Chapter 07 - Planning for Profit and Cost Control

Answers to Questions 1. Budgets are useful for large companies with complex activities as well as small companies. Budgets act as a vehicle for communication by formalizing managements plans in a document that communicates company objectives. The benefits associated with this kind of planning apply to all sizes of companies operating at all levels of complexity. 2. The budget represents the companywide plans stated in financial terms as to how to coordinate operating activities to accomplish goals and objectives. Accordingly, its success depends upon the combined effort of all of the parties involved. A committee that includes representatives from all pertinent departments is necessary to formulate the master budget. 3. The three levels of planning are as follows: (1) Strategic planning the long-run planning activities that address issues such as overall company goals and objectives. (2) Capital budgeting the intermediate financial planning activities of the entire company that concern investments, product selection, and desired profitability. (3) Operations budgeting the short-run financial planning for the companys different departments that culminates in the formation of a master budget. 4. The span of time is the primary factor that distinguishes the three levels of planning from each other. Strategic planning involves long-range decisions; capital budgeting is associated with intermediate-range plans; and operational budgeting is concerned with short-range plans. 5. The perpetual budget has the advantage of keeping management involved in the budget process. Too often budgets are prepared and forgotten. The perpetual budget forces management to maintain a constant focus on the companys goals and objectives.

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6.

The primary advantages associated with budgeting are as follows: Planning formalizes managements plans in a document that communicates company objectives. Coordination forces departments to coordinate their activities in a manner that ensures the attainment of the objectives of the whole company. Performance measurement represents specific, quantitative standards that can be used to evaluate performance. Corrective action acts as an early warning system that promotes corrective action.

7. Budgeted amounts represent managements expectations regarding how the firm as a whole and individual departments within the firm should perform. By comparing actual performance with the expected performance (the budgeted amounts), managers can be effectively evaluated. 8. Mr. Shilovs failure with budgets seems to stem from his misunderstanding of the human element. He states that he made budgets. Experience shows that, in general, employees are more willing to accept budget standards if they participate in the budgeting process. Further, Mr. Shilov appears to have used the budget as a tool for punishment a basis for reprimanding employees. As a result, employees would resent the budget and would be unmotivated to accomplish budget standards. 9. A master budget consists of a series of detailed schedules and budgets that describe the overall financial plans for the forthcoming accounting period. 10. The sales forecast normally functions as the starting point for the development of the master budget. Clearly, production and other related activities depend upon the level of sales.

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11. The desired level of ending inventory must be added to projected sales in order to determine the amount of goods that are needed during the period. The beginning inventory is subtracted from the amount of goods needed in order to determine the amount of goods to be produced. Managing inventory is important because an inventory shortage can result in customer dissatisfaction and loss of sales. Conversely, excess inventory ties up capital investment, creates unnecessary storage cost, and is subject to obsolescence or spoilage. Finding the balance between too much and too little inventory is essential to the profitability of a company. 12. The cash budget is composed of three major components:

(1) Cash receipts expected cash inflows from sales, sale of investments, and borrowing activities, etc. (2) Cash payments expected cash outflows for inventory purchases, selling and administrative expenses, and purchases of investments, etc. (3) Financing activities expected borrowing and repayment activities.

13. Determining the amount of the cash balance to include on the budgeted balance sheet is an insignificant reason for preparing a cash budget. The real purpose of preparing a cash budget is to enable a company to effectively manage its financing and investing activities. If the company can foresee a cash surplus then investment opportunities can be investigated to earn interest or debt can be repaid to reduce interest. If the company anticipates a cash shortage, appropriate sources of financing can be investigated to avoid possible bankruptcy. When dealing with large amounts of money, investing, borrowing, and repayment activities that involve interest can be critical to profitability.

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14. The pro forma income statement provides information about the expected profitability of the company. The completion of this statement is dependent on the departmental operating budgets. For example, the sales budget provides information about projected sales revenues, the purchases budget provides information as to projected cost of goods sold, the selling and administrative expenses budget provides information about projected operating expenses, and the cash budget provides information as to expected interest revenue and expense. 15. The cash budget, like the pro forma statement of cash flows, provides information as to expected cash receipts and cash payments, but in addition it shows how a firm plans to effectively manage its cash through financing and investing activities. Exercise 7-1A Ms. Huffman appears to be a person with an attitude problem. She does not understand how to involve her colleagues in the budgeting process. She degrades their input and uses the budget as a tool for criticism. In so doing, Ms. Huffman has failed to gain the support of upper-level management. The attitudes of upper-level management will have a significant impact on the effectiveness of the budget. Subordinates develop a keen awareness of management's expectations. If upper-level managers degrade, make fun of, or ignore the budget, subordinates will rapidly follow suit. If budgets are used to humiliate or embarrass subordinates, they will resent the treatment and the budgeting process that enables it. To be effective, upper-level management must accept and portray the budget as a sincere effort to express realistic goals that employees will be expected to accomplish. The proper atmosphere is essential to budgeting success. Once a negative pattern has been established, it is difficult to change. Perhaps the most effective solution in this case is to replace Ms. Huffman.

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Exercise 7-2A a. Sales Budget Cash sales Sales on account Total budgeted sales January $ 40,000 100,000 $140,000 February $ 44,000 110,000 $154,000 March $ 48,400 121,000 $169,400

b. The amount of sales revenue appearing on the 1st quarter income statement is the sum of the monthly amounts ($140,000 + $154,000 + $169,400 = $463,400). Exercise 7-3A a.
Schedule of Cash Receipts Current cash sales Plus collections from accounts receivable Total budgeted collections July August September $ 70,000 $ 75,000 $ 80,000 300,000 90,000 108,000 $370,000 $165,000 $188,000

b.

The current months sales on account will be collected in the following month. Accordingly, the amount of accounts receivable at the end of September is equal to Septembers sales on account ($129,600).

Exercise 7-4A
a.

East Div. West Div. South Div. Total b. Total

1st Quarter $100,000 300,000 200,000 $600,000

2nd Quarter $104,000 306,000 212,000 $622,000

3rd Quarter $108,160 312,120 224,720 $645,000

4th Quarter $112,486 318,362 238,203 $669,051

1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $600,000 $622,000 $645,000 $669,051

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Exercise 7-5A a. Sales for January are expected to be $392,000 ( $560,000 x 0.70) Beginning accounts receivable balance January sales on account Available for collection Less: Ending accounts receivable balance Cash collected $ 96,400 392,000 488,400 (73,600) $414,800

b. It is reasonable to assume that sales will decline in January. Customers tend to buy merchandise in December for Christmas gifts and to cut back on buying in January immediately after Christmas. Exercise 7-6A Sales would likely be highest in late January or early February because of Valentines Day sales. October may also produce higher sales due to buying for Halloween. Other holiday seasons are also likely to boost sales. Accordingly, sales would be high in April for Easter, and November and December for Christmas and Hanukah. Months that would be lower would be May and June. Summer months may pick up due to children being out of school and in the malls. Similarly, sales would be expected to drop off in August and September when school reopens.

