CHAPTER 23

OPERATIONAL BUDGETING

OVERVIEW OF EXERCISES, PROBLEMS, CASES,

AND INTERNET ASSIGNMENT
Learning
Exercises Topic Objectives Characteristics
23–1 Budgeting purchases and payments 4, 5 Mechanical
23–2 Estimating direct materials 4, 5 Mechanical
inventory
23–3 Production budgets 4, 5 Mechanical
23–4 Direct materials budget 4, 5 Mechanical, conceptual
23–5 Budgeting for prepayments 4, 5 Mechanical
23–6 Budgeting for interest expense 4, 5 Mechanical
23–7 Operating expense budget 4, 5 Mechanical
23–8 Budgeting cash receipts 4, 5 Mechanical
23–9 Budgeting ending cash 4, 5 Mechanical
23–10 Preparing a flexible budget 6 Mechanical, conceptual
23–11 Preparing a flexible budget 6 Mechanical, conceptual, ethics
23–12 Budget estimates 2, 3 Conceptual

Problems
23–1 Budgeting manufacturing overhead 4, 5 Mechanical
23–2 Budgeting labor costs 4, 5 Mechanical
23–3 Budgeting manufacturing costs and 4, 5 Mechanical, analytical
cost of sales
23–4 Budgeting manufacturing costs and 4, 5 Mechanical, analytical
cost of sales
23–5 Budgeting for cash 4, 5 Mechanical
23–6 Estimating borrowing requirements 1, 2, 4, 5 Mechanical, conceptual
23–7 Income and cash comparisons 1, 2, 4, 5 Mechanical, conceptual
23–8 Budgeting for cash 1, 2, 4, 5 Mechanical, conceptual
23–9 Preparing and using flexible 2, 4, 5, 6 Mechanical, conceptual
budgets
23–10 Preparing and using flexible 2, 4, 5, 6 Mechanical, conceptual
budgets

Cases
23–1 Interrelationships among budget 2, 5 Mechanical, analytical
estimates
23–2 Distorting budget estimates and the 1–3 Conceptual, ethics, group
CPA’s role

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 223
Business Week Learning
Assignment Topic Objectives Characteristics
23–3 Business Week assignment: Yahoo! 2, 6 Conceptual, writing, real
Japan

Internet
Assignment
23–1 Budgeting Shareware 2, 6 Conceptual

DESCRIPTIONS OF PROBLEMS, CASES,

AND INTERNET ASSIGNMENT
Below are brief descriptions of each problem, case, and the Internet assignment. These descriptions are
accompanied by the estimated time (in minutes) required for completion and by a difficulty rating. The time
estimates assume use of the partially filled-in working papers.

Problems
23–1 Fargo Enterprises 15 Easy
Prepare a budget for manufacturing overhead costs for one month.

23–2 Sun Mountain Foods 15 Easy

Prepare a budget for direct labor cost for one month.

23–3 Renfrow International 25 Medium

Budget such quantities and amounts as the planned production of finished
goods, cost of goods manufactured, finished goods inventory, and the cost of
goods sold.

23–4 Harmony Corporation 20 Medium

Budget such quantities and amounts as the planned production of finished
goods, cost of goods manufactured, finished goods inventory, and the cost of
goods sold.

23–5 Barnum Distributors 50 Strong

Prepare a cash budget for one month.

23–6 Potter Corporation 40 Strong

Analyze collection patterns for accounts receivable and accounts payable.
Assess the company’s ability to generate adequate cash flow to service
additional debt.

23–7 Rizzo’s 30 Strong

Analyze a budgeted income statement and a cash budget, and determine why
income recognition differs from cash flow.

224 © The McGraw-Hill Companies, Inc., 2005

23–8 Marley Wholesale 60 Strong
Prepare a monthly cash budget for three months in support of a loan
application. Determine whether a scheduled loan repayment can be met at the
end of the period.

23–9 Four Flags 50 Medium

Prepare a statement comparing actual results with a flexible budget and
comment on the company’s performance.

23–10 Braemar Saddlery 45 Medium

An excellent problem for demonstrating the importance of flexible budgeting.
Due to an increase in production, the production department exceeds its
budget by large amounts. Student is asked to prepare a flexible budget
showing that the company actually did very well in controlling costs.

Cases
23–1 Budgeting in a Nutshell 30 Medium
A short budgeting case that shows the interrelationships among budgeted
financial statements. but more importantly, it provides an opportunity for
students to review the relationships between cash flows and accrual
accounting. A real favorite.

23–2 An Ethical Dilemma 20 Medium

A company in need of bank financing has inflated its master budget figures due
to a large receivable with a questionable likelihood of being collected. The
company’s CPA is aware of the problem and knows that if the company is
denied credit, his accounting firm will not be paid. Students must decide whether
the role of a CPA is to serve the client or to serve the client’s creditors.

Business Week Assignment

23–3 Business Week Assignment: Yahoo! Japan 20 Easy
The case describes an unusual business strategy of the Japanese Yahoo
subsidiary and asks students to speculate about the role of budgeting.
Internet Assignment
23–1 Budgeting Shareware 30 Medium
Student is asked to explore free software available on the Internet to help
companies with budgeting.

