:!1
CHAPTER 7 OPERATING BUDGETS:
BRIDGING PLANNING AND CONTROL SOLUTIONS
REVIEW QUESTIONS 7.1
A plan for using limited resources.
7.2
Firms budget for (1) planning, (2) coordination, and (3) control (performance evaluation and feedback).
7.3
Operating budgets reflect the collective epression of numerous short!term decisions that conform to the direction set b" long!term plans. Financial budgets #uantif" the outcomes of operating budgets in summar" financial statements.
7.4
$he revenue budget. Organi%ations begin &ith the revenue budget because it is the first line on the income statement. Additionall", organi%ations begin &ith the revenue budget because revenues dictate the volume of operations &hich, in turn, drive man" costs such as those related to materials and labor.
7.5
$he production budget.
7.6
$he budgets for materials, labor, and overhead.
7.7
'ost of goods sold 'ost of beginning finished goods inventor" cost of goods
7.8
manufactured * cost of ending finished goods inventor". $he cash budget is important for managing a firm+s &orking capital. t allo&s companies to determine &hether the" &ill have enough mone" on hand to sustain pro-ected operations.
7.9
(1) nflo&s from operations, (2) outflo&s from operations, and (3) special items.
7.1
ecause most businesses offer credit terms to their customers * as such, the" receive cash a fe& da"s, &eeks, or months after the sale occurs. /oreover, a firm+s credit polic" affects the timing and amount of cash flo&s.
7.11
(1) 0urchases of direct materials, (2) pa"ments for labor, (3) ependitures on manufacturing overhead, and () outflo&s for marketing and administration costs.
7.12
ome eamples include the purchase or sale of e#uipment, the purchase or sale of stock, and the pa"ment of dividends.
7.13
A responsibilit" center is an organi%ational subunit. $here are three t"pes of responsibilit" centers (1) cost centers, (2) profit centers, and (3) investment centers.
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:!2 7.14
$op!do&n is more of an authoritative approach, &hereas a bottom!up approach is more participative, encouraging organi%ation!&ide input into the budgeting process.
7.15
An incremental approach to budgeting can be useful as past trends ma" help &ith future pro-ections. t is pragmatic, as it focuses attention on making changes to the previous "ear+s budget based on actual performance and ne& information. Finall", incremental changes are easier to -ustif" and communicate * it is human nature to compare performance across people and periods.
DISCUSSIONQUESTIONS
7.16
$he span of the operation often determines the need for a formal budget. t is easier to plan and keep track of &hat is happening if the operation is small enough. As the business epands to a point &here it is difficult one person can oversee the &hole operation and multiple people have to make decisions &ith respect to different aspects of the business, planning and coordination become necessar". /oreover, ho& can the o&ner of this epanding business ensure that all other emplo"ees making the various decisions are in fact making them as he &ould make them; ome control also becomes necessar"< udgets serve these purposes.
7.17
9es, this is in general a true statement. =aving a formal &ritten document that different decision units commit to is the most efficient of ensuring that there is proper coordination and there is goal congruence across these units.
7.18
t is true that there is al&a"s likel" to some deviation from &hat is epected. ut, deviations can occur because of factors outside decision makers+ control, and there is not much one can do to avoid these chance deviations. >eviations can also occur because the organi%ational actions and decisions are not in line &ith &hat the" &ere epected to do. " providing a baseline for comparison, budgets allo& us to measure and anal"%e these deviations so that corrective actions can be taken &hen necessar".
7.19
f budgets can be used to create the right organi%ational incentives, and all decision makers in the organi%ations are motivated to do the right thing, then close supervision ma" not be necessar". =o&ever, as discussed in the chapter, budgets cannot be a perfect substitute for supervision monitoring because the" are susceptible to game!pla"ing? no budget can be perfect &hen it comes to setting the right incentives. ome supervision and monitoring is al&a"s beneficial.
7.2
udgets pla" a limited role as a benchmark for performance evaluation in settings &here forecasting is difficult and there is a high level of inherent uncertaint". =o&ever, it is better to have rough budgets than no budgets at all, and supplement budgets &ith other
7.21
monitoring mechanisms such as close supervision. >epending on the si%e of the organi%ation and the number of products it offers, forecasting sales is a difficult eercise because it re#uires careful eamination of market conditions and trends. naccurate sales forecasts can thro& the entire planning process out
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:!3 of gear. o, man" organi%ations devote a lot of time to develop dependable sales forecasts. 7stimating overheads is also difficult especiall" in large organi%ations because there are multiple drivers of overhead. dentif"ing the right drivers and estimating the precise relations bet&een the overhead and its drivers is a difficult but an important step in the budgeting process. 7.22
@ust!in!s"stem is often referred to as a pullB s"stem because an order from a customer triggers all the production and procurement activities. $he idea is to carr" no inventor" in the s"stem, but respond to demand #uickl" b" achieving b" coordinating all necessar" activities smoothl". $o the etent a perfect pull s"stem can be achieved there are minimal inventor" budgets ra& that and reconcile the difference bet&eenthat sales and production. imilarl", there are minimal &ork!in!process inventories account for the difference bet&een material purchase and use.
7.23
$he budgeting process is time consuming in most organi%ations. ome large organi%ations are kno&n to start their budgeting process si months ahead of time. $he benefit of going through several iterations is that budgets become more accurate, serve as better benchmarks to evaluate performance, and there is better coordination across the organi%ation because ever"bod" is a&are of &hat is in it. $he cost is that it takes time and effort.
7.24
oth the cash budget and cash flo& statement reconcile the cash position of a compan" at the beginning of a period to the cash position at the end of the period. ut there are man" differences. First, the cash flo& statement is prepared at the end of the period, and reports past cash inflo&s and outflo&s. econd, the cash flo& statement reports cash flo&s associated &ith investing, financing, and operating decisions of the firm. On the other hand, a cash flo& budget presents a plan of cash inflo&s and outflo&s at a more detailed level, such as &hen and ho& much cash is epected from customers, &hen cash is to be paid to suppliers, and &orking capital re#uirements.
7.25
ome believe that budgets promote a financial emphasis in organi%ations. t is true that budgets are mostl" financial plans of organi%ational activities. $he reason for this is that ultimatel" the performance of a compan" is -udged in terms of the financial returns it generates for its shareholders. ut budgets need not necessaril" be restricted to financial measures. /an" firms are no& benchmarking ke" non!financial measures to ensure organi%ational success.
7.26
oth lines of reasoning have merit. For gro&th companies, it is often difficult to develop precise budgets because of the difficult" in forecasting outcomes from research and development and other gro&th activities. /oreover, rigid budgets are often said to stifle innovation and gro&th b" not giving enough room to eercise discretion to sei%e opportunities in a timel" fashion. On the other hand, budgets that allo& discretion are also sub-ect to misuse because formal control is difficult. Often more informal control mechanisms and closer supervision are needed to achieve a measure of control in such organi%ations.
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:! 7.27
$he advantages of participative budgeting include benefiting of the epertise and kno&ledge of emplo"ees in all levels of the organi%ation b" involving them in the budgeting process, promoting a sense of o&nership and empo&erment among all emplo"ees, ensuring that ever"bod" bu"s into the budget so that implementation is smooth, better communication and coordination. $he disadvantages are that participative budgeting is time consuming, and can lead to conflicts and disagreements that are hard to resolve (as the sa"ing goes !! too man" cooks spoil the broth
7.28
$op!do&n budgeting is preferable &hen decisions need to be taken #uickl", and time is of essence. $op!do&n budgeting is most suitable in smaller organi%ations &ith a narro& and manageable of products and and centrali%ed making. n these settings, top range managers are likel" to services, possess detailed enough decision information for budgeting purposes.
7.29
8ine!item budgeting is a term used to refer to budgets that are built line!item b" line! item. 6suall", budget for line!item cannot be used for another line item even if there is still some mone" left in it. n the government, for eample, each line item in the budget represents a certain use of public mone" such as road construction, maintenance of public buildings, parks, medical care, public securit" etc. $he reason for not allo&ing appropriation of funds set aside for one line!item for another purpose is to ensure the no public good or service is left underfunded. imilar considerations appl" to nonprofit organi%ations. $hese considerations are not as applicable to commercial companies &here the &hole purpose is to allocate funds in a &a" that generates most profits.
7.3
A budget is said to lapse if an" unspent amount in the budget is not carried over to the net period. 9es, the criticism is valid. $here are man" documented instances of such behavior. =o&ever, budget lapsing is a good &a" to force ependitures on some desirable activities and causes. 4esearch and development budgets are a good eample in commercial organi%ations.
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:!D E!ERCISES 7.31
n solving budgeting eercises, &e repeatedl" use the inventor" e#uation.B n its simplest form, the inventor" e#uation is
Beginning balance What we put in * What we take out Ending balance. Ce replace these terms &ith the appropriate account!specific terms &hen computing specific revenue and cost budgets. For 0remium, &e have eginning inventor" 1,:DE Cindo&s 0roduction ,EEE ales ! ; 7nding inventor" 2,DEE &indo&s $hus, &e find S"#$% &'( )"(*+ , 7-25 /0'%. /ultipl"ing :,2DE &indo&s b" the GHE price per &indo& gives $$ )"(*+ ($$0$ '& 435-. 7.32
a. $his eercise illustrates that budgets allo& organi%ations to pro-ect results for various options, helping them make the profit!maimi%ing choice. elo&, &e calculate the annual sales and revenues for each price. S"#$% )'0+ @anuar" Februar" /arch April /a" @une @ul" August eptember October 5ovember >ecember T'"#%
R$$0
%$Price = $60 2,DEE 2,HEE 2,:EE 2,EE 2,IEE 3,EEE 3,1EE 3,2EE 3,EDE 2,IEE 2,:DE 2,HEE
Price = $57 2,HEE 2,:2D 2,DE 2,I:D 3,1EE 3,22D 3,3DE 3,:D 3,32D 3,1:D 3,E2D 2,:D
Price = $60 G1DE,EEE 1DH,EEE 1H2,EEE 1H,EEE 1:,EEE 1E,EEE 1H,EEE 1I2,EEE 13,EEE 1:,EEE 1HD,EEE 1DH,EEE
Price = $57 G1,2EE 1DD,32D 1H2,DE 1HI,D:D 1:H,:EE 13,2D 1IE,IDE 1I,E:D 1I,D2D 1E,I:D 1:2,2D 1H3,:D
34-1
36-7
2-46-
2-91-9
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FO4 5$46'$O4 67 O589
:!H Ce see that pricing at GD: maimi%es 0remium+s revenues. 7ven though the compan" receives a smaller amount for each Cindo&, the increased volume compensates for the lo&er price. b. 0erhaps the most important factor to consider is cost * after all, 0remium is interested in maimi%ing profit, not -ust revenues. 0ricing its product at GD:, 0remium &ill be selling additional 2,HEE &indo&s (3H,:EE * 3,1EE) over the course of the "ear. =o&ever, reducing the price &ill not increase profit unless the additional costs of producing and selling the etra &indo&s are less than GD,IEE ( G2,EI1,IEE ! G2,EH,EEE) or about GD,IEEJ2,HEE G1:.HD per &indo&. Along these lines, 0remium it has enough capacit" produce the higher volume, and if the must higherconsider volume&hether might add to congestion in the to factor". 0remium also needs to consider the accurac" of its demand forecasts and &hether a price cut &ould adversel" affect the perceived #ualit" of its product. Finall", 0remium needs to consider &hat its competitors &ill do in terms of their pricing strateg" * if competitors also reduce their prices, 0remium ma" not en-o" the increase in forecasted demand. 7.33
Ce can appl" the inventor" e#uation to find the missing data, as follo&s
Number of Window >esiredendinginventor" udgetedsales $otalre#uirements ! eginninginventor" udgeted production
!pril 1,EE 1E,EEE 11,EE 1,2EE 1-6
"eptembe r 2,EEE 1D,EEE 1:,EEE
#ecember 3,2EE 2E,EEE 23,2EE
3,EEE 1,EEE
2,2EE 21,EEE
n each instance, &e perform the suitable arithmetic to rearrange the terms and solve for the re#uired item. 7.34
$o begin, &e kno& that eginning inventor" (/arch) 7nding inventor" (Februar") and, >esired ending inventor" (Februar") 1DK of /arch sales. E.1D L 1D,EEE 2,2DE.
