CHAPTER 8

BUDGETING FOR PLANNING AND CONTROL

QUESTIONS FOR WRITING AND DISCUSSION

1. Budgets are the quantitative expressions of appropriate percentage to yield the amount
plans. Budgets are used to translate the of cash expected.
goals and strategies of an organization into
8. If the vice president of sales is a pessimistic
operational terms.
individual, one might expect that she or he
2. Control is the process of setting standards, would underestimate sales for the coming
receiving feedback on actual performance, year. In your role as head of the budget
and taking corrective action whenever actual process, you might increase the budgeted
performance deviates from planned sales figure to take out the individual bias.
performance. Budgets are the standards,
9. If the factory controller is a particularly
and they are compared with actual costs
optimistic individual, it is possible that the
and revenues to provide feedback.
costs for direct materials, direct labor, and
3. Budgeting forces managers to plan, overhead could be underestimated. For
provides resource information for decision example, an optimistic person might assume
making, sets benchmarks for control and that everything will go well, e.g., that there
evaluation, and improves the functions of will be no problems in obtaining an adequate
communication and coordination. supply of materials at the lowest possible
price. As head of the budget process, you
4. The master budget is the collection of all might allow for somewhat higher costs to
individual area and activity budgets. more accurately reflect reality.
Operating budgets are concerned with the
income-generating activities of a firm. 10. The learning curve is the relationship
Financial budgets are concerned with the between unit costs of production and
inflows and outflows of cash and with increasing number of units. As time goes on,
planned capital expenditures. the number of units produced in a time
5. The sales forecast is a critical input for period will increase and the cost per unit will
building the sales budget. It, however, is not decrease. The budgets affected will be the
necessarily equivalent to the sales budget. direct materials purchases budget, the direct
Upon receiving the sales forecast, labor budget, and the overhead budget.
management may decide that the firm can 11. Small firms often do not engage in a
do better or needs to do better than the
comprehensive master budgeting process.
forecast is indicating. Consequently, actions
may be taken to increase the sales potential (Personally, we believe that is a mistake.
for the coming year (e.g., increasing The budgeting process helps management
advertising). This adjustment then becomes more fully understand the business and
the sales budget. helps them to plan for the coming year.)
Even small businesses create cash budgets,
6. Yes. All budgets essentially are founded on however, because cash flow is critically
the sales budget. The production budget important. For example, it is possible to
depends on the level of planned sales. The have positive operating income, but
manufacturing budgets, in turn, depend on negative cash flow (e.g., if sales on account
the production budget. The same is true for are high, but customers are slow to pay).
the financial budgets since sales is a critical
Negative cash flow will put a company out of
input for budgets in that category.
business in short order.
7. An accounts receivable aging schedule
gives the proportion of accounts receivable 12. The master budget has been criticized for
that are, on average, collected in the months the following reasons: it does not recognize
following sale. It is important in creating the the interdependencies among departments,
cash budget, since the sales on account for it is static, and it is results- rather than
past months can be multiplied by the process-oriented. These criticisms are

203
 especially apparent when companies are in 14. A flexible budget is (1) a budget for various
a competitive, dynamic environment. When levels of activity or (2) a budget for the
the environment changes slowly, if at all, the actual level of activity. The first type of
master budget would do a good job of both flexible budget is used for planning and
planning and control. sensitivity analysis. The second type of
budget is used for control, since the actual
13. A static budget is one that is not adjusted for
costs of the actual level of activity can be
changes in activity. Using a static budget for
compared with the planned costs for the
control can be a real problem. For example,
actual level of activity.
suppose that the master (static) budget is
based on the production and sale of 100,000 15. The activity-based budget starts with output,
units, but that only 90,000 units are actually determines the activities necessary to create
produced and sold. Further suppose that the that output, and then determines the
budgeted variable cost of goods sold was resources necessary to support the
$2,000,000, and that the actual variable cost activities. This differs from the traditional
of goods sold was $1,890,000. It looks as if master budgeting process in that the master
the company spent less than expected for budget leaps directly from output to
variable manufacturing costs. However, the resources. Some of the resource levels are
budgeted variable cost was $20 per unit assumed to be fixed. This makes them
($2,000,000/100,000), and the actual independent of volume changes and hides
variable cost per unit is $21 per unit the drivers that actually do affect the fixed
($1,890,000/90,000). Not adjusting the bud- resources. As a result, the budget format
get for changes in activity level can mislead does not support the creation of value and
managers about efficiency. the thinking that would go into determining
the sources of waste.

204
 EXERCISES

8–1

Caddo Company
Production Budget
For the Third Quarter, 20XX
July August September Total
Sales............................................. 12,000 50,000 30,000 92,000
Desired ending inventory.......... 7,500 4,500 4,200 4,200
Total needs............................ 19,500 54,500 34,200 96,200
Less: Beginning inventory........ 1,800 7,500 4,500 1,800
Units to be produced............ 17,700 47,000 29,700 94,400

8–2

1. Galvin Company
Sales Budget
(in thousands)
Quarter 1 Quarter 2 Quarter 3 Quarter 4 Year
Road warrior:
Units............ 15,000 16,500 20,000 25,500 77,000
Unit price.... × $50 × $50 × $50 × $50 × $50
Sales............ $ 750,000 $ 825,000 $1,000,000 $1,275,000 $ 3,850,000

Prepster:
Units............ 84,000 24,500 98,000 35,000 241,500
Unit price.... × $30 × $30 × $30 × $30 × $30
Sales............ $ 2,520,000 $ 735,000 $2,940,000 $ 1,050,000 $ 7,245,000
Total sales........ $3,270,000 $1,560,000 $3,940,000 $ 2,325,000 $11,095,000

2. Galvin Company probably asked the marketing vice president for sales
quantity and price estimates. This vice president might have considered the
level of the past year’s sales of the two products, the actions of competitors,
the state of the economy, and so on. However, the high demand for the
prepster could be due to the recommendations of pediatricians to stop
having children carrying heavy backpacks to school.