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 225
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
1. Planning is the process of setting financial and operational goals, including cost levels, and deciding
upon the actions that will achieve these goals. Exercising control over costs means monitoring actual
results, comparing those results to the plan, and taking corrective action when actual results fall below
expectations. In short, control is the function of keeping actual results in line with the plan.
2. A business may expect to benefit from preparing a formal budget in several ways, including (three
required):
a. The process of preparing the budget forces management to consider all aspects of the company’s
activities and also many aspects of the external business environment. Thus, budgeting should
make managers more aware of the company’s resources, problems, and environment.
b. A budget is a forecast of the outcome of future events. Thus, it may give advance warning of
impending problems, such as cash shortages.
c. The preparation of a budget provides an opportunity to coordinate the efforts of the various
departments in the business so that all are working efficiently toward common goals.
d. The budgeted levels of performance provide a yardstick for evaluating the actual performance of
company personnel.
3. The most widely used budgeting “philosophy” is to set budgeted amounts at reasonable and achievable
levels. A second approach is to set these amounts at levels achievable only under ideal conditions.
When budgeted amounts are set at levels that cannot be achieved under any conditions, however, the
budget loses much of its potential value. If failure to meet the budget becomes a normal and acceptable
condition, the budget provides neither a sound basis for evaluating departments nor a means of drawing
attention to areas of potential improvement.
4. Budgets and schedules included in the master budget of a manufacturing company include (five
required): sales budgets, production budgets (in units), unit cost estimates, manufacturing budgets,
operating expense budgets, estimates of inventory levels, a budgeted income statement, capital
expenditures budgets, cash budgets, and a budgeted balance sheet.
5. The steps in preparing a master budget are:
a. Prepare a sales forecast.
b. Prepare budgets for production, manufacturing costs, and operating expenses.
c. Prepare a budgeted income statement.
d. Prepare a cash budget.
e. Prepare a budgeted balance sheet.
6. Preparation of the sales budget is an early step in the budgeting process because many budgeted
amounts, such as production levels, manufacturing costs, operating expense, and cash payments and
receipts, are dependent upon the projected level of sales volume.
7. Responsibility budgets are subsections of the master budget showing only the business activities that
are under the control of a particular manager. In a large retail store, responsibility sales budgets would
be organized around the individual sales departments, such as men’s clothing, women’s clothing,
shoes, appliances, and automotive products. Each of these departments should have a budgeted
monthly sales level.
8. A flexible budget may be geared to any volume level and therefore can be based on the actual (as
distinguished from the planned) level of volume attained during a budget period. A thorough
knowledge of cost-volume-profit behavior enables management to determine what costs should have
been at the volume of activity actually attained. A comparison between a flexible budget for any

226 © The McGraw-Hill Companies, Inc., 2005

 responsibility center and actual results achieved becomes a reasonable basis for evaluating
performance because differences between planned and actual volume (which may not be within the
control of the person being evaluated) are eliminated from consideration.
9. If a budgeted expenditure can be directly influenced by the manager responsible for such an
expenditure, it is known as a controllable expenditure. Most variable expenses, for example, are
controllable.
The federal budget includes a multitude of expenditures, some of which are not controllable by
government officials to any significant extent. Some examples (two required) of such uncontrollable
government expenditures are interest payments on national debt, social security payments, veterans’
benefits, and commitments outstanding on firm contracts.
10. Companies that experience rapid growth sometimes undergo cash flow problems because, as demand
for their product increases, cash becomes tied up in direct materials, work in process, and finished
goods inventories. Furthermore, as finished goods are sold, cash remains tied up in accounts receivable
until it is ultimately collected. Meanwhile, as cash is tied up in inventory and receivables, expenditures
must be made to pay vendors, employees, interest, taxes, etc. This can put a great deal of strain on a
company and cause severe cash flow problems.

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 227
 SOLUTIONS TO EXERCISES

Ex. 23–1 a. Direct materials budgeted for use during the year ........................................... $250,000
Budgeted direct materials inventory at December 31....................................... 80,000
Total direct materials budgeted to be available ................................................ $330,000
Less: Direct materials inventory at January 1 .................................................. 65,000
Budgeted direct materials purchases for the year............................................. $265,000

b. Amount owed to suppliers at January 1 ............................................................ $ 50,000

Budgeted purchases of direct materials (part a) ............................................... 265,000
Total owed to suppliers during the year ............................................................ $315,000
Less: Amount owed to suppliers at December 31.............................................. 75,000
Budgeted cash payments to materials suppliers during the year .................... $240,000

Ex. 23–2 Direct materials used during the period (10,000 pounds × 10)................ 100,000 pounds
Add: Desired ending inventory................................................................... 6,500
Total pounds of inventory needed .............................................................. 106,500
Less: Estimated purchases required .......................................................... 10,000
Beginning materials inventory.................................................................... 96,500 pounds

Ex. 23–3 a. Sales forecast:

Budgeted sales (in cases)................................................................................. 1,200
Selling price per case....................................................................................... $ 240
Budgeted sales (in dollars).............................................................................. $288,000

Production schedule:
Budgeted sales (cases) ..................................................................................... 1,200
Target ending inventory ................................................................................. 100
Cases budgeted to be available for sale ......................................................... 1,300
Less: Beginning inventory .............................................................................. (150)
Planned production ........................................................................................ 1,150 cases

b. Budgeted variable manufacturing cost per case:

Direct materials ............................................................................................... $ 8
Direct labor (2 hours/case × $10/hour).......................................................... 20
Variable overhead ........................................................................................... 6
Total variable cost per case ........................................................................ $34