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:!: Cith this step, &e can fill in the table partiall"
Number of Window >esired ending inventor" M udgetedsales $otalre#uirements ! eginning inventor"MM udgeted production
ebruar %
&arch
2-25 1E,EEE 12,2DE 1,DEE
3- 1D,EEE 1,EEE 2-25
!pril 3,EEE 2E,EEE 23,EEE 3-
M 2,2DE E.1D L 1D,EEE? 3,EEE E.1D L 2E,EEE MM eginning inventor" (/arch) 7nding inventor" (Februar").
Ce then use the inventor" e#uation to fill in the missing data, as follo&s
Number of Window >esired ending inventor" udgetedsales $otalre#uirements ! eginninginventor" udgeted production
ebruar %
&arch
2-25 1E,EEE 12,2DE 1,DEE 1-75
3- 1D,EEE 1,EEE 2-25 15-75
!pril 3,EEE 2E,EEE 23,EEE 3- 2-
n each instance, &e perform the suitable arithmetic to rearrange the terms and solve for the re#uired item. n particular, &e first solve for Februar" ending inventor" and Februar" production. n turn, this gives us the eginning inventor" for /arch. Ce repeat the process for /arch to get /arch production, and so on. 7.35
a. $he follo&ing table provides the re#uired revenue budget, and income statement. August eptember October 5ovember ndividuals :EE HIE HE H:D Famil" memberships 3EE 3EE 2ID 2IE 4evenue ! ndividual G :E,EEE1 G HI,EEE G H,EEE G H:,DEE 4evenue ! Famil" G ,EEE1 G ,EEE G :,2EE G H,EE $otal 4evenue G 11,EEE G 11:,EEE G 11D,2EE G 113,IEE Nariable cost * ndividual G 2,DEE1 G 2,1DE G 23,EE G 23,H2D Nariable cost ! Famil" G 1,EEE1 G 1,EEE G 1:,:EE G 1:,EE 'ontribution margin G :D,DEE G :,DE G :3,:EE G :2,:D Fied cost G E,EEE G E,EEE G E,EEE G E,EEE 0rofit before taes G 3D,DEE G 3,DE G 33,:EE G 32,:D 1
G:E,EEE :EE L 1EE? G,EEE 3EE L G1HE? G2,DEE :EE L G3D? G1,EEE 3EE L GHE.
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!
b. $he follo&ing table provides the re#uired revenue budget, and income statement.
ndividuals Famil"memberships 4evenue ! ndividual 4evenue!Famil" $otal4evenue Nariable cost ! ndividual Nariablecost!Famil" 'ontribution margin Fiedcost Ad campaign 0rofit before taes
August eptember October 5ovember :EE :EE HIE HD 3EE 3ED 3EE 2ID G:E,EEE G:E,EEE GHI,EEE GH,DEE ,EEE ,EE ,EEE :,2EE G11,EEE G2,DEE 1,EEE G:D,DEE E,EEE G3D,DEE
G11,EE G11:,EEE G11D,:EE G2,DEE G2,1DE G23,I:D 1,3EE 1,EEE 1:,:EE G:H,EEE G:,DE G:,E2D E,EEE E,EEE E,EEE 1E,EEE G2H,EEE
G3,DE
G3,E2D
c. ased on the above, it &ould appear that profits have decreased. ased on pro-ection in part aP, =ercules epected to earn G13H,I2D ( G3D,DEE G3,DE G33,:EE G32,:D). $he pro-ection in part bP sho&s a cumulative profit of G13E,3:D ( G3D,DEE G2H,EEE G3,DE G3,E2D) onl", a decrease of about GH,DDE. =o&ever, &e cannot conclude that the ad campaign is a bad idea. $his is because the ne& members &ill continue to benefit =ercules in the future as &ell (but not indefinitel"). uppose that the average ne& membership is for 12 months. $hen, the epected benefit from the campaign is 12 months L 1E individuals L (G1EE!G3D) D familiesL (G1HE *GHE) P G13,EE, &hich eceeds the cost of the ad campaign. 5ote Firms develop life!c"cleB models to account for such future effects. uch models are crucial in service firms such as cable operators and &ireless providers &ho epect to get a continuing stream of revenue from each ne& customer. $hus, these firms are &illing to take a lossB in the first fe& months b" spending a lot to get ne& customers.
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:!I
7.36
$he follo&ing table provides the re#uired information. 5otice the use of the inventor" e#uation to back out the amount of purchases.
August ndividuals Famil"memberships upplies needed 7 ndinginventor" $otalneeded !eginninginventor" 0urchases 1
eptember :EE 3EE 13,HEE1 D,EEE 1,HEE D,EEE 13-6
October HIE 3EE 13,DEE ,DEE 1,EEE D,EEE 13-
HE 2ID 13,2IE ,DEE 1:,:IE ,DEE 13-29
13,HEE :EE L 1E 3EE L 22.
5otice that the beginning inventor" in eptember is the ending inventor" in August. Ce also calculate supplies needed as Q of individual memberships L G1E Q of famil" memberships L G22. Finall", notice that &e cannot compute the purchases in 5ovember because &e do not kno& the re#uired ending inventor". 7.37
8et us begin b" calculating the operating cash flo&.
Item ndividualfees Famil" 0repaid (individual) 0repaid (famil") $otal inflo&s 0urchase(current) 0urchases(prior) Nariablecosts Fiedcosts $otal outflo&s
Detail (HIE!1E)LG1EE (3EE*HE)LG1HE (1EJ12) M (12 L 1EE L IEK) (HEJ12) L(12 L 1HE L IEK)
E.HLG13,EEE E.LG13,HEE (HIELG2D)(3EELGD) G1,EEE!G12,DEE
Operatingcashflo&
alakrishnan, /anagerial Accounting 1e
September GD1,EEE 3,EE 1H,2EE ,HE G11,2E G:,EE D,E 3E,:DE 2,DEE G:2,IE G1,:DE
FO4 5$46'$O4 67 O589
:!1E Ce can no& prepare the cash budget.
Item eginningbalance Operatingcashflo& pecial items ! e#uipment Amounttakenout 7ndingbalance
7.38
September G H,EEE 1,:DE (2E,EEE) (1D,EEE) G12,:DE
$his eercise is trick"B in the sense that &e cannot directl" appl" the inventor" e#uation to the ne& sales pro-ection for April. $his is because &e do not kno& the srcinal or revised sales for April. =o&ever, &e kno& the original production for April. 6sing this data, &e can back out the srcinal sales as 113,EEE units (as sho&n in the table belo&). $he revised sales therefore IEK of 113,EEE 1E1,:EE units. Ce could then back out the ($/%$ ('*/'0 &'( A(/# "% 16-5 0/%. 5otice that there is no change in the beginning inventor" for April. $his is because /arch is almost over and Rant% &ould have alread" built up inventor" as per the srcinal budget. =o&ever, because /a"+s estimates are do&n 1EK, the desired ending inventor" for April &ould be do&n 1EK, from 22,EEE to 1I,EE.
>esired ending inventor" udgetedsales $otalre#uirements !eginninginventor" udgeted production 1
A(/# '#; 22,EEE 113,EEE 1
13D,EEE 1D,EEE 12E,EEE
A(/# 0$; E.I L 22,EEE 1I,EE E.I L 113,EEE 1E1,:EE
121,DEE 1D,EEE 16-5
113,EEE 12E,EEE 1D,EEE * 22,EEE.
7.39
$he ke" point in this problem is that &e have to perform the calculations separatel" for each t"pe of bo (although &e use the same inventor" e#uation for all boes). Additionall", it+s important to remember that the ending inventor" for an" one month e#uals the beginning inventor" of the follo&ing month * thus, &e can calculate the beginning inventor" for /arch as 2EK of /arch+s sales (&hich is the ending inventor" of Februar").
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!11
S<"## '=$%:
&arch >esired ending inventor" (.2E L net month+s sales) udgetedsales $otal 4e#uirements ! eginning inventor" (.2E L current month+s sales)
3,EEE 1E,EEE 13,EEE
!pril ,EEE 1D,EEE 1I,EEE
2,EEE
3,EEE
B$$ ('*/'0
11-
16-
R$$0$ $ ( ales L G2.:D)
27-5
41-25
)$/< '=$%:
&arch >esired ending inventor" (.2E L net month+s sales) udgetedsales $otalre#uirements ! eginning inventor" (.2E L current month+s sales) B$$ ('*/'0
H,EEE 2D,EEE 31,EEE
!pril ,EEE 3E,EEE 3,EEE
D,EEE 26-
H,EEE 32-
93-75 R$$0$ B$ ( ales L G3.:D)
112-5
L"($ '=$%:
&arch >esired ending inventor" (.2E L net month+s sales) udgetedsales $otalre#uirements ! eginning inventor" (.2E L current month+s sales) B$$ ('*/'0 R$$0$ B$ ( ales L GD.EE)
alakrishnan, /anagerial Accounting 1e
,EEE 1D,EEE 1I,EEE 3,EEE 16- 75-
!pril D,EEE 2E,EEE 2D,EEE ,EEE 21- 1-
FO4 5$46'$O4 67 O589
:!12
7.4
a. Once again, &e appl" the inventor" e#uation to solve this problem. 6sing the information provided, &e have (units in linear feet)
>esired ending inventor" (in linear feet) 5eeded for production $otal re#uirements ! eginning inventor" B$$ (*+"%$% (linear feet) P(*+"%$% $ budgeted purchases L GE.:D per foot
>etail EK of April needs E.E L 1D,EE boes L 12 feetJbo. 1,EEE 12,EEE boes to be
)"(*+ :D,E
produced L 12 feetJbo. 21I,E DE,EEE R iven 169-84
127-38
b. os&orth &ould use 1,EEE linear feet of cardboard strips to produce the boes. T+$ '"# <"$(/"#% *'% 1,EEE L GE.:D 18-. An inventor" cost flo& assumption is not re#uired in this instance because the entire inventor" (beginning inventor" plus purchases) is valued at GE.:D per linear foot. c. ecause os&orth has different la"ers of inventor" &ith differing prices, the cost flo& assumption no& becomes important. Cith FFO, the firm &ill consume the oldest la"er first before consuming purchases. $hus, &e have Frombeginninginventor" DE,EEElinear feetSGE.:EJft G3D,EEE From /arch purchases I,EEEM linear feet SGE.:DJft G:E,DEE T'"< # "$(/"#%*'% 15-5 M I,EEE 1,EEE * DE,EEE 5otice that the cost of materials usage has decreased. Ch"; 6nder the FFO cost flo& assumption used b" oso&orth, the materials in beginning inventor" &ill be used up first. os&orth+s beginning inventor" is valued at G3D,EEE. $hat difference of G2,DEE (DE,EEE linear feet L E.EDJft) causes the cost of material usage to decrease.