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Exercise 7-7A a. Inventory Purchases Budget Budgeted cost of goods sold Plus: Desired ending inventory Total inventory needed Less: Beginning inventory Required purchases (on account) January $50,000 5,400 55,400 5,000 $50,400 February $ 54,000 6,000 60,000 5,400 $ 54,600 March $60,000 7,500 67,500 6,000 $61,500

Exercise 7-7A (continued) b. The amount of cost of goods sold appearing on the first quarter pro forma income statement is the sum of the monthly amounts ($50,000 + $54,000 + $60,000 = $164,000). Since the quarter ends on March 31, the ending inventory for March is also the ending inventory for the quarter, $7,500.

c.

Exercise 7-8A a. Schedule of Cash Payments for Inventory Purchases April May Payment for current accounts payable $90,000 $108,000 Payment for previous accounts payable 8,000 10,000 Total budgeted payments for inventory $98,000 $118,000 June $118,800 12,000 $130,800

b. Since 90% of the current purchases on account are paid in cash during the month of purchase, 10% will remain payable at the end of the month, $13,200 ($132,000 x 0.10).

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Exercise 7-9A a. Budgeted cost goods sold for July is $315,000 ($300,000 x 1.05) Ending inventory balance Budgeted cost of goods sold Total inventory needed Less: Beginning inventory balance Budgeted purchases b. $ 29,000 315,000 344,000 (28,000) $316,000 $ 35,000 221,200 $256,200

Junes payables balance paid in July Cash paid for July purchases ($316,000 x 0.70) Projected cash payments for July

Exercise 7-10A a. Schedule of Cash Payments for S&A Expenses Equipment lease expense Prior month's salary expense, 100% Cleaning supplies Insurance premium Rent Miscellaneous expenses Total payments for S&A expenses Depreciation is a noncash charge. Oct. Nov. Dec. $6,000 $ 6,000 $ 6,000 0 6,100 6,600 2,800 2,730 3,066 7,200 0 0 1,700 1,700 1,700 700 700 700 $18,400 $17,230 $18,066

b. Since salaries expense is paid in the month following the month it is incurred, the amount payable at the end of December will be the amount of salary expense incurred in December, $7,000. c. Since the insurance premium is prepaid for 6 months on October 1, the amount of prepaid insurance at the end of December will be $3,600 [$7,200 ($1,200 x 3)].

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Exercise 7-11A a. An inventory purchases budget prepared with the sales manager's estimate:
Sales Cost of goods sold Plus: Desired ending inventory Total inventory needed Less: Beginning inventory Required purchases 1st Quarter $380,000 $228,000 18,600 246,600 29,000 $217,600 2nd Quarter 3rd Quarter 4th Quarter $310,000 $280,000 $480,000 $186,000 $168,000 $288,000 16,800 28,800 30,000 202,800 196,800 318,000 18,600 16,800 28,800 $184,200 $180,000 $289,200

b. An inventory purchases budget prepared with the marketing consultant's estimate:

Sales Cost of goods sold Plus: Desired ending inventory Total inventory needed Less: Beginning inventory Required purchases 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $520,000 $460,000 $410,000 $650,000 $312,000 $276,000 $246,000 390,000 27,600 24,600 39,000 30,000 339,600 300,600 285,000 420,000 29,000 27,600 24,600 39,000 $310,600 $273,000 $260,400 $381,000

Exercise 7-12A a. Budgeted payments for January: Sales commissions Rent Miscellaneous Total* $25,000 16,000 2,000 $43,000

*The amount of utilities is not included because the cash payment will be made in February. The amount of depreciation is not included because the depreciation does not require a cash payment. Recall that cash is paid at the time of purchase rather than when the depreciation is recognized.

b. The full $5,000 balance for the utilities charge will remain payable at the end of January. c. The problem implies that the monthly charge for depreciation is $4,000. Accordingly, the amount of depreciation to be recognized on an annual income statement would be $48,000 ($4,000 x 12).

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Exercise 7-13A a.
Cash Budget Section 1: Cash receipts Beginning cash balance Add cash receipts Total cash available (a) Sections 2: Cash Payments For inventory purchases For S&A expenses For interest exp at 2% per month Total budgeted disbursements (b) Sections 3: Financing Activities Cash surplus (shortage) (a b=c) Borrowing (repayment) (dc) Ending cash balance (d)
1 2

July $ 42,500 180,000 222,500 165,526 54,500 0 220,026 2,474 11,526 $ 14,000

August $ 14,000 200,000 214,000 140,230 60,560 2311 201,021 12,979 1,021 $ 14,000

September $ 14,000 240,600 254,600 174,152 61,432 2512 235,835 18,765 (4,765) $ 14,000

11,526 x 2% = 231 (rounded) (11,526+1,021) x 2% = 251 (rounded). Note that $4,765 is repaid at the end of month in addition to interest that still has to be paid in September.

b. Cash flow from operating activities is equal to total (i.e., sum of the monthly amounts) cash receipts from customers minus the total (i.e., sum of the monthly amounts) of cash payments for inventory, S&A expense, and interest [i.e., $620,600 ($220,026 + $201,021 + $235,835) = ($36,282) net cash outflow.] c. Cash flow from financing activities is the amount borrowed less repayments (i.e., $11,526 + $1,021 $4,765 = $7,782 net cash inflow.)

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Exercise 7-14A a.
Cash Collections Collections from Mays receivables balance Collections from Junes credit sales ($600,000 x .80) Cash sales from June Total cash receipts Desired cash balance Cash disbursements Total cash needs Cash shortage (amount needed to be borrowed)

$ 60,000 480,000 150,000 30,000 700,000 $690,000 730,000 $40,000

b. The interest expense for June is $0 because the loan is taken at the end of June. c. The interest expense for July is $300 ($40,000 x 9% 12). Exercise 7-15A a. Pro forma income statement prepared with Mr. Wings estimate:
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Sales revenue $187,000 $220,000 $231,000 $286,000 Cost of goods sold 112,200 132,000 138,600 171,600 Gross profit 74,800 88,000 92,400 114,400 S. & Adm. expenses 18,700 22,000 23,100 28,600 Net income $ 56,100 $ 66,000 $ 69,300 $ 85,800 Total $924,000 554,400 369,600 92,400 $277,200

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b. Pro forma income statement prepared with Ms. Sullivan's estimate:

Sales revenue Cost of goods sold Gross Profit S & A expenses Net income 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $178,500 $210,000 $220,500 $273,000 107,100 126,000 132,300 163,800 71,400 84,000 88,200 109,200 17,850 21,000 22,050 27,300 $ 53,550 $ 63,000 $ 66,150 $ 81,900 Total $882,000 529,200 352,800 88,200 $264,600

c. Forecasting is not likely to be 100% accurate. Therefore, different executive officers within the same company may have different estimates about the future. In addition to legitimate differences caused by honest opinions, self-interest may also contribute to differences. For example, Glenda Sullivan may want to establish low budgetary figures for sales because these figures will become the standards for the evaluation of Sarah's future performance. With low standards, she would have a better chance of reaching the standards. Problem 7-16A a. Sales Budget Sales on account January $200,000 February $220,000 March Total $242,000 $662,000

b. Sales revenue for the quarter is equal to the sum of the monthly amounts ($200,000 + $220,000 + $242,000 = $662,000).