205
8–2 Concluded
3. Production budget for road warriors:
Quarter 1 Quarter 2 Quarter 3
Sales.............................................. 15,000 16,500 20,000
Desired ending inventory........... 3,300 4,000 5,100
Total needs............................ 18,300 20,500 25,100
Less: Beginning inventory......... 1,300 3,300 4,000
Units to produce.................... 17,000 17,200 21,100

Production budget for prepsters:

Quarter 1 Quarter 2 Quarter 3
Sales.............................................. 84,000 24,500 98,000
Desired ending inventory........... 2,450 9,800 3,500
Total needs............................ 86,450 34,300 101,500
Less: Beginning inventory........ 1,170 2,450 9,800
Units to produce.................... 85,280 31,850 91,700

8–3

1. APO Company
Purchase Budget for Fabric
For the Fourth Quarter, 20XX
October November December Total
Units to be produced................. 42,000 90,000 50,000 182,000
DM per unit (oz.)......................... × 0.20 × 0.20 × 0.20 × 0.20
Production needs................ 8,400 18,000 10,000 36,400
Desired ending inventory (oz.). 3,600 2,000 1,600 1,600
Total needs.......................... 12,000 20,000 11,600 38,000
Less: Beg. inventory.................. 1,680 3,600 2,000 1,680
DM to be purchased (oz.)... 10,320 16,400 9,600 36,320
Cost per ounce........................... × $3.50 × $3.50 × $3.50 × $3.50
Total purchase cost............ $ 36,120 $57,400 $ 33,600 $
..................................127,120

206
8–3 Concluded
2. APO Company
Purchase Budget for Polyfiberfill
For the Fourth Quarter, 20XX
October November December Total
Units to be produced................. 42,000 90,000 50,000 182,000
DM per unit (oz.)......................... × 8 × 8 × 8 × 8
Production needs....................... 336,000 720,000 400,000 1,456,000
Desired ending inventory (oz.). 288,000 160,000 128,000 128,000
Total needs.......................... 624,000 880,000 528,000 1,584,000
Less: Beg. inventory.................. 134,400 288,000 160,000 134,400
DM to be purchased (oz.)... 489,600 592,000 368,000 1,449,600
Cost per ounce........................... × $0.05 × $0.05 × $0.05 × $0.05
Total purchase cost............ $ 24,480 $ 29,600 $ 18,400 $ 72,480

3. APO Company
Direct Labor Budget
For the Fourth Quarter, 20XX
October November December Total
Units to be produced................. 42,000 90,000 50,000 182,000
Direct labor time per
unit (hours).......................... × 0.10 × 0.10 × 0.10 × 0.10
Total hours needed.................... 4,200 9,000 5,000 18,200
Wages per hour.......................... × $15 × $15 × $15 × $15
Total direct labor cost........ $63,000 $ 135,000 $ 75,000 $ 273,000

8–4

Audio-2-Go, Inc.
Sales Budget
For 2007
Model Units Price Total Sales
A-1................................ 10,000 $ 65 $ 650,000
A-2................................ 33,000 75 2,475,000
A-3................................ 50,000 72 3,600,000
A-4................................ 16,500 120 1,980,000
A-5................................ 6,000 200 1,200,000
A-6................................ 15,000 180 2,700,000
Total.......................... $12,605,000

8–5

207
1.
January February March April May
Sales............................ 150 140 145 160 200
Desired EI.................... 28 29 32 40 52
Needed................... 178 169 177 200 252
Less: BI....................... 84 28 29 32 40
Unit purchases...... 94 141 148 168 212

2. Sales price = $8 (monthly dollar sales/unit sales)

Cost × 1.60 = Price
Cost = $8/1.60
Cost = $5

Unit Unit Total

Month Purchases Cost Cost
January........ 94 $5 $ 470
February....... 141 5 705
March............ 148 5 740
April.............. 168 5 840
May............... 212 5 1,060

8–6

Schedule of Cash Receipts

May June
Cash sales:
($75,000 × 75%)............................... $56,250
($80,000 × 75%)............................... $60,000
Checks*................................................... 18,250 19,467
Total................................................. $74,500 $ 79,467

*Check collections for: May June

(0.25 × $75,000)............................... $18,750
(0.25 × $80,000)............................... $20,000
Less: Bad checks
(0.02 × $18,750)............................... (375)
(0.02 × $20,000)............................... (400)
Less: Service charge
[($18,750/$75) × $0.50]................... (125)
[($20,000/$75) × $0.50]................... (133)
$18,250 $19,467

8–7

208
Revised sales estimates:
April ($60,000 × 1.20)...................................... $72,000
May ($75,000 × 1.20)....................................... 90,000
June ($80,000 × 1.20)..................................... 96,000

Schedule of Cash Receipts

May June
Cash sales:
($90,000 × 5%)................................................. $ 4,500
($96,000 × 5%)................................................. $ 4,800
VISA/Mastercard:
[(0.75 × $72,000) – $1,890]............................. 52,110
[(0.75 × $90,000) – $2,363]............................. 65,137
American Express:
[(0.20 × $72,000) – $792]................................ 13,608
[(0.20 × $90,000) – $990]................................ 17,010
Total......................................................................... $ 70,218 $86,947

