Final Paper Accounting 206
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chapter 6
Budgeting
Learning Objectives
• Understand the need for, nature of, and benefits associated with budgeting.
• Know about organizational behavior dimensions of the budgeting process.
• Know the components of a master budget.
• Be familiar with alternative types of budget cycles.
• Understand the concepts and methods associated with flexible budgeting and how technology can enhance budgeting and planning.
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CHAPTER 6Section 6.1 Purpose of Budgeting
Chapter Outline
6.1 Purpose of Budgeting
6.2 Benefits of Budgeting Responsibility Accounting Budgets Drive Efficiency Human Behavior
6.3 Budgeting Drawbacks Quality Estimates The Comprehensive Budget Sales and Cash Collections Budgets
6.4 Production Budget Purchases and Payments for Materials Direct Labor Budget Factory Overhead Budget SG&A Budget Budgeted Income Statement Cash Budget Distribution of Budgets Budget Cycles
6.5 Flexible Budgets Using Flexible Budgets in Business Management Considering Per-Unit Costs and Profit Impacts Extending Flexible Budgeting
6.6 Benefits of Technology in Budgeting
6.1 Purpose of Budgeting
If you have worked in a medium to large-sized organization, you have probably had some level of involvement with a budget and the budget process. Although many may not see the need for a budget, and often question the value of the entire exercise, by the end of this chapter it is hoped that you will appreciate the importance of budgeting. The substantial positive benefits of budgeting usually offset and justify the time and effort. Budgets are detailed financial plans that quantify future expectations and actions. These expectations and actions relate to numerous facets of business, including planned sales, staffing needs, acquisition of materials to support production, financing, and expendi- tures for plant assets. Budgets are important in proper control of all facets of business operation. They provide benchmarks against which to compare actual results, establish guidelines for expenditures, and may be used to establish forward-looking guidance to persuade investors and creditors to invest or lend to a business.
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CHAPTER 6Section 6.2 Benefits of Budgeting
6.2 Benefits of Budgeting
A large organization is complex. There are many people and parts that must be coordi-nated to work together in a cohesive manner. As such, the budget becomes a vital tool for both communicating expected outcomes and coordinating the actions of all factors of production. Only through a budget can abstract and general plans be converted into spe- cific goals and objectives. Satisfaction of the budgetary guidelines is expected to result in fulfillment of the identified goals and objectives. When things do not go as planned, the budget is the tool that provides a mechanism for identifying and focusing on departures from the plan. The budget provides the benchmarks against which to judge success or failure, and it facilitates timely corrective measures.
Responsibility Accounting
Responsibility accounting is a term meaning that units and their managers are held accountable for transactions and events under their direct influence and control. Budgets should be aligned with units of responsibility. This results in a push down of budgeted revenues and expenses to lower levels within the organization. It becomes difficult to avoid accountability for outcomes when budgeted results are not met. Each unit must assume responsibility for meeting its plan. This forces managers to pay attention to sales results, cost controls, and organization efficiency. Deviations are not always suggestive of the need for corrective actions, but they do require unit managers to explain outcomes.
Very few businesses have unlimited resources. Indeed, most businesses face constraints. There are more opportunities than available capital permits pursuing. Thus, it is common for unit managers to compete for budgetary allocations from within the available resource pool. For example, each business unit may have employees desiring a pay raise, equip- ment in need of updating, new projects that require startup funding, and so forth. The sum of the resource demands can easily exceed the anticipated level of access to funds. A successful manager is one who can make a strong case for his or her resource needs, understand the needs of other units, and ultimately adopt a strategy that meshes his or her unit’s plan with the greater needs of the overall organization. Once the business plan is agreed upon, a successful manager will support the plan and work for the organization’s ultimate success. Many managers have difficulty with these concepts, and they respond by working divisively by constantly fighting against the adopted business plan. The bud- get reflects the adopted business plan quantitatively. Only by having all team members support the plan can organizational effectiveness be maximized.
Budgets Drive Efficiency
An organization is made more efficient by improved rates of throughput in the procure- ment, production, and customer delivery process. You have probably witnessed a pro- duction bottleneck. Maybe you have been frustrated at a fast-food restaurant when a particular food item was not ready to meet customer demand. The entire operation can bog down over one missing ingredient. You probably concluded that the business was rapidly losing current and future business because of the situation. Most business opera- tions are subject to these types of constraints. Interestingly, the budget process plays a major role in avoiding these problems. As you will soon see, the comprehensive budget attempts to include planning considerations to ensure that all factors of production are
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CHAPTER 6Section 6.2 Benefits of Budgeting
available when needed. Budgets allow managers to learn in advance of potential bottle- necks; advance knowledge is a key to solving and avoiding business constraints.
Without a well-thought-out budget, an organization will suffer from inefficiencies. The budget serves a vital role in planning for success. This is true in personal affairs as well as in running a business. It is also true for other types of entities, such as municipalities, state governments, churches, not-for-profit hospitals, and countless other organizations. Accordingly, the budget process should be taken quite seriously. Unfortunately, such is not always the case. As you will see in the ensuing discussion, human behavior traits can at times interfere with an optimal budget process. One needs to be aware of these attributes and contemplate their effects. You see, managerial accounting is more than just number crunching.
Human Behavior
A large business may form a budget committee with senior representatives from each business unit. These individuals should possess knowledge about all phases of business operations. They should be able to provide insight into sales and production. Their role also includes being an advocate to make the case for resources needed by their business unit. Their initial charge may be to formulate budget guidelines and gather data necessary to formulate the preparation of a comprehensive budget. However, many organizations extend the committee’s work to include a monitoring role. In this context, the committee will meet regularly throughout the period to monitor progress against the budget, and it will make suggestions for budgetary and operational revisions. Be aware that the budget committee’s recommendations are strikingly influential to the fate of an organization.
The work of the budget committee includes a significant communication component. In some organizations, the budget information will flow from senior management down through the organization. Other organizations attempt to pull information up from within. These different approaches have earned the alternative monikers of top–down or bottom–up budgeting.
The top–down approach to budgeting begins with upper level management establish- ing guidelines that the budget committee is intended to instill in the organization. These guidelines cover topics such as anticipated sales, acceptable expenditure levels and rates, and policies for compensation adjustments. Mid- and lower level personnel have almost no input in goal setting. Their role in constructing the budget consists mainly of compil- ing numerical data in support of the given corporate goals. The top–down approach can foster resentment because the budget is viewed as dictatorial. Such budgets can also intro- duce ethical challenges when lower level managers feel forced to meet unrealistic targets given to their units. However, an advantage is that the top–down approach serves to give the organization a clear picture of expectations at the top, which then translates its way down into the entire organization. Top–down budgets can set the tone for the organiza- tion and signal expected sales and production activity that the organization is supposed to reach. All parties should be in a position to know top managements’ overall goals and, it is hoped, understand the parameters that are put in place for achievement of those goals.