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c. Schedule of Cash Receipts Receipts from January sales Receipts from January sales Receipts from January sales Receipts from February sales Receipts from February sales Receipts from March sales Total

January February $140,000 $ 40,000 154,000 $140,000 $194,000

March $ 20,000 44,000 169,400 $233,400

d.
Schedule of Cash Receipts Receipts from January sales Receipts from January sales Receipts from January sales Receipts from February sales Receipts from February sales Receipts from February sales Receipts from March sales Receipts from March sales Receipts from March sales Total January February $140,000 $ 40,000 154,000 44,000 $22,000 169,400 48,400 $24,200 $140,000 $194,000 $233,400 $70,400 $24,200 March $ 20,000 April May

The accounts receivable as of March 31, 2012 is equal to the amount due to be collected in April and May from the first quarter sales, $94,600 ($70,400 + $24,200).

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Problem 7-17A a. Inventory Purchases Budget Budgeted cost of goods sold Plus desired ending inventory Inventory needed Less beginning inventory Required purchases (on account) April May $60,000 $70,000 7,000 8,000 67,000 78,000 3,600 7,000 $63,400 $71,000 June $80,000 8,600 88,600 8,000 $80,600

b. Since the quarter ends on June 30, the ending inventory for June is also the ending inventory for the quarter (i.e., $8,600). c. Schedule of Cash Payments Payment of current accounts payable Payment of previous accounts payable Total budgeted payments for inventory April May $38,040 $42,600 14,800 25,360 $52,840 $67,960 June $48,360 28,400 $76,760

d. Since 60% of the current purchases on account are paid in cash during the month of purchase, 40% will remain payable at the end of the month (i.e., $80,600 x .40 = $32,240).

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Problem 7-18A This is a typical problem for what-if analysis. Students can use a computerized spreadsheet to try different possible scenarios. a. The budgeted net income for the next year: $340,000x115%= $391,000 Assume x = Desired sales Sales Cost of goods sold S&A = NI X 0.7 X ($60,000 + .10 X) = $391,000 .20 X $60,000 = $391,000 X = $2,255,000 Alternatively, you can use the contribution margin ratio to determine sales. Contribution margin ratio = Sales (100%) Variable costs (80%) = 20% (Net income + Fixed cost) CM ratio = ($391,000+$60,000) 20% = $2,255,000 Pro Forma Income Statement Sales revenue Cost of goods sold Gross profit Selling & admin. expenses Net income $2,255,000 1,578,500 676,500 285,500* $ 391,000

*($2,255,000 x 10% + $60,000) = $285,500 % increase required: ($2,255,000 $2,000,000) $2,000,000 = 12.75%

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Problem 7-18A (continued) b. Budgeted cost of goods sold with a 2% cut: $1,400,000 x 98% = $1,372,000 Budgeted gross profit: $2,000,000 $1,372,000= $628,000 The budgeted level of selling and administrative expenses: $628,000 $391,000 = $237,000 Pro Forma Income Statement Sales revenue Cost of goods sold Gross profit Selling & admin. expenses Net income $2,000,000 1,372,000 628,000 237,000* $ 391,000

*The figure means that management has to cut the selling and administrative expenses by $23,000 ($237,000 $260,000) in order to reach the presidents goal. c. Projected sales revenue to increase by 15%: $2,000,000 x 115%= $2,300,000 Projected cost of goods sold: $2,300,000 x 70% = $1,610,000 Pro Forma Income Statement Sales revenue Cost of goods sold Gross profit Selling & admin. expenses Net income $2,300,000 1,610,000 690,000 340,000 $ 350,000

Since the projected net income under the given scenario will be only $350,000, which is short of the original $391,000, the company cannot reach its goal. Problem 7-19A a.

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Schedule of Cash Payments for S&A Expenses July Salary expense $18,000 Prior month's sales commissions, 100% 0 Supplies expense 360 Prior month's utilities, 100% 0 Rent 6,600 Miscellaneous 690 Total payments for S&A expenses $25,650 Depreciation is a noncash charge.

August $18,000 1,700 390 1,100 6,600 690 $28,480

September $18,000 1,700 420 1,100 6,600 690 $28,510

b. Since utilities are paid in the month following the month they are incurred, the amount payable at the end of September will be the amount of utilities expense incurred in September which is $1,100. c. Since sales commissions are paid in the month following the month they are incurred, the amount payable at the end of September will be the amount of sales commissions expense incurred in September which is $1,700.

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Problem 7-20A Cash Budget Beginning cash balance Add cash receipts Cash available (a) Less cash payments For inventory purchases For S&A expenses Interest exp at 1% per month Total budgeted payments (b) Payments minus receipts Surplus (Shortage) (a b) Financing Activity Borrowing (repayment) (c) Ending cash balance (a b + c)
1 2

January $ 8,000 100,000 108,000 90,000 31,000 4001 121,400 (13,400) 19,000 $ 5,600

February $ 5,600 106,000 111,600 72,000 32,000 5902 104,590 7,010 (2,010) $ 5,000

March $ 5,000 126,000 131,000 85,000 27,000 5703 112,570 18,430 (13,430) $ 5,000

($40,000) x 1% = $400 ($40,000 + $19,000) x 1% = $590 3 ($40,000 + $19,000 $2,010) x 1% = $570 (rounded).