8–8
1. Cash Budget
For the Month of October, 20XX
Beginning cash balance.............................................. $ 1,980
Collections:
Cash sales............................................................. 10,000
Credit sales:
October ($65,000 × 50%)............................... 32,500
September ($90,000 × 30%).......................... 27,000
August ($80,000 × 15%)................................ 12,000
Total cash available..................................................... $83,480
Less disbursements:
Inventory purchases:
October ($75,000 × 70% × 40%).................... $21,000
September ($110,000 × 70% × 60%)............. 46,200
Salaries and wages............................................... 2,000
Rent........................................................................ 2,700
Taxes...................................................................... 5,000
Other operating expenses................................... 800
Owner withdrawal................................................. 4,000
Advertising............................................................ 500 82,200
Total cash needs........................................... $ 1,280
8–8 Concluded

209
2. The ending cash balance does not meet the desired level of $2,000. To
quickly adjust the expected ending cash balance, the owner could consider
withdrawing less for his own salary or decreasing discretionary expenses.

8–9

1. From payments in May for credit sales in:

February ($65,000 × 0.9 × 0.05)................ $ 2,925

March ($70,000 × 0.9 × 0.25)..................... 15,750
April ($80,000 × 0.9 × 0.30)....................... 21,600
May ($85,000 × 0.9 × 0.40)........................ 30,600
Total....................................................... $70,875

2. April credit sales = $80,000 × 0.9 = $72,000

Decrease in cash from April credit sales = (0.02 × $72,000) = $1,440

8–10

David Campbell’s
Schedule of Anticipated Cash Receipts
August September
Cash sales.............................................................. $ 15,000 $ 16,000
Received from sales in:
June (0.8)($85,000)(0.18)(1.02).......... 12,485 —
July ....................(0.8)(0.65)($55,000) 28,600
(0.8)(0.18)($55,000)(1.02).......... 8,078
August (0.8)(0.15)($75,000).................... 9,000
(0.8)(0.65)($75,000).................... 39,000
September (0.8)(0.15)($80,000).................... — 9,600
Total......................................................................... $ 65,085 $ 72,678

210
8–11
1. August September
July ...................(1/3)($35,000)(0.98) $ 11,433
—
(2/3)($35,000)............................. 23,333 —
August (1/3)($40,000)(0.98)................... — $ 13,067
(2/3)($40,000)............................. — 26,667
Total............................................................ $ 34,766 $ 39,734

2. July August
July 1: (1/3)($25,000)(0.98).................. $ 8,167 —
11: (1/3)($35,000)(0.98).................. 11,433 —
21: (1/3)($35,000)(0.98).................. 11,433 —
Aug. 1: (1/3)($35,000)(0.98).................. — $ 11,433
11: (1/3)($40,000)(0.98).................. — 13,067
21: (1/3)($40,000)(0.98).................. — 13,067
Total............................................................ $ 31,033 $ 37,567

3. Monthly cost of temporary clerk = 2 × 4 × $22 = $176

This is a good idea as long as monthly purchases exceed $8,800 ($176/0.02)
because the savings from taking the cash discount (2% of purchases) will
more than pay for the clerk.

8–12
1. Production budget for August:
Sales................................................ 2,500
Desired ending inventory.............. 840
Total needs............................... 3,340
Less: Beginning inventory........... 1,000
Units to produce...................... 2,340

2. August purchases budget for table legs:

Units to be produced..................... 1,600

DM per unit (oz.)............................. × 4
Production needs........................... 6,400
Desired ending inventory*............ 4,320
Total needs..................................... 10,720
Less: Beginning inventory............ 4,200
DM to be purchased (oz.).............. 6,520

*Desired ending inventory = (1,800 × 4) × 0.60 = 4,320.

211
8–12 Concluded

3. Number of direct labor hours = 1,800 units × 0.3 direct labor hour per unit
= 600 direct labor hours

Number of employees = Direct labor hours/Hours per week

= 600/(40 × 4) = 3.75

8–13
1. Zebro Products
Overhead Budget
For the Year Ended December 31, 20XX
Formula 30,000 DLH*
Variable costs:
Maintenance............................. 0.20 $ 6,000
Power........................................ 0.50 15,000
Indirect labor............................ 1.50 45,000
Total variable costs......... $ 66,000
Fixed costs:
Maintenance............................. $ 10,000
Indirect labor............................ 43,600
Rent........................................... 24,000
Total fixed costs.............. 77,600
Total overhead costs....................... $143,600
*Counter wipes: (0.01 × 500,000)................. 5,000
Floor wipes: (0.05 × 500,000)...................... 25,000
Total direct labor hours.......................... 30,000

212
8–13 Concluded
2. 10% higher:
Zebro Products
Overhead Budget
For the Year Ended December 31, 20XX
Formula 33,000 DLH*
Variable costs:
Maintenance............................. 0.20 $ 6,600
Power........................................ 0.50 16,500
Indirect labor............................ 1.50 49,500
Total variable costs......... $ 72,600
Fixed costs:
Maintenance............................. $ 10,000
Indirect labor............................ 43,600
Rent.......................................... 24,000
Total fixed costs.............. 77,600
Total overhead costs....................... $150,200
*30,000 DLH × 110% = 33,000.

20% lower:
Zebro Products
Overhead Budget
For the Year Ended December 31, 20XX
Formula 24,000 hours*
Variable costs:
Maintenance............................. 0.20 $ 4,800
Power........................................ 0.50 12,000
Indirect labor............................ 1.50 36,000
Total variable costs......... $ 52,800
Fixed costs:
Maintenance............................. $ 10,000
Indirect labor............................ 43,600
Rent.......................................... 24,000
Total fixed costs.............. 77,600
Total overhead costs....................... $130,400
*30,000 DLH × 80% = 24,000.

