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Chapter 8
Chapter 8
The Master Budget
Questions
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Chapter 8
1.Budgeting translates goals and objectives into the required resources, activities, and arrangements needed to accomplish those goals and objectives. The translation is extended to assign activities and allocate resources to departments and personnel who are responsible for execution of the budget.
2.The strategic plan defines the basic purposes and goals of an organization. As such, the strategic plan identifies the key variables that will largely determine the success of the organization. Some of the major factors taken into account in formulating the strategic plan include the state of the local and global economy, trends in technology and materials, and the legislative and political climates.
3.Longer term (strategic) plans contain insufficient detail to direct a business. Although the longer term plans provide general direction for a business, they are too vague to provide guidance on a day-to-day basis. Consequently, shorter term (tactical) plans are compiled to implement the longer term plans for a specific period. The shorter term plans can be made with greater attention given to current organizational and environmental constraints (current market, material and labor conditions). Also, the roles of specific middle- and lower- level managers can be determined in the detailed short-term plans.
4.The budget represents the cornerstone for a company’s management planning system. Budgeting utilizes goals, objectives, and forecasts in developing plans for production, revenues, costs, cash flows, and resource procurement. Budgeting originates with strategic planning. As goals are implemented and programs developed, management needs information about various alternatives so they can be evaluated. When a specific plan of action is determined, the budget becomes management’s master plan.
Control is really an extension of planning rather than a separate managerial function. Without formal planning, there can be little control.
5.An operating budget presents units expected to be sold or used by a company and the price/costs associated with those units. The sales and production budgets are operating budgets. Financial budgets detail the funds to be generated or used during the budget period (cash budget and capital expenditure budget). The results from the operating budgets are the sources of input for the financial budgets. For example, sales projected in the sales budget impact the cash collections/receipts portion of the cash budget.
6.The master budget begins with a "demand driven" estimate of sales. It is, however, possible that demand does not "exist" at the point the budget is prepared (for example, when the company is introducing a new product); thus, estimates would be made about sales. Without sales or expected sales, the company would have no need to acquire resources or remain in operation.
The production is prepared next as it follows directly from the sales budget. The production and purchases budgets are similar in that they begin with a key variable to their particular area, add ending inventory, and subtract beginning inventory. These budgets differ in that the key variable for the production area is sales, but the key variable for purchases is production. The production budget is used to schedule needed material, labor, and overhead. The purchases budget is used to determine the amount and timing of material input to the production process as well as provide input into the cash budget as to the amount and timing of cash disbursements for such purchases.
To predict overhead cost for a specific volume of production, costs must be separated into those that are volume dependent (variable costs), and those that are volume independent (fixed costs). The expected overhead for a given period is the sum of the projected fixed cost plus the total variable cost. The total variable cost is a function of the variable cost per unit and the expected volume of production.
Selling and administrative budgets follow and then the cash budget is prepared. Managers estimate collections from sales through historical company data on collection patterns, industry trends/patterns, and judgment. Current economic information can play an important part in estimating the collection pattern since inflation or deflation, interest rates, and employment affect both business and consumer ability to pay.
Cash collections are important in the budgeting process because of their impact on the cash budget and the availability of funds with which to make disbursements for operating and capital expenditures, and ownership distributions.
After all of these budgets are prepared, a pro forma set of financial statements is prepared to visualize the financial expected results of operations and balance sheet position.
This sequence is necessary because the information from one budget is often a primary input into another budget.
7.A firm’s production budget is influenced by the finished goods inventory policy because that policy dictates the quantity of goods that are expected to be on hand at the end of the period. Thus, a company cannot simply make production equal to sales if some finished goods are expected. Additionally, the finished goods from one period become the
beginning inventory for the next period, which also influences the quantity of production needed. The computation for production is sales plus desired finished goods inventory minus beginning inventory.
8.Cash is a very important resource for an organization because it is the medium of exchange for organizational inputs and outputs. A shortage of cash creates liquidity problems and may prevent the firm from acquiring inputs that are crucial to its survival. A firm can cover periods of cash shortages with loans, equity sales, or sales of assets.