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Problem 7-21A a. 1st Quarter Peaches $231,000 Oranges 440,000 Total $671,000 2nd Quarter 3rd Quarter $252,000 $315,000 495,000 627,000 $747,000 $942,000 4th Quarter $252,000 418,000 $670,000 Total $1,050,000 1,980,000 $3,030,000

b. Budgeted cost of goods sold: $3,030,000 x 60% = $1,818,000 Budgeted Annual Income Statement Sales revenue $3,030,000 Cost of goods sold 1,818,000 Gross profit 1,212,000 Selling & admin. expenses 700,000 Net income $512,000 c. Inventory purchases budget for peaches
Sales Cost of goods sold Plus: desired ending inventory Inventory needed Less: beginning inventory Required purchases 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $231,000 $252,000 $315,000 $252,000 $138,600 $151,200 $189,000 $151,200 30,240 37,800 30,240 34,000 168,840 189,000 219,240 185,200 27,720 30,240 37,800 30,240 $ 141,120 $158,760 $181,440 $154,960

Inventory purchases budget for oranges

Sales Cost of goods sold Plus: desired ending inventory Inventory needed Less: beginning inventory Required purchases 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $440,000 $495,000 $627,000 $418,000 $264,000 $297,000 $376,200 $250,800 59,400 75,240 50,160 56,000 323,400 372,240 426,360 306,800 52,800 59,400 75,240 50,160 $270,600 $312,840 $351,120 $256,640

Problem 7-22A (Note: All computations are rounded to the nearest whole dollar.)

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a. & b.
Sales Budget Cash sales Sales on account Total budgeted sales Schedule of Cash Receipts Current cash sales Plus collections from A/R Total collections Oct. $ 48,000 72,000 $120,000 Oct. $48,000 0 $48,000 Nov. $ 60,000 90,000 $150,000 Nov. $ 60,000 72,000 $132,000 Dec. $ 75,000 112,500 $187,500 Dec. $ 75,000 90,000 $165,000 Pro Forma Data $112,500(a) 457,500(b)

$345,000 (c)

(a) Ending accounts receivable balance appearing on balance sheet. (b) Sales revenue appearing on income statement (sum of monthly amounts). (c) Cash receipts from customers on statement of cash flows (sum of monthly amounts).

c. and d.
Inventory Purchases Budget Budgeted cost of goods sold Plus: Desired ending inventory Inventory needed Less: Beginning inventory Required purchases (on account) Oct. Nov. $72,000 $ 90,000 9,000 11,250 81,000 101,250 0 9,000 $81,000 $ 92,250 Dec. $112,500 12,000 124,500 11,250 $113,250 Pro Forma Data $274,500(a) 12,000(b) 33,975(c)

Schedule of Cash Payments Budget for Inventory Purchases Pmt. of current month's accts. pay. $56,700 $64,575 $ 79,275 Pmt. for prior month's accts. pay. 0 24,300 27,675 Total budgeted pmts. for inventory $56,700 $88,875 $106,950

$252,525(d)

(a) Cost of goods sold appearing on pro forma income statement (sum of monthly amounts). (b) Ending inventory balance appearing on pro forma balance sheet. (c) Ending accounts payable balance appearing on pro forma balance sheet ($113,250 -$79,275). (d) Cash payments for inventory purchases (sum of monthly amounts).

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Problem 7-22A (continued) e. and f.

Selling and Administrative Expense Budget Salary expense Sales commissions, 5% of sales Supplies expense, 2% of sales Utilities Depreciation on store fixtures Rent Miscellaneous Total S&A expenses Oct. Nov. Dec. $18,000 $18,000 $18,000 6,000 7,500 9,375 2,400 3,000 3,750 1,400 1,400 1,400 4,000 4,000 4,000 4,800 4,800 4,800 1,200 1,200 1,200 $37,800 $39,900 $42,525 Pro Forma Data $ 9,375(a) 1,400(b) 12,000(c) 120,225(d)

Schedule of Cash Payments for S&A Expenses Salary expense $18,000 $18,000 Prior month's sales comm., 100% 0 6,000 Supplies expense 2,400 3,000 Prior month's utilities, 100% 0 1,400 Depreciation on store fixtures 0 0 Rent 4,800 4,800 Miscellaneous 1,200 1,200 Total payments for S&A expenses $26,400 $34,400 Depreciation is a noncash charge.

$18,000 7,500 3,750 1,400 0 4,800 1,200 $36,650 $97,450 (e)

(a) Ending sales commissions payable account balance shown on pro forma balance sheet. (b) Ending utilities payable account balance shown on pro forma balance sheet. (c) Accumulated depreciation appears on the pro forma balance sheet (sum of monthly amounts). (d) S&A expense appearing on pro forma income statement (sum of monthly amounts). (e) Total cash payments for S&A expenses on pro forma statement of cash flows (sum of monthly amounts).

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Problem 7-22A (continued) g.

Cash Budget Oct. Beginning cash balance Add cash receipts Cash available (w) Less payments For inventory purchases For S&A expenses Purchase of store fixtures Interest expense* Total budgeted payments (x) Payments minus receipts Surplus (shortage) (w x) Financing activity Borrowing (repayment) (y) Ending cash balance (w x+ y) $ 0 48,000 48,000 Nov. $ 12,900 132,000 144,900 88,875 34,400 0 2,120 125,395 19,505 Dec. $ 12,000 165,000 177,000 106,950 36,650 0 2,045 145,645 31,355 185,140(e) 12,000(g) Pro Forma Data $345,000(a) 252,525(b) 97,450(c) 164,000(d) 4,165 (f)

56,700 26,400 164,000 0 247,100 (199,100) 212,000 $ 12,900

(7,505) (19,355) $ 12,000 $ 12,000

*October ($0 x 0.01); November ( $212,000 x 0.01); December [( $212,000 $7,505) x 0.01] (a) Operating activities section of pro forma Statement of Cash Flows (sum of monthly amounts). (b) Operating activities section of pro forma Statement of Cash Flows (sum of monthly amounts). (c) Operating activities section of pro forma Statement of Cash Flows (sum of monthly amounts). (d) Investing activities section of pro forma Statement of Cash Flows. The investment in store fixtures also appears on the pro forma balance sheet. (e) Financing activities section of pro forma Statement of Cash Flows (sum of monthly amounts). (f) Operating activities section of pro forma Statement of Cash Flows (sum of monthly amounts). (g) The ending cash balance appears on the pro forma balance sheet and as the last item on the pro forma statement of cash flows.