228 © The McGraw-Hill Companies, Inc., 2005

 c. Manufacturing cost budget:
Variable manufacturing costs:
Direct materials (1,150 cases × $8/case) ......................................................... $ 9,200
Direct labor (1,150 cases × $20/case) .............................................................. 23,000
Variable overhead (1,150 cases × $6/case) ..................................................... 6,900
Total variable manufacturing costs ............................................................ $ 39,100
Fixed manufacturing overhead........................................................................... $220,000
Total cost of finished goods manufactured ........................................................ $259,100

Manufacturing cost per unit ($259,100/1,150 units) ......................................... $225.30

d. Ending inventory value:

Target ending inventory (cases) × Manufacturing cost per unit = 100 cases ×
$225.30/case
Ending inventory value = $22,530

Ex. 23–4 a. Production schedule:

Budgeted sales (units) ..................................................................................... 5,500
Target ending inventory ................................................................................. 480
Units budgeted to be available for sale.......................................................... 5,980
Less: Beginning inventory .............................................................................. (620)
Planned production ........................................................................................ 5,360 doors

b. Materials requirements based on planned production of 5,360 doors:

Steel: (5,360 doors × 20 pounds/door) ............................................. 107,200 pounds
Glass: (5,360 doors × 6 square feet/door)........................................ 32,160 square feet

Materials purchases budget:

Steel Glass
Direct materials used .................................................... 107,200 lbs. 32,160 sq. ft.
Target ending inventory ............................................... 80,000 lbs. 4,000 sq. ft.
Direct materials available for use ................................ 187,200 lbs. 36,160 sq. ft.
Less: Beginning inventory ............................................ (40,000) lbs. (6,000) sq. ft.
Raw materials to be purchased (units)........................ 147,200 lbs. 30,160 sq. ft.
× Budgeted purchase price per unit............................. × $4 × $2
Budgeted direct materials purchases........................... $588,800 $60,320

c. Safe ’n Bright may wish to increase its ending inventory level of steel if the price of
steel this year is expected to be much lower than the price next year. However, the cost
savings must be greater than the increased storage and capital costs associated with
carrying a large amount of inventory. A decrease in glass inventory may be required to
accommodate the storage requirements of the increased amount of steel. Also, glass is
fragile and often difficult to store. Safe ’n Bright may simply be following a policy of
trying to lower the inventory of glass to minimize the amount of losses due to breakage
and the costs associated with storage.

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Ex. 23–5 First, calculate prepayments to be expired during the period:
Total costs and expenses............................................................................................. $325,000
Less: Amount financed with current payables........................................................ 300,000
Depreciation expense ....................................................................................... 20,000
Prepayments to be expired during the period.......................................................... $ 5,000

Next, let X equal the beginning prepayments balance and 2X equal the ending prepay-
ments balance. We may then solve for the ending prepayments balance as follows:
Beginning Prepayments + Cash Payments − Expired Prepayments = Ending Prepayments
X + $8,000 − $5,000 = 2X
X = Beginning Prepayments = $3,000
2X = Ending Prepayments = $6,000

Ex. 23–6 a. Budgeted interest expense reported on the February income statement is computed as
follows:
$100,000 principal × 1% per month = $1,000

b. In part a, February interest expense is computed as $1,000. The remaining $200 is used
to reduce the note’s principal to $99,800. Interest expense in March can now be com-
puted as follows:
$99,800 principal × 1% per month = $998
Thus, the amount applied to the note’s principal in March is:
$1,200 − $998 = $202

c. The remaining carrying value of the note at the end of March is:
$100,000 − $200 − $202 = $99,598
April interest expense on the note is approximately:
$99,598 principal × 1% per month = $996
The remaining $204 of the $1,200 payment is applied to the principal of the note. Thus,
the note’s carrying value at the end of April is:
$100,000 − $200 − $202 − $204 = $99,394

230 © The McGraw-Hill Companies, Inc., 2005

Ex. 23–7 The portion of last month’s selling and administrative expenses that was variable totaled
$160,000 ($320,000 ÷ 2). Thus, last month’s variable cost per unit (when a unit is defined
in terms of sales dollars) can be computed as follows:
$160,000 total variable costs ÷ $800,000 sales = $0.20 per sales dollar
The upcoming month’s total selling and administrative budget is computed as follows:
Budgeted sales ............................................................................................................. $900,000
Variable selling and administrative costs ................................................................. 0.20
Total variable selling and administrative costs........................................................ $180,000
Fixed selling and administrative costs ($160,000 + $5,000) .................................... 165,000
Total selling and administrative costs budgeted ...................................................... $345,000

Ex. 23–8 Estimated cash collections on accounts receivable for the month of February:
On accounts receivable representing sales in:
January —within discount period, $600,000 × 15% × .98 ................................... $ 88,200
—after discount period, $600,000 × 7%................................................. 42,000
February —within discount period, $800,000 × 60% × .98 ................................. 470,400
—after discount period, $800,000 × 15% ............................................. 120,000
Total estimated cash collections during February................................................... $720,600

Ex. 23–9 a. Cash balance on March 1 ............................................................................... $500,000

Collections on January sales ($300,000 × 15%)............................................ 45,000
Collections on February sales ($400,000 × 30%).......................................... 120,000
Collections on March sales ($600,000 × 50%) .............................................. 300,000
Total cash available......................................................................................... $965,000
Less: Expenditures .......................................................................................... 400,000
Cash balance on March 31 ............................................................................. $565,000

b. Cash balance on April 1 (from a)................................................................... $ 565,000