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!13 5ote $he usage budget for /arch &ould not change if os&orth uses the 8FO method. $he firm &ould not be dipping into the la"er of beginning inventor", meaning that all 1,EEE linear feet used &ould be valued at GE.:D per foot. 7.41
Ce compute budgeted cash inflo&s using the follo&ing table
4evenues 'ash collections from current revenues 'ash collected one month later 'ash collected t&o months later 'ash collected three months later T'"# C"%+ C'##$*/'0%
N'$<$( G13D,EEE
D$*$<$( G1DE,EEE
E,DEE
D,EEE
DH,EEE 33,:DE H,EEE 136-25
D,EEE 3D,EEE H,:DE 14-75
5otice that the collections for 5ovember include 3EK of 5ovember sales (E.3E L G13D,EEE), EK of October sales (E.E L G1E,EEE), 2DK of eptember sales (E.2D L G13D,EEE), and DK of August sales (E.ED L G12E,EEE). Ce need to stagger sales in this fashion because it takes ruce 3 months to collect cash from his sales. 7.42
As &ith the prior problem (&hich deals &ith receivables), it is most convenient to calculate ruce+s cash outflo&s using a table such as the follo&ing O*'$(
0urchases 12E,EEE 'ash pa"ment for current purchases G:2,EEE 'ash pa"ment for prior month purchase 2,DEE 'ash pa"ment for purchases made 2 months ago I,EEE T'"# C"%+ O&#'
19-5
N'$<$(
D$*$<$(
11E,EEE 12E,EEE GHH,EEE G:2,EEE 3H,EEE 33,EEE I,DEE 12,EEE 111-5 117-
5otice that the total cash outflo& for >ecember includes pa"ments for >ecember purchases (E.HE L 12E,EEE), for 5ovember purchases (E.3E L 11E,EEE), and for October purchases (E.1E L 12E,EEE). Ce compute the cash outflo&s for October and 5ovember in a similar fashion. 7.43
$he follo&ing items pertain to October, and illustrate the logic for the cash budget. 1. $otal cash available beginning balance receipts GI,DEE G1,1EE G23,HEE. 2. $otal disbursement um of pa"ments for materials, labor and overhead. acking out the numbers, for the pa"ments for overhead &e have G1,3EE !G,EE !G,DE GD,DE 3. alance prior to financing total available * total pa"ments (or, disbursements). $hus, G23,HEE ! G1,3EE GD,3EE. alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!1 . orro&ing needed (if an") /inimum balance * balance prior to financing. D. 7nding balance (October) eginning balance (5ovember) $he follo&ing table provides the completed cash budget. C"%+ B$ > ?'(+ Q"($(
eginning cash balance 'ashreceipts $otal cash available 'ash disbursements 0a"ments for materials 0a"ments for labor 0a"ments for overhead $otal disbursements alance prior to financing /inimum cash balance Financing orro&ingJ(repa"ment) 7nding cash balance
'ctobe r GI,DEE 1,1EE
No(embe r GI,DEE
#ecembe r GI,DEE
17-9
18-4
23-6
G2:,EE
G2:,IEE
,EE ,DE 5-45 1,3EE 5-3 I,DEE
3-63 :,2DE D,I2E 1H,EE 1-6 I,DEE
,1EE 7-21 D,:2E 1:,E3E 1-87 I,DEE
4-2 9-5
1-1; 9-5
1-37; 9-5
$he firm+s ending loan balance is therefore G,2EE ! G1,1EE ! G1,3:E 1-73. 7.44 $he follo&ing table provides Rilbert+s cash budget for 5ovember and >ecember. No(ember Opening balance of cash 4eceipts from current sales (:EK of current revenues) 4eceipts from prior month sales (3EK of prior month revenues) $otal available ! 0urchase cost ( 'OR HEK of revenues) ! /arketing and admin. epenses 7nding balance of cash
#ecember
G1H,EEE 3D,EEE
G2:,EEE 2,EEE
12,EEE
1D,EEE
GH3,EEE
G,EEE
3E,EEE H,EEE 27-
3H,EEE D,EEE 43-
5otice that Rilbert+s 5ovember collections include :EK of 5ovember sales (G3D,EEE) and 3EK of October sales (G12,EEE). ased on our anal"sis, it appears that Rilbert &ill have plent" of cash on hand and, thus, &ill not need to borro& mone".
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!1D
7.45
a. Ce can do this problem in t&o &a"s. $he short method is to recogni%e that Tris &ould have collected all of her sales for /arch and April b" /a" 31. he also &ould have collected DEK of /a" sales in /a". $hus, her accounts receivable &ould be DEK of /a" sales or 23- ( GH,EEE L E.DE). $he longer method is to &rite do&n her accounts receivable, using a format similar to that for inventor" accounts. Ce have
Opening balance for receivables 'urrent sales $otal collectible ! 'ollections for prior month ! 'ollections for current month 'losing balance for receivables
A(/#
G2D,EEE E,EEE GHD,EEE 2D,EEE 2E,EEE 2-
)"@
G2E,EEE H,EEE GHH,EEE 2E,EEE 23,EEE 23-
b. Again, &e can do this problem in t&o &a"s. $he short method is to recogni%e that Tris &ould have paid for all of her purchases in /arch and April b" /a" 31. he also &ould have paid for EK of purchases in /a". $hus, her accounts pa"able &ould be 2EK of /a" purchases or E.2E L GE,EEE 8-. $he longer method is to &rite do&n her accounts pa"able, using a format similar to that for inventor" accounts. Ce have
Opening balance for pa"ables 'urrent purchases $otal pa"able ! 0a"ments for prior month ! 0a"ments for current month 'losing balance for pa"ables
A(/#
)"@
GH,EEE 32,EEE 3,EEE H,EEE 2D,HEE 6-4
GH,EE E,EEE H,EE H,EE 32,EEE 8-
7.46
$his is an open!ended #uestion &ith man" possible vie&s on the Cilma+s best course of action. Ce summari%e some possible arguments belo&. ome might argue that Cilma should follo& cott Ford and @ake+s 8e&is lead and pad her budget as &ell. $he problem appears to be ver" rigid standards and a formulaic approach to incentive compensation. $he founder+s approach, some ma" argue, leaves the managers no choice, but to build in some cushion. ndeed, &e might -ustif" @ake+s actions as beneficial in the long term, although &e onl" have his &ord that the cushion is for long!term improvements. ome might #uestion cott+s ecessiveB lo&!balling, although ho& much is OTB and ho& much is ecessiveB is not resolved easil". alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!1H
At the other etreme, clearl" the firm+s plans contain information kno&n to be false. 7thical standards for accounting professionals preclude Cilma from kno&ingl" compromising the integrit" of information. $hus, she might have no choice but to tr" and rectif" the situation as much as possible. >oing so, ho&ever, might pit her against the other managers, limiting her effectiveness. Overall, a pragmatic approach might involve attempting to educate the o&ner about the pitfalls of his methods. ndeed, Cilma might find that 4o" is &ell a&are of the padding b" his managers and that this is the Ugame+ that all in the firm agree to (implicitl"). n this case, Cilma+s conscience is recommendation clear and, in our opinion, she &ould compl" &ith and accounting standards as &ell. $hus, our is for Cilma to speak &ith 4o" feel him out on his vie&s about budget padding before taking the net step. 7.47
$his #uestion is likel" to provoke a range of ans&ers. 'learl", the manager eperienced an unfavorable and uncontrollable event. 9et, should 'arrie revise the budget; Ce see the issue as t&o separate problems. $he first is a planning problem in terms of scheduling production, ordering materials, and so on. 5aturall", the firm should take the latest information into account for such decisions. $he second problem is &hether the manager+s performance targets should be changed. One could argue either for or against a change * &e are inclined to not change the performance targets in this instance. First, as 'arrie notes, a change re#uires that she define a Ubig+ event, and this is a slipper" slope. t &ould not be long before an" adverse event triggered a re#uest for a target reset. econd, good managers are supposed to deal &ith risk. nsulating riskthe defeats purpose. $hird,spur managers often are ver" innovative &hen theirthem backagainst is against &all.the $his event might management into un!chartered territor". And, the final argument is &ill the manager ask for a target reset if the fire &ere in a competitor) plant;B
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!1:
PROBLE)S 7.48
a. lueteel appears to have enough capacit" to meet its annual sales forecast. Annual sales are 112,DEE units (2,EEE 2,DEE 33,EEE 2:,EEE) and the firm has installed capacit" for 12E,EEE units (12 months L 1E,EEE units per month). b. 'learl", lueteel needs to build up inventor" to meet the demand surge in V3. lueteel could do this b" building up inventor" in V1 and V2. $he compan" &ould need to begin is limited ecess * the ecess capacit" in V2inisV1 notbecause enough there to make the etra unitscapacit" to meet is theV2 demand for V3. $he follo&ing table illustrates one possible production schedule that enables the firm to meet its sales forecast.
alesfor#uarter 0roductionfor#uarter nventor"atendof#uarter
Q"($( 1 2,EEE 2D,DEE 1,DEE
Q"($( 2 2,DEE 3E,EEE 3,EEE
Q"($( 3 33,EEE 3E,EEE E
Q"($( 4 2:,EEE 2:,EEE E
n realit", the firm might &ish to build up more inventor" in V1 so that the factor" has some slack in V2 and V3 to deal &ith unanticipated problems. Another alternative is to produce something like 2,DEE? 2,DEE? 2,DEE, 2:,EEE cabinets in the four #uarters. $his schedule smoothes out production (from a hiring standpoint), leaves some additional capacit" in V2 and V3 if needed, and lightens a bit in V, perhaps for additional maintenance, and to secure desired "ear!end inventor". c. $he '7O+s basic approach appears to be sound. /odern management practice is to limit the amount of inventor" as much as possible. uch curtailing of capacit" has several advantages. First, it reduces the capital tied up. econd, it reduces obsolescence. $hird, a lo& inventor" polic", if done in con-unction &ith suitable changes to production processes, could help the firm improve #ualit" and increase responsiveness. =o&ever, the lo& inventor" polic" comes &ith a cost. For lueteel, a %ero inventor" polic" &ould curtail V3 sales to 3E,EEE units. Other than building inventor", the onl" &a" to meet demand is b" adding to capacit", &hich &ill increase capacit" for all four #uarters. d. nventor" gives firms a &a" to moveB capacit" across periods, as sho&n in part bP. =o&ever, such movement is costl" because of storage costs and the cost of capital tied up in inventor", as &ell as intangible #ualit" costs. $he best solution is, of course, situation specific, but the problem highlights that holding inventor" has both costs and benefits. alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!1
7.49
t is convenient to compute /ina+s epected cash inflo&s using a table such as the follo&ing
ales
O*'$( G1H,EEE
'ash from current sales GI,2EE 'redit sales (current month) 3D,EEE 'redit (one month later) 'redit (t&o months later) $otal
33,2DE ,:HE 122-21
N'$<$( G1:D,EEE
GD2,DEE D,I2E 3,:DE D,32E 147-49
D$*$<$( G1IE,EEE
GD:,EEE I,EEE D:,EE :,EEE 17-4
$hirt" percent of /ina+s sales are made for cash, so the collections for October include 3EK of October sales (E.3E L G1H,EEE). $he remainder of :EK credit purchases for October is calculated as follo&s EK of the credit sales in eptember (E.E L E.:E L G12D,EEE), DEK of the credit sales in August (E.DE L E.:E L GID,EEE) and K of the credit sales in @ul" (E.E L E.:E L D,EEE). Ce need to stagger sales in this fashion because /ina takes several months to collect cash from her sales. Ce compute the collections for 5ovember and >ecember in a similar fashion. 5otice that /ina &riting off 2K of her credit sales has no impact on her epected cash inflo&. $he &rite off &ould, ho&ever, reduce her balance of accounts receivable b" increasing the balance of allo&ance for doubtful accounts ($he other side of the entr" is an epense in the income statement.) 7.5
$he numerical ans&er to this #uestion is relativel" straightfor&ard. Ash&ini &ill commit G1DE,EEE in April, G1D,EEE in /a" and G21E,EEE in @une. =o&ever, her bank statement &ill record a cash outflo& e#ual to received items G1DE,EEE in /a", G1D,EEE in @une, and G21E,EEE in @ul". $his discrepanc" bet&een committed outflo&s and actual outflo&s highlights t&o observations. First, &e might have to pa" for some purchases before &e receive the items. uch arrangements are common in international settings, and in settings &here the seller has a great deal of bargaining po&er. econd, Ash&ini+s actual cash outflo& (in the sense of an outflo& from her bank account) &ould take place the same month she receives the items. =o&ever, she needs to budget a bit differentl" because the bank &ould place a holdB on the mone". $his hold means that the mone" &ould not be available to Ash&ini for other purposes. $hus, the problem emphasi%es that cash budgets must include the commitment of cash, even if the actual outflo& might take place later. Ce often see this in purchase budgets that go into future months to sho& commitments triggered b" current purchases. n cases like the one Ash&ini faces, firms &ould often have a separate line item for committed funds that the" &ould remove from available cash balances. alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!1I
5ote Ash&ini+s problem is similar, in principle, to depositing a check at a bank but not having access to the funds until the check clears. 7.51
a. $he follo&ing table provides Rar"+s income statement for October through >ecember. n this statement, notice that the cost of purchases EK of sales. (Rar" marks up G1 of cost to G1.2D in sales. o, G1 in sales G1J1.2D GE.E in cost.)
