CHAPTER6

OPERATIONALANDFINANCIALBUDGETING
61SalesForecasting
(a)Themostcriticalfactorsforahighfashionclothierarethestateof
theeconomyandthetastesofconsumers.Salesforthistypeofcompanyare
probablyhardesttoforecastbecausechangesintastearesohardto
forecast.Athleticshoesweresellingverywellinto1998,thenslowed
considerablyasthe"brownshoes"typifiedbyTimberland'sofferingsbecame
morefashionable.
(b)Amanufacturerofcarpetingmustpayspecialattentiontoleading
indicatorssuchashousingstartsandbuildingpermitsissued.Carpetisa
deriveddemandproduct,thoughthereplacementmarketiscertainly
significant.
(c)Agrocerychainisconcernedaboutthegrowthofareasitserves,whether
competitorsaremovingin,andgeneraleconomicconditions.Thegrocery
businessholdsupinbadtimes,butthesalesofotheritemstypically
stockedbyagrocerychainwillfalloffduringrecessions.
(d)AdvertisingrevenuesforaTVstationdependonsuchfactorsasthe
ratingsofitsprogramsandeconomicconditions,bothnationalandlocal.
Someadvertisingisnational,somelocal,sobothmatter.

2SalesForecasting

EffectsofExternalEvents
NotetotheInstructor:Answeringthisquestioniscomplicatedsomewhat
becausetheindicatedeventmay(1)affectthesalesforecastinquantity,
(2)promptachangeinpricesorachangeinsalesmix,or(3)producesome
combinationofthesechanges.Thefollowinganswersemphasizetheeffectson
theforecastofquantities.
(a)Youwouldrevisetheforecastdownwardbecausethecutinthegovernment
programwillresultinfewerfamiliesbuyinghomesand,therefore,
appliances.
(b)Theforecastwouldprobablyberevisedupward.Jewelryisaluxury
item,andspendingonluxuryitemsislikelytoincreaseasdisposable
personalincomeincreases.Someindividualswillenterthemarketwho
previouslywouldnothave,andsomeindividualswillpurchasemoreexpensive
jewelrythantheymighthavebefore.
(c)Youwouldrevisethesalesforecastupward.Decreasesincomputer
priceswillleadtopeoplebuyingmorecomputers,andtoyoursellingmore
partstothemakers.
(d)Twopossibilitiesarise.First,thehigherthepricesofenergy,the
morelikelypeopleandbusinesseswillreplaceold,inefficientequipment.
Thiseffectwillincreaseyoursales.However,totheextentthatheating
(sayinMiami)andairconditioning(sayinMinnesota)areluxuryitemsand
boughtatthemargin,salesmightdecline.
(e)Thesalesforecastshouldprobablybeadjustedupward.Improved
insulationshouldreducetherequirementsforenergytoheat(orcool),and
therisingenergycostsshouldgeneratesomeadditionalinsulationsales.

6 1

(f)Salesforecastsforfutureyearsshouldbereviseddownward.High
schoolstudentsareanimportantgroupofprospectivecollegestudents.
However,thedeclinecouldbepartiallyoffsetifalargerproportionofhigh
schoolgraduatescontinuesineducationand/orthereisanincreaseinthe
numberofpersonsenteringcollegeafterseveralyearsawayfromschool.(If
theforecastednumberoftotalstudentsdeclines,thecompanymightbe
expectedtoadopthigherpricestopartiallyoffsetthesmallermarket.)

6
3What'sHappeningHere?
Calprobablywentthroughtheyearbeingcarefulabouttravel
expenditures,thensawthathewouldbeunderbudgetifhecontinuedatthe
samepace.Fearingacutthefollowingyearifhedidnotspendhis
allowance,CalsentpeopleallovertheplaceinDecember.

64CashBudgeting

EffectsofNewInformation
(a)Aslowdownincollectionscanbeexpected,socashreceiptsexpectations
mustberevised.Perhaps,inthosemonthswhereprojectedcashbalancesare
relativelyclosetothedesiredminimum,borrowingwillbeindicated.The
cashdisbursementsbudgetmayalsoneedrevisionifinterestrateshaverisen
beyondthoseexpectedatthetimeoftheoriginalbudget.
(b)Theeffectsofanincreaseinthesalesbudgetwouldbealagged
increaseinthecashreceiptsbudget,revisionoftheproductionand
purchasesbudgets,andacorrespondingrevisionofthecashdisbursements
budgets.
(c)Thecashdisbursementsbudgetmustberevisedtospeedupthepayments
tosuppliers.Thisrevisionmayindicatetheneedforadditionalshortterm
financing.
(d)Thechangeininventorypolicywillaffectthepurchasesbudgetand,
therefore,thecashdisbursementsbudget.Itisnotpossible,however,tobe
specificaboutthedirectionofthechangewithoutsomeideaofthe
monthtomonthswingsinsaleslevels.

6
5RelationshipsofProfitandCash
Thisquestiondrawsattentiontonormallead/lagsituationforcash
flows.Thestatedchangesincashbalancesareinlinewiththestated
changesinsalesvolumes,giventhenormalexpectationsaboutcashoutflows
formerchandisepurchasesprecedingcashinflowsfromsales.Asacompany
grows,itscashreceiptstendtolagbehinditscashdisbursementsaslongas
thetimetopayforpurchasesislessthanthetimeaunitspendsin
inventoryplusthetimethatcustomerstaketopay.Onlyexceptionalterms
fromsupplierswillallowreceiptstokeeppacewithdisbursements.
Thereverseistruewhensalesaredeclining.Thecompanyisthenpaying
forfewerunitsthanitiscollectingfor,soreceiptsdonotfallasfastas
disbursements.
66AreBudgetsBadatGE?
Welchapparentlybelievesthatsalesbudgetsaresetwithoutregardto
conditionsinaparticularindustryandfolloweddespitechangesinexternal
circumstances.Nothinginthechaptersuggeststhatbudgetsshouldfollow
suchprinciples.Ratherthechapterpointsoutthatonebenefitofbudgets
isthattheyhelpmanagerstodeterminewhetherchangesduringtheperiod