Collections on February sales ($400,000 × 15%).......................................... 60,000
Collections on March sales ($600,000 × 30%) .............................................. 180,000
Collections on April sales ($700,000 × 50%)................................................. 350,000
Total cash available......................................................................................... $ 1,155,000
Less: Expenditures .......................................................................................... 400,000
Cash balance on April 30................................................................................ $ 755,000

c. Cash balance on May 1 (from b).................................................................... $ 755,000

Collections on March sales ($600,000 × 15%) .............................................. 90,000
Collections on April sales ($700,000 × 30%)................................................. 210,000
Collections on May sales ($800,000 × 50%) .................................................. 400,000
Total cash available......................................................................................... $ 1,455,000
Less: Expenditures .......................................................................................... 400,000
Cash balance on May 31 ................................................................................. $ 1,055,000

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Ex. 23–10 Flexible budget at 90,000-unit level of activity:
Sales ($1,600,000 ÷ 80,000 units = $20 per unit; 90,000 × $20 =
$1,800,000)............................................................................................................ $ 1,800,000
Cost of goods sold ($960,000 ÷ 80,000 units = $12 per unit; 90,000 ×
$12 = $1,080,000) ................................................................................................. 1,080,000
Gross profit on sales .............................................................................................. $ 720,000
Operating expenses [($4 variable expenses per unit* × 90,000 units) +
$90,000]................................................................................................................. 450,000
Operating income .................................................................................................. $ 270,000
Income taxes ($270,000 × 30%) ............................................................................ 81,000
Net income .............................................................................................................. $ 189,000

*$410,000 − $90,000 = $320,000 variable operating expenses;

$320,000 ÷ 80,000 units = $4 variable expenses per unit.

Ex. 23–11 AMALFI LEATHER GOODS

Performance Report—Finishing Department
For the Current Month
11,000 Units Variances
Flexible
Budget Actual Favorable Unfavorable
Manufacturing costs:
Direct materials used*.................... $330,000 $320,000 $10,000
Direct labor* ................................... 110,000 115,000 $5,000
Variable manufacturing
overhead* ...................................... 22,000 21,500 500
Fixed manufacturing overhead ..... 150,000 149,200 800
Total manufacturing costs ................. $612,000 $605,700 $11,300 $5,000

*Budgeted variable manufacturing costs are restated from the 10,000 units of production
level to the 11,000-unit level by multiplying the cost at the 10,000-unit level by 110%.

Ex. 23–12 a. To purposely distort budget estimates for personal gain is an unethical practice and
should be avoided. In addition to ethical implications, distorting a sales forecast can
have a significant impact on a company’s ability to plan for future operations. The
sales budget is an integral part of the master budgeting process. It impacts production
estimates, inventory requirements, cash flow expectations, etc.
b. To avoid the manipulation of sales forecasts, the company may wish to consider (1)
soliciting sales estimates from multiple sources, (2) educating the sales manager by
showing him the profound impact that his estimates have on planning and controlling
operations, and (3) designing a reward system that ties the sales manager’s annual
bonus to the accuracy of his forecasts.

232 © The McGraw-Hill Companies, Inc., 2005

 SOLUTIONS TO PROBLEMS
15 Minutes, Easy PROBLEM 23–1
FARGO ENTERPRISES
FARGO ENTERPRISES
Budget for Manufacturing Overhead Costs
For the Month Ended January 31, 20__
Total Dept. A Dept. B
Fixed manufacturing overhead:
Dept. A: 6,000 units × $12 $ 7 2 0 0 0 $ 7 2 0 0 0
Dept. B: 6,000 units × $10 6 0 0 0 0 $ 6 0 0 0 0

Variable manufacturing overhead:

Dept. A: 5,000 units scheduled for production × $6 3 0 0 0 0 3 0 0 0 0
Dept. B: 5,000 units scheduled for production × $4
× 125% 2 5 0 0 0 2 5 0 0 0
Totals $ 1 8 7 0 0 0 $1 0 2 0 0 0 $ 8 5 0 0 0

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 233
15 Minutes, Easy PROBLEM 23–2
SUN MOUNTAIN FOODS
SUN MOUNTAIN FOODS
Budget for Direct Labor Costs
For the Month Ended November 30, 20__
Dry
Total Roasting Packing
Dry roasting: 200,000 pounds × .025 hours/pound
× $8.40 per hour × 106% $ 4 4 5 2 0 $ 4 4 5 2 0
Packing: 200,000 pounds × .012 hours/pound × $7.50
per hour × 96% 1 7 2 8 0 $ 1 7 2 8 0
Totals $ 6 1 8 0 0 $ 4 4 5 2 0 $ 1 7 2 8 0

234 © The McGraw-Hill Companies, Inc., 2005

25 Minutes, Medium PROBLEM 23–3
RENFROW INTERNATIONAL

a. Planned production of finished goods (in units):

Budgeted sales 1 5 0 0 0 0
Add: Finished goods inventory, end of quarter 2 8 0 0 0
Units budgeted to be available for sale 1 7 8 0 0 0
Less: Finished goods inventory, beginning of quarter 3 8 0 0 0
Planned production of finished goods 1 4 0 0 0 0

b. Cost of finished goods manufactured:

Planned production of finished goods (in units—part a ) 1 4 0 0 0 0
Budgeted manufacturing cost per unit $ 2 8
Cost of finished goods manufactured (140,000 × $28 per unit) $39 2 0 0 0 0

c. Finished goods inventory at quarter-end (average cost):