The bottom–up approach is highly participative. Top management initiates the budget process by providing general guidelines, but it is the lower level employees who are pri- marily responsible for developing the budget. Individual budgets from lower levels are
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CHAPTER 6Section 6.3 Budgeting Drawbacks
compiled to form divisional budgets, which are in turn regrouped at successfully higher levels within the organization. Top management’s budget committee eventually receives the overall plan. The committee reviews this document and identifies areas in need of coordination and revision. As you would suspect, it often becomes necessary to engage in several iterations of asking specific units within the organization to fine-tune their indi- vidual budgets. Because this type of budget is prepared by those with the best knowledge of their units, it can provide for a more realistic and accurate plan. Performance evalua- tion is enhanced because it removes the excuse that the original budget was unrealisti- cally imposed from higher up. Proponents of the bottom–up approach claim a number of benefits leading to positive effects on employee performance. A primary benefit is that the budget is at least partially self-imposed, generating improved morale and results. Cer- tainly, the approach is more in keeping with contemporary team-based theories about optimization of an organization.
6.3 Budgeting Drawbacks
You should be aware of certain drawbacks with budgeting. A bottom–up approach to the budget preparation process can be very time-consuming. This entails added cost. Employees can become frustrated with planning tasks, especially when they are addition- ally under pressure to continue to produce products and meet customer needs. Managers may use a bottom–up approach to try to pad their budgets. Human behavior suggests that participants in the budget process will attempt to create a cushion in their budget by underestimating expected sales and overestimating anticipated costs. In other words, they try to leave room in the budget to ensure that they will meet their goals. This phenomenon can be particularly acute when bonuses are tied to actual versus budgeted results. Padding does little to advance organizational efficiency. In addition, padding of planned expenses may induce wasteful overspending. Managers may fear a future loss of funding if they do not spend all budget amounts. This problem seems to be amplified in governmental entities that lack a revenue/profit motive. The managerial accountant’s engagement with budgeting entails considerable skill and judgment to maximize benefits to the entity.
At the opposite end of the spectrum, a top–down approach can introduce unattainable guidelines for revenues and expenses. When employees believe that they have no chance of achieving a budget, they may feel frustrated and capitulate to an attitude of certain failure. They may cease to try and may even engage in wasteful activities. This is akin to fielding a team for the second half of a game when the first half went so badly that there is no chance to win. Performance typically suffers. You probably never thought of budgeting as an exercise in organizational psychology, but that is certainly the case.
Quality Estimates
Budgets require significant speculation about future conditions. Thus, a certain amount of error is unavoidable. That the future is unknowable can result in the budget team becoming cavalier about its prognostications. This trap is to be avoided. Although many things about the future cannot be known with certainty, there is ample past information on which to build forward-looking models. Such models should be based on reason and logic, not haphazard guesswork. Careful study, statistical analysis, macroeconomic data and forecasts, and similar tools all provide a strong foundation on which to formulate and evaluate budgets.
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CHAPTER 6Section 6.3 Budgeting Drawbacks
Often, the starting point for constructing a budget is the prior year’s budget. One assumes previous budgets have been constructed with great diligence. Adjustments to prior bud- gets are made based on observed prior variances and new information about future expec- tations. This results in a new budget that is equivalent to an old budget, plus or minus indicated changes. This overall budgeting framework is termed incremental budgeting. An entirely different approach is known as zero-based budgeting. With the zero-based approach, no planned expenditure is protected by the status quo. Each budget item must be justified during each budget cycle. This is a time-consuming and expensive way to develop a budget, and many will question whether cost savings that can be identified via the process are justified by the effort. Thus, business managers should view such a method as useful but perhaps one that should be used on a selective basis. Consider that this approach can be deployed on a rolling basis that only periodically causes the complete reexamination of budgets within specific business units or related to specific product lines.
The Comprehensive Budget
A comprehensive budget (or master budget) is the cornerstone documentation revealing a business’s anticipated sales, expenses, financial needs, and so forth. The comprehen- sive budget is actually a compilation of a number of individual budgets. The lynchpin is the sales budget. Once anticipated sales are factored in, you have a benchmark for logi- cally planning production and selling, general, and administrative components. In turn, production data are central to determining the need for materials and labor, as well as establishing the benchmark for the application of factory overhead. You can think of the comprehensive budget as a compilation of numerous individual interlocking blocks, as shown in Exhibit 6.1:
Exhibit 6.1
SALES BUDGET
PRODUCTION BUDGET
SG&A BUDGET
FACTORY OVERHEAD
BUDGET
MATERIALS BUDGET
LABOR BUDGET
Budget Building Blocks
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CHAPTER 6Section 6.3 Budgeting Drawbacks
The budget blocks shown in Exhibit 6.1 can also be linked to their income statement and cash (financial) impacts, as will be shown in the following illustrations. Budgeted financial statements are often seen as the culmination of the budgeting process. Quite obviously, a business must have a pathway to successful future performance as reflected in a thought- ful budget. In addition to the operating budget components, businesses may extend their budgets to plan for major capital expenditures. Decisions related to capital budgeting are discussed in a later chapter.
Considerable effort is needed to coordinate the construction of a comprehensive bud- get. It guides actions over the entire budget period and all phases of activity, including purchasing, staffing, and most other resource procurement and deployment actions. For most organizations, the comprehensive budget begins with an assessment of anticipated sales. The expected level of sales defines production activities as well as the expected selling, general, and administrative expenditures. Production activities are broad. They encompass purchasing of materials, deployment of labor, and allocation of overhead. In addition, consideration must be given to the beginning and ending inventory levels of materials and finished goods. All plans must be dovetailed to match the cash flow of the organization as well as expected financial statement outcomes. As you will soon see, the comprehensive budget is composed of a series of individual budgets, all of which dovetail together in a cohesive manner.
Sales and Cash Collections Budgets
As noted previously, the comprehensive budget begins with a projection of sales. Antici- pated activity is incorporated into a sales budget. The determination of anticipated vol- ume should be based on prior sales patterns, economic conditions, competitive actions, and so forth. Where a company has multiple products, consideration must be given to each. You will soon see how projected sales drive the budgets for all other factors of pro- duction; in this regard, it can become quite important to know the exact product mix that is contemplated within the sales budget.
By now, you clearly understand that sales do not necessarily equal cash collections. There are often delays between the date of sale (on account) and conversion of the transaction to cash (i.e., collection). A company needs knowledge of both. Whereas sales drive pro- duction levels, cash flow is necessary to support production. Thus, the comprehensive budget process requires mapping of both sales and collections. How this occurs is best demonstrated with an example. Exhibit 6.2 is the sales and cash collections budget for Wheat Treat. Wheat Treat produces a very large specialized bread roll for use at banquets and weddings. The company is experiencing significant growth.