6 2

indicatepermanentortemporarydifferences.ItalsoappearsthatWelchdoes
notbelievethatparticipationisimportant.
WelchsviewswerereportedbyThomasJ.Martin,Managing:Ideas%
Solutions,Fortune,May29,1995,1457.
67BudgetedIncomeStatementsandPurchasesBudget(15minutes)

MayJune
Sales$250,000$220,000
Costofgoodssoldat60%150,000132,000
Grossprofit100,00088,000
Othervariablecostsat10%25,00022,000
Contributionmargin75,00066,000
Fixedcosts22,00022,000
Income$53,000$44,000
Costofgoodssold($250,000x60%)$150,000
Desiredendinginventory($220,000x60%)132,000
Totalrequirements282,000
Beginninginventory95,000
Purchases$187,000
68CashBudget,Continuationof67(20minutes)
Cashreceiptsbudget
Sales budget
Collections from:
Current month, 60%
Prior month, 40%
Totals

May
$250,000

June
$220,000

$150,000
122,000
$272,000

$132,000
100,000
$232,000

Cashdisbursementsbudget

MayJune
Purchasesofpriormonth(67)$180,000$187,000
Variablecostsat10%ofsales25,00022,000
Fixedcosts($22,000$3,000)19,00019,000
Totalcashdisbursements$224,000$228,000
Cashbudget

MayJune
Beginningbalance$30,000$78,000
Receipts272,000232,000
Totalavailable302,000310,000
Disbursements(requirement1)224,000228,000
Endingbalance$78,000$82,000

6
9BudgetedIncomeStatementandPurchasesBudget(20minutes)
1.Budgetedincomestatementforfirstthreemonthsof20X9
Sales($70,000+$70,000+$90,000)$230,000
Costofsalesat60%138,000
Grossprofit92,000
Fixedcosts($12,000x3)36,000

6 3

Income$56,000

6 4

2.Purchasesbudget

JanuaryFebruaryMarchTotal
Costofsales*$42,000$42,000$54,000$138,000
Desiredendinginventory**63,00081,00072,00072,000
Totalrequirements105,000123,000126,000210,000
Beginninginventory55,00063,00081,00055,000
Purchases$50,000$60,000$45,000$155,000
*60%ofmonth'ssales
**1.5xcomingmonth'scostofsales;$63,000=1.5x$42,000;$81,000=
1.5x$54,000;$72,000=1.5x$80,000x.60(Aprilcostofsales)
NotetotheInstructor:Weurgestressingthatinventory,andhence
purchases,mustbestatedincostdollars,notsellingprices.Despitethe
attentionpaidtothispointinthechapter,somestudentswillinsiston
interpreting"oneandonehalftimesthecomingmonth'sbudgetedsales"as
meaningthatinventoryis1.5timessalesforthecomingmonth,notcostof
sales.

10CashBudgetandProFormaBalanceSheet(Continuationof6

9)(2025
minutes)
1.Cashreceiptsbudget
JanuaryFebruaryMarchTotal
Salesbudget$70,000$70,000$90,000
Collectionsfrom:
Currentmonth(60%)$42,000$42,000$54,000$138,000
Priormonth(40%)30,00028,00028,00086,000
Total$72,000$70,000$82,000$224,000
2.Cashdisbursementsbudget
JanuaryFebruaryMarchTotal
Purchases(69)$50,000$60,000$45,000
Paymentsforpurchases:
Currentmonth(40%)$20,000$24,000$18,000$62,000
Priormonth(60%)18,00030,00036,00084,000
Fixedcosts12,00012,00012,00036,000
Total$50,000$66,000$66,000$182,000
3.Cashbudget
JanuaryFebruaryMarchTotal
Beginningbalance$20,000$42,000$46,000$20,000
Receipts72,00070,00082,000224,000
Available92,000112,000128,000244,000
Disbursements50,00066,00066,000182,000
Endingbalance$42,000$46,000$62,000$62,000
4.ProFormaBalanceSheetasofMarch31,20X9
Assets
Cash(cashbudget)$62,000
Accountsreceivable(40%ofMarchsalesof$90,000)36,000
Inventory(69purchasesbudget)72,000
Totalassets$170,000
Equities
Accountspayable(60%x$45,000Marchpurchases)
$27,000
Stockholders'equity

143,000*
Totalequities$170,000

6 5

*$87,000beginningbalance+$56,000income,from69

6
11BudgetedIncomeStatementandPurchasesBudget(20minutes)
1.Budgetedincomestatements
JanuaryFebruaryMarchTotal
Sales$100,000$130,000$160,000$390,000
Costofsalesat40%40,00052,00064,000156,000
Grossprofit60,00078,00096,000234,000
Othervariablecostsat30%30,00039,00048,000117,000
Contributionmargin30,00039,00048,000117,000
Fixedcosts22,00022,00022,00066,000
Income$8,000$17,000$26,000$51,000
2.Purchasesbudget
JanuaryFebruaryMarchTotal
Costofsales$40,000$52,000$64,000$156,000
Desiredendinginventory*104,000128,000120,000120,000
Totalrequirements144,000180,000184,000276,000
Beginninginventory50,000104,000128,00050,000
Purchases$94,000$76,000$56,000$226,000
*Inventoriesaretwicecostofsalesforthecomingmonth,$104,000=
$52,000x2,etc.The$120,000is$150,000(Aprilbudgetedsales)x40%x2.
NotetotheInstructor:Intheirentirety,theseassignmentsareabit
morechallengingthan69and610.Thelatterdonothavedepreciation,
thoseofthisexercisedo.Thecashbalancein612dropsinthefaceof
positiveincome,givingyoutheopportunitytopursuetheimportantpoint
thatcashandincomearenotthesame.
Thesamepointaboutcostdollarsversussalesthatisdiscussedinthe
NotetotheInstructorin69alsoapplieshere.
6-12 Cash Budget and Pro Forma Balance Sheet (Continuation of 6-11)
minutes)
1.

Cash receipts budget

Sales budget
Collections from:
Current month (20%)
Prior month (80%)
Total
2.