Finished goods inventory, beginning of quarter $ 9 7 5 0 0 0
Add: Cost of finished goods manufactured (part b ) 39 2 0 0 0 0
Budgeted cost of goods available for sale $48 9 5 0 0 0
Units budgeted to be available for sale (part a ) 1 7 8 0 0 0
Average cost per unit ($4,895,000 ÷ 178,000 units) $ 2 7 .50
Finished goods inventory, end of quarter
(28,000 units × $27.50) $ 7 7 0 0 0 0

d. Cost of goods sold:

Budgeted cost of goods sold available for sale (part c ) $48 9 5 0 0 0
Less: Finished goods inventory, end of quarter (part c ) 7 7 0 0 0 0
Cost of goods sold $41 2 5 0 0 0

Alternative computation
Budgeted sales, 150,000 units × $27.50 (part c ) $41 2 5 0 0 0

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 235
20 Minutes, Medium PROBLEM 23–4
HARMONY CORPORATION

a. Planned production of finished goods (in units):

Budgeted sales 1 5 0 0 0 0
Add: Finished goods inventory, Mar. 31 (end of quarter) 2 0 0 0 0
Units budgeted to be available for sale 1 7 0 0 0 0
Less: Finished goods inventory, Jan. 1 (beginning of quarter) 3 0 0 0 0
Planned production of finished goods 1 4 0 0 0 0

b. Cost of finished goods manufactured:

Planned production of finished goods (part a ) 1 4 0 0 0 0
Budgeted manufacturing cost per unit (given) $ 3 9
Cost of finished goods manufactured (140,000 units × $39) $54 6 0 0 0 0

c. Finished goods inventory, Mar. 31 (FIFO method):

Finished goods inventory, Mar. 31 (20,000 units × $39)* $ 7 8 0 0 0 0

*Using the first-in, first-out method, the ending inventory consists

of the most recently manufactured units.

d. Cost of goods sold:

Finished goods inventory, Jan 1. (beginning of quarter) $10 8 0 0 0 0
Add: Cost of finished goods manufactured (part b ) 54 6 0 0 0 0
Cost of goods available for sale $65 4 0 0 0 0
Less: Finished goods inventory, Mar. 31 (part c ) 7 8 0 0 0 0
Cost of goods sold $57 6 0 0 0 0

236 © The McGraw-Hill Companies, Inc., 2005

50 Minutes, Strong PROBLEM 23–5
BARNUM DISTRIBUTORS
BARNUM DISTRIBUTORS
Cash Budget
For the Month Ended November 30, 20__
Cash balance at beginning of month $ 2 9 6 0 0
Receipts:
Collections on receivables (Schedule A) $7 7 8 8 0 0
Sale of fully depreciated equipment 8 4 0 0 7 8 7 2 0 0
Total cash available $8 1 6 8 0 0
Payments:
Payments for purchases of merchandise (Schedule B) $4 8 6 5 0 0
Payments on operating expenses ($220,000 − $35,000) 1 8 5 0 0 0
Payment on note payable 9 8 5 0 0 7 7 0 0 0 0
Cash balance at end of month $ 4 6 8 0 0

Schedule A—Collections on Receivables in November

September sales: 7% × (40,000 × $11)—actual $ 3 0 8 0 0
October sales: 20% × (60,000 × $11)—actual 1 3 2 0 0 0
November sales: 70% × (80,000 × $11)—estimated 6 1 6 0 0 0
Total collections on receivables $7 7 8 8 0 0

Schedule B—Payments for Purchases of Merchandise

On October purchases (see below), 50% of $434,000 $2 1 7 0 0 0
On November purchases (see below), 50% of $539,000 2 6 9 5 0 0
Total payments for purchases of merchandise $4 8 6 5 0 0

Purchases
Computation of Purchases Units ($7 Per Unit)
Inventory at end of September (2,000 + 10% of 60,000) 8 0 0 0
Purchases in October (60,000 + 10,000* − 8,000) 6 2 0 0 0 $4 3 4 0 0 0
Available for sale in October 7 0 0 0 0
Sales in October 6 0 0 0 0
Inventory at end of October 1 0 0 0 0
Purchases in November (80,000 + 7,000† − 10,000) 7 7 0 0 0 $5 3 9 0 0 0
Available for sale in November 8 7 0 0 0
Sales in November (estimated) 8 0 0 0 0
Inventory at end of November 7 0 0 0

*2,000 + 10% of 80,000 = 10,000 units

†2,000 + 10% of 50,000 = 7,000 units

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 237
40 Minutes, Strong PROBLEM 23–6
POTTER CORPORATION

a. Budgeted cash receipts for the quarter:

Collections on prior period receivables $2 0 0 0 0 0
Collections on 65% of $500,000 sales 3 2 5 0 0 0
Total receipts collected during the quarter $5 2 5 0 0 0

b. Payments of current payables budgeted for the quarter:

Beginning current payables $ 8 5 0 0 0
New payables during quarter 3 5 0 0 0 0
Total payables $4 3 5 0 0 0
Ending current payables ($85,000 + $20,000) 1 0 5 0 0 0
Payments on current payables $3 3 0 0 0 0

c. If beginning prepayments equal the ending prepayments, the

amount expired during the period equals the prepayments
made during the period, or $20,000.

d. Cash budget:
Beginning cash $ 1 0 0 0 0
Cash received from customers (part a ) 5 2 5 0 0 0
Cash available $5 3 5 0 0 0
Less: Payments on current payables (part b ) 3 3 0 0 0 0
Prepayments (part c ) 2 0 0 0 0
Debt service (interest and principal) 1 4 5 0 0 0
Taxes 4 5 0 0 0
Ending cash balance (deficit) $ (5 0 0 0 )

e. Given a minimum required cash balance of $10,000, the company

must attempt to obtain a loan of $15,000.

f. A bank will look for evidence that Potter has the ability to service
new debt. In view of the fact that the company is experiencing
cash flow problems and that its debt ratio is already 80%, it is
unlikely that a new loan will be approved.

