Key performance indicator for the company. Top management tends to review and discuss the visitorship figure very carefully. The inital estimation is made by the hhead of marketing. He or she will back up the estimation by gathering information such as competitors’ visitorship figures, projections of tourist arrivals from the tourism board, previous year’s visitorship of Wonder World, and the company’s advertising strategy for the coming year, As ticket prices for adults and childeen are quite different, the total fore- cast visitorship figure is broken down into adults and children. After many rounds of meetings and discussions, budgeted visitorship for year 20X1 is as follows: Number of Vieitors 750,000 250,000 After the estimation of the visitorship figure, revenue per visitor is then estimated, For gate collections, adults and children are charged different prices. Therefore, information regarding the average gate collections from adults and children is collated separately. As regards spending in the souvenir shop and food and beverages, itis not possible to distin- guish between adult and child spending in these items. Average spending per visitor is then budgeted for both the souvenir shop and food and beverages by the two respective department heads. Based on the average price charged by Wonder World and other histor- ical data, the following revenues per visitor are budgeted and approved by the top ‘management: With the tmdgeted nimber of visitors and revenues per visitor from each category. the budgeted revenues are computed:Master Budgeting Revenue Gate collections: Adults'.. - $9,750,000 Gale collections: Children? 2,250,000 ‘Souvenir shop* a «4,000,000 Food and heverages* é “6,000,000 Total revenue... ¥22,000,000 Note 170,000 x $13 31,000,000 x $4 2250,000 x $9 1,000,000 x $6 In terms of cost of sales on souvenirs and food and beverages, the company normally makes use of the historical cost of sales % and takes into account any expected price ‘changes from the suppliers. For the coming year, the expected cost of sales % is 50% on sales for both the souvenir shop and food and beverages. Cost of Sales ‘Souvenir shop’ ........ $2,000,000 For expenses, how the items are budgeted will depend on the nature of each item. Wonder World’s expenses can be categorized as follows: Expenses Peanial 2S ete $1,100,000 Salaries at 3,500,000 Advertising. seeeee 1,200,000 Maintenance <....2. 0.22.60... 980,000 Depreciation. ‘ £890,000 Utities 1! 580,000 Other operating expenses 490,000 Total. . $8,740,000 Regarding rental expense, Wonder World has an agreement with its Iandlord to pay either a Jump sum of $200,000 or 5% of the revenue, whichever is higher. Since the opening of the attraction, Wonder World's 5% of revenue has always exceeded the $200,000 lump sum by very far amount. Therefore, its budgeted rent can simply be computed at 5% of sales. Salary expense is a top expense item for Wonder World. Each year, the head of finance will analyze and discuss salary expense with top management and recommend the appro- priate amount to be budgeted for nest year. Generally, fr salaries, the zero-based approach is preferred for estimating the budgeted figure. For incremental approach, we take last year’s expense and adjust for changes in headcounts and rates of pay. For the zero-based approach, we do not start off with last year’s figure; instead, we review from scratch the number of staff required based on tasks and duties to be performed. Suitable rates of pay for different levels of staff are discussed. With this method, any inappropriate stafT number cof pay will not be carried forward into next year. su512 a Chapter 10 Advertising is more of a discretionary item for Wonder World. The marketing man- ager will propose the amount to be spent and estimate he effect of the advertising before seeking the approval ofthe top management. For TV advertising, viewership demography, together with detailed costing, will have to be presented to the top management for approval. Inthe end, the top management will decide on the types of advertisement and the total amount to be spent. “Maintenance expenditure is more of technical area and safety cannot he compro- mised. The maintenanee manager has a bigger role to play in terms of the amount required ‘The maintenance manager will ist down the various maintenance and enhancement jobs required to be done next year and estimate the total budget required for these jobs. Top ‘management wil then go through the list and discuss the timing ofthe jobs with the main- tenance manager. Top management usually approves maintenance jobs for safety reasons ‘while considers enhancement jobs based on financial cireumstances and their pacts on autrating more visitrs, ‘Depreciation expense is mainly computed by the finance department, The expense can be computed by using all the existing depreciable asses’ values and depreciation policies plus any applicable aditional deprecation for assets to be acquired inthe coming year. I fll plained purchases are according tothe original plan, the depreciation expense budget can be fairly accurate, “The maintenance department is also responsible for estimating the amount to be bud- geted for utilities. Current facilities, planned new facilities, and change in rates of utilities ‘wll be taken into account to estimate the utilities expense for next year. 1t should be noted that Wonder World's utilities are not so sensitive to change in number of vistors. Even witha very low level of visitors, air conditioning and lightings for all the indoor fac have to be kept on. Also, the life suppor system, which consumes alot of electricity, tobe continuously run for fishes and dolphins. Other operating expenses suchas egal and audit fees, travel, and fish fod are estimated based on a combination of historical