(20-25

January
$100,000

February
$130,000

March
$160,000

Total

$ 20,000
90,000
$110,000

$ 26,000
80,000
$106,000

$ 32,000
104,000
$136,000

$ 78,000
274,000
$352,000

Cash disbursements budget

January
Prior month's purchases (6-11)
60,000
Other variable costs (30% of sales) 30,000
Fixed costs*
18,000
Total
$108,000

February
March
$ 94,000 $ 76,000
39,000
48,000
18,000
18,000
$151,000 $142,000

Total
$230,000
117,000
54,000
$401,000

* $22,000 - $4,000 depreciation

3.

Cash budget

Beginning balance

January
$ 50,000

6 6

February
$ 52,000

March
7,000

Total
$ 50,000

Receipts
110,000
106,000
Available
160,000
158,000
Disbursements
108,000
151,000
Ending balance
$ 52,000 $ 7,000
4.
Pro forma balance sheet as of March 31, 20X4
Assets

136,000
143,000
142,000
$ 1,000

Cash (cash budget)

Accounts receivable (80% of $160,000 March sales)
Inventory (purchases budget from 6-11)
Fixed assets ($150,000 - $12,000 depreciation)
Total assets

352,000
402,000
401,000
$ 1,000

1,000
128,000
120,000
138,000
$387,000

Equities
Accounts payable (March purchases, from 6-11)
Stockholder's equity
Total equities

$ 56,000
331,000*
$387,000

* $280,000 Beginning balance + $51,000 income

Note to the Instructor: You might ask the class why cash is budgeted to
dive to $1,000, a decrease of $49,000, when budgeted income for the quarter
was $51,000. An analysis appears below. The reasons are that cash
collections were $38,000 less than sales ($390,000 sales - $352,000 cash
receipts), payments to suppliers were $74,000 higher than cost of sales
($230,000 from cash budget - $156,000 cost of sales), and depreciation was
$12,000. The $74,000 difference between payments for merchandise and cost of
sales was a $70,000 ($120,000 - $5,000) increase in inventory less a $4,000
increase in payables ($56,000 March A/P from pro forma balance sheet, or March
purchases budget, less $60,000 beginning balance).
Income
Depreciation
Increase in receivables, $128,000 - $90,000
Increase in inventory, $120,000 - $50,000
Decrease in accounts payable, $60,000 - $56,000
Change in cash

$ 51,000
12,000
(38,000)
(70,000)
( 4,000)
$(49,000)

613BudgetforServiceCompany

AprilMayJuneTotal
Salesofmerchandise$14,000$17,000$13,000$44,000
Costofsalesat90%12,60015,30011,70039,600
Grossprofit1,4001,7001,3004,400
Designfees6,0009,5007,50023,000
Total7,40011,2008,80027,400
Fixedexpenses4,1004,1004,10012,300
Income$3,300$7,100$4,700$15,100
Otherformatsfortheincomestatementsarepossible.MsDavismight
wantatwocolumnincomestatementshowingthetwotypesofsalesseparately.

14PurchasesBudget

UnitsandDollars(20minutes)
1.(a)Purchasesbudgetunits

6 7

FebruaryMarchAprilMayJune
Sales1,9002,2002,3002,1001,700
Desiredendinginventory*1,1001,1501,050850
Totalrequirements3,0003,3503,3502,950
Beginninginventory1,0001,1001,1501,050
Purchases2,0002,2502,2001,900

*50%ofbudgetedsalesforthefollowingmonth:1,100=2,200x.50,1,150
=2,300x.50,1,050=2,100x.50,850=1,700x.50

(b)Purchasesbudgetdollars
FebruaryMarchAprilMayJune
Costofsalesat$4$7,600$8,800$9,200$8,400$6,800
Desiredendinginventory*4,4004,6004,2003,400
Totalrequirements12,00013,40013,40011,800
Beginninginventory4,0004,4004,6004,200
Purchases$8,000$9,000$8,800$7,600

*budgetedcostofsalesforthenextmonthx50%,or$4timesdesiredunits
fromrequirement(a).
2.WestopwithMay.DeterminingJunepurchasesrequiresknowingJuly
sales.
NotetotheInstructor:Somestudentswilldeterminedollarpurchases
forrequirement1bbymultiplyingtheanswersinrequirement1abythe$4
unitcost.Theresultingdollaramountsforpurchasesarecorrect,of
course.

6
15BudgetedIncomeStatementforaManufacturer(510minutes)
Sales(50unitsx$40)$2,000
Variablecosts:
Manufacturing,materials(50x$12)$600
other(50x$14)700
Commissions,15%ofsales3001,600
Contributionmargin400
Fixedcosts,manufacturing$150
other70220
Profit$180

16ProductionBudgetforaManufacturer(Continuationof6

15)(510
minutes)
Variablemanufacturingcosts(50units):
Materials(50unitsx4lbs.perunitx$3perlb.)$600
Othervariablemanufacturingcost[50unitsx($26$12)]700
Fixedmanufacturingcosts150
Totalproductioncost$1,450

17PurchasesBudgetforaManufacturer(Continuationof6

15and6

16)
(10minutes)
Dollars
PoundsPoundsx
$3
Materialneededforproduction(50unitsx4lbs.)200$600
Materialneededforendinginventory
55unitsx4lbs.x20%44132

6 8

Totalrequired244732
Materialinbeginninginventory,given34102
Requiredpurchases210$630

6
18ExpenseBudgetsandVariances(5minutes)
NotetotheInstructor:Wedonotwishtointroducethedifference
betweenflexiblebudgetsbasedonoutputandonthosebasedoninputatthis
stage.Weusedbothinputandoutput,andhadnoefficiencyvariance,inthe
assignmentsothatstudentswouldnotbeconfusedbyoveruseorunderuseof
theresource.
Thebudgetvarianceis$450unfavorable
Flexiblebudgetallowance,$22,700+($1.815x14,000hours)$48,110
Actualcost48,550
Flexiblebudgetvariance,unfavorable$450
Theflexiblebudgetallowanceismuchmoreusefulthantheoriginal
budgetof$49,925becauseitreflectstheactualactivityandthecotthat
shouldhavebeenincurredbasedontheworkdoneduringtheperiod.The
responsiblemanagerdidnotsave$1,375onutilities,giventhatheworked
lessthantheoriginallybudgetedamount.
NotetotheInstructor:Becausetheyhaveseencostpredictionformulas
inChapter3,studentsusuallyhavelittletroublewiththeconceptofa
flexiblebudgetallowanceinChapter6.Nevertheless,wedevelopedthis
simpleexercisetoemphasizethebudgeted/actualdistinctionbecausestudents
oftenerrindeterminingaflexiblebudgetallowanceinChapter11(on
standardcosts)andinthechaptersonproductcosting(Chapters1214).