4evenues 0urchases cost 'ontribution /argin 'ash fied costs 5on cash fied costs 0rofit before taes
O*'$(
N'$<$(
D$*$<$(
G:D,EEE 3E,EEE GID,EEE D,EEE 1E,EEE
GD2D,EEE 2E,EEE G1ED,EEE D,EEE 1E,EEE 1-
GDH2,DEE DE,EEE G112,DEE D,EEE 1E,EEE 17-5
Overall, Rar" appears to be running a profitable business, &ith breakeven sales of G:D,EEE. ('heck G:D,EEE L '/4 of 2EK ! GID,EEE E). $hus, &hile Rar" is at breakeven in October, he is &ell past the re#uired volume in 5ovember and >ecember. b. $he follo&ing table provides Rar"+s cash budget for October * >ecember. n this statement, 'ollections * 1 month are the collections from prior month sales (e.g., October E.3E of eptember sales) and 'ollections * 2 months are the collections from sales 2 months ago (October E.:E L August sales). 8ike&ise, purchases * current month DEK of current month purchases and purchases * 1 month are DEK of the prior months purchases.
'ollections ! 1 month 'ollections ! 2 months $otal cash available 0urchase ! current month 0urchase month ago 'ash fied costs 5et cash from operations opening balance , E0/0 "#"0*$
O*'$( N'$<$( D$*$<$( G1E,H2D G12,DEE G1D:,DEE 32,12D 32,12D 332,DEE GH,:DE G:E,H2D GIE,EEE 1IE,EEE 21E,EEE 22D,EEE 1:,DEE 1 1IE,EEE2 21E,EEE D,EEE D,EEE D,EEE GH,2DE (G1,3:D) (G3E,EEE) D,EEE 11,2DE (3,12D) 11-25 3-125; 33-125;
1
G1:,DEE (H,:DEJ1.2D) L E.DE.
2
G1IE,EEE (:D,EEEJ1.2D) L E.DE.
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!2E Overall, Rar" appears to be facing a cash crunch. Available cash dips from G11,2DE in October to an anticipated shortfall of (G33,12D) in >ecember. $his occurs even though sales have increased in this time period. c. Rar"+s problem is common among firms &hich eperience gro&th. n essence, Rar" is pumping mone" into &orking capital because he is financing his customers+ purchases. =e is pa"ing his suppliers faster than his customers are pa"ing him. $hus, &hen his business gro&s, he has to put more mone" into the business. Ce can see this b" calculating that the accounts receivable at the start of October is G:IH,:D ( :EK of August sales eptember sales), &hereas it is GI3E,EEE ( :EK of 5ovember sales >ecember sales) at the start of @anuar" net "ear. Rar" needs to find &a"s to manage this imbalance. One avenue is to borro&, but he has to consider interest costs. $he other avenue is to accelerate collections or defer pa"ments, but then customers might cut back on orders and suppliers might raise prices. oth actions are costl" to Rar". Rar" &ould need to estimate his epected profit to evaluate each option. 7.52
Ce kno& that the 'OR/ is the outflo& from the C0 inventor" account. >irect materials, direct labor, and overhead are the inflo&s into this account. Appl"ing the inventor" e#uation then helps us fill in the re#uired data. 8ike&ise, &e kno& that the 'OR is the cost of the items removed from finished goods inventor". $hus, &e can compute 'OR b" appl"ing the inventor" e#uation to the FR inventor" account. 5otice that 'OR/ is the linking number bet&een the t&o accounts. $his amount is the outflo& from the C0 account and is the inflo& into the FR account.
8et us begin &ith the C0 account. Ce have
OpeningC0 >irectmaterialsusage >irectlabor Nariableoverhead $otalinflo&intoC0 ! Nariable cost of goods manufactured 7nding C0
)"@ G1E,EEE 2DE,EEE 2HD,DEE 12D,EEE 2E,DEE DD,EEE 275-5
0$ 275-5 2E,EEE 3D,EEE 1D,EEE 1,ED,DEE D:,EEE 471-5
eginning &ith /a", &e appl" the standard inventor" e#uation to obtain ending inventor" as G2:D,DEE. $he ending inventor" in /a" is the beginning inventor" for @une. $his allo&s us to calculate the remaining ;+sB for @une.
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!21 5et, let us appl" the inventor" e#uation to the FR inventor" account.
OpeningFR 'ostofgoodsmanufactured 'ost of goods available for sale ! 'ost of goods sold 7nding FR inventor"
)"@ G22E,EEE DD,EEE :HD,EEE H1D,EEE 15-
0$ 15- D:,EEE :2,EEE 499- G22D,EEE
Once again, our computation uses the fact that the ending inventor" in /a" the beginning inventor" in @une. 7.53
$his problem highlights the planning role for budgets. 8et us first determine the variable and fied costs corresponding to 5aomi+s operations. I$< >irect materials >irect labor elling W Adm. Fied costs
D$"/# GE,EEEJ12E,EEE units G:2E,EEEJ12E,EEE units G12E,EEEJG2. million
C(($0 *'% E=$*$ *'% GJunit G.EJunit GHJunit GH.3EJunit DK of sales G DK of sales G G,EEE G,EEE
Cith this data in hand, let us prepare a pro-ected income statement if 5aomi raises her price to G22 per unit. Price = $22 & Number of units sold = 120,000 4evenues(12E,EEEunitsLG22) Nariable costs >irectmaterials >irectlabor
G2,HE,EEE GD2,EEE :DH,EEE
elling and administration 'ontribution /argin Fied costs /anufacturing /arketingandsales
DE,EEE 12E,EEE
Reneral administration
22,EEE
P('&/$&'($"=$% 4eturn on sales (G33H,EEEJG2,HE,EEE)
alakrishnan, /anagerial Accounting 1e
132,EEE
G1,1H,EEE G1,22,EEE
G,EEE 336-
12.:3K
FO4 5$46'$O4 67 O589
:!22 8et us repeat the eercise &ith the lo&er!price, high!volume strateg". Price = $19 & Number of units sold = 17,000 4evenues(1:D,EEEunitsLG1I) G3,32D,EEE Nariable costs >irectmaterials G::E,EEE >irectlabor 1,1E2,DEE ellingandadministration 'ontribution/argin Fied costs /anufacturing /arketingandsales
GDE,EEE 12E,EEE
Reneraladministration
22,EEE
P('&/ $&'($"=$% 4eturn on sales (G3I,2DEJG3,32D,EEE)
1HH,2DE
G2,E3,:DE G1,2H,2DE
G,EEE 398-25
11.IK
oth strategies meet 5aomi+s goals of increasing her profit and return on sales. =o&ever, the t&o income statements conflict in terms of epected profit and epected profitabilit". $he higher!price, lo&er volume strateg" has lo&er profit but higher profitabilit". 5aomi+s choice therefore depends on her goals and the nature of the product market. n some instances, such as often occurs &ith premium products, it can make most sense to go for a high margin strateg", sacrificing volume. n other instances, such as &ith consumer goods, it might make more sense to lock up the market b" going for sales gro&th. 4egardless, pro-ecting future income statements under alternate formats help firms put a number on the tradeoff and make a more informed choice. n 5aomi+s case, she does not appear to have a sustainable competitive advantage for the t"pes of products she offers (the barriers to entr" are likel" minimal) * thus, &e &ould argue for setting a lo&er price and getting a larger share of the market. 7.54
$he participative budget described here seems participative in name onl". $he goal for participative budgets is to take advantage of locali%ed kno&ledge that operating personnel possess. n virtuall" ever" instance, the participative input is sub-ect to oversight and discussion. ome amount of revision is also common. =o&ever, ecessive and arbitrar" revie& that substitutes a top!do&n target for a bottom!up estimate makes a mocker" of the process, eliminating its value. uch a gutting appears to be the case in $im+s firm. /elanie+s statement hints at a ver" autocratic st"le that essentiall" sa"s, /" &a" or the high&a".B $he revision process also appears to be arbitrar" and capricious. $here is little incentive for the salespersons to spend much time and effort in pro-ecting the true epected sales because the" kno& that the target &ould be revised up&ards and $im+s estimate &ill alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!23 prevail. $his problem la"s the foundation for an interesting discussion about the costs and benefits of participative budgeting. Chile these budgets are useful, the" also give rise to game pla"ing and slack. 4evie&s b" top management cut do&n on slack, but also remove some of the benefits. =o& best to manage the tradeoff is an open!ended problem &ith no clear ans&er. 4esearch has identified factors that increase game pla"ing (ecessive reliance on incentives, uncertain environment, lack of management eperience at the top, lack of trust) but eecuting the tradeoff &ell remains an art. 7.55
a. $he follo&ing tables provide the re#uired classifications. $he classification into manufacturing and selling depends is some&hat intuitive. $he classification into fied versus variable costs is sub-ective to some degree. Ce gain confidence in this estimate b" computing unit costs (for manufacturing epenses) and the cost per sales dollar (for selling epenses) * if these costs sta" mostl" the same as volume changes, then &e classif" the epense as variable. f, ho&ever, these costs decrease markedl" as volume increases, then &e classif" the epense as fied.
>irect materials >irect labor hours 0lant maintenance 0lant depreciation ndirect labor
)"0&"*(/0 ); S$##/0 S; ) ) ) ) )
?/=$ ?; V"(/"#$ V; V V ? ? V
) ) ) S S )
? V ? ? V ?