9.They are similar in that they both focus on the balance of cash and explain the change in cash balance over a period of time. However, there are substantial differences between the two. For example, the cash budget typically covers shorter time periods and has as its primary objective the identification of periods of cash shortages and cash excesses. The statement of cash flows has as its primary purpose the identification of the activities (operating, investing, and financing) that explain the change in the cash balance for a period.
10.Budgetary slack results from an overestimation of expected expenses or an underestimation of expected revenues so that the budget will be more easily achieved. Because managerial performance is evaluated based on a comparison of actual and budgeted performance, the actual performance will appear to be more favorable if sufficient slack is impounded in the budget.
11.The budget manual provides for standards of performance and quality control in the budgeting process. Having and using a budget manual communicates top management’s commitment to an effective budgeting process for lower-level managers.
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Chapter 8
Exercises
12.Business loans ($3,000,000 x .065) $195,000
Consumer loans ($2,000,000 x .13) 260,000
Investments ($800,000 x .035) 28,000
Total projected revenue $483,000
13. January February March
Budgeted sales 25,600 24,000 32,000
Ending inventory 12,000 16,000 19,200
Total required37,600 40,000 51,200
Beginning inventory (7,400)(12,000)(16,000)
Budgeted production30,20028,000 35,200
14. Quarter Total
1st 2nd 3rd 4th
Sales 540,000 680,000 490,000 550,000 2,260,000
End. inv. 68,000 49,000 55,000 60,000 60,000
Total 608,000 729,000 545,000 610,000 2,320,000
Beg. inv. (54,000) (68,000) (49,000) (55,000) (54,000)
Production 554,000 661,000 496,000 555,000 2,266,000
15.Sales of boots42,960
EI of boots 5,800
Total 48,760
BI of boots (2,152)
Production 46,608
46,608 x 2.5 ft. = 116,520 ft.
116,520 ft. ÷ 3 ft. per yard = 38,840 yards
Yards needed for production 38,840
Ending inventory 3,000
Total 41,840
Beginning inventory (2,000)
Yards to purchase 39,840
16.a., b. Sales (feet)380,000
EI 20,000
Total 400,000
BI (24,500)
Production 375,500
Concrete Gravel
Production in ft. 375,500 375,500
Lbs. per ft. x 8 x 15
Lbs. for prod. 3,004,0005,632,500
EI 68,600 92,500
Total 3,072,600 5,725,000
BI (82,000) (65,300)
Purchase (lbs)2,990,6005,659,700
Cost per lb. x $0.11 x $0.05
Cost$ 328,966$ 282,985
17. a. Boxes TraysTotal
Production budget
Units of sales 84,000 60,000144,000
Units desired in ending inv. 1,200 450 1,650
Units needed 85,20060,450145,650
Units in beginning inv. (1,000) (300) (1,300)
Budgeted production 84,200 60,150144,350
b.Purchases budget - Material A Total
Pounds needed for production:
(84,200 x 2) + (60,150 x 1) = (168,400 + 60,150) 228,550
Desired ending inventory 2,500
Total requirements 231,050
Less beginning inventory (2,000)
Pounds to be purchased 229,050
Cost per pound x $0.05
Total cost of Material A purchases$11,452.50
Purchases budget - Material B
Pounds needed for production:
(84,200 x 3) + (60,150 x 4) = (252,600 + 240,600)493,200
Desired ending inventory 3,400
Total requirements 496,600
Less beginning inventory (5,000)
Pounds to be purchased 491,600
Cost per pound x .08
Total cost of Material B purchases$39,328
Material purchases:
Material A229,050 lbs.$11,452.50
Material B491,600 lbs. 39,328.00
Total720,650 lbs.$50,780.50
Materials purchases budget – Boxes
Purchase requirements for production:
Material A (84,200 x 2 x $0.05)$ 8,420.00
Material B (84,200 x 3 x $0.08) 20,208.00