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CHAPTER 6Section 6.4 Production Budget
Exhibit 6.2
Notice that the upper portion of Exhibit 6.2 begins with expected sales, in units. Each unit is anticipated to sell for $7.50. Thus, the determination of quarterly sales is not particularly difficult. The anticipated cash collections require a bit more explanation. Assume that cus- tomers are given credit terms, and the normal result is that 60% of sales in each quarter are collected within the quarter. The remaining 40% are presumed to be collected in the following quarter. Looking closely at the second quarter, note that total sales are forecast at $450,000. Sixty percent of $450,000 is $270,000, which is shown as cash collections from the second quarter’s sales. The other 40% of $450,000, or $180,000, is shown as collected in the third quarter. This allocation of sales to cash collections is repeated for each quarter (collec- tions in the first quarter would relate to sales from the last quarter of the prior year, which are not shown here). Wheat Treat’s sales and cash collections are fairly straightforward. You can well imagine that the complexity could increase if collection activities spanned longer periods of time, including the possibility of uncollectibles. Also, note that the quarterly effects are compiled into an annual total within the final column. Although this exhibit is informative, it is only the point of beginning in the budget construction process.
6.4 Production Budget
The sales, in units, are carried forward from the sales budget into the production bud-get. It should be obvious why sales are a key driver in the decision about how many units to produce. However, beginning and ending inventory are also important to con- sider. Budgeted unit production level is reflective of units sold, plus desired ending fin- ished goods inventory, minus beginning finished goods inventory. Very simply, in units, the following formula applies:
Planned Production 5 Sales 1 Desired Ending Inventory 2 Beginning Inventory
50,000
$ 7.50
$ 375,000
$ 225,000
140,000
$ 365,000
SALES:
Units
X Sales price per unit
Estimated sales
COLLECTIONS:
From current quarter sales
From prior quarter sales
Cash collections
1st Quarter
WHEAT TREAT Sales and Cash Collections Budget
For the Year Ending December 31, 20X4
60,000
$ 7.50
$ 450,000
$ 270,000
150,000
$ 420,000
2nd Quarter
65,000
$ 7.50
$ 487,500
$ 292,500
180,000
$ 472,500
3rd Quarter
80,000
$ 7.50
$ 600,000
$ 360,000
195,000
$ 555,000
4th Quarter
255,000
$ 7.50
$ 1,912,500
$ 1,812,500
Annual Recap
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CHAPTER 6Section 6.4 Production Budget
Exhibit 6.3 shows the production budget for Wheat Treat. The planned ending finished goods inventory for each quarter may appear as a random amount. However, careful inspection for Wheat Treat reveals that it plans to end each quarter with an inventory of 20% of the next quarter’s anticipated sales (e.g., third quarter sales of 65,000 units 3 20% 5 13,000 ending inventory for the second quarter). Thus, a systematic process can be fol- lowed to arrive at the various inventory levels. Test your understanding of this concept by looking at the fourth quarter. What can you infer about the company’s planned sales for the first quarter of 20X5? The answer is 100,000 units (20,000/20%).
Exhibit 6.3
Purchases and Payments for Materials
Purchases of materials are driven by the level of production. Continuing the Wheat Treat example, the next budget component appears to be a bit more intimidating, but only because it involves more computations. The concepts are straightforward. To begin, each quarter’s scheduled production is carried forward from the preceding budget. An addi- tional fact is that each finished unit requires 10 pounds of raw materials. Thus, you can understand how the total raw material needs are to be calculated. Of course, raw material that is needed for production is not synonymous with purchases of raw materials. One must take into account beginning and ending raw materials. Here, it is assumed that each quarter begins with raw materials sufficient to produce 10% of the quarter’s needs. Look at Exhibit 6.4, and carefully note how materials needed, plus the desired ending stock, minus the beginning stock, results in an amount equal to anticipated purchases for the period.
50,000
12,000
62,000
(10,000)
52,000
Quarterly sales in units
Planned ending finished goods
Units needed
Less: Beginning finished goods
Production level
1st Quarter
WHEAT TREAT Production Budget
For the Year Ending December 31, 20X4
60,000
13,000
73,000
(12,000)
61,000
2nd Quarter
65,000
16,000
81,000
(13,000)
68,000
3rd Quarter
80,000
20,000
100,000
(16,000)
84,000
4th Quarter
255,000
20,000
(10,000)
265,000
Annual Recap
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CHAPTER 6Section 6.4 Production Budget
Exhibit 6.4
The raw materials purchases must be multiplied by the price per unit to arrive at the expected cost of raw material purchases. Last, it is again important to consider the cash flows necessary for the direct material purchases. This illustration presumes that cash payments required will be 75% of those purchases made within the quarter of purchase (e.g., second quarter purchases of $92,550 3 75% 5 $69,413) and 25% in the next follow- ing quarter (e.g., second quarter purchases of $92,550 3 25% 5 $23,138). The cash pay- ments in the first quarter, related to the prior quarters purchases, are simply assumed in this illustration.
Direct Labor Budget
The direct labor budget calculations are relatively simple. Potential complications might relate to developing staffing plans to meet the needs identified within the direct labor budget. This could expand to include the human resources department as it relates to plans for additional hiring or reductions in force. Exhibit 6.5 reveals that each unit of production requires one-quarter hour of direct labor, and direct labor costs $11 per hour. There are no “beginning” and “ending” direct labor hours that can be stored up. And, as is typically the case, labor is generally paid as incurred (weekly, biweekly, or monthly). Thus, it is assumed that cash paid for direct labor is equivalent to the direct labor cost for each quarter, and thus the cash flow needs are equal to the cost of direct labor.
52,000
10
520,000
61,000
581,000
(52,000)
529,000
$ 0.15
$ 79,350
PURCHASES:
Scheduled production
X Raw materials per unit (lbs.)
Total raw material needs (lbs.)
Plus: Target ending raw material
Total units needed (lbs.)
Less: Target beg. raw material
Raw material purchases (lbs.)