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Problem 7-22A (continued) h. Patel Company Pro Forma Income Statement For the Quarter Ended December 31, 2012 Sales revenue $457,500 Cost of goods sold (274,500) Gross margin 183,000 S&A expenses (120,225) Operating income 62,775 Interest expense (4,165) Net income $ 58,610 i. Patel Company Pro Forma Balance Sheet December 31, 2012 $ 12,000 112,500 12,000 $164,000 (12,000) 152,000 $288,500 $ 33,975 1,400 9,375 185,140 58,610 $288,500

Assets Cash Accounts receivable Inventory Store fixtures Accumulated depreciation Book value of fixtures Total assets

Liabilities Accounts payable Utilities payable Sales commissions payable Line of credit liability Equity Retained earnings Total liabilities and equity

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Problem 7-22A (continued) j. Patel Company Pro Forma Statement of Cash Flows For the Quarter Ended December 31, 2012 Cash flows from operating activities Cash receipts from customers Cash payments for inventory Cash payments for S&A expenses Cash payments for interest expense Net cash flows from operating activities Cash flows from investing activities Cash payment for store fixtures Cash flow from financing activities Net Inflow from line of credit Net increase in cash Plus: Beginning cash balance Ending cash balance $ 345,000 (252,525) (97,450) (4,165) $ (9,140) (164,000) 185,140 12,000 0 $ 12,000

Problem 7-23A a. Pro forma income statement assuming 5% growth: Sales revenue Cost of goods sold Gross profit Selling & administrative expenses Net income Budget $4,200,000 2,625,000 1,575,000 945,000 $ 630,000

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Problem 7-23A (continued) b. Pro forma income statement with 10% growth: Sales revenue Cost of goods sold Gross profit Selling & administrative expenses Net income Excess of actual net income over budget: $660,000 $630,000 = $30,000 Bonus: $30,000 x 15% = $4,500 c. Pro forma income statement assuming 15% growth: Sales revenue Cost of goods sold Gross profit Selling & administrative expenses Net income Budget $4,600,000 2,875,000 1,725,000 1,035,000 $ 690,000 Actual Result $4,400,000 2,750,000 1,650,000 990,000 $ 660,000

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d. e.

Zero The process of participative budgeting is recommended. This process requires two-way communication between the president and divisional vice presidents. Any disagreement about the budget assumptions should be fully discussed and pros and cons well considered. If the president believes that the divisional budget is unrealistic, he should tell the vice president directly and explain the reasons. Participative budgeting is more than just a budget proposal from a subordinate and a review and final decision by the superior. The process described in the problem is nothing but gamesmanship.

Exercise 7-1B The primary deficiencies in Mullins budgeting process are the absence of leadership and top management participation and the failure of the controller and department managers to coordinate their efforts. As a result of these flaws, department managers proposed budgets that would satisfy their individual needs at the expense of the companys best interests. Ms. Morgar should have established general corporate goals early in the budgeting process. She neednt dictate company goals based on her personal ambitions; rather, she could have created a high-level committee to evaluate the companys long-term competitive position in the market and to advise her regarding possible alternative future company goals. Once top management establishes company goals, individual departments should propose departmentlevel goals and budgets to support the companys general goals. Mr. Judson should have coordinated the budgeting process among the different departments to ensure that they would propose individual budgets in support of the companys overall goals.

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Exercise 7-2B a. Revenues Budget Food sales Beverage and liquor sales Total budgeted revenues
b.

July $40,000 24,000 $64,000

August September $42,000 $44,100 25,200 26,460 $67,200 $70,560

The total revenue Gardners will report on the 3rd quarter pro forma income statement is the sum of the monthly amounts, $64,000 + $67,200 + $70,560 = $201,760. Exercise 7-3B a.
Schedule of Cash Receipts Current cash sales Plus: Collections from accounts receivable Total budgeted collections April May June $120,000 $140,000 $150,000 310,000 480,000 568,000 $430,000 $620,000 $718,000

b.

Since the current months sales on account will be collected in the following month, the amount of accounts receivable at the end of June is equal to Junes credit sales of $500,000.

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Exercise 7-4B a.
Moore Pickrell Rice Total This Quarter 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $160,000 $166,400 $173,056 $179,978 $187,177 200,000 202,000 204,020 206,060 208,121 320,000 329,600 339,488 349,673 360,163 $680,000 $698,000 $716,564 $735,711 $755,461

b. Budgeted Income 1st Quarter

$698,000

2nd Quarter
$716,564

3rd Quarter
$735,712

4th Quarter

Annual $755,461 $2,905,736

Exercise 7-5B a. The expected cash collections in July are 50% of that months expected sales revenues. The computation follows: $300,000 x 50% = $150,000 b. The expected cash collections in August are the sum of 50% of Julys expected revenues and 50% of Augusts expected revenues. The computation follows: $300,000 x 50% + $280,000 x 50% = $290,000 Exercise 7-6B Sales would likely be high in February because of Valentines Day sales, in May because of Mothers Day sales, in June because of Fathers Day sales, and in December because of Christmas sales. Sales should be relatively stable in other months since birthdays and other personal events occur in a normal distribution pattern.

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Exercise 7-7B a. Inventory Purchases Budget Budgeted cost of goods sold Plus desired ending inventory Inventory needed Less beginning inventory Required purchases (on account)
b.

January February $80,000 $56,000 8,960 9,600 88,960 65,600 12,000 8,960 $76,960 $56,640

March $60,000 10,080 70,080 9,600 $60,480

The amount of cost of goods sold reported on the first quarter income statement is the sum of the monthly amounts, $80,000 + $56,000 + $60,000 = $196,000.

c. Since the quarter ends on March 31, the ending inventory for March is also the ending inventory for the quarter, $10,080. Exercise 7-8B a. Schedule of Cash Payments for Inventory Purchases Oct. Nov. Dec. Payment for current accounts payable $28,000 $21,000 $25,200 Payment for previous accounts payable 9,000 12,000 9,000 Total budgeted payments for inventory $37,000 $33,000 $34,200 Since 70% of current accounts payable are paid in cash in the month of purchase, 30% will remain payable at the end of any month,$10,800 ($36,000 x .30) at the end of December.
b.

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Exercise 7-9B a. Budgeted cost goods sold for February is $328,000 ($320,000 x 1.025). Desired February ending inventory balance Budgeted cost of goods sold Inventory needed in February Less: beginning inventory balance (January) Budgeted February purchases b. Januarys payables balance paid in February Cash paid for February purchases ($333,000 x 0.60) Projected cash payments for February Exercise 7-10B a.
Schedule of Cash Payments for Selling and Administrative Expenses January February March Equipment depreciation* $ 0 $ 0 $ 0 Prior month's salary expense, 100% 0 3,400 3,200 Cleaning supplies 1,000 940 1,100 Insurance premium 7,200 0 0 Equipment maintenance expense 500 500 500 Leases expense 1,600 1,600 1,600 Miscellaneous expenses 400 400 400 Total payments for S&A expenses $10,700 $6,840 $6,800 *Depreciation is a noncash charge.

$ 30,000 328,000 358,000 (25,000) $333,000

$ 30,000 199,800 $229,800

b. Since salary expense is paid in the month following the month it is incurred, the amount payable at the end of March will be the amount of salary expense incurred in March, $3,600. c. Since the annual insurance premium is prepaid on January 1, the amount of prepaid insurance at the end of March will be $5,400 [$7,200 ($600 x 3)].