Total cost of materials for box production$26,628.00
Materials purchases budget – Trays
Purchase requirements for production:
Material A (60,150 x 1 x $0.05)$ 3,007.50
Material B (60,150 x 4 x $0.08) 19,248.00
Total cost of materials for tray production$22,255.50
c.Direct labor budget
Required hours: Boxes (84,200 x 2)168,400
Trays (60,150 x 0.5) 30,075
198,475
d.Overhead budget Boxes Trays
Activity base (hours) 168,400 30,075
Multiply by rate x $1.60 x $1.60
Overhead applied $269,440 $48,120 $317,560
18.a. January February March
Nov. sales (30% × $41,500) $12,450
Dec. sales (30% × $38,000) 11,400
Dec. sales (30% × $38,000) $11,400
Jan. sales (40% × $39,500 × 99%) 15,642
Jan. sales (30% × $39,500) 11,850
Jan. sales (30% × $39,500) $11,850
Feb. sales (40% × $44,000 × 99%) 17,424
Feb. sales (30% × $44,000) 13,200
Mar. sales (40% × $29,500 × 99%) 11,682
Total collections $39,492 $40,674 $36,732
b.Feb. sales to be collected in April (30% × $44,000) $13,200
Mar. sales to be collected in April (30% × $29,500) 8,850
Mar. sales to be collected in May (30% × $29,500) 8,850
Total A/R balance at March 31 $30,900
19.a.$607,500Balance at October 1
(450,000)Remainder of September billings
$157,500Remainder of August billings
÷ 25%% of August billings uncollected at end of September
$630,000 August billings
- $450,000Remainder of September billings
÷ 80%% uncollected at end of September
$562,500September billings
x 3%% estimated uncollectible
$ 16,875Total September billings expected to be uncollectible
c.October collections of August billings ($630,000 × 22%) $138,600
October collections of September billings ($562,500 × 55%) 309,375
October collections of October billings ($900,000 × 20%) 180,000
Total October collections$627,975
20.a.$173,250Balance at May 31
( 135,000)Remainder of May credit sales
$ 38,250Remainder of April credit sales
÷ 15%% of April credit sales uncollected at end of May
$255,000April sales on credit
÷ 75%% of total sales made on credit
$340,000Total April sales
- $135,000Remainder of May credit sales
÷ 40%% of May credit sales uncollected at end of May
$337,500May credit sales
c.June collections of April credit sales$ 38,250
June collections of May credit sales
($337,500 × 25%) 84,375
June cash sales ($850,000 × 25%) 212,500
June collections of June credit sales
($850,000 × 75% × 60%) 382,500
Total June collections$717,625
d.Balance from May sales ($337,500 × 15%) $ 50,625
Balance from June sales ($637,500 × 40%) 255,000
Total June 30 A/R balance$305,625
21.Income after taxes$560,000
Accrued income tax expense (no cash involved) 41,000
Decrease in A/R (collected more than sold) 4,000
Decrease in A/P (paid for more than purchased) (3,500)
Depreciation (no cash involved) 23,100
Estimated bad debts (no cash involved) 2,050
Dividends paid (20,000)
Projected increase in cash$606,650
22. CGS [$2,000,000 x (1.00 - 0.40)]$1,200,000
Less decr. in inventory (sold more than bought) (33,750)
Plus decr. in A/P (paid for more than bought) 40,000
Cash payments for inventory $1,206,250
Wages expense 512,500
Other cash expenses 235,250
Total cash disbursements $1,954,000
23. April May June Total
Beginning cash balance$ 3,700 $ 3,600$ 3,600$ 3,700
Cash receipts 8,200 10,100 16,900 35,200
Total cash available$11,900$13,700$20,500$38,900
Cash disbursements:
Payments on account $ 1,300 $ 3,900 $ 5,700$10,900
Wage expenses 5,000 6,100 6,200 17,300
Overhead costs 4,000 4,600 4,400 13,000
Total disbursements $10,300$14,600$16,300 $41,200
Cash excess (inadequacy)$ 1,600 $ (900)$ 4,200$ (2,300)
Minimum cash balance (3,500) (3,500) (3,500) (3,500)
Cash available (needed)$ (1,900)$ (4,400)$ 700$ (5,800)
Financing:
Borrowings (repayments) $ 2,000 $ 4,500 $ (500) $ 6,000
Sell (acquire) investments 0 0 0 0
Receive (pay) interest 0 0 (10) (10)
Ending cash balance $ 3,600 $ 3,600 $ 3,690 $ 3,690
24.a.CGS = $5,000,000 + (0.40 × $20,000,000) = $13,000,000
b.CGS [$900,000 x (1 - 0.35)] $585,000
Increase in Inventory 40,000
Decrease in Accounts Payable 34,000
Total cash payment for inventories $659,000
25.New sales in units = 50,000 x 1.20 = 60,000
New DM cost per unit = [($200,000 ÷ 50,000) x 1.10] = $4.40
New DL cost per unit = [($100,000 ÷ 50,000) x 1.10] = $2.20
Overhead rate = $50,000 ÷ $100,000 = 50% of DL cost
Variable selling expenses = $50,000 - $12,000 = $38,000
$38,000 ÷ $500,000 = 7.6% of sales
Desired NI = 10% of Sales
Sales – CGS – Selling Exp. – Admin. Exp. = Net Income
Sales – DM – DL – OH – SE – AE = NI
Sales – ($4.40 x 60,000) – ($2.20 x 60,000) – [0.5($2.20 x 60,000) - $12,000 – (0.076 x Sales) - $60,000 = (0.10 x Sales)
Sales - $264,000 - $132,000 - $66,000 - $12,000 - (0.076 x Sales) - $60,000 = (0.10 x Sales)
Sales - $534,000 - (0.076 x Sales) = (0.10 x Sales)
Sales - (0.076 x Sales) - (0.10 x Sales) = $534,000
.824 Sales = $534,000
Sales = $648,058 (rounded)
Selling price per unit = $648,058 ÷ 60,000 = $10.80 (rounded)
Sales(60,000 x $10.80) $648,000
Cost of Goods Sold
Direct Material $264,000
Direct Labor 132,000
Overhead 66,000 (462,000)
Gross profit $186,000
Expenses
Selling* ($12,000 + $49,248)$ 61,248
Administrative 60,000 (121,248)
Net income before taxes $ 64,752
* Variable Selling Expenses = (0.076 × $648,000) = $49,248
Proof: $64,752 ÷ $648,000 = 9.99% (off due to rounding)
26.a.Beginning balance $ 750,000
July credit sales 900,000
Cash collections in July (660,000)
Write-offs in July (27,000)
Ending balance $ 963,000
b.Cash collections, $660,000
c.Credit sales, $900,000, and the provision for uncollectible accounts, $20,000.
(CPA adapted)
27. Global Co.
Pro Forma Income Statement
For the Month Ended May 31, 2006
Sales$400,000
Cost of goods sold ($400,000 ÷ 1.60) (250,000)
Gross margin$150,000
Selling and administrative expenses$55,000
Depreciation expense 8,000
Bad debts expense ($400,000 × 0.025%) 10,000 (73,000)
Net income$ 77,000
(CPA adapted)
28.a.Sales (120,000 x $25)$3,000,000
Variable costs (.75 x $3,000,000) (2,250,000)
Fixed costs (400,000)
Net income$ 350,000
b.Sales (120,000 x $25)$3,000,000
Variable costs (.65 x $2,250,000) (1,462,500)
Fixed costs* (750,000)
Net income$ 787,500
*Depreciation is included in fixed costs
c.Assuming all costs related to the machine have been considered in the analysis, the machine should be acquired because income will increase significantly.
29.The spend-it-or-lose-it attitude is induced by the incentives in the budget and evaluation cycle. It is much likelier that a manager will be called to task for overspending rather than underspending the budget. This induces the manager to build slack into the budget. Partly because of the slack in the budget, managers may find themselves in an "underspent" position near the end of the fiscal year. If the manager ends the year with a big budget surplus, the slack built into the budget would be revealed. Naturally, the manager would be fearful of revealing the budgetary slack because a consequence would be that a smaller budget would be awarded in ensuing years.
Both superior and subordinate managers have an ethical obligation to overcome the spend-it-or-lose-it attitude. Honest communication between upper and lower managers is the fastest approach to curing this attitude. Further, upper managers have an obligation to provide incentives to lower managers that do not encourage the spend-it-or-lose-it attitude.