213
8–14
Zebro Products
Performance Report
For the Year Ended December 31, 20XX
Actual Budget Variance
DLH for units produced.......... 30,500 30,500 0
Production costs*:
Maintenance...................... $ 15,600 $ 16,100 $ (500) F
Power.................................. 17,250 15,250 2,000 U
Indirect labor..................... 89,000 89,350 (350) F
Rent.................................... 24,000 24,000 0
Total............................. $145,850 $ 144,700 $1,150 U

*Flexible budget amounts are based on 30,500 DLH:

(0.01 × 550,000 + 0.05 × 500,000) = 30,500 DLH
Maintenance $10,000 + $0.20(30,500) = $16,100
Power $0.50(30,500) = $15,250
Indirect labor $43,600 + $1.50(30,500) = $89,350

8–15

1. Sales revenue:
Pessimistic Expected Optimistic
Sleepeze............................. $2,250,000 $ 3,000,000 $ 3,600,000
Plushette............................ 3,000,000 4,200,000 5,040,000
Ultima................................. 1,800,000 5,000,000 6,000,000
Total sales.................... $ 7,050,000 $12,200,000 $14,640,000

2.
Pessimistic Expected Optimistic
Salaries............................... $ 130,000 $ 130,000 $ 130,000
Depreciation...................... 20,000 20,000 20,000
Office supplies & other.... 21,000 21,000 21,000
Advertising:
Sleepeze & Plushette. . 20,000 20,000 20,000
Ultima............................ 270,000 750,000 900,000
Commissions..................... 262,500 360,000 432,000
Shipping:
Sleepeze....................... 625,000 750,000 900,000
Plushette....................... 500,000 600,000 700,000
Ultima............................ 150,000 375,000 375,000
Total.................................... $ 1,998,500 $ 3,026,000 $3,498,000
8–16

214
1. Activity-based budget:
Research:
Salary...................................... $ 30,000
Internet connection............... 1,920 $ 31,920
Shipping:
Salaries................................... $ 24,500
Telephone............................... 2,500
Ship sleepeze......................... 750,000
Ship plushette........................ 600,000
Ship ultima............................. 375,000 1,752,000
Jobbers:
Salaries................................... $ 18,750
Telephone............................... 2,500
Commissions......................... 360,000 381,250
Basic ads:
Salaries................................... $ 16,000
Advertising............................. 20,000 36,000
Ultima ads:
Salaries................................... $ 20,750
Advertising............................. 750,000 770,750
Manage office:
Salaries................................... $ 20,000
Depreciation........................... 20,000
Telephone............................... 14,080 54,080
Total............................................. $3,026,000

2. Clearly, shipping is the most costly activity, followed by ultima advertising

and commissions to jobbers. It would be worthwhile to investigate shipping
costs to see if those could be reduced, for example, by getting bids from
several shippers. It is unlikely that ultima advertising should be reduced the
first year. It is a very different, and expensive, model, and consumers may
need to be educated as to its benefits. Another method of selling to retail
stores might be worth investigating. For example, the use of a salaried sales
staff.

215
 PROBLEMS

8–17

1. Schedule 1: Sales budget

January February March Total
Units.......................... 20,000 25,000 30,000 75,000
Unit selling price...... × $90 × $90 × $90 × $90
Sales.................... $1,800,000 $ 2,250,000 $ 2,700,000 $
6,750,000

2. Schedule 2: Production budget

January February March Total
Sales (Schedule 1)................... 20,000 25,000 30,000 75,000
Desired ending inventory....... 17,500 21,000 21,000 21,000
Total needs.......................... 37,500 46,000 51,000 96,000
Less: Beginning inventory..... 13,000 17,500 21,000 13,000
Units to be produced......... 24,500 28,500 30,000 83,000

3. Schedule 3: Direct materials purchases budget

January February
Part 714 Part 502 Part 714 Part 502
Units to be produced......... 24,500 24,500 28,500 28,500
Dir. mat. per unit................. × 5 × 3 × 5 × 3
Production needs......... 122,500 73,500 142,500 85,500
Desired EI............................ 62,500 37,500 75,000 45,000
Total needs.................... 185,000 111,000 217,500 130,500
Less: BI............................... 50,000 30,000 62,500 37,500
Dir. mat. to purchase.... 135,000 81,000 155,000 93,000
Cost per unit....................... × $4 × $3 × $4 × $3
Total cost....................... $ 540,000 $243,000 $ 620,000 $
279,000

March Total
Part 714 Part 502 Part 714 Part 502
Units to be produced......... 30,000 30,000 83,000 83,000
Dir. mat. per unit................. × 5 × 3 × 5 × 3
Production needs.......... 150,000 90,000 415,000 249,000
Desired EI............................ 75,000 45,000 75,000 45,000
Total needs.................... 225,000 135,000 490,000 294,000
Less: BI................................ 75,000 45,000 50,000 30,000
Dir. mat. to purchase.... 150,000 90,000 440,000 264,000
Cost per unit....................... × $4 × $3 × $4 × $3

216
 Total cost....................... $ 600,000 $270,000 $1,760,000 $
792,000

8–17 Continued

4. Schedule 4: Direct labor budget

January February March Total

Units to be produced
(Schedule 2)....................... 24,500 28,500 30,000 83,000
Direct labor time per
unit (hrs.)............................ × 2 × 2 × 2 × 2
Total hours needed.................. 49,000 57,000 60,000 166,000
Wages per hour........................ × $15 × $15 × $15 × $15
Total dir. labor cost........... $ 735,000 $ 855,000 $ 900,000 $
2,490,000