6
19BudgetedIncomeStatements(25minutes)

AprilMayJuneJuly
Sales,monthlybase$136.0$136.0$136.0$136.0
Variableat$0.052xvalueof
permitsinpriormonth156.0247.0358.8369.2
Totalsales292.0383.0494.8505.2
Costofsalesat45%131.4172.4222.7227.3
Grossprofit160.6210.6272.1277.9
Othervariablecostsat8%23.430.639.640.4
Contributionmargin137.2180.0232.5237.5
Fixedcosts140.0140.0140.0140.0
Income(loss)($2.8)$40.0$92.5$97.5
NotetotheInstructor:Thisexercisecanbeusedtoexplainalag
relationship.Inthiscase,buildingpermitsprecedesales,whichis
reasonablegiventhatpermitsareissuedpriortothestartofconstruction.
Theonemonthlagisnotnecessarilyrealisticbecauseitassumesthatall
materialswillbeboughtinthemonthafterthepermitissecured.Itis
morelikelythattherewouldbeseveralmonthsofpermitsintheequation,
withdifferingweightsassignedtothevariousmonths.Theresulting
equationwouldbeamultipleregressionequationasillustratedinthe
appendixtoChapter3.Ifwesupposethatmaterialsboughtbybuildersare
spreadoverathreemonthperiod,wewouldhaveanequationoftheform
$Sales=a+b1X1+b2X2+bnXn

wheretheb'sarethecoefficientsforeachmonthandtheX'saremonths
followingtheissuancesofpermits.

6 9

Finally,itisconvenienttothinkofthe$136,000interceptasthe
company'sbusinessthatdoesnotdependonnewconstruction.Replacements,
repairs,doityourselfwork,andothersuchsourcesofdemandfitthis
category.Itshouldbenotedthattheintercept(zerobuildingpermits)is
outsidetherelevantrange,sothatitisnotwarrantedtoassumethatsales
arelikelytobe$136,000ifthereisnobuildingactivity.

6
20FlexibleBudgetandVariances(15minutes)
1.Totalproductioncost=$70,000+[($4+$3+$5)xunitsproduced]
2,3.

BudgetActualVariance
Materials($4x18,000)$72,000$71,800$200F
Labor($3x18,000)54,00056,1002,100U
Variableoverhead($5x18,000)90,00089,0001,000F
Fixedoverhead70,00070,000

Totals$286,000$286,900$900U
621IncomeStatementandPurchasesBudget(15minutes)

MarchApril
Sales,4,000x$20,4,500x$20$80,000$90,000
Variablecosts:
Costofgoodssoldat$832,00036,000
Commissionsat20%16,00018,000
Totalvariablecosts48,00054,000
Contributionmargin32,00036,000
Fixedcosts14,00014,000
Income$18,000$22,000
2.3,000units
Sales4,500
Endinginventory,2xMaysalesof3,7507,500
Totalrequired12,000
Beginninginventory,2xAprilsalesof4,5009,000
Purchases3,000
3.6,250,Junesalesare5,000units,$100,000/$20
Sales3,750
Endinginventory,2xJunesalesof5,00010,000
Totalrequired13,750
Beginninginventory,2xMaysalesof3,7507,500
Purchases6,250

22CashBudget

Quarters(30minutes)
1.Cashbudget,inthousandsofdollars

Quarter.
1234Total
Cashreceipts:
Frompriorquarter$1,700$2,400$2,800$3,200$10,100
1/3ofcurrentquarter's

610

sales1,2001,4001,6001,1005,300
Total2,9003,8004,4004,30015,400
Cashdisbursements3,3504,2404,5203,47015,580
Excess(deficiency)(450)(440)(120)830(180)
Beginningbalance200200200200200
Indicatedendingbalance(250)(240)801,03020
Borrowingrequired4504401201,010
Repayments(830)(830)
Endingbalance$200$200$200$200$200
2.Theloanoutstandingis$180thousand($1,010$830).

6
23FlexibleandStaticBudgetsServiceDepartment(15minutes)
Thememoshouldpointoutthat:
1.The$13,940unfavorablevarianceisbasedonastaticbudget
allowanceof$155,400($169,340$155,400=$13,940).Thisallowancedoes
notrecognizethatactualactivitymightdifferfrombudgetedactivity.Such
anallowanceisappropriateforfixedcosts,butnotforvariableormixed
costs.
2.Abettercomparisonisofactualcostswithaflexiblebudget
allowance,whichdoesconsiderthelevelofactivityactuallyachieved.The
analysisbelowbettershowsperformance,andindicatesthatIcontrolled
costsverywell.
Flexiblebudgetallowance,$12,400+($1.43x112,500)$173,275
Actualcost169,340
Favorablebudgetvariance$3,935

6
24ProductionBudget(1015minutes)

AprilMayJune
Sales18,00024,00025,000
Desiredendinginventory*48,00050,000
Totalrequirements66,00074,000
Beginninginventory41,00048,000
Production25,00026,000
*Nextmonth'sunitsalesx2

25PurchasesBudget(Extensionof6

24)(1015minutes)
(a)Purchasesbudgetinpounds

April
Usedinproduction300,00025,000x12
Desiredendinginventory468,00026,000x150%x12
Totalrequirements768,000
Beginninginventory540,000
Purchases228,000
(b)Purchasesbudgetindollars

April
Usedinproduction$750,000300,000x$2.50
Desiredendinginventory1,170,000468,000x$2.50
Totalrequirements1,920,000
Beginninginventory1,350,000540,000x$2.50
Purchases$570,000228,000x$2.50

611

26JITManufacturing(Extensionof6

24and6

25)(20minutes)
1.Productionbudgets

AprilMay
Sales18,00024,000
Desiredendinginventory800800
Totalrequirements18,80024,800
Beginninginventory800800
Production18,00024,000
Havingconstantinventorymeansthatproductionequalssaleseverymonth.