30.Continuous budgeting means that a budget that covers the coming 12 months of operations is constantly maintained. As one month expires, another month is added to the budget. The advantage of the continuous budget is that a constant planning horizon of 12 months is maintained. If only annual budgets are prepared, the budget covers a fixed period, typically one year. Because budgeting is an ongoing activity, budgeting skills are maintained throughout the year and the time crunch that typically accompanies annual budgeting is avoided. One further benefit is that a continuous budget may be more flexible in that revisions can be made as conditions warrant. The main disadvantage of the continuous budget is the time dedicated to planning activities. Continuous budgeting is more time intensive because planning activities are always under way.
31.Each student will have a different answer. No solution provided.
32.a.Competitors’ actions are extremely important to business planning because those actions will probably affect whether the planning company will succeed in its planned activities. Competitors may decide to offer new products, making other products obsolete; competitors may decide to enter or expand their markets, creating a market decline for other companies; competitors may lower prices, forcing others offering the same or similar products do also lower product prices or increase advertising that would explain higher prices to consumers.
b.Competitors’ actions may affect internal planning activities because of the implications of those actions on sales and related production figures. Also, actions such as “no-interest” installment promotions may impact sales and collection patterns. Changes in products may require changes in production technology or labor needs.
c.Other internal factors that will affect the budgeting process are marketing promotions that are being planning, capital budgeting purchases and payments, stock or bond issuances, new management strategies (such as market entrances or departures), expansion or contraction of the company’s sales force, and technological changes that could affect training needs.
Other external factors that will affect the budgeting process are interest rate changes, war or threats of war, expansion or contraction of oil (or other raw material) supplies, and changes in minimum wage laws.
Problems
33. Production Budget - 2006
Jan.-June July-Dec. Total
Sales budget 580,000720,0001,300,000
Ending inventory 36,000 60,000 60,000
Beginning inventory (25,000) (36,000) (25,000)
Production 591,000 744,0001,335,000
Material A Purchases Budget - 2006
Jan.-June July-Dec. Total
Production 591,000 744,000 1,335,000
Number of pounds x 4 x 4 x 4
Production budget 2,364,000 2,976,000 5,340,000
Ending inventory 135,000 142,000 142,000
Beginning inventory (120,000) (135,000) (120,000)
Purchases 2,379,000 2,983,000 5,362,000
Times cost per lb. x $1.25 x $1.25 x $1.25
Total cost$2,973,750$3,728,750 $6,702,500
Material B Purchases Budget - 2006
Jan.-June July-Dec. Total
Production 591,000 744,000 1,335,000
Number of gallons x 3 x 3 x 3
Production budget 1,773,000 2,232,000 4,005,000
Ending inventory 35,000 38,000 38,000
Beginning inventory (45,000) (35,000) (45,000)
Purchases 1,763,000 2,235,000 3,998,000
Times cost per gal. x $0.80 x $0.80 x $0.80
Total cost$1,410,400 $1,788,000 $3,198,400
34.a.Sales budget 300,000
Ending inventory (375,000 × 0.05) 18,750
Beginning inventory (12,300)
Production Budget 306,450 cans
b.Tea Purchases Budget (pounds);
Production budget [306,450 x (14 ÷ 16)] 268,143.75