238 © The McGraw-Hill Companies, Inc., 2005

30 Minutes, Strong PROBLEM 23–7
RIZZO’S

a. Budgeted income statement:

Budgeted sales $ 7 2 0 0 0
Cost of goods sold (60% of sales) 4 3 2 0 0
Gross profit (40% of sales) $ 2 8 8 0 0
Variable selling & administrative costs (5% of sales) 3 6 0 0
Fixed selling & administrative costs 1 2 0 0 0
Budgeted pretax operating income $ 1 3 2 0 0
Interest expense 4 5 0 0
Pretax income $ 8 7 0 0
Income taxes (35%) 3 0 4 5
Budgeted net income $ 5 6 5 5

b. Cash budget:
Beginning cash, May 1 $ 2 5 0 0 0
Collections on March sales (10% × $65,000) 6 5 0 0
Collections on April sales (60% × $42,000) 2 5 2 0 0
Collections on May sales (30% × $72,000) 2 1 6 0 0
Total cash available $ 7 8 3 0 0
Less: Payments on April payables (20% × $24,000) 4 8 0 0
Payments on May payables (80% × $42,000) 3 3 6 0 0
Variable selling & administrative costs (5% × $72,000 sales) 3 6 0 0
Fixed selling & administrative costs ($12,000 − $4,000) 8 0 0 0
Debt service payments 5 0 0 0
Ending cash, May 31 $ 2 3 3 0 0

c. The company’s cash flow differs from its income because, in

accrual accounting, revenue is recognized when it is earned, not
when cash is received. Further, expenses are recognized when
they are incurred, not when cash is paid. Finally, some cash
payments (e.g., principal payments on debt) are not part of the
determination of net income.

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 239
60 Minutes, Strong PROBLEM 23–8
MARLEY WHOLESALE
a. MARLEY WHOLESALE
Cash Budget
For Third Quarter of Current Year
July August September
Cash balance at beginning of month $ 2 0 0 0 0 $1 6 8 0 0 0 $ 5 3 4 0 0
Receipts:
Bank loan 1 9 4 0 0 0
Collections on receivables (Schedule 1) 1 2 0 0 0 0 2 8 0 0 0 0 3 4 5 0 0 0

Total cash available $3 3 4 0 0 0 $4 4 8 0 0 0 $3 9 8 4 0 0

Disbursements:
Purchase of equipment $ 1 6 0 0 0
Payments on accounts payable (Schedule 4) 1 5 0 0 0 0 $3 9 4 6 0 0 $2 3 5 9 0 0

Total disbursements $1 6 6 0 0 0 $3 9 4 6 0 0 $2 3 5 9 0 0

Cash balance at end of month $1 6 8 0 0 0 $ 5 3 4 0 0 $1 6 2 5 0 0

Supporting Schedules

Schedule 1—Estimated Cash Collections

on Receivables

Receivables outstanding at June 30 $1 2 0 0 0 0 $ 4 0 0 0 0

July sales—80% × $300,000 2 4 0 0 0 0
July sales—19% × $300,000 $ 5 7 0 0 0
August sales—80% × $360,000 2 8 8 0 0 0

Total cash receipts $1 2 0 0 0 0 $2 8 0 0 0 0 $3 4 5 0 0 0

Schedule 2—Estimated Merchandise Purchases

Sales $3 0 0 0 0 0 $3 6 0 0 0 0 $2 7 0 0 0 0
Cost of goods sold (65% of sales) $1 9 5 0 0 0 $2 3 4 0 0 0 $1 7 5 5 0 0
Add: Required ending inventory 2 3 4 0 0 0 1 7 5 5 0 0 1 3 0 0 0 0 *
Total merchandise required $4 2 9 0 0 0 $4 0 9 5 0 0 $3 0 5 5 0 0
Less: Beginning merchandise inventory 9 0 0 0 0 2 3 4 0 0 0 1 7 5 5 0 0

Budgeted merchandise purchases on open account $3 3 9 0 0 0 $1 7 5 5 0 0 $1 3 0 0 0 0

*Cost of goods sold for October, 65% × $200,000, or

$130,000.

240 © The McGraw-Hill Companies, Inc., 2005

 PROBLEM 23–8
MARLEY WHOLESALE (concluded)

July August September

Schedule 3—Estimated Cash Payments
for Operating Expenses

Fixed expenses $ 3 6 0 0 0 $ 3 6 0 0 0 $ 3 6 0 0 0
Variable expenses (8% of sales) 2 4 0 0 0 2 8 8 0 0 2 1 6 0 0
Total operating expenses $ 6 0 0 0 0 $ 6 4 8 0 0 $ 5 7 6 0 0
Less: Depreciation expense included above 4 4 0 0 4 4 0 0 4 4 0 0

Operating expenses incurred on open account $ 5 5 6 0 0 $ 6 0 4 0 0 $ 5 3 2 0 0

Schedule 4—Estimated Cash Payments

on Accounts Payable (Including
Operating Expenses)

Accounts payable balance on June 30 (includes

accrued operating expenses) $1 5 0 0 0 0
Merchandise purchases (Schedule 2) $3 3 9 0 0 0 $1 7 5 5 0 0
Expenses incurred on open account (Schedule 3) 5 5 6 0 0 6 0 4 0 0

Total cash required for accounts payable and

operating expenses $1 5 0 0 0 0 $3 9 4 6 0 0 $2 3 5 9 0 0

b. It is apparent from the three-month budget that Marley will not be able to pay the bank the full
$200,000 due on his loan at September 30. The projected cash balance is $162,500, and he might
expect to reduce his loan by $140,000 to $150,000, depending on the minimum cash balance neces-
sary for operation. It appears that he should either arrange for an extension of time beyond
September 30 for repayment of a part of the loan or seek a new source of financing.