5. Schedule 5: Overhead budget

January February March Total
Budgeted direct labor
hours (Schedule 4)............ 49,000 57,000 60,000 166,000
Variable overhead rate............ × $3.90 × $3.90 × $3.90 × $3.90
Budgeted var. overhead.......... $191,100 $222,300 $234,000 $ 647,400
Budget fixed overhead............ 205,000 205,000 205,000 615,000
Total overhead................... $396,100 $ 427,300 $439,000 $
1,262,400

6. Schedule 6: Selling and administrative expense budget

January February March Total
Planned sales (Schedule 1).... 20,000 25,000 30,000 75,000
Variable selling &
administrative expense
per unit............................... × $3.75 × $3.75 × $3.75 × $3.75
Total variable expense............ $ 75,000 $ 93,750 $112,500 $
281,250
Fixed selling &
administrative expense:
Salaries........................ $ 30,000 $ 30,000 $ 30,000 $ 90,000
Depreciation................ 5,000 5,000 5,000 15,000
Other............................ 10,000 10,000 10,000 30,000
Total fixed expenses............... $ 45,000 $ 45,000 $ 45,000 $
135,000
Total selling &

217
 administrative exp...... $120,000 $138,750 $157,500 $
416,250

218
8–17 Continued
7. Schedule 7: Ending finished goods inventory budget
Unit cost computation:
Direct materials Part 714 (5 × $4) = $ 20
Part 502 (3 × $3) = 9............................ $29.00
Direct labor (2 × $15)............................................................... 30.00
Overhead:
Variable (2 × $3.90)........................................................... 7.80
Fixed (2 × $3.705)*............................................................ 7.41
Total unit cost.......................................................................... $74.21
*$615,000/166,000.
Units Cost per Unit Total Amount
Finished goods......................... 21,000 $74.21 $1,558,410

8. Schedule 8: Cost of goods sold budget

Direct materials used (Schedule 3):
Part 714 (415,000 × $4.00)................................... $1,660,000
Part 502 (249,000 × $3.00)................................... 747,000 $
2,407,000
Direct labor used (Schedule 4).................................. 2,490,000
Overhead (Schedule 5)............................................... 1,262,400
Budgeted manufacturing costs......................... $6,159,400
Add: Beginning finished goods (13,000 × $74.21)*. 964,730
Goods available for sale..................................... $7,124,130
Less: Ending finished goods (Schedule 7).............. 1,558,410
Budgeted cost of goods sold............................. $
5,565,720
*Assumes that these units cost the same as current quarter’s production.

9. Schedule 9: Budgeted income statement

Sales (Schedule 1)............................................................................. $
6,750,000
Less: Cost of goods sold (Schedule 8)........................................... 5,565,720
Gross margin............................................................................... $
1,184,280
Less: Selling and administrative expense (Schedule 6)............... 416,250
Income before taxes................................................................... $ 768,030

219
8–17 Concluded
10. Schedule 10: Cash budget
January February March Total
Beg. balance............................. $ 162,900 $ 33,800 $ 0 $ 162,900
Cash receipts........................... 1,800,000 2,250,000 2,700,000 6,750,000
Cash available................... $1,962,900 $ 2,283,800 $ 2,700,000 $
6,912,900
Less disbursements:
Purchases.......................... $ 783,000 $ 899,000 $ 870,000 $2,552,000
DL payroll........................... 735,000 855,000 900,000 2,490,000
Overhead*.......................... 296,100 327,300 339,000 962,400
Marketing & admin.*......... 115,000 133,750 152,500 401,250
Land.................................... 90,000 90,000
Total.............................. $1,929,100 $ 2,305,050 $ 2,261,500 $
6,495,650
Ending balance........................ $ 33,800 $ (21,250) $ 438,500 $ 417,250
Borrowed/repaid...................... 0 21,250 (21,250) 0
Interest paid.............................. 0 0 (213) (213)
Ending balance................. $ 33,800 $ 0 $ 417,037 $ 417,037
*Excludes depreciation, which is a noncash expense.

8–18

1. Schedule of purchases:
Cost of sales + 0.3333 Cost of sales = Sales
Cost of sales = 0.75 Sales

August September October November

Cost of sales........................ $ 90,000 $67,500 $ 75,000 $101,250
Desired end. inventory*...... 27,000 30,000 40,500 45,000
Total requirements....... $117,000 $97,500 $115,500 $146,250
Less: Beg. inventory........... 36,000 27,000 30,000 40,500
Purchases..................... $ 81,000 $ 70,500 $ 85,500 $105,750
*0.40 × next month’s cost of sales.

Since purchases are paid for in the following month, accounts payable at the
end of August is $81,000. Inventory for August 31 is $27,000.

220
8–18 Continued
Accounts receivable for August 31 is computed as follows:

From August: 0.8 × $120,000 × 0.8* = $

76,800
From July: 0.8 × $100,000 × 0.3 = 24,000
Total........................................... $ 100,800

*By August 31, 20% of August credit sales have been collected, leaving 80%
still on account.

Given accounts payable, the total assets must equal $569,750 ($81,000 +
$220,000 + $268,750). Cash is computed as the difference between total
assets and all other assets except cash ($569,750 – $425,000 – $33,750 –
$100,800). This difference is $10,200.