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Exercise 7-11B a. An inventory purchases budget prepared with Rachels estimate:

Sales Cost of goods sold Plus: ending inventory Inventory needed Less: beginning inventory Required purchases 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $360,000 $400,000 $300,000 $420,000 $216,000 $240,000 $180,000 $252,000 36,000 27,000 37,800 35,000 252,000 267,000 217,800 287,000 25,000 36,000 27,000 37,800 $227,000 $231,000 $190,800 $249,200

b. An inventory purchases budget prepared with David's estimate:

Sales Cost of goods sold Plus: ending inventory Inventory needed Less: beginning inventory Required purchases 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $300,000 $320,000 $340,000 $480,000 $180,000 $192,000 $204,000 $288,000 28,800 30,600 43,200 35,000 208,800 222,600 247,200 323,000 25,000 28,800 30,600 43,200 $183,800 $193,800 $216,600 $279,800

Exercise 7-12B a. Budgeted payments for January: Office lease Utilities Office supplies Miscellaneous Total* $4,000 1,900 2,400 1,000 $9,300

*The referral fees are not included because cash payment for them will be made in February. The depreciation is not included because depreciation does not require a cash payment. Cash for depreciable assets is paid when the assets are purchased rather than when depreciation is recognized. b. The full $5,000 balance for the referral fees will remain payable at the end of January. c.Since the office lease is $4,000 each month, the annual lease expense will be $48,000 ($4,000 x 12).

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Exercise 7-13B a.
Cash Budget Beginning cash balance Add cash receipts Cash available (a) Less disbursements For inventory purchases For S&A expenses Interest expenses at 1% per month Total budgeted disbursements (b) Cash surplus (shortage) (a b) Financing activity Borrowing (repayment) (c) Ending cash balance (a b + c)
1 2

July $ 16,000 180,000 196,000 158,000 37,000 0 195,000 1,000

August September $ 4,000 $ 4,000 192,000 208,000 196,000 212,000 153,000 36,000 301 189,030 6,970 171,000 39,000 0 210,000 2,000 $ 2,000 4,000

3,000 (2,970) $ 4,000 $ 4,000

$3,000 x 1% = $30 ($3,000 $2,970) x 1% = $0 (rounded)

b. Net cash flows from operating activities equals total (sum of the monthly amounts) cash receipts from customers minus total (sum of the monthly amounts) cash payments for inventory, S&A expenses, and interest. The computation follows: ($180,000 + $192,000 + $208,000) ($195,000 + $189,030 + $210,000) = $580,000 $594,030 = $(14,030) net cash outflow c. Net cash flows from financing activities is the amount borrowed less repayments. The computation follows: $3,000 $2,970 + $2,000 = $2,030 net cash inflow

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Exercise 7-14B a.
Cash Collections Collections from June 30 receivables balance Collections from Julys credit sales ($320,000 x 0.75) July cash sales Total cash receipts in July Desired cash balance Cash disbursements in July Total July cash needs Cash shortage (amount to borrow)

$ 50,000 240,000 70,000 15,000 380,000 $360,000 395,000 $ 35,000

b. There will be no interest reported on the July pro forma income statement because the money was borrowed on the last date of the month. c. Estimated interest expense for August is $350 [$35,000 x (12% 12)]. Exercise 7-15B a. Pro forma income statement prepared with Mr. McFerrins estimate:
Sales revenue Cost of goods sold Gross margin S&A expenses Net income *rounded 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $252,000 $210,000 $226,800 $329,700 126,000 105,000 113,400 164,850 126,000 105,000 113,400 164,850 31,500 26,250 28,350 41,213* $ 94,500 $ 78,750 $ 85,050 $123,637 Total $1,018,500 509,250 509,250 127,313 $ 381,937

b. Pro forma income statement prepared with Ms. Desters estimate:

Sales revenue Cost of goods sold Gross margin S&A expenses Net income 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $259,200 $216,000 $233,280 $339,120 129,600 108,000 116,640 169,560 129,600 108,000 116,640 169,560 32,400 27,000 29,160 42,390 $ 97,200 $ 81,000 $ 87,480 $127,170 Total $1,047,600 523,800 523,800 130,950 $ 392,850

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Exercise 7-15B (continued) c. Forecasting is not likely to be 100% accurate. It is based on inexact factors such as judgment and economic predictions. Different executive officers in the same company will probably have different future expectations. In addition to legitimate differences of opinion, self-interest may also contribute to disagreement. For example, Millard McFerrin, who deals with customers credit problems and uncollectible accounts, may want stricter criteria for granting customer credit, which would naturally result in lower sales growth. On the other hand, Dorothy Dester, who deals with market potential and sales commissions, may want looser criteria for customer credit, which would result in greater sales growth. Problem 7-16B a. Sales Budget Sales on account January $540,000 February $594,000 Total $1,134,000

b. Sales revenue for January and February is equal to the sum of the monthly amounts ($540,000 + $594,000 = $1,134,000). c. Schedule of Cash Receipts Receipts from December sales Receipts from January sales Receipts from January sales Receipts from February sales Receipts from February sales Total January $ 90,000 432,000 February $108,000 475,200 $522,000 $583,200

d. The accounts receivable as of February 28, 2012 is equal to the amount due to be collected in March, $118,800 ($594,000 x 20%).

Problem 7-17B a. Inventory Purchases Budget

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Nov.

Dec.

Chapter 07 - Planning for Profit and Cost Control

Budgeted cost of goods sold Plus desired ending inventory Inventory needed Less beginning inventory Required purchases (on account) *$800,000 x .75 x .20 = 120,000

$450,000 112,500 562,500 90,000 $472,500

$562,500 135,000 697,500 112,500 $585,000

$675,000 120,000* 795,000 135,000 $660,000

b. Since the quarter ends on December 31, the ending inventory for December is also the ending inventory for the quarter (i.e., $120,000). c. Schedule of Cash Payments Payment of current accounts payable Payment of previous accounts payable Total budgeted payments for inventory Oct. $330,750 90,000 $420,750 Nov. Dec. $409,500 $462,000 141,750 175,500 $551,250 $637,500

d. Since the quarter ends on December 31, the ending accounts payable balance for December is the balance in accounts payable that will appear on the end of quarter pro forma balance sheet. 70% of the current purchases on account are paid in cash during the month of purchase, therefore, 30% will remain payable at the end of the month (i.e., $660,000 x .30 = $198,000).