information and naman judgment, In general, les sig- nificant items should be allocated less time 10 estimate based on he custaskl-benefit rue a8 SALARY BUDGET ‘Qantas announced that it would cut its salary budget by letting go of 1,500 jobs in order to stay Ccompettve, Some 20% of Qantas’ management and head office support jobs would be lost under this plan. With the sky-high je¥uel prices and uncertain economic outline, Qantas had to budget ‘careful in order to survive. Apart from cutting jobs, the aie also planned to close a few cal ‘centers, including the one in London. ‘AS wth other companies in lve service industry, one ofthe topreest items for airines i payrol, Cher top expencitures include fuel, plane depreciation, and maintenance. Since fuel prices are nat ‘under the control of aitines, and plane depreciation and maintenance are harder to cut, airines ‘during economic downturn wil resort to cutting payroll cost fst. For the aie industry, payroll ‘cost can constitute more than 20% ofthe total cost, and therefore a reduction of this cost can have a high impact on the bottarine Source: Revers, “Qantas Cuts 4 pct of Workforce, Pres Growth Plan," Jy 18, 2008, ‘Since all revenue and expense items have been budgeted, the budgeted income state- ‘ment will then be just a summary of all revenues and expenses, as follows: Revenue... =... Cost of goods sold... Expenses.......2..0- + $22,000,000 | |Master Budgeting ‘This confirms that the company is expected to do well with over $8 million profit in the BUDGETING SOFTWARE FOR A SMOOTHER TAKE-OFF For Ms. Normah Din, a budget and planing manager at Malaysia Aires MAS), the period fom Octo- ber to March used to be a mad scramble for her and her department. From October, the department ‘would be keying in figures from budget proposals from over 70 offices around the word. Changes, Updates, and consoldation of information would then be mace manualy during the next few months. The budgeting process coud take upto March when the na approved budget plans wer distributed. £8y utlzing budgeting software, the individual ofces key inthe raw data themselves. They can react faster to budget changes and input them into the system accordingly. Budget reports are ‘automaticaly sorted by geographical regions. Impact of utuating fue costs and parking and han dling fees canbe predicted through the use ofthe software, The budgeting process time has been cut fram six months to three months, Staff atthe Budget and Planing Department can now focus ‘more on reviewing figures rather than entering data ‘Source: "Timely Budget Planing Takes Of" DigitalLife, January 20, 2007, 2007 Singapore Press Holdngs Limite. Costs and Benefits of Budgeting Budgeting is time-consuming and costly. There are many steps in producing an entire ‘budget. Past information and economic outlook as well as managerial expectations are utilized to help form the budget. Despite the best efforts, the projected figures may stil be far from realistic. To make things worse, budgets are often inaccurate because of budgetary slack. Managers prefer to set a lower target for the sales budget so as to make it easily achievable. This padded sales budget will then be utilized to produce other budgets such as ‘the direct labor budget, direct materials budget, and overhead budget which are unnecessarily reduced to match the understated sales target. Ultimately, the entire budget may be very "unrealistic because of the conservative sales target. As a result, all the budgets including the income statement budget, the balance sheet budget, and the cash budget would be meaningless. Budgetary slack is hard 10 avoid if employees are involved in setting the budget and their performance, together with their remuneration, is dependent on whether the budget is met or not. On the other hand, without the employees’ involvement in putting ‘the budget together, he top management may set an unrealistic target because of insuMictent detailed ground knowledge. Therefore, it has been argued that budgets should be abandoned. ‘Why, then, are budgets still commonly used by companies? Budgets are very important to help us to plan and coordinate various activities within an organization. ‘Without the need to prepare for a budget, managers may be less likely to think ahead for the future. In large corporations, budgets are particularly useful for top management to express the company’s strategies and missions as quantifiable targets and measures. Despite the various criticisms and shortcomings of budgets, budgets are still being done year after year by many companies. This may suggest that even withthe limitations and costs of budgets we have discussed, the benefits of budgeting such as planning, ‘communicating, coordinating, and allocating of resourees, still outweigh the costs. In order to gain more benefits from budgeting, top managers should not overly rely ‘on meeting budgets as performance measures. Rather, budgets should be used as a plan and a coordinating tool for running the company. Human behaviors toward budgeting, will affect the usefulness, or otherwise, of the budgets. Therefore, effective communication and mutual trust between the top management and its employees are critical in determining the success of budgets, In shor, itis critical for top management to exercise flexibility in making and using budgets 51354 Chapter 10 POSSIBLE WAYS TO IMPROVE THE BUDGETING PROCESS Companies generally prepare budgets each year to plan ther revenues and expenditures and other strategies forthe next year A significant amount of ime is spent onthe budgeting process. However, intodays voll, uncertain, and cornplex wor, itis increasingly mportant for companies to abandon the slow traditional budgeting approach and adopt naw budgeting strategies that wil allow them to adapt auch to changes. Several