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 241
50 Minutes, Medium PROBLEM 23–9
FOUR FLAGS
a. FOUR FLAGS
Comparison of Budgeted and Actual Revenue and Expenses
For the Year Ended December 31, 20__
Flexible Over (or
Budget Actual Under) Budget
Net sales $10 5 0 0 0 0 0 $10 5 0 0 0 0 0 $ – 0 –
Cost of goods sold 63 0 0 0 0 0 61 8 0 0 0 0 (1 2 0 0 0 0 )

Gross profit on sales $ 42 0 0 0 0 0 $ 43 2 0 0 0 0 $ 1 2 0 0 0 0

Operating expenses:
Selling and promotion $ 10 7 1 0 0 0 $ 10 2 0 0 0 0 $ (5 1 0 0 0 )
Building occupancy 4 1 7 0 0 0 4 2 0 0 0 0 3 0 0 0
Buying 5 7 0 0 0 0 5 9 4 0 0 0 2 4 0 0 0
Delivery 2 1 6 0 0 0 1 8 3 0 0 0 (3 3 0 0 0 )
Credit and collection 9 3 0 0 0 9 0 0 0 0 (3 0 0 0 )
Administrative 5 6 2 5 0 0 5 6 4 0 0 0 1 5 0 0

Total operating expenses $ 29 2 9 5 0 0 $ 28 7 1 0 0 0 $ (5 8 5 0 0 )

Operating income $ 12 7 0 5 0 0 $ 14 4 9 0 0 0 $ 1 7 8 5 0 0

b. Comment on performance:
Operating income was better than budgeted by $178,500. This result may be attributed to five
factors: (1) a better-than-budgeted merchandise purchasing performance; (2) smaller expenditures
than budgeted for selling and promotion expenses; (3) smaller delivery expense than planned;
(4) smaller credit and collection expenses than planned; (5) these factors were offset in part by the
fact that the total of building occupancy expenses, buying expenses, and administrative expenses was
$28,500 larger than the amount budgeted.
If the overexpenditure for buying expenses and the favorable cost of goods sold performance are
related, as might be expected, the net effect is favorable. By spending more for buying, the com-
pany has realized savings in merchandise costs that have increased the gross profit on sales over
what was anticipated.
An interesting question is whether the savings in selling and promotion expenses actually bene-
fited the company. Although these expenditures were $51,000 less than budgeted for the actual
sales volume, actual sales were $1,500,000 less than originally forecast. Management should
carefully investigate its advertising strategy to see if the “savings” in selling expenses are having a
negative impact upon sales and gross profit.
Actual delivery and credit and collection expenses are smaller than budgeted. These differences
warrant investigation. Either unusual savings have been achieved, or the budget estimates are not
realistic.

242 © The McGraw-Hill Companies, Inc., 2005

45 Minutes, Medium PROBLEM 23–10
BRAEMAR SADDLERY
a. BRAEMAR SADDLERY
Performance Report for Custom Saddle Production Dept.
For the Year Ended December 31, 20__
Budgeted Costs Actual Over
for 6,000 Units Costs (or Under)
Per Unit Total Incurred Budget
Variable manufacturing costs:
Direct materials $ 3 0 00 $ 1 8 0 0 0 0 $1 7 1 0 0 0 $ (9 0 0 0 )
Direct labor 4 8 00 2 8 8 0 0 0 2 6 1 5 0 0 (2 6 5 0 0 )
Indirect labor 1 5 00 9 0 0 0 0 9 5 5 0 0 5 5 0 0
Indirect materials, supplies, etc. 9 00 5 4 0 0 0 4 8 4 0 0 (5 6 0 0 )
Total variable
manufacturing costs $ 1 0 2 00 $ 6 1 2 0 0 0 $5 7 6 4 0 0 $ (3 5 6 0 0 )

Fixed manufacturing costs:

Lease rental $ 7 50 $ 4 5 0 0 0 $ 4 5 0 0 0 $ – 0 –
Salaries of foremen 2 0 00 1 2 0 0 0 0 1 2 5 0 0 0 5 0 0 0
Depreciation and other 1 2 50 7 5 0 0 0 7 8 6 0 0 3 6 0 0
Total fixed
manufacturing costs $ 4 0 00 $2 4 0 0 0 0 $2 4 8 6 0 0 $ 8 6 0 0
Total manufacturing costs $ 1 4 2 00 $8 5 2 0 0 0 $8 2 5 0 0 0 $ (2 7 0 0 0 )

b. The revised performance report above shows that although actual costs exceeded the original
budget by $75,000, these costs were actually $27,000 below the amount that would have been
budgeted for the actual production of 6,000 units under flexible budget procedures. The president
was right in requesting that the accountant fix the performance report “so it makes sense.” Based
on budgetary estimates, the company did very well in controlling its variable costs.