Assets L&OE
Cash.......................................... $ 10,200
Accounts receivable............... 100,800
Inventory.................................. 27,000
Plant and equipment............... 431,750
Accounts payable............ $ 81,000
Common stock................. 220,000
Retained earnings............ 268,750
Totals......................... $569,750 $ 569,750

221
8–18 Continued
2. Cash Budget
For the Period Ending November 30
September October November Total
Beginning cash balance.... $ 10,200 $ 10,900 $ 17,425 $ 10,200
Cash collections a................ 104,400 100,800 110,200 315,400
Total cash available.... $114,600 $ 111,700 $127,625 $
325,600

Cash disbursements:
Accounts Payable b...... $ 81,000 $ 70,500 $ 85,500 $
237,000
Salaries and wages..... 10,000 10,000 10,000 30,000
Utilities......................... 1,000 1,000 1,000 3,000
Other............................. 1,700 1,700 1,700 5,100
Property taxes............. 15,000 — — 15,000

Advertising fees.......... — 6,000 — 6,000

Lease............................ — — 5,000 5,000
Total disburse...... $108,700 $ 89,200 $103,200 $
301,100
Minimum cash balance.... 10,000 10,000 10,000 10,000
Total cash needs......... $118,700 $ 99,200 $113,200 $
311,100
Excess (deficiency)............ $ (4,100) $ 12,500 $ 14,425 $ 14,500
Financing:
Borrowings.................. $ 5,000 $ 5,000
Repayments................. $ (5,000) (5,000)
Interestc........................ (75) (75)

Total financing..... $ 5,000 $ (5,075) $ (75)

Ending cash balance d........ $ 10,900 $ 17,425 $ 24,425 $ 24,425
a
Cash collections:
Cash sales......................... $ 18,000 $ 20,000 $ 27,000 $ 65,000
Credit sales:
Current month............. 14,400 16,000 21,600 52,000
Prior month.................. 48,000 36,000 40,000 124,000
From two months ago 24,000 28,800 21,600 74,400
Total collections............... $104,400 $ 100,800 $110,200 $
315,400
b
For Accounts Payable taken from the balance sheet developed in Requirement
1.
c
$5,000 × 0.09 × (2/12) (beginning of September to end of October).

222
d
Includes minimum cash balance of $10,000.

223
8–18 Concluded
3. Creighton Hardware Store
Balance Sheet
November 30
Cash.......................................... $ 24,425
Accounts receivable a.............. 110,400
Inventoryb................................. 45,000
Plant and equipment c.............. 413,000
Accounts payable b........... $105,750
Common stock................. 220,000
Retained earnings d........... 267,075
Totals......................... $ 592,825 $ 592,825
a
(0.8 × $135,000 × 0.8) + (0.8 × $100,000 × 0.3).
b
From purchases schedule prepared in Requirement 1.
c
[425,000 – 3(4,000)].
d
If total assets equal $592,825, then liabilities plus stockholders’ equity must
also equal that amount. Subtracting accounts payable and common stock
from total liabilities and stockholders’ equity gives retained earnings of
$267,075.

8–19
1. a. Production budget:

January February March Total

Sales in units......................... 20,000 24,000 16,000 60,000
Plus: ending inventory......... 12,000 8,000 9,000 9,000
............Total units required 32,000 32,000 25,000
69,000
Less: beginning inventory... 10,000 12,000 8,000 10,000
Units to be produced........ 22,000 20,000 17,000 59,000

b. Direct labor budget (hours):

January February March Total

Units to be produced............ 22,000 20,000 17,000 59,000
Direct labor hours per unit. . × 4.0 × 4.0 × 3.5
Total labor budget (hours) 88,000 80,000 59,500 227,500

224
8–19 Concluded
c. Direct materials budget:

January February March Total

Units to be produced............ 22,000 20,000 17,000 59,000
Cost per unit.......................... × $10 × $10 × $10 × $10
Total direct materials....... $220,000 $200,000 $170,000 $590,000

d. Sales budget (dollars):

January February March Total

Sales in units......................... 20,000 24,000 16,000 60,000
Sales price per unit............... × $80 × $80 × $80 × $80
Total sales revenue.......... $1,600,000 $1,920,000 $1,280,000 $
4,800,000

2. Bullen & Company

Budgeted Contribution Margin
First Quarter, 2007
January February March Total
Direct labor hours per unit..... 4.0 4.0 3.5
Direct labor rate per hour........ × $15 × $15 × $16
Direct labor cost....................... $ 60 $ 60 $ 56

Sales units................................ 20,000 24,000 16,000 60,000

Sales revenue........................... $ 1,600,000 $ 1,920,000 $1,280,000 $

...................................4,800,000
Direct labor cost....................... 1,200,000 1,440,000 896,000 3,536,000
Materials cost........................... 200,000 240,000 160,000 600,000
Contribution margin........... $ 200,000 $ 240,000 $ 224,000 $ 664,000

225
8–20
Friendly Freddie’s
Cash Budget
October through December
October November December
Beginning cash balance.......................... $ 8,800 $ 8,600 $ 9,120
Receipts:
Cash sales........................................... $ 14,000 $ 29,000 $ 44,000
Collections of sales on account 1...... 118,200 126,340 134,080
Note receivable repayment................ 13,000
Total cash receipts................................... $145,200 $155,340 $178,080
Cash available.......................................... $154,000 $163,940 $187,200
Disbursements:
Payment of inventory purchases 2..... $116,400 $108,640 $124,160
Operating expenses........................... 38,000 41,000 46,000
Loan repayment.................................. 5,000 4,000
Interest3................................................ 180 80
Total disbursements................................ $154,400 $ 154,820 $174,240
Cash balance............................................ $ (400) $ 9,120 $ 12,960
Bank loan 4................................................. 9,000
Adjusted cash balance............................ $ 8,600 $ 9,120 $ 12,960
1
Collections of sales on account:
October November December
July 6% of $130,000............... $ 7,800
August 20% of $104,000............. 20,800
6% of $104,000............... $ 6,240
September 70% of $128,000............. 89,600
20% of $128,000............. 25,600
6% of $128,000............... $ 7,680
October 70% of $135,000............. 94,500
20% of $135,000............. 27,000
November 70% of $142,000............. 99,400
December 0.......................................
Total...................................................... $118,200 $ 126,340 $134,080
2
Payments for inventory purchases:
October November December
September purchases (97% of $120,000). . $116,400
October purchases (97% of $112,000)....... $108,640
November purchases (97% of $128,000)... $124,160
3
Total collections:
November—2% of $9,000
December—2% of $4,000
4
Loans must be taken out and repaid in multiples of $1,000.