7ngineering design 6tilities 0lant administration /arketing administration ales force commissions 0lant supervision ased on the above &e conclude that (1) Nariable manufacturing costs (2) Nariable selling costs (3) Fied manufacturing costs () Fied selling costs
alakrishnan, /anagerial Accounting 1e
>irect materials, direct labor, indirect labor, utilities ales commissions 0lant maintenance, plant depreciation, engineering design, plant administration, and plant supervision /arketing administration
FO4 5$46'$O4 67 O589
:!2
b. 6sing the above table, &e obtain the follo&ing estimates (averages of three "ears) 6nitprice Nariable manufacturing costs Nariable selling costs $otal fied costs
GDH.EEJunit G2:.H:Junit (the average for 3 months) GE.E3 per sales G G2,1:,EEE (the average for 3 months)
$hus, &e could &rite the firm+s contribution margin statement as follo&s 6nits 4evenues
1DE,EEE G,EE,EEE
Nariable manufacturing costs
,1DE,DEE
Nariablesellingcosts
2D2,EEE
'ontribution /argin
G3,II:,DEE
$otal fied costs P('&/$&'($"=
%$2,1:,EEE 1-819-5
c. $his problem illustrates a #uick and dirt"B &a" to budget operations. n essence, the firm is using the 'N0 relation to pro-ect its goals for the coming "ear. $he parameters for the 'N0 relation are the average of operations for the past three "ears. Chile this approach has merit, there are potential concerns. First, given the significant change in operations, it is likel" that the demand pro-ection falls outside the firm+s relevant range of operations * thus, 7sse ma" need to add additional capacit" to manage the additional demand. $he simple 'N0 relation ignores these complications. A second ma-or problem is the omission of an" kind of detailed breakdo&n or basis for the sales forecast * this is particularl" important given the optimistic nature of the forecast * 7sse could find itself in an a&k&ard position if sales fall dramaticall" short of pro-ections. 7.56
a. Cith the given data, &e could &rite the firm+s contribution margin statement as follo&s O(//0"#
6nits
R$/%$ B$
A%<$0
1DE,EEE
4evenues Nariable manufacturing costs
1DE,EEE
G,EE,EEE
G,EE,EEE
,1DE,DEE
,1DE,DEE
Nariablesellingcosts
2D2,EEE
2D2,EEE
'ontribution /argin
G3,II:,DEE
G3,II:,DEE 1
$otal fied costs P('&/ $&'($"=$% 1
2,1:,EEE 1-819-5
565- 565-
G2,:3,EEE 1-254-5
GDHD,EEE (22D,EEE 12D,EEE 1EE,EEE E,EEE :D,EEE).
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!2D 5otice that &e have collapsed all of the increase in fied costs into one line item. $his increase reflects the additional capacit" costs that stem from increasing the firm+s production capabilities * as &e &ill learn in 'hapters I and 1E, cost allocations provide us &ith a &a" to estimate such changes in capacit" costs. b. Ce could pro-ect the income statement for 12D,EEE units, using the estimates for fied and variable costs that &e derived for the previous problem. Ce have
O(//0"#
6nits 4evenues
1DE,EEE G,EE,EEE
Nariable manufacturing costs
,1DE,DEE
Nariablesellingcosts
2D2,EEE
'ontribution /argin
G3,II:,DEE
$otal fied costs
R$/%$ B$
R$$0$C'% $( 0/
125- G:,EEE,EEE
GDH.EE G2:.H: per unit GE.E3persalesG
G3,331,2DE
2,1:,EEE
P('&/ $&'($ "=
%$3,D,:DE 21E,EEE 2,1:,EEE
1-819-5
1-153-25
5otice that 7sse+s profit decreases substantiall", b" 3:K, if the firm produces 12D,EEE units. c. ased on our anal"sis, 7sse &ill more profitable situation if it produces 1DE,EEE units and invests in additional capacit" resources. =o&ever, if the compan" decides to go ahead and make the investment to meet the budgeted volume of 1DE,EEE and demand falls short of epectations, either in the coming "ear or in future "ears, then 7sse &ill havefirms to eatB the additional fied costs.of$his helps seere&ards. ho& budgets enable to evaluate options in terms theirproblem potential risksusand 7.57
$he follo&ing table provides the re#uired income statement.
ales
Q"($( 1 Q"($( 2 Q"($( 3
Q"($( 4
GEH,EEE
G DI,DEE
>iscounts1 5et ales 'ost of merchandise 2 'redit card fees3 Fied costs P('&/
GD2I,2DE
G2E,DEE
D2,I2D GEH,EEE 2E,EEE
G:H,32D 3HD,EEE
H,IH :,H21 1ED,EEE 14-54
1ED,EEE 1-296;
DI,DE G2E,DEE 2IE,EEE
GD3D,EDE
T'"#
G1,IDE,2DE 112,3:D G1,3:,:D
1E,EEE
1,3D,EEE
H,:2
,DH1
2I,EH
1ED,EEE
1ED,EEE
18-772
11-489
2E,EEE 43-469
5otes 1. >iscounts "ale L .DE L .2E in Vuarters 2 and . 2. 'ost of merchandise alesJ1.D. 3. 'redit card fees .E2 L .E L Net "ale. . Fied costs G3D,EEE L 3 months per #uarter.
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!2H 7.58
a. $he follo&ing table provides the re#uired monthl" budget. I$< ubscription fees asic'able 7tended asic 0remium'hannels nternetconnection
/odemfees $otalsubscriptions >iscounts 0remium channels undling 5et 4evenues 'ontentfees 'ontentfee(0remium) Franchise fee (pudcit") nternetfee nternet fee Operating costs nstallation 4epair 8inemaintenance Operating costs $otal costs P('&/$&'($T"=
%$D$"/#
A<'0
DE,EEELE.EDLG2E DE,EEE L E.ID L GDE 1D,EEELG1E 2H,EEELGD 2E,EEELG3
HE,EEE G3,ED,EEE
,EEE L G(2EKM1E) 2D,DEELGD Fied 1D,EEELGH 1EK L 5et 4evenues 2H,EEELG3D Fied 2DESGHE HEE S G3D 3DSG:D Fied
GDE,EEE 2,3:D,EEE 1DE,EEE 1,1:E,EEE
,EEE 12:,DEE G3,HHI,DEE G1,EE,EEE IE,EEE 3HH,IDE I1E,EEE D,EEE 1D,EEE 21,EEE 2,H2D DE,EEE G3,3E,D:D 328-925
b. $here are man" similarities in the process. One similarit" includes the focus on output activit" (number of subscribers) for the firm+s various products ($N, 0remium channels, nternet) as the starting point. $his estimate serves as the basis for both revenues and costs (e.g., franchise fees). @ust like a manufacturing firm, the service firm has both variable and fied costs. $here are a fe& differences, though. For eample, there is not much room for a production or purchases budget for /edia /ogul. $he primar" service is to act as a pass through agent bet&een the $N content providers and the retail customer. Other than this difference in orientation, &e &ould argue that the budgeting process is more alike than not.
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!2:
7.59
5ot!for!profit organi%ations, &hich often operate multiple programs, face uni#ue planning, control, and reporting needs. From the output side, !'are needs to track budgets and actual results b" program so that it could assess the effectiveness of individual activities. From the input side, !'are also might need to track epenses and activities b" specific grants. For eample, suppose 6A> gives !'are a grant of G1,EEE,EEE. !'are &ould need to submit periodic reports that sho& ho& it used funds.process. Often, the mone" ma" be spent for multiple programs, &hich complicates thethese reporting From a regulator" vie& point, !'are needs to submit reports to the 4 and other agencies (e.g., Form IIE). $hese forms have specific epense categories such as fund raising epenses. From a control perspective, a significant amount of cost is common across programs. uch costs often pertain to personnel because the same set of people might &ork on several programs simultaneousl". Of course, !'are also needs to have appropriate epense approval and reporting policies in place because of the significant fiduciar" responsibilit" it bears to&ards donors. Often, charities &ill voluntaril" undergo annual audits (b" suitabl" #ualified accountants) to increase confidence among donors. $hus, &e see that not!for!profit institutions such as !'are re#uire sophisticated budgeting and control s"stems to meet their various information needs. 6suall", such organi%ations prepare a program!centered the" estimate for each needs of the to man" programs the" might eecutebudget, during&herein a "ear. n addition, thecosts organi%ation budget for common activities such as a fund!raising campaign or office administration. Riven the number of eternal constituents, the budgeting process at !'are t"picall" &ould be more detailed and involved than the process for a for!profit organi%ation (&hose primar" goal is to make mone"). ndeed, for each program, !'are needs to estimate the activit" volume and associated costs. /oreover, each program might comprise several modules (such as the number of senior centers visited, &ith each visit being a module) that might be scaled up or do&n based on the availabilit" of funds and actual epenses. 6suall", accounting s"stems in such organi%ations allo& the data to be aggregated along multiple dimensions. For eample, an" specific ependiture &ould be classified as to program ('orneal transplant), source of funds (Taufman Foundation grant Q1!DH:! 2EED), and functional categor" ($ravel Airfare). Overall, this problem looks at ho& budgeting needs might s"stematicall" differ across organi%ations. 7.6
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!2 $o prepare an income statement, &e need to be able to calculate the cost of goods sold ('OR). $his is the outflo& from the finished goods (FR) inventor" account. =o&ever, &e do not have the inflo& into the FR account. For 0eterson, the inflo&s into the FR account comprise materials and labor (because all overhead epenses are fied). Once again, &hile &e kno& labor costs, &e do not kno& the materials used in production. =o&ever, &e do have information about the amount of materials purchased and epected inventories. $hus, &e can back out the materials issued, as sho&n belo& Q"($( 1
Opening balance for materials 0urchases $otal available ! 7nding balance /aterials used for production
Q"($( 2
Q"($( 3
Q"($( 4
GEE,EEE G2E,EEE G1D,EEE G2D,EEE 23D,EEE 211,2EE 222,3EE 2E:,DEE GH3D,EEE GH31,2EE GH3:,3EE GH32,DEE 2E,EEE 1D,EEE 2D,EEE 1E,EEE G21D,EEE G21H,2EE G212,3EE G222,DEE
n this table, notice that &e link #uarters b" the fact that ending inventor" in V1 beginning inventor" in V2. 8et us no& compute 0eterson+s 'OR/. Q"($( 1
/aterials used for production >irect labor 'ost of goods manufactured
Q"($( 2
Q"($( 3
Q"($( 4
G21D,EEE G21H,2EE G212,3EE G222,DEE 2E,EEE 2,DEE 23,DEE 2,HEE GDD,EEE GHE,:EE GDE,EE G:1,1EE
5et, &e use the inventor" e#uation for the FR inventor" to determine 'OR. Q"($( 1
Opening balance 'ost of goods manufactured $otal available ! 7nding balance 'ost of goods sold
Q"($( 2
Q"($( 3
Q"($( 4
G3E,EEE G3IE,EE G3D,HEE G3I1,2DE DD,EEE HE,:EE DE,EE :1,1EE G3D,EEE GD1,1EE G3H,EE GH2,3DE 3IE,EE 3D,HEE 3I1,2DE 3IH,DEE G,HEE GHD,DEE GD,1DE GHD,DE
Again, notice that ending balance in V1 opening balance in V2.
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!2I
Ce are finall" read" to prepare the 0eterson+s contribution margin income statement.
4evenue ! Nariable cost of goods sold 'ontribution margin ! Fied manufacturing costs ! Fied selling epenses 0rofit before taes
Q"($( 1
Q"($( 2
G:ID,2EE ,HEE G3DE,HEE 1DE,EEE E,EEE
G3,2EE HD,DEE G3H,:EE 1:2,2DE ID,EEE
Q"($( 3
GH,DE D,1DE G1I,3EE 1HI,2DE 1EH,EEE
Q"($( 4
GDH,2DE HD,DE G3IE,EE 1:,3EE 1EE,EEE
12-6
11-45
144-5
116-1
7.61
8et us begin b" first constructing 0eterson+s budgeted cash collections. Ce have
Opening receivables balance ales $otal collectible C'##$*/'0% 7nding balance
Q1
Q2
Q3
Q4
G12D,EEE :ID,2EE GI2E,2EE 814-173 G1EH,E2:
G1EH,E2: 3,2EE GIE,22: 829- G111,22:
G111,22: H,DE GI:D,H:: 86-417 G11D,2HE
G11D,2HE DH,2DE GI:1,D1E 857-343 G11,1H:
5otice that collections include all of the opening balance. $he" also include all sales for the first t&o months of the #uarter and HEK for the third month. Alternativel", &e compute the ending balance as EK of the last month+s sales (all else &ould have been collected) and back out the collections. 5et, &e compute the cash outflo& for purchases.