X Estimated cost per pound
Cost of raw material purchases
1st Quarter
WHEAT TREAT Direct Materials Budget
For the Year Ending December 31, 20X4
61,000
10
610,000
68,000
678,000
(61,000)
617,000
$ 0.15
$ 92,550
2nd Quarter
68,000
10
680,000
84,000
764,000
(68,000)
696,000
$ 0.15
$ 104,400
3rd Quarter
84,000
10
840,000
89,000
929,000
(84,000)
845,000
$ 0.15
$ 126,750
4th Quarter
265,000
10
2,650,000
89,000
2,739,000
(52,000)
2,687,000
n/a
$ 403,050
Annual Recap
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Annual Recap
For current quarter purchases
For prior quarter purchases
Cash payments for materials
PAYMENTS:
$ 59,513
15,000
$ 74,513
$ 69,413
19,838
$ 89,250
$ 78,300
23,138
$ 101,438
$ 95,063
26,100
$ 121,163 $ 386,363
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CHAPTER 6Section 6.4 Production Budget
Exhibit 6.5
Factory Overhead Budget
Wheat Treat’s factory overhead budget is presented in Exhibit 6.6. The company’s over- head consists of both variable and fixed components. The variable overhead is expected to be $0.80 per direct labor hour. The fixed factory overhead is expected to be $19,875 per quarter. All of this would be determined based on a careful analysis of the company’s cost structure.
Exhibit 6.6
In Exhibit 6.6, notice that the variable overhead driver was considered to be direct labor hours. The direct labor hours were derived by reference to the direct labor budget. Also, notice that $2,500 of the amount incurred for overhead was related to depreciation. Because depreciation does not consume cash, it is subtracted from each quarter’s total overhead to arrive at the amount of cash that is needed to support overhead costs each period.
52,000
0.25
13,000
$ 11.00
$ 143,000
Scheduled production
X Direct labor hours per unit
Total direct labor hours
X Cost per direct labor hour
Cost of direct labor
1st Quarter
WHEAT TREAT Direct Labor Budget
For the Year Ending December 31, 20X4
61,000
0.25
15,250
$ 11.00
$ 167,750
2nd Quarter
68,000
0.25
17,000
$ 11.00
$ 187,000
3rd Quarter
84,000
0.25
21,000
$ 11.00
$ 231,000
4th Quarter
265,000
0.25
66,250
$ 11.00
$ 728,750
Annual Recap
13,000
$ 0.80
$ 10,400
19,875
$ 30,275
(2,500)
$ 27,775
Direct labor hours
X Variable factory overhead rate
Total variable factory overhead
Fixed factory overhead
Total factory overhead
Less: Depreciation
Cash paid for factory overhead
1st Quarter
WHEAT TREAT Factory Overhead Budget
For the Year Ending December 31, 20X4
15,250
$ 0.80
$ 12,200
19,875
$ 32,075
(2,500)
$ 29,575
2nd Quarter
17,000
$ 0.80
$ 13,600
19,875
$ 33,475
(2,500)
$ 30,975
3rd Quarter
21,000
$ 0.80
$ 16,800
19,875
$ 36,675
(2,500)
$ 34,175
4th Quarter
66,250
$ 0.80
$ 53,000
79,500
$ 132,500
(10,000)
$ 122,500
Annual Recap
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In a later chapter, you will learn about applying factory overhead in determining a prod- uct’s full cost, so this is an excellent point to begin to introduce this concept. Notice that Wheat Treat is anticipating $132,500 of total overhead. If, as is often the case, overhead is applied based on direct labor hours, then the total overhead application rate would be $2 per hour ($132,500 divided by 66,250 hours). This $2 is included in the schedule shown in Exhibit 6.7, which shows the calculation of per-unit cost at $4.75. The per-unit amounts for direct materials and direct labor were derived in prior schedules. Likewise, we previously noted that the company plans to end the year with 20,000 units in inventory. Thus, one is able to project the dollar cost of ending inventory.
Exhibit 6.7
SG&A Budget
Wheat Treat will also need to develop a selling, general, and administrative expenses (SG&A) budget. SG&A usually contains both variable and fixed components. Variable components can include shipping costs, sales commissions, and other costs that tend to vary based on sales volume or other potential measures of activity. Wheat Treat’s bud- get is based on the assumption that each unit sold triggers an additional $1.25 in cost (Exhibit 6.8). The fixed SG&A components tend to include management and clerical sala- ries, planned advertising campaigns, the costs associated with office space, insurance, and similar unavoidable costs that are not a function of business volume (over the relevant planned range of operations). Wheat Treat is planning for $30,000 per quarter, divided between salaries, office, and other costs. The budget is based on an assumption that all SG&A costs are all funded in cash as incurred.
10 lbs.
0.25 hours
0.25 hours
Cost Component
Direct material
Direct labor
Applied factory overhead
X Units in ending finished goods inventory
Ending finished goods inventory
Units
WHEAT TREAT Ending Finished Goods Inventory
For the Year Ending December 31, 20X4
$ 0.15
$ 11.00
$ 2.00
Per Unit Cost
$ 1.50
2.75
0.50
$ 4.75
20,000
$ 95,000
Per Unit Total
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Exhibit 6.8
Budgeted Income Statement
At this juncture, there are numerous individual budgets. Although they are interesting and perhaps useful at lower levels of operation and management, we are lacking an over- all picture of company-wide expectations. For instance, is the company expected to be profitable? To answer important “macrolevel” questions requires drawing together the individual budgeting building blocks into a comprehensive picture. Exhibit 6.9 is the bud- geted income statement for Wheat Treat for 20X4.
Exhibit 6.9
50,000
$ 1.25
$ 62,500
$ 20,000
8,000
2,000
$ 30,000
$ 92,500
Estimated units sold
X Per unit variable SG&A
Total variable SG&A
Fixed SG&A
Salaries
Office
Other
Total fixed SG&A
Total budgeted SG&A
1st Quarter
WHEAT TREAT Selling, General, and Administrative Budget
For the Year Ending December 31, 20X4
60,000
$ 1.25
$ 75,000
$ 20,000
8,000
2,000
$ 30,000
$ 105,000
2nd Quarter
65,000
$ 1.25
$ 81,250
$ 20,000
8,000
2,000
$ 30,000
$ 111,250
3rd Quarter
80,000
$ 1.25
$ 100,000
$ 20,000
8,000
2,000
$ 30,000
$ 130,000
4th Quarter
255,000
$ 1.25
$ 318,750
$ 80,000
32,000
8,000
$ 120,000
$ 438,750
Annual Recap
Sales
Cost of goods sold
Beginning finished goods
Cost of goods manufactured
Goods available for sale
Less: Ending finished goods inventory
Cost of goods sold
Gross profit
SG&A
Income before interest and taxes
Interest
Income before taxes
Income taxes
Net income
$ 47,500
1,258,750
$1,306,250
$ 95,000
$1,912,500
1,211,250
$ 701,250
438,750
$ 262,500
2,000
$ 260,500
60,500
$ 200,000
WHEAT TREAT Budgeted Income Statement
For the Year Ending December 31, 20X4
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The information in the income statement was derived from various portions of the previ- ous budgets, along with a few added assumptions. To help you understand the income statement amounts, please refer to the notes in Table 6.1.