226
8–21
1. Overhead rate = $423,167/13,446 = $31.47
Predicted Actual
Month Overhead Overhead Variance
January.......................... $ 31,470 $ 32,296 $ 826 U
February......................... 29,267 31,550 2,283 U
March.............................. 34,617 36,280 1,663 U
April................................ 33,044 36,867 3,823 U
May................................. 36,820 36,790 30 F
June................................ 37,764 37,800 36 U
July................................. 38,865 40,024 1,159 U
August............................ 37,449 39,256 1,807 U
September...................... 33,673 33,800 127 U
October.......................... 38,079 33,779 4,300 F
November....................... 37,984 37,225 759 F
December....................... 34,113 27,500 6,613 F
Total.......................... $ 423,145 $ 423,167 $ 22 U

2. The regression for overhead cost as a function of machine hours gives the
following formula:
Overhead cost = $8,699.64 + $23.71 (machine hours)

Predicted Actual
Month Overhead Overhead Variance
January.......................... $ 32,410 $ 32,296 $ 114 F
February......................... 30,750 31,550 800 U
March.............................. 34,781 36,280 1,499 U
April................................ 33,595 36,867 3,272 U
May................................. 36,440 36,790 350 U
June................................ 37,152 37,800 648 U
July................................. 37,981 40,024 2,043 U
August............................ 36,915 39,256 2,341 U
September...................... 34,069 33,800 269 F
October.......................... 37,389 33,779 3,610 F
November....................... 37,318 37,225 93 F
December....................... 34,401 27,500 6,901 F
Total.......................... $ 423,201 $ 423,167 $ 34 F

The flexible budget based on machine hours is better than the budget using only
the plantwide overhead rate because the flexible budget divides overhead costs
into fixed and variable components. This division would at least give the
controller the ability to make a rough calculation of the marginal cost of running
additional machine hours at the factory. However, the regression equation on
which the flexible budget is based is not particularly good (adjusted R 2 of 0.345).

227
8–22

1. The multiple regression for overhead cost gives the following formula:

Overhead cost = $6,035.99 + $4.56 (machine hours) + $771.10 (setups)

+ $29.94 (purchase orders)

Predicted Actual

Month Overhead Overhead Variance

January.......................... $ 32,485 $ 32,296 $ 189 F
February....................... 31,642 31,550 92 F
March............................ 36,227 36,280 53 U
April....................... 36,643 36,867 224 U
May................................ 36,868 36,790 78 F
June................................ 37,971 37,800 171 F
July............................... 39,583 40,024 441 U
August.......................... 39,041 39,256 215 U
September.................... 33,972 33,800 172 F
October........................ 34,356 33,779 577 F
November..................... 37,359 37,225 134 F
December..................... 27,037 27,500 463 U
Total.......................... $ 423,184 $ 423,167 $ 17 F

The flexible budget based on multiple regression is much better than the one
based on simple regression. Multiple regression enables the controller to
use three independent variables, each based on a different driver. We can
see that the R2 has improved considerably (to 0.99). In addition, if we
compare the monthly variances of the two budgets, the flexible budget using
three variables shows much smaller monthly variations. As a result, this
budget will be more useful to the controller for planning and decision
making. Finally, the use of the three independent variables moves the factory
closer to the more powerful technique of activity-based budgeting.

228
8–22 Concluded

2. The multiple regression for overhead cost gives the following formula:

OH = $5,715.47 + $3.74 (machine hours) + $767.03 (setups) + $34.68 (purchase

orders) + $887 (Party)

Predicted Actual
Month Overhead Overhead Variance
January.......................... $ 32,287 $ 32,296 $ 9U
February......................... 31,670 31,550 120 F
March.............................. 36,341 36,280 61 F
April................................ 36,648 36,867 219 U
May................................. 36,850 36,790 60 F
June................................ 37,702 37,800 98 U
July................................. 40,150 40,024 126 F
August............................ 39,083 39,256 173 U
September...................... 33,901 33,800 101 F
October.......................... 33,878 33,779 99 F
November....................... 37,235 37,225 10 F
December....................... 27,364 27,500 136 U
Total.......................... $ 423,109 $ 423,167 $ 58 U

The flexible budget based on multiple regression with the four variables is better
than the one using multiple regression with three variables. The R 2 for both
regressions is 0.99, so that is not the deciding factor. Instead, we see that the
addition of the “Party” variable begins to move the budget even more in the
direction of activity-based budgeting, since the throwing of the parties is an
activity. In this case, we see that each party costs the factory about $887. Now,
managers can begin to balance the cost of the parties with the benefits (probably
improved morale).