measures can be adopted to help make the budgeting process more effective. These include scenario planning, zerobased budgeting, roling forecasts, and quarterly budgeting. Central to al ofthese measures is a substantial increase in the CFO's role and a radical speeding up of the bud- eting process. In addition, the process can be improved by reviewing and revising key performance indicators if necessary, reducing the tine the budget process consumes, decreasing the budgeting data less data ‘can sometimes actualy be more mearingful data, and inking incentives to controling variables only. ‘Atypical budgeting process can take many months and consumes a lot of company/s resources. CFOs could accelerate the process by better coordinating the negotiations between top management ‘and divisions. For example, it makes Seise for up mniagement to focus on a division's overall perfor ‘mance and leave the dision's departmental performances to its head. Finally, linking incentives to relative targets such as market share, customer satisfaction, success in research and development, ‘and other controllable variables should improve employees’ performance. Source: Malet Akten, Masso Giordano, ad Mari A Schifl,“histn-Tme Budgeting fora Vote Econ omy McKinsey Quarter, May 2008, pp. 115-121, en nneanln ‘This chapter first discusses the reasons and processes of budgeting. It then describes some ‘budgeting terms and the behavioral aspects of budgeting, The botion-up, vr pautcipaive, badycts has positive motivational effects, but when budgeted figures are used as a performance and evaluation tool, managers ae likely to incorporate budgetary slack. Top-down budgeting caries & ‘isk of untealistc budget targets if top management is not well informed. ‘Budget lapsing is used to prevent risk-adverse managers from accumulating unnecessary ‘savings but may encourage wasteful spending toward the end of the year. Incremental budgets ‘ae based on past year's information and therefore are easier and quicker to produce, but inefficient spending may be earred forward. On the other hand, zero-based budgeting requires ‘managers to budget items from scratch to avoid ineficieny, but this can be quite costly and time- consuming to do. “Top-management’s attude toward the use of budget has @ great impact on the accuracy ofthe ‘budgeted figures. I is vital to member that budgets should not be used too idly, especially in performance evaluation and compensation. “The chapter then describes how the various operating budgets for « manufacturing company and a service provider relate to each other. Finally, the costs and benefits of budgeting are discussed. ‘Mynor Corporation manufactures and sells a seasonal product that has peak sales inthe third quar- tet The following information concerns operations for Year 2—the coming year—and forthe first toro quarters of Year 3: 4. The company's single product sells for $8 per unit. Budgeted sales in units for the next six ‘quarters are as Follows (all sales are on creditMaster Budgeting Budgeted unit sales 40,000 60,000 100,000 50,000 70,000 80,000 Sales are collected in the following pattern: 75% in the quarter the sales are made, and the remaining 25% in the following quarter. On January 1, Year 2, the company’s balance sheet showed $65,000 in accounts receivable, all of which willbe collected in the fist quarter ofthe ‘year. Bad debts are negligible and can be ignored. & The company desires an ending finished goods inventory atthe end of each quarter equal 10 30% of the budgeted unit sales for dhe next quarter, On December 31, Year 1, the company had 12,000 units on hand, 4d. Five pounds of raw materials are required to complete one unit of product. The company re- ‘quires ending raw materials inventory at the end of each quarter equal to 10% of the Following ‘quarter's production needs, On December 31. Year 1. the company had 23,000 pounds of raw ‘materials on hand. ©The raw material costs $0.80 per pound, Raw material purchases are paid for in the follow- ing pattern: 60 paid in the quarter the purchases are made, and the remaining 40% paid in the following quarter. On January 1, Year 2, the company’s balance sheet showed $81,500 in aceounts payable for raw material purchases, all of which will be paid for in the first quarter of the year. Regie Prepare te following udgets and schedules forthe year, showing both quarterly and ol gues: 1. sales bodget and a schedule of expected eash collections. 2. A production budget. 3. cect materials budset and a schedule of expected cash payments for purchases of materials Solution to Review Problem |, The sales budget is prepared as follows: Budgeted unitsales........ 40,000 60,000 100.000 50,000 250,000 x88 XS x88 XS x88 ‘Sollng pice per unit. “Total sales Based on the budgeted sales above, the schedule of expected cash collections is prepared as. follows: ‘Accounts receivable, beginning balance .. '$ 65,000 First-quarter sales ($320,000 x 75%, 25%) 240,000 $ 80,000 ‘Second-quarter sales ($480,000 x 75%, 25%). ‘360,000 $120,000 “Third quarter sales ($800,000 x 75%, 25%)... 600,000 $200,000, Fourth-quarter sales ($400,000 x 75%) 300,000 Tolal cash collections. $805}000 $440,000 $720,000 $500,000516 Chapter 10 2, Based on the sales budget in units the production budget is prepared as follows: Year art seaLeoee) Tees 3 ae ear oe Tare Budgeted unt sales 40,000 60,000 100,000 50.000 260.000 70,000 0,000 ‘Add desired encing frished goods Inveniony~ 48.000 30,000 15,000 21,000" 21,000 24,000 Tela needs. - 5,000 90,000 115000 71,000 271,000 94,000 Less beginning shed goods ventory 12000 amo0 15000 12.000 21,000 Recued producton : 446,000 72,000 65,000 56,000 259,000 73,000 “Thirty percent of the folowing quarter's budgeted sales in uns. ‘Thiny percent of ine budgeted Year 3 first-quarter sales. 