612

Purchasesbudgetinpounds

April
Usedinproduction216,00018,000x12
Desiredendinginventory19,20024,000/15x12
Totalrequirements235,200
Beginninginventory14,40018,000/15x12
Purchases220,800
Purchasesbudgetindollars

April
Usedinproduction$540,000216,000x$2.50
Desiredendinginventory48,00019,200x$2.50
Totalrequirements588,000
Beginninginventory36,00014,400x$2.50
Purchases$552,000220,800x$2.50
2.Costsavingopportunitiesthatmightbeincludedinthememo:

(a)Reducedfloor

spacerequirements.Thismightpermitsublettingor
expansionwithoutincreasingfloorspace.
(b)Reducedinvestmentininventory.Cashtiedupininventorycannotbe
usedforotherpurposes.Reducingtheinvestmentininventorypermitscash
tobeusedelsewhere.Thecashcouldearnareturnifinvestedelsewhere;or
itmightbeusedtoreduceinterestcosts,eitherbypayingoffdebtorby
reducingborrowingrequirements.
(c)Reducedstoragecosts.Reducinginventoryshouldreducehandling,
insurance,personalpropertytaxes,pilferage,shrinkage,andothercosts.
(d)Reducedreworkandinspectioncosts.Costsavingsintheseareasare
likelyifthecompany'smovetoJIToperatingconditionsincludesassigning
someinspectionresponsibilitiestomanufacturingpersonnel.Additionally,
wheninventoriesarelow,defectiveunitscannothideforlengthyperiods.
Workersfinddefectivesquickerandcaneliminatetheircausesquicker.
NotetotheInstructor:Somestudentswillmistakenlyassertthatcosts
arelowerbecausethecompanyproducesandbuyslessunderthesepolicies.
Thisisnotso,thoughthenumbersusedherecreatetheimpression.Overall
costsmightgodownbecauseofincreasedefficiencyandlesswaste,butthe
costsofproductionandofpurchasesdonotfallnearlyasmuchasindicated
here.
627CashBudgetNurserySchool(1525minutes)
1.Cashdisbursementsbudget
Payroll:
Teacher'ssalary,$21,000x1.15$24,150
Teacher'sassistant4,000
Totalpayroll28,150
Payrollrelatedcost,$28,150x[$2,144/($21,000+$4,000)]2,414
Supplies,$3,240x105%3,402
Food,$2,162x105%2,270
Equipmentrelatedcosts1,650
Licenses,$285+$50335
Miscellaneous1,226
Total$39,447
2.About$110perchildpermonth

613


Revenuerequired$39,447
dividedbynumberofmonths9
Monthlyrevenuerequired$4,383
dividedbyenrollment40
Monthlyfee$109.58

6
28PreparingFlexibleBudgets(1015minutes)

DirectLaborHours

Cost10,00012,00014,000
Supplies$28,000$28,800$29,600
Repairs12,30012,46012,620
Power27,60030,00032,400
Depreciation14,70014,70014,700
Supervision8,00011,00014,000
Totals$90,600$96,960$103,320
Forthefirstfourcosts,theallowancesarethefixedcosts,plusthe
variablecomponentmultipliedbydirectlaborhours.Supervisionis$8,000
plus$3,000foreach2,000hourincreasebeyond10,000hours.
NotetotheInstructor:Thisbasicassignmentpermitsyoutodiscuss
somepointsofflexiblebudgeting.Forexample,determiningthetotalbudget
allowancesforallcostsexceptsupervisionissimplyamatterofmultiplying
thedirectlaborhoursbythevariablerateandaddingthefixedamount.
Thus,onecouldgroupthefirstfourcostsintoasingleformulafora
flexiblebudgetallowance.Thatformulais:$1.68DLHplus$65,800.
Supervisioncan'tbeincludedinthisformulabecausethevariableportionis
not$1.50perDLH($1,500increasefor1,000DLH),but$1,500foreach1,000
DLHabove10,000.Note,however,thatbudgetingthefirstfouritemsasa
groupisnotadvantageousfortworeasons.First,thecompanyislikelyto
wanttocompareactualandbudgetedcostsforeachcostelement.Second,the
cashpaymentpatternsofthecostsmightdiffer.

6
29Relationships(30minutes)
1.900units,becauseinventoriesaretoremainconstant.
2.$15,300(materialcostsof$5,400+laborcostsof$6,300+$3,600
variableoverheadcostsofmanufacturing)
3.$420
Sellingprice$60
Variablecosts($6+$7+$4+$1)18
Contributionmargin$42
Contributionmarginonextraunits(10x$42)$420
4.$34,480
Variablecosts(910x$18)$16,380
Fixedcosts18,100
Totalcosts$34,480
Wecouldalsoaddcurrentbudgetedcostsandincrementalcosts,asfollows.
Costs,asbudgetedfor900units($16,200+$18,100)$34,300
Variablecostsfor10extraunits(10x$18)180
Totalcosts$34,480

614

5.About431units,$18,100/$42
6.$17,900
Newcontributionmargin(currentlessadditionalvariablecost)$40
Numberofunitsplanned900
Totalcontributionmarginusingnewvariablecosts$36,000
Fixedcosts18,100
Income$17,900
Wecanalsocomputethedeclineincontributionmargin,asfollows:
Currentincome$19,700
Reductionincontribution,900unitsx$21,800
Newincome$17,900
7.About1,014units[($18,100+$4,800+$19,700)/$42]
8.$24,810
Materials(930x$6)$5,580
Labor(930x$7)6,510
Variableoverhead(930x$4)3,720
Totalvariablecosts15,810
Fixedmanufacturingcosts9,000
Totalmanufacturingcostswithproductionof930units$24,810