Opening pa"ables balance 0urchases $otal 0a"able P"@<$0% 7nding balance
Q1
Q2
Q3
Q4
G12H,DEE 23D,EEE G3H1,DEE 322-333 G3I,1H:
G3I,1H: 211,2EE G2DE,3H: 215-167 G3D,2EE
G3D,2EE 222,3EE G2D:,DEE 22-45 G3:,EDE
G3:,EDE 2E:,DEE G2,DDE 29-967 G3,D3
As &ith collections, pa"ments include all of the opening balance. $he" also include all purchases for the first t&o months of the #uarter and DEK for the third month. Alternativel", &e compute the ending balance as DEK of the last month+s purchases (0eterson+s &ould have paid all other bills.) alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!3E
Cith these estimates in hand, &e are no& read" to construct the overall cash budget.
Opening balance 'ollections $otal available 0a"ments forpurchases 8 aborcosts
Q1 Q2 Q3 Q4 G:D,EEE 111,E G22,I23 G 3:E,1E 814-173 829- 86-417 857-343 GI,1:3 GIE,E G1,EI,3E G1,22:,3 322,333 21D,1H: 22E,DE 2EI,IH: 2E,EEE 2,DEE 23,DEE 2,HEE
Fied manufacturing costs Fiedsellingcosts , E0/0 "#"0*$
13D,EEE E,EEE 111-84
1D:,2DE ID,EEE 228-923
1D,2DE 1EH,EEE 37-14
1DI,3EE 1EE,EEE 59-616
n our computations, notice that &e have removed G1D,EEE each #uarter for non!cash manufacturing overhead epenses. 5otice that the cash balance is gro&ing &hile income (see the prior problem) sta"s relativel" stable over the four #uarters. Ch" is this; $his occurs because &e assumed that 0eterson hoards all of its cash * thus, the cash balance increases each #uarter b" the amount of income (there also is a G1D,EEE difference due to the non!cash overhead epense, &hich is accounted for in the income statement but not in the cash budget). n realit", 0eterson &ould not maintain such a large cash balance but &ould reinvest the proceeds back in its o&n business or else&here.
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!31
)INI CASES 7.62 $his is a fairl" involved problem, best done on a spreadsheet. Ce follo& the same template as in the tet. Ce begin &ith 0umpkin 0atch+s revenue budget
a.(see ehibits beginning net page)
alakrishnan, /anagerial Accounting 1e
FO4 5$46'$O4 67 O589
:!32
E=+// 1 P</0 P"*+ > R$$0$ B$
S"0"( ales in units 0riceperunit 4evenues D$#=$ ales in units 0riceperunit 4evenues
$otal 4evenues
"eptembe r
!ugut
1E,EEE G1: G1:E,EEE
11,EE G1: G1I3,EE
12,EEE G1: G 2E,EEE
1D,HEE G1: G2HD,2EE
1,EEE G1: G3EH,EEE
22,EEE G1: G3:,EEE
I,EEE G1: G 1,D13,EEE
3,DEE G2H GI1,EEE
,EEE G2H G1E,EEE
,DEE G2H G11:,EEE
D,EEE G2H G13E,EEE
D,DEE H,EEE G2H G2H G13,EEE G1DH,EEE
2,DEE G2H G:1,EEE
G2H1,EEE
G2I:,EE
G 321,EEE
G3ID,2EE
:.32
'ctober
No(ember
#ecembe r
*ul%
GI,EEE
GD3E,EEE
$otal
G 2,2D,EEE
:!33
Ce net prepare 0umpkin 0atch+s production budget E=+// 2 P</0 P"*+ > P('*/'0 B$
*ul%
!ugut
S"0"( ales in units (see 7hibit 1) 1E,EEE 11,EE >esired ending inventor" +Note ,-2,DE 3,EEE $otal re#uirements 12,DE 1,EE ! eginning inventor"+Note .2,DEE 2,DE 6nits to be produced 1E,3DE 11,DDE D$#=$ ales in units (see 7hibit 1)
3,DEE
,EEE
>esired ending inventor" +Note ,-1,EEE $otal re#uirements ,DEE 1,12D D,12D ! eginning inventor"+Note .:D 1,EEE 6nits to be produced 3,H2D ,12D
"eptembe r
'ctobe r
12,EEE 1D,HEE 3,IEE ,DEE 1D,IEE 2 E,1EE 3,EEE 3,IEE 12,IEE 1H,2EE ,DEE
D,EEE
1,2DE D,:DE 1,3:D H,3:D 1,12D 1,2DE ,H2D D,12D
No(ember
#ecembe r
1,EEE D,DEE 23,DEE ,DEE 1I,EEE
22,EEE ,DEE 2H,DEE D,DEE 21,EEE
D,DEE
H,EEE
1,DEE 1,EDE :,EEE :,EDE 1,3:D 1,DEE D,H2D D,DDE
+Note ,-/ >esired ending inventor" e#uals 2DK of the follo&ing month+s forecasted sales volume in units. >esired ending inventories for @anuar", 2EEI are ,EEE standard units and 1,EEE delue units, as stipulated in the problem tet. +Note .- $he beginning inventor" for @ul" is the desired ending inventor" of @une, &hich e#uals 2DK of the @ul" forecast.
:.33
:!3
5et, &e prepare the materials usage budget E=+// 3 P</0 P"*+ > D/($* )"$(/"#% U%"$ B$
S"0"( 6nits of production (see 7hibit 2) 0lastic ( units of production L 1 pound per set L G3 per pound) Other materials ( units of production L G1) tandard materials cost
"eptembe r
*ul%
!ugut
1E,3DE
11,DDE
12,IEE
G31,EDE
G3,HDE
G3,:EE
1E,3DE 11,DDE G1,EE GH,2EE
'ctobe r
No(ember
#ecembe r
1H,2EE
1I,EEE
21,EEE
G,HEE
GD:,EEE
G H3,EEE
12,IEE 1H,2EE GD1,HEE GH,EE
D$#=$ 6nits of production (see 7hibit 2) 0lastic ( units of production L 1.DE pounds per set L G3 per pound) Other materials ( units of production L G1.2D) >elue materials cost
,D31 D,1DH G2E, G23,:1I
D,:1 H,EH G2H,DI G2I,HI
B'+ P('*% $otal units of production $otalplastic $otal other materials $otal materials cost
13,I:D 1D,H:D G:,3H3 GD3,213 G1,1 G1H,:EH GH2,2 GHI,I1I
1:,D2D 21 ,32D GDI,D13 G:1,HH3 G1,H1 G22,HEH G:,1I GI,2HI
3,H2D G1H,313
,12D G1,DH 3
,H2D G2E,13
:.3
D,12D G23,EH 3
1I,EEE 21,EEE G:H,EEE G ,EEE
D,H2D
D,DDE
G2D,313
G2,I:D
:,E31 H,I3 G32,3 G31,I13
2,H2D 2H,DDE G2,313 G:,I:D G2H,E31 G2:,I3 G1E,3 G11D,I13
:!3D
For direct labor costs, &e have E=+// 4 P</0 P"*+ > D/($* L"'( B$
*ul% S"0"( 6nits of production (see 7hibit 2) 8aborhoursperunit 8aborcostperhour >irect labor cost
'ctober
No(ember
#ecembe r
1E,3DE 11,DDE 12,IEE 1H,2EE 1I,EEE 21,EEE E.DE E.DE E.DE E.DE E.DE E.DE G1H G1H G1H G1H G1H G1H G2,EE GI2,EE G1E3,2EE G12I,HEE G1D2,EEE G1H,EEE
D$#=$ 6nits of production (see 7hibit 2)
3,H2D
8abor hours per unit 8aborcost per hour >irect labor cost $otallabor cost
"eptembe r
!ugut
,12D
,H2D
D,12D
D,H2D
D,DDE
E.:D G1H G3,DEE
E.:D G1H GI,DEE
E.:D G1H GDD,DEE
E.:D G1H GH1,DEE
E.:D G1H GH:,DEE
E.:D G1H GHH,HEE
G12H,3EE
G11,IEE
G1D,:EE
G1I1,1EE
G21I,DEE
G23,HEE
$he third component is manufacturing overhead costs E=+// 5 P</0 P"*+ > )"0&"*(/0 O$(+$" B$
*ul% V"(/"#$ )"0&"*(/0 O$(+$" ?/=$ )"0&"*(/0 O$(+$" 'ashepenses >epreciation and other non!cash epenses $otalfiedoverhead
E
!ugut E
G2H,EEE G2H,EEE G22,EEE G22,EEE G,EEE G,EEE
:.3D
"eptembe r E
'ctobe r E
No(ember E
#ecembe r E
G2H,EEE G2H,EEE G2H,EEE G2H,EEE G22,EEE G22,EEE G22,EEE G22,EEE G,EEE G,EEE G,EEE G,EEE
:!3H
$otal /anufacturing Overhead G,EEE Ce net compute the variable cost of goods manufactured
G,EEE
G,EEE
G,EEE
G ,EEE
E=+// 6 P</0 P"*+ > V"(/"#$ C'% '& G''% )"0&"*($ From 7hibit *ul%
!ugut
S"0"( 0lastic Othermaterials >irect manufacturing labor
G31,EDE 1E,3DE 2,EE
G3,HDE 11,DDE I2,EE
G3,:EE 1 2,IEE 1E3,2EE
G,HEE 1H,2EE 12I,HEE
G12,2EE
G13,HEE
G1D,EE
G1I,EE
G1H,313 ,D31 3,DEE
G1,DH3 D,1DH I,DEE
G2E,13 D,:1 DD,DEE
G23,EH3 H,EH H1,DEE
3 3
tandard cost of goods manufactured D$#=$ 0lastic Other/aterials >irect /anufacturing 8abor
3 3
"eptember
'ctober
G ,EEE
No(ember
#ecember
GD:,EEE GH3,EEE 1I,EEE 21,EEE 1D2,EEE 1H,EEE G 22,EEE
G2D2,EEE
G2D,313 G2,I:D :,E31 H,I3 H:,DEE HH,HEE
>elue cost of goods manufactured
GH,3
G:3,21I
G2,EI
GIE,IHI
GII,
GI,D13
$otal variable cost of goods manufactured
G1,D
G211,1I
G23H,I
G2D,3HI
G32:,
G3DE,D13
:.3H
:!3:
As goods manufactured flo& through the FR inventor" account, let us eamine the cost flo& through the FR inventor" account as &ell. E=+// 7 C'% '& ?/0/%+$ G''% I0$0'(@ "% '& 0$ 3- 28 "tandard #elue Nariable cost per unit+gi(enG12.EE G1:.EE C'% '& ?/0/%+$ G''% I0$0'(@ "% '& #@ 31- 28
"tandard V"(/"#$ C'% $( U0/ 0lastic Othermaterials >irectlabor $otal
G3.EE 1.EE .EE G12.EE
#elue G.DE 1.2D 12.EE G1:.:D
C'% '& B$/00/0 "0 E0/0 ?/0/%+$ G''% I0$0'(@ "%$ '0 ?I?O /0$0'(@ "**'0/0;
S"0"( eginning inventor" in units Nariable cost per unit eginning inventor" cost
7nding inventor" in units Nariable cost per unit 7nding inventor" cost D$#=$ eginning inventor" in units Nariable cost per unit eginning inventor" cost 7nding inventor" in units Nariable cost per unit
*ul%
!ugut
"eptembe r
2,DEE G12.EE G3E,EEE
2,DE G12.EE G3,2EE
3,EEE G12.EE G3H,EEE
2,DE G12.EE G3,2EE
3,EEE G12.EE G3H,EEE
:D G1:.EE G1,:D 1,EEE G1:.:D
1,EEE G1:.:D G1:,:DE 1,12D G1:.:D
:.3:
'ctobe r 3,IEE G12.EE GH,EE
No(ember
#ecembe r
,DEE G12.EE GD,EEE
D,DEE G12.EE GHH,EEE
3,IEE ,DEE G12.EE G12.EE GH,EE GD ,EEE
D,DEE G12.EE GHH,EEE
,DEE G12.EE GD,EEE
1,12D 1, 2DE G1:.:D G1:.:D G1I,IHI G22,1 1,2DE 1,3:D G1:.:D G1:.:D
1,3:D 1,DEE G1:.:D G1:.:D G2,EH G2H,H2D 1,DEE 1,EDE G1:.:D G1:.:D
:!3
7nding inventor" cost
G1:,:DE
G1I,IHI
:.3
G 22,1
G2,EH
G 2H,H2D
G1,H3
:!3I
Ce are no& read" to compute the variable cost of goods sold. E=+// 8 P</0 P"*+ > C'% '& G''% S'# B$
S"0"( eginning Finished Roods nventor" (see 7hibit :) 'ost of Roods /anufactured (see 7hibit H)
'ostofRoodsAvailableforale ! 7nding Finished Roods nventor" (see 7hibit :) Nariable'ostofRoodsold D$#=$ eginning Finished Roods nventor" (see 7hibit :) 'ost of Roods /anufactured (see 7hibit H) 'ost of Roods Available for ale
! 7nding Finished Roods nventor" (see 7hibit :) Nariable 'ost of Roods old
*ul%
!ugut
G3E,EEE 12,2EE
G3,2EE 13,HEE G1:2,E E 3H,EEE
G1D,2EE 3,2EE G12E,EEE
G13H,EE
"eptembe r
'ctober
No(ember
#ecembe r
G3H,EEE 1D,EE
GH,EE GD,EEE GHH,EEE 1I,EE 22,EEE 2D2,EEE G21,2E G1IE,EE E G22,EEE G31,EEE H,EE D,EEE HH,EEE D,EEE
G1,EEE
G1:,2E E
G21H,EEE
G2H,EEE
G1,:D G1:,:DE G1I,IHI G22,1 G2,EH G2H,H2D H,3 :3,21I 2,EI IE,IHI II, I,D13 G:I,21I GIE,IHI G1E2,EH3 G113,1D: G12,2DE G12D,13 1:,: 1I, 22,1 2,E DE IHI H 2H,H2D 1,H3 GH1,HI G:1,EEE G:I,:D G,:DE GI:,H2D G1EH,DEE
:.3I
:!E
8et us finish the final piece, marketing and administrative epenses. E=+// 9 P</0 P"*+ > )"($/0 "0 A
'ommissions (HK of revenues) Other (K of revenues) Nariable 'osts
G1:E,EEE
G1I3,EE
1E,2EE H,EE G1:,EEE
11,H2 :,:D2 G 1I,3E
G 2E,EEE
G2HD,2EE
12,2E 1D,I12 ,1HE 1E,HE G2E,EE G 2H,D2E
No(ember
G3EH,EEE
#ecembe r
G3:,EEE
1,3HE 22,E 12,2E 1,IHE G3E,HEE G3:,EE
D$#=$
4evenues (see 7hibit 1) 'ommissions (HK of revenues) Other (K of revenues) Nariable 'osts $otal Nariable /arketing and Administrative 'osts
GI1,EEE
G1E,EE E
D,HE H,2E 3,HE ,1HE GI,1EE G 1E,EE
G2H,1EE
G2 I,:E
G 11:,EEE
G13E,EE E
:,E2E :,EE ,HE D,2EE G11,:EE G 13,EEE
G13,EEE
G1DH,EEE
,DE I,3HE D,:2E H,2E G1,3EE G1D,HEE
G32,1EE
G3I,D2E
G,IEE
GD3,EEE
G3,EEE :,EEE 1,DEE G11,DEE
G3,EEE :,EEE 1,DEE G11,DEE
G3,EEE G3,EEE :,EEE :,EEE 1,DEE 1,DEE G11,DEE G11,DEE
Fied /arketing and Administrative 'osts alaries and &ages 4ent >epreciation (non!cash) $otal Fied /arketing and
G3,EEE :,EEE 1,DEE G11,DEE
G3,EEE :,EEE 1,DEE G11,DEE
:.E
:!1
Administrative 'osts
:.1
:!2
Cith all of the data in hand, &e can construct the income statement, as follo&s. P</0 P"*+ > B$$ I0*'<$ S"$<$0
4evenues (see 7hibit 1) Nariable 'osts /anufacturing (see 7hibit ) /arketing W Admin (see 7hibit I) $otal 'ontribution /argin Fied 'osts /anufacturing (see 7hibit D) /arketing W Admin (see 7hibit I) $otal Fied 'osts
*ul% G2H1,EEE
!ugut G2I:,EE
11,HI 2E:,EE 2H,1EE 2I,:E GD3,31
GHE,22E
"eptembe No(embe #ecembe r 'ctober r r 1otal G321,EEE G3ID,2EE GI,EEE GD3E,EEE G2,2D,EEE 223,:D 2:D,IDE 313,H2D 3:E,DEE 1,D:3,21I 32,1EE 3I,D2E ,IEE D3,EEE 22D,EE GHD,E2D
G:I,:3E
GIE,:D
G1EH,DEE
GDD,31
G,EEE G,EEE G,EEE G,EEE G,EEE G,EEE G2,EEE 11,DEE 11,DEE 11,DEE 11,DEE 11,DEE 11,DEE HI,EEE GDI,DEE GDI,DEE GDI,DEE GDI,DEE GDI,DEE GDI,DEE G3D:,EEE
ad >ebt 7pense ( 4evenues from 2 months ago L E.HE L E.E2)
2,HE
2,HE
P( '& / B $ & '( $ T"=$ %
8- 7 9;
1 - 92 ;
:.2
3,132 2 - 393
3,D: 1 6 - 6 56
3,D2 2 7-1 23
,:2 4 2- 2 58
2E,DE 7 7 - 8 1
:!3
As &e learned in the tet, the cash budget consists of collections, pa"ments, and special items. 8et us begin &ith collections.
R$*$/"#$% $ *ul% 'ash collections E.EK G1E,EE 'redit * to be received this month H.EK 1D,HHE 'redit * to be received net month 2.EK 1EI,H2E 'redit * to be received in t&o months 1E.K 2,1 $otal 'ollections 2D:,H 7pected ad >ebt 1.2K 3,132 C"%+ R$*$/$ 'ashales 'redit * this month 'redit * last month 'redit * 2 months ago C"%+ C'##$*$
!ugut G11I,12E
No(embe #ecembe "eptember 'ctober r r G12,EE G1D,EE G1:I,HEE G212,EEE
1:,H
1I,2HE
23,:12
2H,IE
31,EE
12D,E:H
13,2E
1HD,I
1 ,DE
2 22,HEE
32,1H2 2 I,22H 3,D:
3,HH 31:,1 3,D2
2,H2 3IE,D ,:2
,I2 3,H12 D,3
D:,2E D23,HE H,3HE
G1E,EE G11I,12E 1D,HHE 1:,H I2,EE 1EI,H2E 23,:HE 23,:HE G23H,22E G2:E,3H
G12,EE G 1D,EE G1:I,HEE G 212,EEE 1I,2HE 23,:12 2H,IE 31,EE 12D,E:H 13,2E 1HD,I 1,DE 2,1 32,1H2 3,HH 2,H2 G3EE,I2 G3,:: GE:,1I2 G:D,EH2
G2,HE G2,HE G3,132 G3,D: G3,D2 B" D$ E=$0%$ 5otice that HK 1EK of the HEK that is credit, 2K :EK of the HEK of sales that are on credit and so on.
:.3
G,:2
:!
5et, let us turn to pa"ments for purchases. $he other pa"ments are relativel" eas" to compute from earlier ehibits. E=+// 1 P</0 P"*+ > P#"%/* I0$0'(@ F U%"$ B$
*une S"0"( 6nits of 0roduction (see 7hibit 2) 0lastic 5eeded (lbs) D$#=$ 6nits of 0roduction (see 7hibit 2) 0lastic 5eeded (lbs) P#"%/* U%"$ B$ 0lastic nventor" (lbs at month end) 0lastic 5eeded (lbs) 0lastic from nventor" (lbs) 0lastic purchased (lbs)
13,EEE
13,EEE.EE
*ul%
!ugut
"eptember
'ctober
No(ember
#ecember
@anuar"
1E,3DE 1E,3DE.EE
11,DDE 11,DDE.EE
12,IEE 12,IEE.EE
1H,2EE 1H,2EE.EE
1I,EEE 1I,EEE.EE
21,EEE 21,EEE.EE
1,DEE 1,DEE.EE
3,H2D D,3:.DE
,12D H,1:.DE
,H2D H,I3:.DE
D,12D :,H:.DE
D,H2D ,3:.DE
D,DDE ,32D.EE
D,1DE :,:2D.EE
1:,:3:.DE 1D,::.DE 13,EEE.EE 2E,D2D.EE
G3D,31.2 D G3D,31.2 D
G1,1DH.2 D G1,1DH.2 D
G3,I:.DE
G3D,D:.D E G3D,D:.D E
'ash ettlement of AcctsJ0a"able
G1I,DEE.E E
G3E,::.D E
G2I,:DH.2 D
G3D,31.2 D
G1,1DH.2 D
G3,I:.D E
G3D,D:.DE
$otal 'ash 0a"ment
GDE,2:.D E
GHE,D3.: D
GHD,D:.D E
G:H,I:.D E
GD,13.: D
G:I,D:D.E E
GDE,D:.DE
0lastic 0urchase (AcctsJ0a"able)
G1I,DEE.EE G1I,DEE.EE
G3E,::.DE
:.
G3,I:.D E
1E,EEE.EE 2H,22D.EE 2H,22D.EE 1E,EEE.EE
G2I,:DH.2 D G2I,:DH.2 D
0lastic0urchase ('ash)
G3E,::.D E
1I,3:.DE 23,:.DE 2:,3:.DE 2I,32D.EE 2H,22D.EE 1 :,:3:.DE 1 I,3:.DE 2 3,:.DE 2 :,3:.DE 2I,32D.EE 1:,:3:.DE 1I,3:.DE 23,:.DE 2:,3:.DE 2I,32D.EE 1I,3:.DE 23,:.DE 2:,3:.DE 2I,32D.EE 2H,22D.EE
G1D,EEE.EE G1D,EEE.EE
:!D
b. Cith both of these pieces in hand, &e can no& compute the cash budget.