Table 6.1: Additional assumptions
Sales Annual recap within sales budget
Beginning finished goods Last year’s ending finished goods (assumed)
Cost of goods manufactured Production budget quantity times per-unit cost from inventory schedule (265,000 3 $4.75)
Goods available for sale Subtotal
Ending inventory Inventory schedule
Cost of goods sold Subtotal
Gross profit Subtotal
SG&A Annual recap within SG&A budget
Income before interest and taxes Subtotal
Interest Assumed amount
Income before taxes Subtotal
Income taxes Assumed provided by tax department
Net income Subtotal
The budgeted income statement is essential for allowing management to know the expected outcome for the period. With this information, management knows whether operational adjustments are necessary to ensure satisfactory performance for the year. Furthermore, as deviations from budget take place, management is keenly positioned to know what the effect will be on the overall performance of the enterprise. Imagine trying to anticipate future outcomes without a comprehensive budget. Perhaps you can begin to appreciate why the budget process is indeed so important to business success.
Cash Budget
Another macrolevel view of the enterprise’s expectations can be derived by reference to the cash budget. Although we now know that Wheat Treat is looking forward to a $200,000 profit, we do not yet know much about its cash flows. You might be surprised to find that Wheat Treat will actually run out of cash unless the company makes plans for additional borrowings! How can this be? Begin by looking at the cash budget shown in Exhibit 6.10.
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Exhibit 6.10
Without an adequate supply of cash, a business’s plans cannot be realized. Even success- ful businesses can occasionally find themselves squeezed. Causes include delays in col- lecting receivables and capital expenditure decisions. Wheat Treat is expecting both. You have already seen the reconciliation of sales to cash receipts in a prior schedule. Also notice that the second quarter of the year involves a land purchase for $150,000. Given these fac- tors, the company expects a second quarter cash shortage of $66,363. By knowing this in advance, and being able to explain why it is not a systemic problem, the company should be able to arrange for borrowings to bridge over the anticipated shortfall. This planned bor- rowing is reflected in the lower portion of the schedule. By the fourth quarter, operations have generated sufficient cash to repay half of the loan and all of the accrued interest.
It is perhaps obvious at this point, but each value (e.g., cash receipts) is taken from one of the prior budgets. The only exceptions relate to the assumed values for beginning cash, the land purchase, and the schedule borrowings/repayments. Take time to relate the val- ues to previous schedules.
Distribution of Budgets
Budgets are normally prepared for internal use only. Nevertheless, external financial statement users may have a keen interest in knowing what they reveal. Investors and lenders surely would prefer to know what management is thinking about the future, as reflected in budgets. Businesses would not normally choose to make such information broadly available. However, in special circumstances, such as a condition of a loan, a business may conclude that its best interests are served by revealing its internal projec- tions. When this occurs, professional standards include fairly complex disclosure rules, including language noting that the company is not vouching for the achievability of
$ 50,000 365,000
$ 415,000
$ 74,513 143,000 27,775 92,500 10,000
– $ 347,788 $ 67,213
– – –
$ 67,213
Beginning cash balance Plus: Customer receipts Available cash Less: Disbursements Direct materials Direct labor Factory overhead SG&A Taxes Land purchase Total Disbursements Cash surplus/(deficit) Financing: Planned borrowing Planned repayment Interest on repayment Ending cash balance
1st Quarter
WHEAT TREAT Cash Budget
For the Year Ending December 31, 20X4
$ 67,213 420,000
$ 487,213
$ 89,250 167,750 29,575
105,000 12,000
150,000 $ 553,575 $ (66,363)
100,000 – –
$ 33,638
2nd Quarter
$ 33,638 472,500
$ 506,138
$ 101,438 187,000 30,975
111,250 18,000
– $ 448,663 $ 57,475
– – –
$ 57,475
3rd Quarter
$ 57,475 555,000
$ 612,475
$ 121,163 231,000 34,175
130,000 20,500
– $ 536,838 $ 75,638
– (50,000) (2,000)
$ 23,638
4th Quarter
$ 50,000 1,812,500
$ 1,862,500
$ 386,363 728,750 122,500 438,750 60,500
150,000 $ 1,886,863 $ (24,363)
100,000 (50,000) (2,000)
$ 23,638
Annual Recap
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the results. Notwithstanding that assertion, the involved accountant nevertheless has a duty to prepare the reports carefully and to possess a reasonable basis for the assump- tions utilized in preparing the information. Public companies will sometimes provide forward-looking guidance to their shareholders, but it is invariably accompanied by additional cautionary language.
Budget Cycles
You will normally see budgets that are prepared for specific time intervals. These budgets may relate to a month, quarter, year, or other clearly identifiable time period. Sometimes, the budget may relate to a natural business cycle. For example, a wheat farmer’s crop does not follow a calendar year. What use could one make of a calendar year budget in this case? The budget would clearly need to relate to the time period extending from at least planting through harvest. In other business environments, a budget may be continuous in nature. Such budgets are constantly being updated to reflect the addition of future months or quarters. With the completion of one period, another period is pulled into the budget. This rolling approach allows management better insight into business adaptations that are needed for changing economic conditions.
6.5 Flexible Budgets
The comprehensive budget illustration you just studied presumed a static budget. In other words, the budget was developed for a single level of activity. A shortcoming of this approach is that it is insensitive to volume fluctuations. This presents special chal- lenges for managing a business and for performance evaluation. As actual output varies from the anticipated level, significant deviations in revenues and expenses will naturally occur. These variances can produce quite misleading signals. For example, if a company produces and sells more products than anticipated, you would also expect an increase in selected variable expenses. This will appear as a cost overrun when actual results are com- pared to the static budget. Although the natural response to a cost overrun is to assume that this is a bad thing, it may well be that the growth signifies great success. The opposite effects can also be true. Adjusting budgets and budget models for the effects of volume fluctuations is the goal of flexible budgeting.
A flexible budget can best be explained with a simple example. Assume that Old Time Dominoes manufactures simulated ivory dominoes. Direct materials are budgeted to cost $1 per set, direct labor is budgeted at $0.50 per set, and variable factory overhead is antici- pated to run $0.70 per set. The company plans for fixed factory overhead of $12,000 per month. The middle column of Exhibit 6.11 reveals the details of the $34,000 monthly bud- get, based on the usual anticipated production run of 10,000 sets.
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CHAPTER 6Section 6.5 Flexible Budgets
Exhibit 6.11
During May, Old Time Dominoes received a large order from a company that wanted to award sets of dominoes to employees as a thank-you gift. The company was pleased with the added business but disturbed by the unfavorable budget variances. For most expense categories, the company seems to have spent more than was budgeted, producing several unfavorable indicators.