Ending inventory [18,750 x (14 ÷ 16)] 16,406.25
Beginning inventory (750.00)
Purchases 283,800.00
c.Sugar Purchases Budget (pounds)
Production budget [306,450 x (2 ÷ 16)] 38,306.25
Ending inventory [18,750 x (2 ÷ 16)] 2,343.75
Beginning inventory (200.00)
Purchases 40,450.00
d.($3.50 × 283,800) + ($0.40 × 40,450) = $993,300 + $16,180 = $1,009,480
e.($1,009,480 × 0.30) × 0.98 = $296,787.12
35.a. January February March Total
Sales3,2002,600 3,700 9,500
Ending inventory 650 925 900 900
Beginning inventory (800) (650) (925) (800)
Production 3,050 2,875 3,675 9,600
b. (Felt) January February March Total
Production (yds.) 2,287.50 2,156.25 2,756.25 7,200.00
End. inv. 431.25 551.25 540.00 540.00
Beg. inv. (457.50) (431.25) (551.25) (457.50)
Purchases 2,261.25 2,276.25 2,745.00 7,282.50
Cost per yd. x $5.00 x $5.00 x $5.00 x $5.00
$ of purchases $11,306.25 $11,381.25$13,725.00$36,412.50
(Ribbon) January February March Total
Production (in.) 61,000 57,500 73,500 192,000
End. Inv. 11,500 14,700 14,400 14,400
Beg. Inv. (12,200) (11,500) (14,700) (12,200)
Purchases 60,300 60,700 73,200 194,200
Cost per inch x $0.15 x $0.15 x $0.15 x $0.15
$ of purchases $ 9,045.00 $ 9,105.00$10,980.00 $29,130.00
Total purchases $20,351.25 $20,486.25$24,705.00 $65,542.50
c. Month of Payment
January February March Total
Month of purchase:
December $ 3,800.00 $ 3,800.00
January 15,955.38 $ 4,070.25 20,025.63
February 16,061.22 $ 4,097.25 20,158.47
March 19,368.72 19,368.72
Totals $19,755.38 $20,131.47 $23,465.97$63,352.82
d. January February March Total
Factory overhead:
$5,200 + $1.25(unit) $ 9,012.50 $ 8,793.75 $ 9,793.75 $27,600.00
Non-factory overhead:
$2,800 + 10% (rev.) 8,560.00 7,480.00 9,460.00 25,500.00
Totals $17,572.50 $16,273.75 $19,253.75$53,100.00
e. January February March Total
Beg. Balance$18,760.00 $12,312.12 $12,346.90 $ 18,760.00
Collections 58,080.00 48,960.00 62,640.00 169,680.00
Cash available $76,840.00 $61,272.12$74,986.90$188,440.00
Cash needed:
Purchases $19,755.38$20,131.47$23,465.97$ 63,352.82
Overhead 17,572.50 16,273.75 19,253.75 53,100.00
DL ($4 per hat) 12,200.00 11,500.00 14,700.00 38,400.00
Taxes 5,000.00 0.00 0.00 5,000.00
Bonuses 15,000.00 0.00 0.00 15,000.00
Total $69,527.88 $47,905.22$57,419.72$174,852.82
Cash excess $ 7,312.12 $13,366.90$17,567.18$ 13,587.18
Min. Balance 12,000.00 12,000.00 12,000.00 12,000.00
Cash (needed) avail. $ (4,687.88) $ 1,366.90 $ 5,567.18 $ 1,587.18
Financing:
Borrow (repay) 5,000.00 (1,000.00) (4,000.00) 0.00
Sell (invest) (1,000.00) (1,000.00)
Receive (pay) interest 0.00 (20.00) (120.00) (140.00)
Ending cash balance $12,312.12$12,346.90$12,447.18$ 12,447.18
36.a.$1,200,000 ÷ 0.60 = $2,000,000
b.($2,000,000 × 0.70) - ($1,200,000 - $75,000) = $275,000
c.Total expenses = 85% of sales
Total variable costs = 70% of sales
Total fixed costs = 85% - 70% = 15%
Fixed costs = 0.15 x $2,000,000 = $300,000
Fixed S&A expenses = $300,000 - $75,000 = $225,000
d.Cash receipts: $2,000,000 × 0.55 = $1,100,000
Total expenses: $2,000,000 × 0.85 = $1,700,000
Depreciation (37,500)
Pending expenses $1,662,500
Percent paid in cash x 0.65
Cash disbursement$1,080,625
37.a.January sales: ($34,560 + $1,440) ÷ 0.50 = $72,000
Collections = (72,000 x 0.48) + ($120,000 x 0.50) = $34,560 + $60,000 = = $94,560
b.Beginning inventory $ 52,400
Purchases ($120,000 x 0.65 x 0.60) + ($130,000 x 0.65 x 0.30) 72,150
Cost of Goods Sold ($120,000 × 0.65) (78,000)
Ending inventory $ 46,550
c.First determine expected earnings for February:
Sales $120,000
CGS (78,000)
Gross margin $ 42,000
Operating expenses (21,500)