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Problem 7-18B This is a typical problem for what-if analysis. Students can use a computerized spreadsheet to try different possible scenarios. Budgeted net income for the next year: $60,000 x 120%= $72,000 Budgeted cost of goods sold for the next year: $350,000 $500,000 = 70% of sales Budgeted selling and administrative expenses for the next year: $68,000 +10% of sales. a. The budgeted sales that meet the goal: If sales = X Sales Cost of goods sold S&A expenses = NI 1X .70X ($68,000 + .10X) = $72,000 .20X $68,000 = $72,000 .20X = $140,000 X = $700,000 ($700,000 $500,000) $500,000 = 40% increase in sales Pro Forma Income Statement Sales revenue Cost of goods sold Gross profit Selling & admin. expenses Net income $700,000 490,000 210,000 138,000* $ 72,000

*($700,000 x 10% + $68,000) = $138,000 b. Budgeted cost of goods sold with a 3% cut: $350,000 x 97% = $339,500 Budgeted gross profit: $500,000 $339,500= $160,500 The budgeted level of selling and administrative expenses: If X = S&A expenses Gross Profit X = $72,000 $160,500 X = $72,000 X = $88,500

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Problem 7-18B (continued) Pro Forma Income Statement Sales revenue Cost of goods sold Gross profit Selling & admin. expenses Net income

$500,000 339,500 160,500 88,500* $ 72,000

*The figure means that management has to cut the selling and administrative expenses by $1,500 in order to reach Mr. Morris goal. c. Projected sales revenue to increase by 25%: $500,000 x 125%= $625,000 Projected cost of goods sold: $625,000 x 70% = $437,500 Pro Forma Income Statement Sales revenue Cost of goods sold Gross profit Selling & admin. expenses Net income $625,000 437,500 187,500 150,000 $ 37,500

Since the projected net income under the given scenario will be only $37,500, which is far short of the original $60,000 and the desired $72,000, the company cannot reach its goal.

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Problem 7-19B a. Schedule of Cash Payments for S&A Expenses January February March Salary expense $ 9,000 $ 9,000 $ 9,000 Prior month's sales commissions 0 600 640 Prior month's advertising expense 0 500 500 Prior month's telephone expense 0 1,000 1,080 Rent 10,000 10,000 10,000 Miscellaneous 800 800 800 Total payments for S&A expenses $19,800 $21,900 $22,020 Depreciation is a noncash charge. b. Since telephone expense is paid in the month following the month it is incurred, the amount payable at the end of March will be the amount of telephone expense incurred in March, $1,100. c. Since sales commissions are paid in the month following the month they are incurred, the amount payable at the end of February will be the amount of sales commissions expense incurred in February, $640.

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Problem 7-20B Cash Budget Beginning cash balance Add cash receipts Cash available (a) Less cash payments For inventory purchases For S&A expenses Interest exp at 1% per month Total budgeted payments (b) Payments minus receipts Surplus (shortage) (ab) Financing Activity Borrowing (repayment) (c) Ending cash balance (a b + c)
1 2

April $ 36,000 320,000 356,000 410,000 80,000 01 490,000 (134,000) 194,000 $ 60,000

May $ 60,000 470,000 530,000 420,000 106,000 2,9102 528,910 1,090 59,000 $ 60,090

June $ 60,090 624,000 684,090 464,000 132,000 3,7953 599,795 84,295 (24,295) $ 60,000

$0 x 1.5% = $0 194,000 x 1.5% = $2,910 3 ($194,000 + $59,000) x 1.5% = $3,795 Problem 7-21B When necessary, all computations are rounded to the nearest dollar. a. 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Total Computer $550,000 $605,000 $682,000 $ 803,000 $2,640,000 Calculator 260,000 286,000 301,600 338,000 1,185,600 Total $810,000 $891,000 $983,600 $1,141,000 $3,825,600

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Problem 7-21B (continued) b. Budgeted cost of goods sold: $3,825,600 x 75% = $2,869,200 Budgeted Annual Income Statement Sales revenue $3,825,600 Cost of goods sold 2,869,200 Gross profit 956,400 Selling & admin. expenses 500,000 Net income $ 456,400 c. Inventory purchases budget for palm-size computers:
1st Quarter Sales Cost of goods sold Plus: desired ending inventory Inventory needed Less: beginning inventory Required purchases 2nd Quarter 3rd Quarter 4th Quarter

$550,000
$412,500 45,375 457,875 78,000 $379,875

$605,000
$453,750 51,150 504,900 45,375 $459,525

$682,000
$511,500 60,225 571,725 51,150 $520,575

$803,000
$602,250 88,000 690,250 60,225 $630,025

Inventory purchases budget for programmable calculators:

1st Quarter Sales Cost of goods sold Plus: desired ending inventory Inventory needed Less: beginning inventory Required purchases $195,000 21,450 216,450 32,000 $184,450 2nd Quarter 3rd Quarter 4th Quarter

$260,000 $286,000
$214,500 22,620 237,120 21,450 $215,670

$301,600
$226,200 25,350 251,550 22,620 $228,930

$338,000
$253,500 42,000 295,500 25,350 $270,150

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Problem 7-22B (Note: All computations are rounded to the nearest whole dollar.)

a. & b.
Sales Budget Cash sales Sales on account Total budgeted sales Schedule of Cash Receipts Current cash sales Plus: Collections from accts. rec. Total collections January February $ 75,000 $ 82,500 175,000 192,500 $250,000 $275,000 January February $ 75,000 $ 82,500 0 175,000 $75,000 $257,500 March $ 90,750 211,750 $211,750(a) $302,500 827,500(b) March $ 90,750 192,500 $283,250 $615,750 (c) Pro Forma Data Pro Forma Data

(a) Ending accounts receivable balance appearing on balance sheet. (b) Sales revenue appearing on income statement (sum of monthly amounts). (c) Cash receipts from customers on statement of cash flows (sum of monthly amounts).

c. and d.
Inventory Purchases Budget Budgeted cost of goods sold Plus desired ending inventory Inventory needed Less beginning inventory Required purchases (on Acct.) Jan. $125,000 27,500 152,500 0 $152,500 Feb. Mar. $137,500 $151,250 30,250 33,000 167,750 184,250 27,500 30,250 $140,250 $154,000 Pro Forma Data $413,750(a) 33,000(b) 61,600(c) Pro Forma Data $385,150(d)

Schedule of Cash Payments Budget for Inventory Purchases January February March Pmt of current month's A/P $91,500 $ 84,150 $ 92,400 Pmt for prior month's A/P 0 61,000 56,100 Total budgeted pmts. for invent. $91,500 $145,150 $148,500

(a) Cost of goods sold appearing on pro forma income statement (sum of monthly amounts). (b) Ending inventory balance appearing on pro forma balance sheet. (c) Ending accounts payable balance appearing on pro forma balance sheet ($154,000 x 0 .40). (d) Cash payments for inventory purchases on statement of cash flows (sum of monthly amounts).