Because of the added volume, the company actually produced 11,000 sets of dominoes. This is not apparent in the preceding report. The company actually needs to prepare a flexible budget to understand better the effectiveness of its cost control. A flexible budget will reveal the amount of expenses that are anticipated for the given level of production. The following example shows that variable costs are “budgeted” at a higher overall level. Because production was 10% greater than normal, so are the budgeted variable expense components within the middle column in Exhibit 6.12.
Exhibit 6.12
The flexible budget outcomes paint an entirely different conclusion. There were only slight deviations from budget, as revealed by the variances related to selected expense catego- ries. This information is probably far more useful for performance evaluation purposes.
$ 11,000
5,100
7,900
$ 24,000
11,500
$ 35,500
Variable expenses:
Direct materials
Direct labor
Variable factory overhead
Total variable expenses
Total factory overhead
Total manufacturing costs
Actual
OLD TIME DOMINOES Expense Budget
For the Month Ending May 31, 20XX
$ 10,000
5,000
7,000
$ 22,000
12,000
$ 34,000
Budget
$ (1,000)
(100)
(900)
$ (2,000)
500
$ (1,500)
Variance
$ 11,000
5,100
7,900
$ 24,000
11,500
$ 35,500
Variable expenses:
Direct materials
Direct labor
Variable factory overhead
Total variable expenses
Total factory overhead
Total manufacturing costs
Actual (11,000 sets)
OLD TIME DOMINOES Flexible Expense Budget
For the Month Ending May 31, 20XX
$ 11,000
5,500
7,700
$ 24,200
12,000
$ 36,200
Budget (11,000 sets)
$ –
400
(200)
$ 200
500
$ 700
Variance
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Using Flexible Budgets in Business Management
A flexible budget can be prepared either before or after actual production is known. Pre- paring a flexible budget “after the fact” may help explain variances and aid in performance evaluation, but it does little to facilitate corporate planning. For planning purposes, it is better to prepare the flexible budget (or a financial model of the anticipated outcomes) in advance. By anticipating fluctuations in volume, a business is empowered to anticipate needed adjustments to materials and labor. Exhibit 6.13 is an example of a flexible budget that contemplates outcomes based on four different possible outcomes.
Exhibit 6.13
Considering Per-Unit Costs and Profit Impacts
The preceding perspective on flexible budgeting focused on total costs. These data can be modified for analysis purposes. One modification is to calculate per-unit costs, as shown in Exhibit 6.14.
Exhibit 6.14
In Exhibit 6.14, the total manufacturing costs were divided by the total units, yielding a calculation of per-unit cost. It is immediately apparent that per-unit cost declines as vol- ume increases. This occurs because the fixed cost pool is spread across more units. This
$ 9,000 4,500 6,300
$ 19,800 12,000
$ 31,800
Variable expenses: Direct materials Direct labor Variable factory overhead Total variable expenses Total factory overhead Total manufacturing costs
Budget (9,000 sets)
OLD TIME DOMINOES Flexible Expense Budget/Alternative Scenarios
For the Month Ending May 31, 20XX
$ 10,000 5,000 7,000
$ 22,000 12,000
$ 34,000
Budget (10,000 sets)
$ 11,000 5,500 7,700
$ 24,200 12,000
$ 36,200
Budget (11,000 sets)
$ 12,000 6,000 8,400
$ 26,400 12,000
$ 38,400
Budget (12,000 sets)
$ 9,000 4,500 6,300
$ 19,800 12,000
$ 31,800
$ 3.53
Variable expenses: Direct materials Direct labor Variable factory overhead Total variable expenses Total factory overhead Total manufacturing costs
Total manufacturing costs per unit (total cost divided by units)
OLD TIME DOMINOES Flexible Expense Budget/Per Unit Cost Assessment
For the Month Ending May 31, 20XX
$ 10,000 5,000 7,000
$ 22,000 12,000
$ 34,000
$ 3.40
$ 11,000 5,500 7,700
$ 24,200 12,000
$ 36,200
$ 3.29
$ 12,000 6,000 8,400
$ 26,400 12,000
$ 38,400
$ 3.20
Budget (9,000 sets)
Budget (10,000 sets)
Budget (11,000 sets)
Budget (12,000 sets)
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extended analysis enables a better understanding of the need to fully utilize fixed capacity to generate maximum efficiency. Furthermore, the tool can facilitate logical pricing deci- sions. You have probably heard how giant retailers such as Wal-Mart drive tough business deals to get low prices from their suppliers. One reason suppliers are willing to respond is because the orders tend to be quite large, enabling them to squeeze maximum efficiency out of their existing cost structure.
Another advantage of flexible budgeting is that it aids overall profitability analysis. Con- sider Exhibit 6.15, which is based on an assumed selling price of $10 per set.
Exhibit 6.15
This report adds information to the flexible budget about sales in dollars. The net of the total sales and total manufacturing costs reflects the amount of income that will be avail- able to cover anticipated SG&A costs and provide for a profit margin. The managers of the manufacturing operation may not be provided with information about SG&A, and their flexible budget may stop at the point shown in the preceding budget. However, at higher levels with the organization, more may be known about (including responsibility for) SG&A costs, and the flexible budget could be expanded to include information about these costs.
Extending Flexible Budgeting
For simplicity, the flexible budget illustration in this chapter reveals aggregated amounts. In actuality, a flexible budget would usually resemble the comprehensive budget. The comprehensive flexible budget would permit a drill down to the smallest levels of oper- ational detail. This information would allow management to pinpoint exactly where operational efficiencies and inefficiencies are occurring, thereby providing an excellent tool for performance evaluation. When performance evaluation is only based on a static bud- get, there is a reduction in incentive to drive sales increases. This occurs because increases in volume tend to produce greater costs that may appear as unfavorable variances.
$ 90,000
$ 9,000
4,500
6,300
$ 19,800
12,000
$ 31,800
$ 58,200
Total Sales
Variable expenses:
Direct materials
Direct labor
Variable factory overhead
Total variable expenses
Total factory overhead
Total manufacturing costs
Income available to cover SG&A
OLD TIME DOMINOES Income to Cover SG&A
For the Month Ending May 31, 20XX
$ 100,000
$ 10,000
5,000
7,000
$ 22,000
12,000
$ 34,000
$ 66,000
$ 110,000
$ 11,000
5,500
7,700
$ 24,200
12,000
$ 36,200
$ 73,800
$ 120,000
$ 12,000
6,000
8,400
$ 26,400
12,000
$ 38,400
$ 81,600
Budget (9,000 sets)
Budget (10,000 sets)
Budget (11,000 sets)
Budget (12,000 sets)
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6.6 Benefits of Technology in Budgeting
By now, it has surely occurred to you that computers are most helpful in preparing budget information, especially as it relates to flexing the budget for constant changes in volume and cost. The budget preparation is not nearly as tedious and costly as it once was. In the past, building a budget required a number of iterative rounds of information sharing such that each level within an organization found it necessary to do and redo its financial plans based on new information and directives. Today’s electronic tools and budgeting models provide embedded links such that the slightest tweak by one unit is transferred into the budget models deployed by other units.