*ul%
!ugut
"eptembe r
'ctober
#ecembe r
eginning'ash 'ollections (ee 4eceivables udget) $otal'ashAvailable
G1H,EEE G1D,HD1 23H,22E 2:E,3H G2D2,22E G2H,E1I
! 0urchases! plastic (see 7hibit 1E) ! Other materials (see 7hibit H) ! >irect labor (see 7hibit ) ! /anufacturing overhead (see 7hibit D) ! Nariable marketing W admin costs (7hibit I) !alaries(see7hibitI) !4ent(see7hibitI)
DE,2 HE,D HD,D :H,I D,1 :I,D:D 1,1 1H,:EH 1,H1 22,HEH 2H,E31 2:,I3 12H,3EE 11,IEE 1D,:EE 1I1,1EE 21I,DEE 23,HEE 2H,EEE 2H,EEE 2H,EEE 2H,EEE 2H,EEE 2H,EEE 2H,1EE 2I,:E 32,1EE 3I,D2E ,IEE D3,EEE 3,EEE 3,EEE 3,EEE 3,EEE 3,EEE 3,EEE :,EEE :,EEE :,EEE :,EEE :,EEE :,EEE
'ash balance before financing W special items >ividend ! pa"out !5otespa"able(for e#uipment) 'ashbalance before financing 8oanJ(8oan 4epa"ment) 7nding cash balance
(G1,3I)
G1D,EI G1D,ID 3EE,I2 3,:: G31H,E13 G3H,:1I
No(ember
G1D,DED G1D,122 E:,1I2 :D,EH2 G22,HI: GIE,1
G1,EI G,ID 2E,EEE
(G1,ID)
G11,122
1D,EEE (1H,3I) 32,EEE
1,EI 1,EEE
(1D,EDH) 31,EEE
(1,ID) 1:,EEE
11,122 ,EEE
G1D,HD1
G 1D,EI
G1D,ID
:.D
G 1D,DED
G1D,122
GDI,E:1
DI,E:1 ( ,EEE) G1D,E:1
c.
$his report summari%es the pro forma income statement and cash budget for the second half of fiscal "ear 2EE.
I0*'<$ S"$<$0
$otal unit sales are epected to be 11:,DEE &ith revenues of G2,2D,EEE. $otal contribution margin is epected to be GDD,31. $otal profit before taes (0$) is epected to be G::,E1. 0$ is epected to be negative in @ul" and August, and then increase to G2,2D in >ecember. tandard unit sales are epected to be I,EEE &ith revenues of G1,D13,EEE. 'onsistent &ith the historical seasonalit" of tandard sets, revenue is epected to be G1:E,EEE in @ul" and gro& consistentl" throughout the period to G3:,EEE in >ecember. tandard+s overall contribution margin is epected to be G2I3,:EE. >elue unit sales are epected to be 2,DEE, &ith revenues of G:1,EEE. Also seasonal, >elue+s revenue is epected to be GI1,EEE in @ul" and gro& to G1DH,EEE in >ecember. >elue+s overall contribution margin is epected to be G1H1,H1. Nariable /arketing and Administration costs for both tandard and >elue are epected to remain at a constant 1EK of sales. $otal fied costs are epected to remain constant at GDI,DEE per month during the period.
C"%+ B$
0umpkin 0atch+s month!end cash balances before financing are epected to be &eak &ith the eception of >ecember &hen the balance is epected to be GDI,E:1. /oreover, bank loan financing &ill be re#uired each month through 5ovember to maintain the 'ompan"+s G1D,EEE minimum balance re#uirement. $otal re#uired financing is epected to be GI,EEE for the period ( G23,EEE G1,EEE G31,EEE G1:,EEE G,EEE), &ith GD,EEE ( GII,EEE ! GEEE) being outstanding at "ear!end. Riven the 'ompan"+s poor epected cash performance for the period, it is recommended that the follo&ing actions be taken to improve &orking capital management. •
•
4econsider the polic" to have each month+s ending plastic inventor" e#ual to the net month+s manufacturing needs. $his polic" results in the purchase of plastic inventor" sooner than is needed. 4econsider the practice of stocking 2DK of the net month+s forecasted demand in finished goods inventor". A reduction from 2DK &ould improve cash flo&.
1
•
•
•
5egotiate HE da" pa"ment terms &ith plastic and other material suppliers to defer more pa"ments be"ond the month of purchase. mplement 3E da" pa"ment terms for credit sales. $his &ould accelerate collection of the 12K of total sales that remain outstanding after 3E da"s. $he 'ompan" should also focus on its collection activities to ensure sales are collected in 3E da"s. Focus on reducing direct labor costs. >irect labor is the largest component of 0umpkin 0atch+s cost structure. $he 'ompan" should evaluate capital investments to automate the manufacturing process. Chile such investments &ould result in large upfront cash outflo&s re#uiring financing, the" ma" be net present value positive &hen considering direct labor cost savings.
7.63
/ar"+s problem is common. Firms have to trade off several factors &hen setting budget targets and designing incentive schemes. First, sales personnel often possess superior information about sales prospects for the net fe& months, #uarters, or even "ears. $he" obtain this information via their dail" interactions &ith customers, other sales representatives, and trade association meetings. Obviousl", such information is of great value from a planning perspective. $he firm &ould like to have the most detailed and accurate information about sales estimates because these estimates form the basis for the firm+s entire budget. =o&ever, sales personnel have incentives not to divulge this information. $his second factor arises because of the agenc" conflict that &e introduced in 'hapter 1. As &e learned there, sales personnel are risk ! and effort!averse. f the" give out information, then the" have to &ork hard to meet the resulting target. $here is no built!in slack to guard against unanticipated adverse events. $hus, sales personnel often build in a little cushion (padding or slack) in their sales forecasts. ales personnel must also be motivated to &ork hard to meet the target. t is easier to get their private information if the data have no effect on ho& the" are rated. Firms use incentive contracts to induce the sales personnel to reveal their private information and to &ork hard at meeting the resulting target. =o&ever, because such contracts are based on output targets and environmental factors affect the actual output, such contracts impose risk on the sales person. A &ell performing, hard!&orking sales person might not meet her target simpl" because of unfavorable economic circumstances outside her control. $hus, the contract has to limit the risk imposed. =o&ever, imposing some risk is critical to motivate the sales person to &ork hard. nducing information is also a t&o!edged s&ord. On the one hand, &e can get good information if it &ill not affect the sales compensation. ut, &e can set much better targets and incentive s"stems if &e have good information. /ar"+s suggested schemes are all compromises that reflect tradeoffs among these factors. 8et us eamine each in turn.
2
•
A salar" onl" scheme &ill induce the sales person to reveal private information about sales targets. After all, their pa" is fied and there is no reason to build cushions into the budget. =o&ever, once the target has been set, the sales personnel have no incentive to &ork hard to meet the target. Ce have good information, but &e cannot use it to motivate the sales force< ales gro&th is unlikel" &ith this compensation scheme. $he incentive is not to &ork hard b" doing -ust enough to get b".
•
/an" firms follo& this kind of a scheme (actual parameters &ill of course var") to balance the forces. 4aising the budget, either b" some arbitrar" percentage or via negotiation, helps to remove some of the slack. Ce prefer negotiation (ideall" based on data about macro conditions and prior eperience) to a mechanical ad-ustment. (/echanical ad-ustments onl" induce the sales force to build the ad-ustment into their initial forecast<) n a t"pical budget, there are several rounds of negotiations before firms agree on targets. A variable commission allo&s the incentive to operate after the target as &ell. n contrast, the eisting contract induces sales personnel to -ust meet the target and stop? there is no benefit to eceeding the target b" much. =o&ever, a variable scale also accentuates the incentive to lo& ball the target. Firms often balance the incentives b" starting the bonus at IEK of the target (much like /ar"+s idea). Firms also usuall" cap the maimum bonus pa"able to 12EK (sa") of the target. ales gro&th is likel" under this s"stem although it is not likel" to vastl" eceed industr" averages. $he eistence of a target!based pa" s"stem puts natural breaks on sales personnel+s incentives to set high targets (or provide information that high targets are even achievable.)
•
•
Ad-usting based on an industr" gro&th rate is a good idea and one that relies on relative performance evaluation. $his s"stem ensures that artlett gro&s at the same rate as the industr". $he bang!bangB nature of the compensation contract, though, ensures that sales personnel have no incentive to eceed the industr" gro&th rate. $he final incentive scheme takes the idea of relative performance evaluation to the etreme and implements it &ithin the firm. uch rank and "ankB s"stems (populari%ed b" the legendar" '7O of Reneral 7lectric, @ack Celch) force managers to ecel b" pitting them against each other. Chile such s"stems have much to recommend them, &e note that the" also dampen the incentives to cooperate. $hus, the" &ork &ell &hen &e have multiple persons doing roughl" the same task (as in artlett+s case). $he" are ineffective &hen &e re#uire team &ork and cooperative kno&ledge sharing.
Overall, &e believe that /ar" should give active consideration to the rank and "ank s"stem. $he described environment seems ideall" suited for relative performance
3
evaluation as man" reps are selling the same drugs to essentiall" similar clientele. Chile geographical differences surel" eist, benchmarking against peers appears to be a &inner in this setting. 7.64
$his is an open!ended #uestion, &ith no obvious correct ans&er. /aking a forecast of future activit" is, b" nature, an imprecise activit". $here could be, and often is, legitimate disagreement about the feasible level of activit". $hus, this area is one &here individuals can massageB the numbers to attain a desired result. From a control perspective, managers therefore scrutini%e these numbers carefull". 7she is caught bet&een a rock and a hard place. ticking to her guns &ould probabl" get her fired or at least increase the chance of shutting off funding. $he latter outcome also adversel" affects the man" recipients of the charit"+s efforts to distribute computing e#uipment. A lot is riding on her estimate. =o&ever, accepting the '7O+s recommendation is also problematic. $he '7O+s estimate appears to be too ros" and is designed to get this "ear+s funding approved. Tno&ingl" submitting false estimates to grantors compromises information integrit", putting her actions outside the ethical norms epected of accounting professionals. Our recommendation is for 7she to collect more data that might support a rosier estimate, or confirm a pessimistic estimate. he might also provide a range of possible outcomes (best case, &orst case) so that the grantor has complete information about the charit"+s prospects. 7.65
$here is no$he one firm correct to athis #uestion.loss On and the one hand, not a&arding afor bonus -ustifiable. hasans&er incurred substantial re&arding performance this is result seems odd. Furthermore, revising budgets causes them to lose their bite.B After all, &ould the manager argue for a target reset if Florida eperienced much nicer &eather than epected and tourism boomed; ecause the manager has control over operations, she should be held accountable for delivering results. On the other hand, the forecast clearl" did not account for the actual turn of events. t also appears that the manager and staff &orked hard to keep costs under control. 5otice that fied costs have increased b" G12E,EEE onl" even though hurricane related repair cost G1E,EEE. Further, the operations have also cut back on fied marketing and selling epenses. Fuel costs appear to account for the bulk of direct materials (the actual is 2DK of sales versus the budget of 1:K of sales). $he onl" item that seems out of line is direct labor * there is an unepected increase from 3IK of sales to HK of sales. ndeed, &e &ould epect the ratio to drop as the tourism industr" dried up and more deck hands &ere laid off. Ce &ould also consider long!term effects of this decision. $he o&ner, &ho ma" be &ealth" and have other sources of income, has a much greater abilit" to bear risk than do the manager and staff. A&arding a bonus (albeit lo&er than last "ear) as a token of
appreciation &ould go a long &a" in building lo"alt" and emplo"ee morale. n the long run, the success of the operations relies on staff attitude * interactions &ith staff are a crucial part of the overall customer eperience, &hich drives repeat business and &ord of mouth. $aking all of these arguments into account, one could reasonabl" argue for at least some bonus. 6suall", &e &ould argue for holding the manager accountable for her choices * in this instance, ho&ever, some budget revisions seem called for given the nature and magnitude of the uncontrollable events.
D