6
30RelationshipsAmongSalesandProductionBudgets(30minutes)
Salesbudget(units)
JanuaryFebruaryMarchAprilMayJuneJuly
3,0003,4004,200(7)4,600(12)6,200(14)5,800(21)5,400
(20)
Productionbudget(units)
JanuaryFebruaryMarchAprilMayJune
EI5,100(1)6,3006,900(8)9,300(13)8,7008,100
(19)
Sales3,0003,400(4)4,200(7)4,600(12)6,200(14)5,800
Total8,100(2)9,700(5)11,100(9)13,90014,900(15)13,900
(18)
BI4,500(3)5,1006,300(10)6,9009,300(13)8,700
(17)
Prod3,6004,600(6)4,800(11)7,0005,600(16)5,200
1.150%ofFebruarysales11.910
2.1+Januarysales12.2/3of8
3.2Januaryproduction13.Apriltotalrequirementsminus
Aprilsales
4.Februarysalesforecast
14.2/3ofAprilendinginventory
5.4+Februaryendinginventory15.14+Mayendinginventory
6.5beginninginventory16.1513
7.2/3ofFebruaryEI17.Mayendinginventory
8.Aprilbeginninginventory18.17+Juneproduction
9.7+819.18Junesales
10.Februaryendinginventory20.2/3ofJuneendinginventory

615

21.2/3ofMayendinginventory
NotetotheInstructor:Manystudentsfindthisproblemquite
difficult.Inanycase,theorderinwhichtheblanksarefilledinwill
differamongindividuals.

31One

MonthCashBudget

Discounts(30minutes)
Beginningbalance$73,000
Collections:
Junesales($260,000x80%x45%)$93,600
Julysales($300,000x80%x30%)72,000
Augustcashsales($340,000x20%)68,000
Augustcreditsales($340,000x80%x20%)54,400288,000
Cashavailable361,000
Disbursements:
Julypurchases($210,000x98%x1/3)$68,600
Augustpurchases*123,480
S&Aexpenses($102,000$21,000)81,000273,080
Budgetedbalance,endofAugust$87,920

*2/3xAugustpurchases(below)

GrossNet
Costofsales(gross=$340,000x60%)$204,000$199,920
Desiredendinginventory(gross=
$300,000x60%x2.5)450,000441,000
Required654,000640,920
Beginninginventory(gross=$455,700/98%)465,000455,700
Purchases$189,000$185,220
NotetotheInstructor:The2%purchasediscountwillgivesome
studentsdifficulty.Thesubjectisusuallymentionedinthefirstfinancial
accountingcourse,butthecoverageofthegrossandnetmethodsvariesamong
schools.
Webelievethatthebetterinterpretationoftheinventorypolicyisthat
thecompanyshouldhaveenoughgoodstocover2.5timesthecomingmonth's
budgetedsales,sowedonotsolvetheproblemassumingthatthedollar
amountofinventory,netofpurchasediscounts,shouldbe$450,000,which
wouldmaketheendinginventoryatgross$459,184($450,000/98%).However,
departmentstoresfrequentlytreatpurchasediscountsasrevenue,andyou
mightwishtotaketheopportunitytodiscussthispractice.
Anotherpointthatisillustratedinthisproblem,andinothersinthe
chapter,isthatthebeginninginventoryisnotalwaysequaltothebudgeted
amount.Ifthefirmdidhave2.5timesAugustsalesonhandatJuly31,it
wouldhave$510,000(gross,ornetof$499,800),whichis$340,000x60%x
2.5.Studentsseemtoneedconstantremindingthatbudgetsarebasedon
expectationsandthatactualresultswillnotalwaysequalbudgetedresults.
Moreover,becauseofthetimingofpurchasesortemporaryshortagesofcash
orahostofothercauses,thefirmmaynotreachabudgetedlevelof
inventoryevenifitssalesexpectationsarerealized.Inthisproblem,the
firmcouldhavehadhighersalesinJulythanexpectedand,ifitcouldnot
respondquicklyandchangeitspurchasing,couldeasilyhavewoundupshort
ofwhatwouldhavebeenitsbudgetedinventorylevelatJuly31.

6
32BudgetinginaCPAFirm(25minutes)

616

JanuaryMay
throughthrough

AprilDecemberTotal
Revenues(1)$143,200$190,800$334,000
Expenses($16,100monthly)64,400128,800193,200
Income$78,800$62,000$140,800

617

(1)Scheduleofrevenues
JanuaryMay
throughthrough
AprilDecember

(4months)(8months)
Ms.Watson
40%x1,400hrs.x$100$56,000
60%x1,400hrs.x$100$84,000
Staffaccountants:
200hrs.x2peoplex4monthsx$5080,000
120hrs.x2peoplex8monthsx$5096,000
Clerical:
40%x600hrs.x2peoplex$157,200
60%x600hrs.x2peoplex$1510,800
Total$143,200$190,800

33SalesForecasting

ScatterDiagramandRegression(35minutes)
1.Ascatterdiagramiseasytoconstruct,buttheformulasforpredicting
saleswilldifferamongstudents.Regressionanalysisyieldstheformula:
Sales=$437,500+($1,542xthousandsofhousingunitsbuilt).
2.$3,213,100[($437,500+($1,542x1,800)]
Theresultsherewilldifferbecauseslightlydifferentformulaswillbe
developed.Thehighr2oftheregression(.9986)indicatesthatconsiderable
confidencecanbeplacedintheforecastprovidedthatunderlyingconditions
donotchange.Thestandarderrorisalsolow,indicatingagoodfit.Lotus
123outputappearsbelow.Weroundedthefixedcomponent.
RegressionOutput:
Constant437.4892
StdErrofYEst18.21279
RSquared0.998565
No.ofObservations6
DegreesofFreedom4
XCoefficient(s)1.542274
StdErrofCoef.0.029226

6
34FlexibleBudget,MultipleDrivers(20minutes)
CaseA
VariableLevelofTotalVariableFixedTotal
ComponentxActivity=Amount+Component=Cost
Inspection$120.00110$13,200$72,500$85,700
Maintenance2.4015,00036,00061,20097,200
Dataprocessing0.25220,00055,0009,70064,700
Purchasing180.0012021,60063,60085,200
Other2.207,00015,400278,800294,200
$627,000
CaseB
VariableLevelofTotalVariableFixedTotal
ComponentxActivity=Amount+Component=Cost
Inspection$120.0075$9,000$72,500$81,500
Maintenance2.4022,00052,80061,200114,000
Dataprocessing0.25360,00090,0009,70099,700
Purchasing180.00407,20063,60070,800
Other2.2011,00024,200278,800303,000
$669,000

618


6
35BudgetingandBehavior(15minutes)
1.A1303,becauseofthehighercontributionmargin(indollarsperunit
and
percentage)andpotentialforgrowth.
2.D165,becausetheyareeasiertosellandthesalesquotaisbasedon
dollarsofsales,notcontributionmarginproduced.
3.Thesalespeopleshouldbejudgedbyotherfactorsbesidesdollarsales.
Contributionmarginshouldplaysomepart.Possibly,separatequotascould
beestablishedforeachproduct.AspecialcommissionmightbeofferedonA
1303sales.Ifsalespeoplearenotwellacquaintedwiththeadvantagesand
usesofA1303,thecompanyshouldundertakeaneducationalprogram.Inany
case,
suggestionsforpromotionalplanscouldbesolicitedfromthesalespeople.