3, Based on the production budget, raw materials will need to be purchased during the year as follows ‘Year 2 Quarter Quaner 1 y 2 4 Year? A Required production (units) 48000 72,000 85,000 56,000 259,000 73,000 Faw materials needed per unit (pounds). Sigh pes cee Ee RMT SEN Se Production needs (pounds) 230,000 360000 425,000 280,000 1,295,000 965,000, ‘Add desired ending inventory of raw materials (pounds). 96,000 42,500 28,000 _96,500' 96,500 “otal needs (pounds) 286,000 402,600 453,000 316,500 1,981,500 Less beginning inventory of raw materials (pounds) 28.000 36,000 42,500 28.000 23,000 Faw materials to be purchased (pounds) 243,000 288,500 1,308,500 “Ten porcent of the folowing quarter's production needs in pounds. ‘Ten pereant ofthe Year 3 first-quarter production needs in pounds. ‘Based on the raw material purchases above, expected cash payments are computed as follows: Year2 Quarter 1 2 3 4 Year2 Cost of raw materials tobe purchased at $0.80 per pound. $194,400 $293,200 $328,400 $290,800 $1,046,800 ‘Accounts payable, beginning balance § 81,600 $81,500 First-quarter purchases ($194,400 x 60%, 40% 116600 $ 77,760 194,400 ‘Second-quarlor purchases ($293,200 x 60%, 40%) 1751920 $117,280 293,200 Third-quarter purchases ($328,400 x 60%, 40%) 5 197/080 $131,360 328,400 Fourth-quarter purchases ($280,800 % 60%) ee 198,480 “otal cash oisbursements, $106,140 $259,680 $314,320 $269,640 $1,035,980 ‘Budget 4 quantitative plan for acquiring and using resources over a specified inne pesiod, (p.483) Budget committee A group of key managers who are responsible for overall budgeting policy and for coordinating the preparation of the budget. (P. 489) Continuous budget A 12-month budget that rolls forward one month as the current month is completed. (p. 484)Master Budgeting Control Those steps taken by management to increase the likelihood that all parts of the organization are working Woxetler (0 uchieve de yoals set down at the planning stage. (483) Direet labor budget A detailed plan that shows the direct labor-hours required to full the production budget. (p. 498) Direct materials budget A detailed plan showing the amount of raw materials that must be purchased to fulfill the production budget and to provide for adequate inventories. (p. 496) Ending fished goods inventory budget A budget showing the dellar amount of unsold finished goods inventory that will appear on the ending balance sheet, (P. S01) Manufacturing overhead budget A detailed plan showing the production costs, other than direct materials and direct labor, that will be incumred over a specified time period. (. 499) Master budget A number of separate but interdependent budgets that formally lay out the ‘company’s sales, prodvetion, and financial goals and that culminates in a cash budget, ‘budgeted income statement, and budgeted balance sheet. (P. 490) ‘Merchandise purchases budget detailed plan used by a merchandising company that shows the amount of goods that must be purchased from suppliers during the period. (p. 496) Participative budget Sce Seipimpased budget. (p. 483) Perpetual budget See Continuous budget. (p. 484) Planning Developing goals and preparing budgets o achieve those goals. (p. 483) Production budget A detailed plan showing dhe numberof units that must be produced during « period in order to satisfy hoth sales and inventory needs. (p. 490) Responsibility accounting A system of accountability in which managers are held responsible fot those items of revenue and cost—and only those items—over which they can exert significant control. The managers are held responsible for differences between budgeted and sotal results. (p. 483) Sales budget A detailed schedule showing expected sales expressed in both dollars and units. (p.493) imposed budget A method of preparing budgets im which managars prepare their own, budgets. These budgets are then reviewed by higher-level managers, and any issues re resolved by mutual agreement. (p. 485) Selling and administrative expense budget A detailed schedule of planned expenses that wil ‘be incurred in areas other than manufacturing during a budget period. (p. 501) Sat 87 10-1 What is a budget? What is budgetary control? 10-2 Discuss some of the major benefits to be gained from bu 10-3. What is meant by the term responsibilty accounting? 10-4 What isa master budget? Briefly describe its contents, 10-5. Why isthe sales forecast the starting point in budgeting? 10-6 “As a practical matter, planning and control mean exactly the same thing” Do you agree? Explain 10-7 Describe the low of budget data in an organization. Who are the participants in the budgeting process, andl how do they participate? 10-8. What is a selF-imposed budget? What are the major advantages of self-imposed budgets? What caution mast be exercised in their use? 10-9 How can budgeting assist a company in planning its workforce staffing levels? 10-10 “The principal purpose of the cash budget is to see how much cash the company will have Jn the bank atthe end of the year” Do you agree? Explain. “Muliple-choice questions are provided on the text website at www.nheducationasia/lc/garison, 4Chapter 10 [hoda, Lo4b, Lo4e] Available wth Megraw-Hlls Conect® Accounting. “The Excel workshest form that appears on the next page is to be used to recreate the Review Problem on pages $14-515. Download the workbook containing this form from the Online Learning Center at www:mhedueation asia/ole/garison. On the website you will also receive instructions about how to use this worksheet form, am alia ha eoceret : Sa Ne Po pames Cees "You should proceed ta the requirements below only after completing your worksheet. Reured: 1. Check your worksheet by changing the budgeted unit sales in Quarter 2 of Year 2 in cell C5 {to 75,000 units. Me total expected eash collections forthe year should now be $2,085,000. IF you do not get