229
8–23

1. Fixed costs:
Rent
Depreciation
Salaries
Utilities
Janitorial services
Accounting and financial services
Insurance
Other expenses

Variable costs:
Office supplies, driver is number of patients
Medical supplies, driver is number of 15-minute time slots

2.
Dorian Dermatology Associates
Overhead Budget
For the Month of May
Rent............................................................................... $ 1,200
Depreciation................................................................. 1,000
Supplies [(800 × $10) + (1,200 × $5)]......................... 14,000
Salaries
Office manager....................................................... $ 2,083
Medical assistants................................................. 3,000
Receptionist........................................................... 1,250 6,333
Utilities.......................................................................... 500
Janitorial services....................................................... 250
Accounting and financial services........................... 2,400
Insurance..................................................................... 3,000
Other expenses........................................................... 700
Total......................................................................... $ 29,383

230
8–24
1.
Cost per Amount of Total
Activity Driver Unit of Driver Driver Cost
Schedule appointments # phone calls $ 1.00 875 $ 875
Initial screening # patients 7.25 800 5,800
Assist doctors # procedures 7.25 400 2,900
File insurance # claims 9.27 650 6,026
Handle disputed claims # disputed claims 123.50 40 4,940
Provide facilities 8,550
Total......................................................................................................... $
29,091

2. Clearly, the cost of each disputed claim is quite high. The office manager
should think about the reasons why claims are disputed, e.g., errors in filing
the initial claim, failing to provide sufficient information for unusual
diagnoses. Then, perhaps the number of disputes can be reduced.

8–25
1. a. An imposed budgetary approach does not allow input from those who
are directly affected by the process. This can tend to make the
employees feel that they are unimportant and that management is
concerned only with meeting budgetary goals and not necessarily with
the well-being of employees. The employees will probably feel less of a
bond with the organization and will feel that they are meeting standards
set by others. An imposed budgetary approach is impersonal and can
give employees the feeling that goals are set arbitrarily or that some
people benefit at the expense of others. Goals that are perceived as
belonging to others are less likely to be internalized, increasing the
likelihood of dysfunctional behavior. Furthermore, imposed budgets fail
to take advantage of the knowledge subordinate managers have of
operations and local market conditions.

b. A participative budgetary approach allows subordinate managers

considerable say in how budgets are established. This communicates a
sense of responsibility to the managers and fosters creativity. It also
increases the likelihood that the goals of the budget will become the
managers’ personal goals, due to their participation. This results in a
higher degree of goal congruence. Many feel that there will be a higher
level of performance because individuals who are involved in setting
their own standards may work harder to achieve them. When managers
are allowed to give input in developing the budget, they tend to feel that
its success or failure reflects more personally on them.

231
8–25 Concluded
2. a. In an imposed budgetary setting, communication flows from the top to
the bottom and is mostly a 1-way flow. Any upward flow would have to
do with understanding the budgets being communicated. For
participative budgeting, the communication flows are necessarily in both
directions, with much of the communication being initiated by
subordinate managers.

b. The first communication process leaves the impression that the

opinions and thoughts of lower-level managers are unimportant. They
may feel that no input is being solicited because their input is not
valued. The second process, however, conveys the impression that
opinions and views are important and valued. This tends to create a
greater feeling of worth to the organization and a stronger commitment
to achieving its goals.

8–26
1. a. The reasons that Marge Atkins and Pete Granger use budgetary slack
include the following:
 They are hedging against the unexpected, thereby reducing
uncertainty and risk.
 The use of budgetary slack allows employees to exceed
expectations and/or show consistent performance. This is
particularly important when performance is evaluated on the basis
of actual results versus budget.
 Employees are able to blend personal and organizational goals
through the use of budgetary slack as good performance generally
leads to higher salaries, promotions, and bonuses.

b. The use of budgetary slack can adversely affect Marge and Pete by:
 Limiting the usefulness of the budget to motivate their employees to
top performance.
 Affecting their ability to identify trouble spots and take appropriate
corrective actions.
 Reducing their credibility in the eyes of management.
 Also, the use of budgetary slack may affect management decision
making, as the budgets will show lower contribution margins (lower
sales, higher expenses). Decisions regarding the profitability of
product line, staffing levels, incentives, etc., could have an adverse
effect on Marge’s and Pete’s departments.

232
8–26 Concluded
2. The use of budgetary slack, particularly if it has a detrimental effect on the
company, may be unethical. In assessing the situation, the specific
provisions of the “Standards of Ethical Conduct for Management
Accountants” that should be considered are:

Competence: Clear reports using relevant and reliable information should be

prepared.

Integrity: Any activity that subverts the legitimate goals of the company
should be avoided. Favorable as well as unfavorable information should be
communicated.

Objectivity: Information should be fairly and objectively communicated. All

relevant information should be disclosed.

233
 COLLABORATIVE LEARNING EXERCISE

8–27
1. Cash sales ($700,000 × 0.20)............................................................... $140,000
Credit sales ($700,000 × 0.80 × 0.30).................................................. 168,000
Cash received in March from March sales.................................. $ 308,000

2. April cash sales ($625,000 × 0.80 × 0.25)........................................... $125,000

Collection of credit sales in:
February ($650,000 × 0.80 × 0.25)................................................. 130,000
March ($700,000 × 0.80 × 0.40)...................................................... 224,000
April ($625,000 × 0.80 × 0.30)......................................................... 150,000
Total receipts............................................................................. $ 629,000

3. February purchases for:

February sales ($650,000 × 0.40 × 0.70)............................................. $182,000
Ending inventory ($700,000 × 0.40 × 0.30)......................................... 84,000
Total February purchases............................................................. $ 266,000

4. February cost of goods sold = $650,000 × 0.40 = $260,000

5. Cash disbursements in April for operating expenses:

Variable operating expenses from March ($700,000 × 0.10)........... $ 70,000

Fixed expenses:
Advertising (1/12 × $720,000)........................................................ 60,000
Salaries (1/12 × $1,080,000)........................................................... 90,000
Insurance (1/4 × $180,000)............................................................. 45,000
Property taxes (1/2 × $240,000).................................................... 120,000
Total....................................................................................................... $ 385,000

CYBER RESEARCH CASE

8–28

Answers will vary.

234