Modern business information systems are often highly sophisticated. Budget data, although not central to a traditional general ledger system, are nonetheless incorporated into a sophisticated modern database of accounting information. These systems include real-time feedback on budget versus actual performance, often in graphical form. Further- more, budgeted expenditures can be reflected as authorization “tags,” thereby expediting execution of approved business purchases (i.e., approved expenditures have a shortened purchasing cycle requiring less management action for final approval).
Indeed, electronic data interchange between companies and their suppliers and custom- ers facilitates an interlocking of selected budgeting data. As product demand increases or decreases, computerized flexible budgets can be adjusted on a real-time basis to send signals throughout the modern organization (including electronic data interchange with suppliers). The net result is that the supply chain is immediately adjusted to match raw material orders to anticipated production levels, thereby eliminating significant waste. The presence of a sophisticated supply chain management system is a hallmark feature of today’s successful business. For example, inventory investment is minimized in an optimal manner. Furthermore, obsolescence is greatly reduced. Computer systems are designed to adjust purchases automatically based on real-time flow of goods all the way through to an end customer. Surely you have noticed the proliferation of chain stores such as Best Buy, Lowes, Bed Bath and Beyond, and Kohl’s. One feature they all have in com- mon is a robust information system in support of their supply chain management. Despite their gigantic size, they probably have a better pulse on their business volume and prod- uct flow than any “mom-and-pop” one-location retailer. It is fair to say that the growth of these retail giants would not have occurred without modern technology in support of their business processes. You can easily think of their information technology as the “ulti- mate” in perfecting business performance via a real-time flexible budget.
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CHAPTER 6Concept Check
Concept Check
The five questions that follow relate to several issues raised in the chapter. Test your knowledge of the issues by selecting the best answer. (The correct answers can be found at the end of your text.)
1. Preparing the comprehensive budget begins with consideration of a. direct labor budget. b. ending inventory levels. c. cash disbursements. d. anticipated sales.
2. Calculating fixed unit manufacturing costs results in a. constant unit costs as production increases. b. constant unit costs as production decreases. c. increasing unit costs as production increases. d. increasing unit costs as production decreases.
3. Which of the following will result in a direct materials efficiency variance that is not favorable?
a. The actual unit cost of direct materials exceeds the standard cost of direct materials. b. The actual cost per unit of direct materials was less than the standard cost of
direct materials. c. The actual quantity of direct materials used per unit exceeds the standard quan-
tity of direct materials allowed per unit. d. The actual quantity of direct materials used per unit is less than the standard
quantity of direct materials allowed per unit.
4. Parno Fitters has beginning inventory of 15,000 units. Sales are expected to be 41,000 units. The anticipated ending inventory is 12,500 units. How many units must be produced?
a. 41,500 b. 46,000 c. 38,500 d. 43,500
5. Preparation of the cash budget takes all but which of the following items into con- sideration?
a. Depreciation expense b. Cash received from customers c. Inventory payments d. Payments to suppliers
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budget committee An entity within a company that can be made up of senior representatives from each business unit. Their role includes being an advocate to make the case for resources needed by their business unit.
budgets Detailed financial plans that quantify future expectations and actions.
comprehensive budget The cornerstone documentation revealing a business’s anticipated sales, expenses, financial needs, and so forth. It is sometimes referred to as the master budget.
flexible budgeting Adjusting budgets and budget models for the effects of volume fluctuations.
incremental budgeting Overall budgeting framework in which the previous year’s budget is used as a starting point.
responsibility accounting A term mean- ing that units and their managers are held accountable for transactions and events under their direct influence and control.
zero-based budgeting An approach in which no planned expenditure is protected by the status quo. Each budget item must be justified during each budget cycle.
Critical Thinking Questions
Key Terms
Critical Thinking Questions
1. Briefly discuss the advantages of budgeting. 2. Is a budget a planning tool, a control tool, or both? Explain. 3. When evaluating performance, many organizations compare current results with
the actual results of previous accounting periods. Is an organization that follows this approach likely to encounter any problems? Explain.
4. Explain how a budget assists in coordinating the plans of an organization’s various subunits (divisions, departments, and so forth).
5. Define and fully explain the top–down approach to budgeting. 6. Briefly discuss the concept of slack as it pertains to budgeting. 7. Calabro Corporation, a manufacturer with annual sales approaching $75 million, is
beginning the budget process for the upcoming year. Should Calabro use long-term budgets, yearly budgets, or monthly budgets? Explain your answer.
8. Why is an accurate sales forecast so important in the preparation of a master budget? 9. Why is it necessary to carefully budget direct labor requirements for an upcoming
period? 10. Explain how a cash budget leads to effective management of an organization’s cash
balances.
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CHAPTER 6Exercises
Exercises
1. Overview of the budgeting process Evaluate the comments that follow as being true or false. If the comment is false, briefly explain why.
a. When assessing current performance, a comparison of actual results against a predetermined budget is generally preferred over a comparison of the current period’s actual results with those of the preceding period.
b. Lower level managers are inclined to work harder to achieve budgeted targets if the top–down (rather than the bottom–up) budget approach is used.
c. Virtually all budgets are 1 year in duration. d. Land & Sea plans to sell 36,700 units of its single product during the coming year.
If the beginning and ending finished goods inventories are 15,900 and 17,700 units, respectively, the company’s production budget will reveal that 38,500 units should be manufactured.
e. The last step in the construction of a master budget is the preparation of a cash budget.
2. Schedule of cash collections Sugarland Company sells a single product and anticipates opening a new facility in Charlotte on May 1 of the current year. Expected sales during the first 3 months of activity are as follows: May, $60,000; June, $80,000; and July, $85,000.
Thirty percent of all sales are for cash; the remaining 70% are on account. Credit sales have the following collection pattern:
Collected in the month of sale 60%
Collected in the month following sale 35
Uncollectible 5
a. Prepare a schedule of cash collections for May through July. b. Compute the expected balance in Accounts Receivable as of July 31.
3. Direct material purchases budget Bass Corporation manufactures a home video recorder that requires four No. S1326 circuit boards. Anticipated production of recorders for the upcoming year follows:
Quarter Production (units)
First 8,000
Second 10,000
Third 12,000
Fourth 16,000
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CHAPTER 6Exercises
Bass wants to stock enough circuit boards to meet 30% of the following quarter’s production needs. Circuit boards cost $2.50 each; the cost has been fairly stable dur- ing the past 6 months.