this answer, find the errors in your worlcheet and correct them. Hiave the ftal ‘cash disbursements forthe year changed? Why or why not?Master Budgeting 2, ‘The company has just hired @ new marketing manager who insists that unit sales can be dra- matically increased by napping the selling prive froin 58 w $7. The marketing manager would like to use the following projections in the budget: ‘Budgeted unit sales 50,000 70,000 120,000 80,000 90,000 100,000, Salling price per unit... 87 ‘What aro the total expected cash collections far the year wader this reviged Inndget? ‘What is the total required production for the year under this revised budget? ‘What ste total cost of raw materials to be purchased for the year under this revised budget? ‘What are the total expected cash disbursements for raw materials forthe year under this revised budget? €. After secing this revised budget, the production manager cautioned that due to the limited tailabiliy of a couiplex milling machine, the plant can produce no more than 90,000 units jin any one quarter. Is this a potential problem? Iso, what can be done about it? eere 519 ‘Avalablo with Mograw-Hi's Connect® Accounting. ‘Morganton Company makes one product and it provided the following information to help prepare the master budget for is fist four months of operations: ‘The budgeted selling price per unit is $70. Budgeted unit sales for June, July, August, and September are 8,400, 10,000, 12,000, and 13,000 units, respectively. All sales are on credit. 'bFomy peroant of credit saloe ar collected in the moat of the sale and 6% in the flowing month, ‘The ending finished goods inventory equals 20% of the following month's unit sales, ‘The ending rawy materials inventory equals 10% ofthe following month's raw materials pro: duction needs. Each unit of finished goods requires 5 pounds of raw materials. The raw mate tials cost $2,00 per pound. ‘e. Thirty percent of raw materials purchases are paid for in the month of purchase and 70% in sont £ The direct labor wage rate is $15 per hour. Each unit of finished goods requis labor-houes ‘The variable selling and administrative expense per unit sold is $1.80. The fixed selling and administrative expense per month is $60,000. Recwie ‘What are the budgeted sales for July? What are the expected cash collections for July? What is the accounts receivable balance at the end of July” ‘According tothe production budget, how many units should be produced in July? 161,000 pounds of raw materials are needed to meet production in August, how many pounds ‘of rw mtorials should be purchased in July? 6, Whats the estimated cost of raw materials purchases for July? 7. he cost of raw material purchases in June is $88,880, what are the estimated cash disburse- ‘ments for raw materials purchases in July? ‘What is the estimated accounts payable halance atthe end of July? What isthe estimated raw materials inventory balance a the end of July? Wat i te total estimated direct labor cost for July assuming the direct labor workforce is adjusted 10 match the hours required to produce the forecasted number of units produced?” 11, If the company always uses an estimated predetermined plantwide overhead rate of $10 pet direct laborchour, what isthe estimated unit product cost? 12, What isthe estimated finished goods inventory balance at the end of July? 13. What isthe estimated cost of goods sold and gross margin for July? 1. Whats the estimated total selling and administrative expense for July? 15. What isthe estimated net operating income for July? 2 two direct [Loda, Loab, Lose, Load, Loaf, Logh, Loaiy520 Chapter 10 EXERCISE 10-1 Schedule of Expected Cash Collections [L042] Silver Company makes a product that is very popular as a Mother's Day gift. Thus, peak sales ‘occur in May of each year, as showsn in the company’s sales budget for the second quarter given below: Budgeted sales (allon account)........ $900,000 $500,000 $200,000 $1,000,000 From past experience, the company has leamed that 20% of a month’ sales are collected in the month of sale, another 70% are collected in the month following sale, and the remaining 10% are collected in the second month following sale. Bad debts are negligible and can be ignored. Febuary sales totaled $230,000, and March sales totaled $260,000. ecuied: 1. Prepare a schedule ot expeeted cash collections from sales, by month and in ror, for the seo~ ‘ond quarter 2, Assume thatthe company will prepare a budgeted balance sheet as of June 30. Compute the accounts receivable as ofthat date. EXERCISE 10-2 Production Budget (L04) ‘Down Under Products, Lid, of Australia has budgeted sales of its popular boomerang for the next four months a follows: ‘April... 50,000 May o..es6- 75,000 June. 90,000 duly...222, 80,000 “The company is now in the prooess of preparing a production budget forthe second quarter. Past ‘experience has shown that end-of-month inventory levels must equal 10% ofthe following month's, sales. The inventory atthe end of March was 5,000 units Requies Prepare a prtiction hovlget forthe second quarter: in your budget. show the number of units to be produced each month and for the quarter in total. EXERCISE 10-3 Diroct Materials Budget [LO%c) ‘Three grams of musk ol are required foreach botile of Mink Caress, a very popular perfume made by a small company in western Siberia. The Cost of the musk oil is 150 roubles per kilogram. (Giberia is located in Russia, whoee currency is the rouble.) Budgoted production of Mink Caress is given below by quarters for Year 2 and forthe frst quarter of Year Budgeted production, inbottles.... 