6
36ConflictsinPolicy(30minutes)
Itisnotpossibletokeepinventorywithinthelimits.Therearetwo
solutionsthatviolatethedesiredlimitsinonlyonemonth.Inonemonth
(February),Plan1producesaninventorythatis6,000unitsbelowthe
desiredminimum.Plan2producesaninventorythatis11,000unitsabovethe
desired
maximuminApril.Bothplansofferrelativelystableproduction,whichmight
beimportantinmaintaininggoodlaborrelations.
Ofsomeimportanceistheaccuracyofthesalesforecasts.Forexample,
iftheforecastsarelikelytobeoptimistic,Plan1ispreferablebecauseit
yieldsaninventoryshortagebutstilloffersacushiontocoverproblems
withsuppliers.Butthemostimportantquantitativefactorinchoosing
betweenthetwoplansistherelativecostofbeingoverandunderthe
desiredlevels.Themanagershouldknowtheadditionalcontributionmargin
perunitandtheaddedcostofcarryingaunitinexcessof40,000.Without
informationaboutcosts,itisimpossibletochooseamongthemanyplansthat
wouldmeetthesales,butnottheinventoryobjectives.

Plan1Plan2
MonthProductionEndingInventoryProductionEndingInventory
January72,00027,00072,00027,000
February72,0009,000*90,00027,000
March72,00021,00072,00039,000
April72,00033,00072,00051,000*
May90,00023,00072,00023,000
June72,00015,00072,00015,000
*Outsidestatedlimits

6
37BudgetingAdministrativeExpenses(35minutes)
1.Eightorderclerksandthreedataentryclerksarerequiredandthe
slacktimesavailableare13hoursand25hours,respectively.
OrderDataEntry
ClerksClerks
Calculationofpersonsneeded:
Ordersthatcanbeprocessedperhour310
Hoursperweek3535
Ordersperweek,perperson105350
Requiredfor800ordersperweek83

619

OrderDataEntry
ClerksClerks
Calculationofslacktime:
Ordersperhour310
Timerequiredfor800orders267*80
Timeavailable(numberofpersonsx35hours)280105
Slacktime,inhours1325
*Rounded
2.Thelikelyflexiblebudgetformulais:Totalcosts=$500+($2.90x
ordersprocessed).Thetypicalweekislikelytoproduceanunfavorable
budgetvarianceof$205.
Calculationofcomponentsofbudgetformula:
Fixedcostpurchasingagent'ssalaryof$500
Variablecosts:
Supplies$0.40
Dataentry0.50($5.00/10ordersperhour)
Orderclerks2.00($6.00/3ordersperhour)
Variablecostperorder$2.90
Calculationoflikelybudgetvariance:
Flexiblebudgetallowanceof$500+($2.90x800)$2,820
Totalcostsincurred:
Purchasingagent$500
Supplies320(800x$0.40)
Dataentry525(3x$5.00x35hours)
Orderclerks1,680(8x$6.00x35hours)
Total3,025
Budgetvariance$205U
3.840orders
DataEntryOrder
ClerksClerks
Numberofpersons38
Hoursworkedperweek3535
Totalhoursofwork105280
Ordersthatcanbecompletedperhour103
Totalnumberofordersthatcanbehandled1,050840
Althoughthedataentryclerkscouldhandle1,050orders,thecurrent
capacityofthedepartmentissetbythelowercapacityoftheorderclerks.
4.$2,705+($0.40xordersprocessed)Fixedcostswouldbeallthecosts
listedinrequirement2,exceptthecostofsupplies.

6
38ReportingBudgetVariances(50minutes)
1.Change/
Budget2,000=TotalVariable
AtAtVariableCostatCostatFixed
Cost10,0008,000ChangePortion8,0008,000Amount
Material$20,000$16,000$4,000$2.00$16,000$16,0000
Direct
labor30,00024,0006,0003.0024,00024,0000
Indirect
labor5,0004,0001,0000.504,0004,0000

620

Power8,0007,0001,0000.507,0004,000$3,000
Maintenance6,0005,2008000.405,2003,2002,000
Supplies,
other5,0004,6004000.204,6001,6003,000
Totals$74,000$60,800$13,200$6.60$60,800$52,800$8,000
Thememoshouldsaythatthereportscurrentlyprovideddonothelp
managersbecausethereportsdonotfocusonthebehaviorofcostswhen
activitychanges.Unlessbudgetedproductionequalsactualproduction,itis
hardtotellwhetheroperationswentwellorpoorly.Thememocouldinclude
arevisedreport,asshownbelow.Thecurrentconfusionisunderstandable,
aswitnessedbychangesindirectionofmostofthevariances.
2.