Assuming a beginning circuit board inventory of $23,750, prepare a direct material purchases budget for the first three quarters of the year.
4. Production and cash-outlay computations RPR Inc. anticipates that 120,000 units of product K will be sold during May. Each unit of product K requires four units of raw material A. Actual inventories as of May 1 and budgeted inventories as of May 31 follow:
May 1 May 31
Product K (units) 55,000 60,000
Raw material A (units) 40,000 37,000
Each unit of raw material A costs $8; RPR pays for all purchases in the month of acquisition. Invoices that account for 80% of the cost of materials acquired will be paid within 10 days of receipt, entitling the company to a 2% cash discount.
a. Determine the number of units of product K to be manufactured in May. b. Compute the May cash outlay for purchases of raw material A.
5. Abbreviated cash budget; financing emphasis An abbreviated cash budget for Big Chuck Enterprises follows:
July August September
Beginning cash balance $ 10,000 $ ? $ ?
Add: Cash receipts 50,000 63,000 71,000
Deduct: Cash payments (64,000) (58,000) (64,000)
Cash excess (deficiency) before financing
$ (4,000) $ ? $ ?
Financing
Borrowing to maintain minimum balance
? ? ?
Principal repayment ? ? ?
Interest payment ? ? ?
Ending cash balance $ ? $ ? $ ?
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CHAPTER 6Problems
Big Chuck wants to maintain a $10,000 minimum cash balance at all times. Additional financing is available (and retired) in $1,000 multiples at a 12% interest rate. Assume that borrowings take place at the beginning of the month; retirements, in contrast, occur at the end of the month. Interest is paid at the time of repaying principal and computed on the portion of principal repaid.
a. Find the unknowns in Big Chuck’s abbreviated cash budget. b. Determine the outstanding loan balance as of September 30, after any repay-
ments have been made.
Problems
1. Production and purchases budgets; purchasing policy Mason Inc. manufactures and distributes various parts for lawn mowers. The com- pany’s main product, a bilateral assembly, requires five units of direct material at a cost of $0.60 per unit. To keep production moving smoothly, the firm must main- tain a direct materials inventory equal to 70% of the following month’s production needs. Sales projections in units for the past 6 months of 20X6 follow:
Month Estimated sales
July 9,000
August 12,000
September 16,000
October 22,000
November 29,000
December 26,000
Management wants to carry a finished goods inventory equal to 40% of the follow- ing month’s sales. On June 30, 20X6, the finished goods inventory totaled 3,200 assemblies. On the same date, 30,000 units of direct material were in the warehouse.
Instructions a. Prepare a production budget for July through September. b. Prepare a direct material purchases budget for July through September. c. List several factors that could cause a change in the company’s present direct
material inventory policy.
2. Cash budget for service enterprise; analysis of operations The Eastside Tennis Club frequently experiences cash flow difficulties, with its checking account often below a desired minimum balance of $12,000. The follow- ing information pertains to club operations for the upcoming year (20X2):
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CHAPTER 6Problems
1) The directors anticipate that 400 memberships will be sold. Family memberships ($150) will comprise 60% of this total; the remainder are individual memberships ($50).
2) Members are assessed hourly fees for court time; the rate depends on whether usage occurs during “prime” time or “regular” time. The following hours and rates are expected:
3) Prime time Regular time
Rate per hour $ 10 $ 7
Hours of use 4,300 6,500
4) With the exception of accounts that total $2,500, all billings for memberships and court fees are expected to be collected during the year.
5) John Connors, club pro, is paid a salary of $20,000 plus 20% of all court fee revenues. Connors gives private lessons and expects to earn an additional $3,500. Lesson fees are paid directly to Connors by the participating members.
6) Expenses incurred during 20X1 were as follows: maintenance, $34,000; utilities, $13,500; and taxes, $6,200. Maintenance and utilities are expected to increase by 10% during 20X2; taxes should amount to $6,800. All expenses will be paid when incurred.
7) An examination of the club’s records revealed outstanding accounts payable of $1,000 on January 1, 20X2. These amounts will be paid by the end of February.
8) The addition of one new court and improved lighting will cost $45,000. The club will pay $20,000 down, with the remaining balance financed by a short- term note. Interest and principal payments during 20X2 will amount to $3,600.
9) The cash balance on January 1, 20X2, amounts to $5,000.
Instructions a. Prepare a cash budget for 20X2 for the Eastside Tennis Club. Disregard financing
(except for that noted in item 7) to meet minimum balance requirements. b. Assume that the budget revealed an ending cash balance of $4,400. In light of the
club’s target minimum of $12,000, what actions could the directors take to improve the ending cash position?
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CHAPTER 6Problems
3. Comprehensive budgeting The balance sheet of Watson Company as of December 31, 20X1, follows:
WATSON COMPANY Balance Sheet
December 31, 20X1
Assets
Cash $ 4,595
Accounts receivable 10,000
Finished goods (575 units 3 $7.00) 4,025
Direct materials (2,760 units 3 $0.50) 1,380
Plant & equipment $50,000
Less: Accumulated depreciation 10,000 40,000
Total assets $ 60,000
Liabilities & Stockholders’ Equity
Accounts payable to suppliers $ 14,000
Common stock $25,000
Retained earnings 21,000 46,000
Total liabilities & Stockholders’ equity $ 60,000
The following information has been extracted from the firm’s accounting records:
1) All sales are made on account at $20 per unit. Sixty percent of the sales are collected in the month of sale; the remaining 40% are collected in the following month. Forecasted sales for the first 5 months of 20X2 are as follows: January, 1,500 units; February, 1,600 units; March, 1,800 units; April, 2,000 units; and May, 2,100 units.
2) Management wants to maintain the finished goods inventory at 30% of the following month’s sales.
3) Watson uses four units of direct material in each finished unit. The direct material price has been stable and is expected to remain so over the next 6 months. Management wants to maintain the ending direct materials inventory at 60% of the following month’s production needs.
4) Seventy percent of all purchases are paid in the month of purchase; the remaining 30% are paid in the subsequent month.
5) Watson’s product requires 30 minutes of direct labor time. Each hour of direct labor costs $7.
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CHAPTER 6Problems
Instructions a. Rounding computations to the nearest dollar, prepare the following for January
through March:
1) Sales budget 2) Schedule of cash collections 3) Production budget 4) Direct material purchases budget 5) Schedule of cash disbursements for material purchases 6) Direct labor budget
b. Determine the balances in the following accounts as of March 31:
1) Accounts Receivable 2) Direct Materials 3) Accounts Payable
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