60,000 90,000 150,000 100,000 70,000 ‘Musk oll has become so poptlaras a perfume ingredient that it has become necessary 10 carry large inventories asa precaution against stock-outs, For this reason, the inventory of musk oat the cul of i quer must be equal 6 20% of the following quarter's production needs. Some 36.000 grams of musk ol wil be on hand to star the fist quater of Year 2Master Budgeting Requed: Propare a direct materials budget for musk oil by quarter and in total, for Year 2, the bottom of ‘your budget, show the amount of purchases in rouble for each quarter and for the yea in total. EXERCISE 10-4 Direct Labor Budget (L04¢) ‘The production manager of Rordan Corporation has submitted the following forecast of units to be produced by quarter for the upcoming fiscal year: Units to be produced #000 6500 7,000 7,500 Each unit requires 0.35 direct labor-hours, and direct laborers are paid $12.00 per hour, Reauired: 1. Construct the company’s direct labor budget forthe upcoming fiscal year, assuming thatthe direct labor workforce i adjusted each quarter to match the number of hours required to pro- «duce the forecasted numberof units produced. 2 Construct the company’s direct labor budget for the upcoming fiscal year, assuming that the direct labor workforee isnot adjusted each quarter Instead, assume thatthe company’s «labor workforce consists of permanent employees who are guaranteed to be paid for at Teast 2,600 hours of work each quarter. Ifthe number of required direct labor-hours is Jess than this number, the workers are paid for 2,600 hours anyway. Any hours worked in excess of 2,600 hours in a quarter are paid at the rate of 1.5 times the normal hourly rate Tor direct labor. EXERCISE 10-5 Manufacturing Overhead Budget [LO4c} ‘The direct labor budget of Yuswell Corporation for the upcoming fiscal year contains the following details concerning budgeted direct labor-hours Budgeted direct labor-hours 8,000 8,200 8500 7,800 ‘The company’s variable manufacturing overhead rate iy $3.25 per direct labor-hour and the ‘company’s fixed manufacturing overhead is $48,000 per quarter. The only noncash item included in fixed manufacturing overhead is depreciation, which is $16,000 per quarter. Required: 1, Construct the company’s manufacturing overhead bude forthe upcoming fieal year, 2. Compute the company’s manufacturing overhead rat (including both variable and fixed man- ‘facturing overhead) for the upcoming fiscal yer. Round off tothe nearest whole cent, EXERCISE 10-6 Soling and Administrative Expense Budget [L04f] ‘The budgeted unit sales of Weller Company forthe upcoming fiscal year ate provided below: ‘Budgeted unit sales. 15,000 416,000 14,000 13,000 ‘The company’s variable selling and administrative expense per unit is $2.50, Fixed selling and ‘administrative expenses include advertising expenses of $8,000 per quarter, executive salaries of $35,000 per quarter, and depreciation of $20,000 per quarter. In addition, the company will make ‘insurance payments of $5,000 inthe fist quarter and $5,000 in the third quarter. Finally, property axes of $8,000 willbe paid in the second quarter eyoied Prepare the company’s selling and admi strative expense budget forthe upcoming fiscal yea. 521522 Chapter 10 EXERCISE 10-7 Cash Budget (L.04e] ‘Guile Depa i a retail that iy preparing its budget for tho upcoming fseal year: Management thas prepared the following summary ofits budgeted cash flows: Total cash recoits......... $180,000 $330.000 $210,000 $280,000 Total cash disbursements. ... $280,000 $280,000 $220,000 $240,000 ‘The company’s beginning cash balance forthe upcoming fiscal year will be $20,000. The company requires a minimum cash balance of $10,000 and may borrow any amount needed from a local hhank at a quarterly interest rate of 3%. The company may borrow any amount atthe beginning of ‘any quarter and may repay its loans, ot any part ofits loans, atthe end of any quar. Interest pay- ments are due on any principal atthe time i is repaid, For simplicity, assume that interest is not compounded. Reauied: Prepare the company’s cash budget for the upeoming fiscal year. EXERCISE 10-8 Budgeted Income Statement [LO4H] Gig Harbor Boating is the wholesale distributor of a small recreational catamaran sailboat. Man ‘agement has prepared the following summary data to use in its annual budgeting process: ‘suagotea unit sales... 5 : 400 ‘Seling price per unit $1,950 Gost per unt napa enc $1575 ‘Variable sling and administrative expenses (per uni) s $75 Fhiod seling and administrative expenses (per year)... $108,000, Intorest expense for the year. eerte $14,000 Reauite: Prepare the company’s budgeted income statement. Use the absorption costing income statement format shown in Schedule 9 EXERCISE 10-9 Budgeted Balance Sheet (L047) ‘The management of Mecca Copy, a photocopying center located on University Avenue, has com- piled the following data to use in preparing is budgeted balance sheet for next year: Cash .. Z ‘Accounts receivable $8,100 Supplies inventory... $3,200 Equipment. : $94,000 ‘Accumulated depreciation '$16,000 ‘Accounts payable .... 2... esses $1,800 ‘Common stock $5,000 Retained earings. 2 “The heginning balance of retained earings was $28,000, net income is budgeted to be $11,500, and dividends are budgeted to be $4,800. Required: Prepare the company’s budgeted balance sheet, EXERCISE 10-10 Cash Budget Analysis [LOS] ‘A cash budget, By quariers, is givew below fox a tetail company (000 omitted). The company requires a minimum cash balance of atleast $5,000 to start each quarterMaster Budgeting Cash balance, beginning : fe 4 iT Ver se st Addeolecions temcusiomers.... sss 2 8B OS Tal cash avalale Bei geeat ghee isis ei Less alsoursements Purchase of inventory Gore Menta akc ‘Operating expenses CIveDON 40) RTS Equpment purchases. Beak icy jer eem Dividends Be eaireaie chem ae “Total debursemente Ba NeiBs puma CERNE Excess (efcenoy) of cash avaible over disbursements ‘ Dee aiiaes Financing Borrowings. 