AprilMay
BudgetActualVarianceBudgetActualVariance
Unitproduction7,0007,000

0
10,50010,500

0
Costs:
Material$14,000$14,600$(600)U$21,000$20,800$200
F
Directlabor21,00021,600(600)U31,50031,300200
F
Indirectlabor3,5003,900(400)U5,2505,300(50)
U
Power6,5006,700(200)U8,2508,400(150)
U
Maintenance4,8004,700100F6,2006,2000
Supplies,etc4,4004,580(180)U5,1005,05050
F
Totalcosts$54,200$56,080($1,880)U$77,300$77,050$250
F
Thereportingmethodmightbepartlytoblameforsomeofthevariances.
Forexample,amanagerwhoknowsthatproductionforamonthwillbelower
thanbudgetedcouldbetemptedtoexerciselesscontrolovercostsbecause
thevarianceswillstillprobablybefavorable.Inmonthswhenproductionis
higherthanbudgeted,itisdifficulttodecidewhatamanagermightdo
becausethevariances(basedontheoriginalbudgetofcosts)willprobably
beunfavorableanyway.Amanagerwhohaslearnedto"playthegame"couldbe
temptedtomovecosts,andproduction,fromoneperiodtoanothertoreduce
variances.Wedonotknowwhethermanagersinthiscasecanshiftcostsfrom
periodtoperiod,buttheycanalmostcertainlydosowithproduction.
NotetotheInstructor:Apointworthmentioningnow,althoughitis
takenupingreaterdepthlater,istheinterpretationofthevariancein
unitsofproduction.Thequestionhereiswhetherthevariancesoccurred
becauseoffactorsnotcontrollablebytheproductionmanager,orwhether
theyweretheresultoflackofeffectiveness.Thepossibilityof
manipulationisalsopresent,asdiscussedabove.

6
39UnderstandingBudgets(20minutes)
1.$41,000
ReceivableatDecember31,20X0$31,000
CollectedonJanuarysales($50,000x20%)10,000
Total$41,000
2.$78,000[($60,000+$70,000)x60%]

621

3.$49,000
Januarycostofsales,$50,000x60%$30,000
Requiredendinginventory,requirement278,000
Totalrequirements108,000
Beginninginventory,given59,000
Purchases$49,000

622

4.$3,000
Sales,given$50,000
Costofsales(60%)30,000
Grossprofit20,000
Othervariablecosts(20%)10,000
Contributionmargin10,000
Fixedcosts,given6,000
Incomebeforetaxes4,000
Taxes,at25%1,000
Netincome$3,000
5.$2,800
Balance,12/31(giveninbalancesheet)$33,000
Receiptsfromsales,requirement141,000
Total74,000
Disbursements:
Decemberpurchases(accountspayableat12/31)$9,000
Januarypurchases(80%ofrequirement3)39,200
VariablecostforJanuary(20%ofJanuarysales)10,000
Januaryfixedcosts,cashonly5,000
TaxesonDecemberincome(liabilityat12/31)8,00071,200
Balance$2,800
6.$48,000($60,000x80%)
7.$99,000[$102,000(3x$1,000)]
8.$7,800(20%x$39,000)
Marchcostofsales(60%x$70,000)$42,000
Inventory3/31[60%x($66,000+$65,000)]78,600
Required120,600
Inventory2/28[60%x($70,000+$66,000)]81,600
Purchases$39,000
9.$29,800
Retainedearnings,12/31$28,000
Budgetednetincome(requirement4)3,000
Total31,000
Dividend1,200
Budgetedretainedearnings,1/31$29,800
10.$2,000,fromMarchtaxaccrual.Taxesarepaidinthemonthafter
accrualperitemg.
Sales$70,000
Costofsalesat60%42,000
Grossprofit28,000
Othervariablecostsat20%14,000
Contributionmargin14,000
Fixedcosts6,000
Incomebeforetaxes$8,000
Incometaxesat25%$2,000
640CashBudgetforaStudent(15minutes)
Phelpsmustworkabout81hoursinSeptemberandabout62hoursinthe
othertwomonthstomeethisexpensesandmaintainaminimumbalanceof$100.

623

SeptemberOctoberNovember
Beginningbalance$1,250$100$100
Scholarshipcheck2,000
Cashavailable3,250100100
Disbursements:
Tuition,books,andrent3,28000
Meals300300300
Clothing505050
Datesandmiscellaneous100100100
Totaldisbursements3,730450450
Indicatedbalance(deficit)(480)(350)(350)
Fundsrequiredfromworking1($580)($450)($450)
1Deficitplus$100minimumrequiredbalance
Hoursrequired:
$580/$7.20*80.6
$450/$7.20*62.562.5
*$8hourlywage10%withholdingtax
641AnalysisofBudgetsofaManufacturingFirm(35minutes)
1.$0.80($8,000totalvariablemanufacturingcostsdividedby10,000units)
2.$600,asgiveninthecashdisbursementsbudget.
3.Collectionsareexpectedtobe25%inthemonthofsaleand75%inthe
monthaftersale.Thecashreceiptsbudgetshowsthateachmonth'ssalesare
socollected.(Januarysalescollectionsare$1,500inJanuary,$4,500in
February,andsoon.)
4.$1,000,becausecollectionsinJanuaryonDecembersalesaretobe$750,
whichis75%ofDecembersales.
5.$11,250,whichis75%of$15,000budgetedsalesinMarch($3,750cash
collections/25%).
6.40%inthemonthofsaleand60%inthefollowingmonth.The"current
month"portionofvariableS&Aexpensesinthecashbudgetisalways40%of
thetotaloftheS&Aassociatedwiththatmonth.Forexample,$600paidin
Januaryis40%oftheJanuarytotal($600+$900).
7.$2,250
Marchsales(5,000x$3)$15,000
Variablecost,at25%ofsales$3,750
Unpaidportion,at60%ofvariablecost$2,250
8.$900
Beginningbalance$1,800
Budgetedreceipts($2,250+$6,750+$10,500)19,500
21,300
Budgeteddisbursements($5,350+$8,000+$7,050)20,400
Budgetedendingbalance$900
9.$13,200
Revenueincrease$6,000
Costincrease[($6,000x25%)+(2,000x$0.80)]3,100
Increasedcontributionmargin2,900

624

Currentprofitbudgeted10,300
Revisedprofit$13,200
10.Inventoryisequaltooneandonehalftimesthebudgetedsalesofthe
comingmonth.(ThedesiredendinginventoryinJanuaryis4,500,oneand
onehalftimesFebruary'sbudgetedsalesof3,000,andsoon.)
11.No,becauseonly2,500unitsareonhandatJanuary1.Ifthepolicy
werefollowed,therewouldbe3,000units(2,000unitsx11/2).
12.4,000units,sincethedesiredinventoryatMarch31is6,000units.
Dividing6,000by1.5gives4,000.

625