c. Manufacturing overhead incurred:

Indirect labor $ 9 5 5 0 0
Indirect materials, supplies, etc. 4 8 4 0 0
Total fixed manufacturing costs 2 4 8 6 0 0
Total manufacturing overhead incurred $ 3 9 2 5 0 0
Manufacturing overhead applied, 150% of $261,500 (direct labor) 3 9 2 2 5 0
Underapplied manufacturing overhead $ 2 5 0

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 243
 SOLUTIONS TO CASES
30 Minutes, Medium CASE 23–1
BUDGETING IN A NUTSHELL

The value of this relatively unstructured problem lies in working it, not in the solution. We find that it
does much to refresh the students’ understanding of both accrual accounting and cash flows.
Students should state clearly their assumptions concerning:
• Amounts of cash sales and credit sales
• Collections of accounts receivable
• Purchases of inventory [This must exceed $10 (thousand) just to cover the cost of goods sold.]
• Payments on accounts payable
• Cash paid for expenses (There is no depreciation, so this may equal the amount shown in the
income statement).
The amounts appearing in the budgeted statements will vary, depending upon the assumed amounts.
In all cases, however, the budgeted balance sheet should include cash of $50 and owners’ equity of
$195. The cash budget should reflect a net increase of $10. (Amounts in thousands)
We discuss this case in class and call upon specific students to explain various amounts in their
budgeted balance sheets and cash budgets. The students’ assumptions should support these budgeted
amounts.

244 © The McGraw-Hill Companies, Inc., 2005

20 Minutes, Medium CASE 23–2
AN ETHICAL DILEMMA

a. The primary purpose of a review (or an audit) by an independent CPA is to provide people
outside of the organization with an independent expert opinion on the fairness of the presentation.
If Gamm believes the receivable from Rembrant should be written off, he should insist that it is—
or make clear his reservations in his report. Beta’s budget of future operating results has virtually
nothing to do with the collectibility of this receivable.
The fact that writing off the Rembrant account may force Beta out of business is indeed
unfortunate. But CPAs cannot “turn their heads” just to keep a failing client in business, or their
reports would have no credibility in the business world. Like umpires, CPAs’ jobs are to “call ‘em
as they see ‘em.”
Gamm won’t have to worry about collecting his fee, because this engagement probably has
reached an early end. A company seldom engages a CPA to conduct a review (or audit) when it
knows in advance that the results will be unsatisfactory. The company would not find the CPA’s
report useful, yet completing the engagement would add another creditor to the company’s list.
Instead of arguing, the parties to this dilemma should cooperate. Actually, the last thing most
banks want is to foreclose on assets—they would much rather find some way of getting repaid.
Price and Gamm might together meet with Beta’s bank and discuss the situation. Yes, it appears
that Beta will temporarily fall into violation of the loan agreement. But perhaps there is a better
way to work things out than to put Beta out of business.

b. A banker who discovered that the Rembrant account was Beta’s primary source of revenue and
liquid assets would certainly question whether Beta was in violation of its loan agreement. The
banker would also be wise to seek legal counsel because Gamm’s accounting firm may have been
negligent in allowing the account to be classified as collectible.

Solutions Manual Vol. II, Financial and Managerial Accounting 13/e, Williams et al 245
20 Minutes, Easy CASE 23–3
BUSINESS WEEK ASSIGNMENT:
YAHOO! JAPAN

a. The difficulty of constructing an annual budget when the business strategy is to force a competitor
out of business is in knowing if and when the competitor might exit the business. Projecting
revenues becomes a delicate task. In 2001 there were limited revenues from the Internet auction
business, yet in 2002 there were $95.5 million. Without revenues, making debt payments and
meeting other normal operating expenses becomes very difficult.

b. It is not unethical to charge no price for a service as Mr. Inoue did for the auction service.
However, creating a monopoly situation by leading customers to believe that the internet auction
service would not charge for the service in the long run may create some dissatisfied customers. In
addition, what prevents other Internet auction service providers from entering the business and
undercutting Yahoo! Japan’s share of the auction business in exactly the same manner? Anti-
dumping laws and monopoly restrictions might prevent this sort of business strategy from being
successful in the U.S.

246 © The McGraw-Hill Companies, Inc., 2005

 SOLUTION TO INTERNET ASSIGNMENT
30 Minutes, Medium INTERNET 23–1
BUDGETING SHAREWARE

a. The following features of the budgeting software are identified.

• Prints Statement of Income and Expense—monthly and year to date with the percent of
budgeted amount, and actual through the selected month, budgeted, and variance, in an
annualized format.

• Prints actual compared to budgeted, actual compared to prior year, or a variance from
budgeted.

• Prints income and expenses in pie and bar chart format—shows actual compared to budgeted
or actual compared to prior year amounts.

• Prints line charts—year to date, budgeted, or a comparison for any single account, total
income, total expenses, operating profit, and net profit.

b. Because there are several features that allow comparisons among actual prior year results, this
year’s budgeted information, and actual outcomes, users of this software will be able to spot areas
in need of corrective action. Also, the flexibility of printing charts for a single account or totals can
help pinpoint responsibility for corrective action. By creating bar and pie charts by department,
illustrations of how each department needs to coordinate activities to achieve budget goals can be
emphasized. Finally, the software allows for the creation of variances from budget which can be
used to evaluate the performance of departments or individuals.

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