2 6 - = 2 Fepnyments ching terest) Senn Total financing . = 5 Bet Dies) SR ieee ‘Cash balance, ending i gn, Pas shee eget “Interest wl total $1,000 forthe year Requires: Frill in the missing amounts in the above table. EXERCISE 10-11 Production and Direct Materials Budgets (04%, LO%c} ‘The marketing department of Gacber Industries has submited the following sales forecast for the upcoming fiscal year ‘Budgeted unit sales. 8,000 7,000 6,000 7,000 ‘The company expects to start the first quarter with 1,600 units in finished goods inventory. ‘Management desires an ending finished goods inventory in each quarter equal t0 20% ofthe next (quarters budgeted sales, The desired ending finished goods inventory for the Fourth quarter is 1,700 units, In addition, the beginning raw materials inventory for the frst quarter is budgeted to be 3,120 pounds and the beginning accounts payable for te fist quarter is budgeted to be $14,820. ‘Bach unit requires 2 pounds of raw material that costs $4.00 per pound. Management desires to end each quarter with an inventory of raw materials equal to 20% of the following quarter's production needs. The desired ending inventory for the fourth quarter is 3,140 pounds. Manage- ‘ment plans to pay for 754 of raw material purchases in the quarter acquired and 25% inthe follow ing quarter Reauied: 1, Prepare the company’s production budget forthe upcoming fiscal year. 2. Prepare the company’s diet materials budget aud schedule of expected cash disbursements, for purchases of materials forthe upeoming fiscal yea. [EXERCISE 10-12 Sales snd Production Buiyets (LO, LOab} ‘The marketing department of Jessi Corporation has submitted the following sales forecast for the ‘upcoming fiscal year all sales are on account); Budgeted unit sales... 11,000 12,000 14.000 ys,000 523524 Chapter 10 Te selling price ofthe company's product is $18.00 per unit. Management expects to collect 65% ‘of ses in the quarter in which the sales are made, 30% in the following quarter, and 5% of sales axe expected to be uncollectible, The beginning balance of accounts receivable, all of which is ‘expected to be collected in the first quate, is $70,200. “The company expects to start the fist quarter with 1,680 units in fnished goods inventory. Management desires an ending finished goods inventory in each quarter equal to 15% of the next {quatter’s budgeted sales, The desired ending finished goods inventory for the fourth quarter is 1,850 uni. Require: I. Prepare the company’s sales budget and schedule of expected cash collections, 2. Prepare the company’s production budget for the upcoming fiscal year. EXERCISE 10-13 Direct Materials and Direct Labor Budgets [LOMc, LO‘) The production department of Hareston Company has submitted the following forecast of units 10 be produced by quarter for the upcoming fiscal year: Units to be produced 7,000 8,000 6,000 5,000 In addition, the beginning raw materials inventory for the first quarter is budgeted to be 1.4%) pounds and the beginning accounts payable forthe first quarter is budgeted tobe $2,940. Each unit requires 2 pounds of raw material that costs $1.40 per pound. Management desires to end each quarter with an inventory of raw materials equal to 10% of the following quarter’s production needs, The desired ending inventory forthe fourth quarter is 1,500 pounds. Manage- ment plans to pay for 30% of raw material purchases in the quarter acquired and 20% inthe follow ing quarter. Each unit requires 0,60 direct labor-hours and direct labor-hour workers are paid $14.00 per hour. eqited: 1. Prepare the company’s direct materials budget and schedule of expected cash disbursements for purchases of materials for de upeuning, ial yea: 2, Prepare the company’s direct labor budget for the upcoming fiscal year assuming thatthe direct labor workforce is adjusted each quarter to match the number of hours required to pro- duce the forecasted number of units produced. EXERCISE 10-14 Direct Labor and Manufacturing Overhead Budgets [L04d, LOM4e) ‘The production department of Raredon Corporation has submitted the following forecast of units tobe produced by quarter forthe upcoming fiscal yea: Units to bo produced . . 12,000 14,000 19,000 11,000 Each unit requires 0.70 direc labor-hours, and direct laborhour workers re paid $10.50 per hour. Tnaddition, the variable manufacturing overhead rate is $1.50 per direct labor-hour. The fixed ‘manufacturing ovethead is $80,000 per quarter. The only noncesh element of manufacturing over- head is depreciation, which is $22,000 per quarter, Roars: 1. Prepare the company’s direct labor budget for the upeoming fiscal year, assuming that the direct labor workforce is adjusted each quarter to maich the number of hours required to pro- ‘dave the forecasted number of units produced. 2. Prepare the company’s manufacturing overhead budget. PROBLEM 10-15 Production and Direct Materials Budgets [LO4b, LO4c) Peal Products Limited of Shenzhen, China, manufactures and disributes toys throughout South [East Asia, Thre cubie centimeters (60) of salvont H300 are required to manufacture each unit of ‘Supermix, one ofthe company’s products. The company is now planning raw materials needs forMaster Budgeting the third quarter, the quarter in which peak sales of Supermix occur. To keep production and sales moving smoothly, the company hae the following inventory requirement: ‘a. The finished goods inventory on hand atthe end of each month must be equal to 3,000 units of Supermix plus 204 of the next month’s sales. The finished goods inventory on June 30 is budgeted 10 be 10,000 units ', The raw matetals inventory on hand at the end of each month must be equal to one-half of the following month's production needs for raw materials The raw materials inventory on June 30 is budgeted 1 be 54,000 ce of salve 1300. The company maintains no work in process inventories. AA sales budget for Supermix forthe last six months ofthe year follows uly 35,000 ‘August 40,000 September 50,000 October. 30,000 December 10,000 Requiea: LL Prepare a production budget for Supermix for the months July, August, September, and ‘October 2, Examine the production budget that you prepared in (1) above. Why will the company pro- ‘duce more units than it sells in July and August, and fewer units than i sells in September and ‘October? 3, Propare a direct materials budget showing the quantity of solvent H300 to be purchased for July, August, and September, and for the quarter in total PROBLEM 10-16 Direct Labor and Manufacturing Overhead Budgets [LO4d, LO4e) ‘The Production Department of Hruska Corporation has submited the following forecast of units to be produced by quarter for the upeoming fiscal year Units to be produced 12,000 10,000 19,000 14,000 Bach unit requires 0.2 direct labor-hours and direct laborers are paid $12.00 per hour In addition, the variable manufacturing overhead rae is $1.75 per direct labor-hour. The fxed ‘manntacturing overhead is $86,000 per quarter. Ihe only noncash element of manutacturing over head is depreciation, which is $23,000 per quarter Required 1. Prepare the company’s direct labor budget forthe upeoming fiscal year, assuming thatthe direct labor workforce is adjusted each quarter to match the number of hours required to pro- ‘duce the forecasted number of units procared 2, Prepare the company's manufacturing overhead budget. PROBLEM 10-17 Schedules of Expected Cash Collections and Disbursoments (LO, LO4c, LO4e} ‘You have been asked to prepare a December eash budget for Ashton Company, a distributor of exercise equipment. The following information is available about the company’s operations: ‘Tho eash balance on December | in $40,000. Actual sales for October and November and expected sales for December areas follows: Cah sales . . $65,000 $70,000 $89,000 Sales on account ........ $400,000 $525,000 $600,000 525Chapter 10 ‘Sales on account are collected over a three-month period as follows: 20% collected in the month of sale, 60% collected in the month following sale, and 189 collected in the second ‘month following sale. The remaining 2% is uncollectible, Purchases of inventory will otal $280,000 for December. Thirty percent of a month's inven- tory purchases are paid during the month of purchase. The accounts payable remaining from. ‘November's inventory purchases total $161,000, all of which will be paid in December. 4. Selling and administrative expenses are budgeted at $430,000 for December. Of this amount, $350,000 is for depreciation, fe. Arnew Web server for the Marketing Department costing $76,000 will be purchased for eash ‘during December, and dividends totaling $9,000 wit! be paid during the month, "The company maintains a minimum cash balance of $20,041. An open line of ereditisavail- able from the company’s bank o bolster the cash position as needed, Reauied: |. Prepare a schedule of expected eash collections for December. 2. Prepare a schedule of expected cash disbursements for merchandise purchases for December. 3. Prepare a cash budget for December Indicate in the financing section any borrowing that ‘will be needed during the moath, Assume that any interest will not be paid until te following month. PROBLEM 10-1 Direct Materials and Direct Labor Buds /LOM¥e, LOA) "The production department of Zan Corporation has submitted the following forecast of units to be produced by quarter for the upcoming fiscal year: Units to'be produces 00 3000 7,000 6,000 Tn adaltion, the beginning raw materials inventory for the Ist Quarters budgeted to be 6,000 grams ‘nd the beginning accounts payable for the Ist Quarter is budgeted to be $2,880. ‘Bach unit requires 8 grams of raw material that costs $1.20 per gram. Management desires to ‘end each quavter With an inventory of raw materials equal to 25% of the following quarters pro- ‘duction needs, The desired ending inventory forthe 4h Quarters 8,000 grams. Management plans to pay for 60% of raw material purchases inthe quarter acquired and 40% in the Following quarter. Each unit requires 0.20 direct labor-hours and diect laborers are paid $11,50 per hour, Reauiredt 1. Prepare the company" direct materials budget and schedole of experted cash dichnesements or purchases of materials forthe upcoming fiscal year 2, Prepare the company’s direct labor budget forthe upeoming fiscal year, assuming that the direct labor workforce is adjusted each quarter to match the number of hours required to pro duce the forecasted number of units produced, ‘PROBLEM 10-19 Behavioral Aspects of Budgoting; Ethics and the Manager {L01, LOZ] Norton Company, a manufacturer of infant furniture and carriages, iin the intial stages of prepar- ing the annual budget for next year. Scott Ford has recently joined Norton's accounting staff and is inerested to lear as mach as possible about the company's budgeting process. During a recent Juneh with Marge Atkins, sales manager, and Pete Granger, production manager, Fotd initiated the following conversation. Ford: Since I'm new around here and am going to be involved with the preparation of the an- ‘nual budget, I'd be interested to Team how the two of you estimate sales and production numbers Atkins:: We stat out very methodically by looking at recent history, discussing what we knov about ‘current accounts, potential customers, and the general state of consumer spending. Then, we add that sual dose ofituition to come up with the best forecast we can. Granger: 1 usually take the sales projections as the basis for my projections. Of course, we have to make sn estimate af what this year’s ending inventories wil be, which is sometimes difficult. Ford: Why does that presenta problem? There must have been an estimate of ending inventories in the budget forthe current year