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Problem 7-22B (continued)

e. and f. Selling and Administrative Expense Budget Pro Forma

Salary expense Sales commissions, 8% sales Supplies expense, 4% sales Utilities Depreciation on store fixtures Rent Miscellaneous Total S&A expenses January February March $25,000 $25,000 $25,000 20,000 22,000 24,200 10,000 11,000 12,100 1,800 1,800 1,800 5,000 5,000 5,000 7,200 7,200 7,200 2,000 2,000 2,000 $71,000 $74,000 $77,300 Data $24,200(a) 1,800(b) 15,000(c) 222,300(d)

Schedule of Cash Payments for S&A Expenses Salary expense $25,000 $25,000 $25,000 Prior month's sales comm., 100% 0 20,000 22,000 Supplies expense 10,000 11,000 12,100 100% prior month's utilities, 100% 0 1,800 1,800 Depreciation on store fixtures 0 0 0 Rent 7,200 7,200 7,200 Miscellaneous 2,000 2,000 2,000 Total payments for S&A expenses $44,200 $67,000 $70,100 $181,300(e)

Depreciation is a noncash charge.

(a) Ending sales commissions payable account balance shown on pro forma balance sheet. (b) Ending utilities payable account balance shown on pro forma balance sheet. (c) Accumulated depreciation appears on the pro forma balance sheet (sum of monthly amounts). (d) Total S&A expenses appearing on pro forma income statement (sum of monthly amounts). (e) Total cash payments for S&A expenses on pro forma statement of cash flows (sum of monthly amounts).

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Problem 7-22B (continued)

g. Cash Budget Beginning cash balance Add cash receipts Cash available (w) Less payments For inventory purchases For S&A expenses Purchase of store fixtures Interest expense* Total budgeted payments (x) Payments minus receipts Surplus (shortage) (w x) Financing activity Borrowing (repayment) (y) Ending cash balance (w x + y)

January February March $ 0 $ 50,300 $ 50,000 75,000 257,500 283,250 $615,750(a) 75,000 307,800 333,250 91,500 44,200 350,000 0 485,700 (410,700) 145,150 67,000 0 6,915 219,065 88,735 148,500 70,100 0 6,334 224,934 108,316 385,150(b) 181,300(c) 350,000(d) 13,249(f)

Pro Forma Data

461,000 (38,735) (58,316) 363,949(e) $ 50,300 $ 50,000 $50,000 50,000(g)

*January ($0 x 0.015); February ($461,000 x 0.015); March [($461,000 $38,735) x 0.015] (a) Operating activities section of pro forma statement of cash flows (sum of monthly amounts). (b) Operating activities section of pro forma statement of cash flows (sum of monthly amounts). (c) Operating activities section of pro forma statement of cash flows (sum of monthly amounts). (d) Investing activities section of pro forma statement of cash flows. The investment in store fixtures also appears on the pro forma balance sheet. (e) Financing activities section of pro forma statement of cash flows (sum of monthly amounts). (f) Operating activities section of pro forma statement of cash flows (sum of monthly amounts). (g) The ending cash balance appears on the pro forma balance sheet and as the last item on the statement of cash flows.

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Problem 7-22B (continued)

h. McGriff Gifts Corporation Pro Forma Income Statement For the Quarter Ended March 31, 2011 Sales revenue $827,500 Cost of goods sold (413,750) Gross margin 413,750 S&A expenses (222,300) Operating income 191,450 Interest expense (13,249) Net income $178,201 i. McGriff Gifts Corporation Pro Forma Balance Sheet March 31, 2011 $ 50,000 211,750 33,000 $350,000 (15,000) 335,000 $629,750 $ 61,600 24,200 1,800 363,949 178,201 $629,750

Assets Cash Accounts receivable Inventory Store fixtures Accumulated depreciation Book Value of fixtures Total assets

Liabilities Accounts payable Sales commissions payable Utilities payable Line of credit liability Equity Retained earnings Total liabilities and equity

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Problem 7-22B (continued)

j. McGriff Gifts Corporation Pro Forma Statement of Cash Flows For the Quarter Ended March 31, 2011 Cash flows from operating activities Cash receipts from customers Cash payments for inventory Cash payments for S&A expenses Cash payments for interest expense Net cash flows from operating activities Cash flows from investing activities Cash payment for store fixtures Cash flows from financing activities Net inflow from line-of-credit Net increase in cash Plus beginning cash balance Ending cash balance $615,750 (385,150) (181,300) (13,249) $ 36,051 (350,000) 363,949 50,000 0 $ 50,000

Problem 7-23B a. Pro forma income statement assuming 4% growth: Sales revenue Cost of goods sold Gross profit Selling & administrative expenses Net income Budget $8,320,000 4,992,000 3,328,000 1,331,200 $1,996,800

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Problem 7-23B (continued) b. Pro forma income statement assuming 8% rate: Sales revenue Cost of goods sold Gross profit Selling & administrative expenses Net income c. Excess of actual net income over budget: $2,073,600 $1,996,800 = $76,800 Bonus: $76,800 x 10% = $7,680 d. The process of participative budgeting is recommended. This process requires two-way communication between the president and divisional directors. Any disagreement on budget assumptions should be fully discussed and pros and cons well considered. If the president believes that the divisional budget is unrealistic, he/she should tell the vice president directly and explain the reasons. Participative budgeting is more than just a submission of a budget proposal from a subordinate and a review and final decision by the superior. The process described in the problem is nothing but gamesmanship. It would be unethical if Ms. Rollin proposes only a 4% growth rate because it not only reflects a dishonest estimate but also results in Ms. Rollins personal gain at the expense of her employer. On the other hand, the company's plan to use the excess of actual income over budget as the basis for bonuses is an invitation for unethical behavior. Budget $8,640,000 5,184,000 3,456,000 1,382,400 $2,073,600

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ATC 7-1 a. Financial Statements Income Statement Sales revenue Cost of goods sold Depreciation expense Other expense Operating income Interest expense Net income Statement of Cash Flows Operating Activities: Inflows from sales Outflows for: Purchase of food, etc. Other initial expenses Interest payments Net Operating Activities Investing Activities: Outflow for purchase of trailer cart Financing Activities Inflows from: Contribution by owners Loan from parents Net NCF Financing Activities Net Change in Cash Plus beginning cash Ending cash balance

Budgeted

Amounts $240,000 (192,000) (2,000) (5,000) 41,000 (900) $40,100

Computations 12 x $20,000 12 x $16,000 ($15,000 $5,000) 5 $20,000 $15,000 $15,000 x .06

$240,000 12 x $20,000 (192,000) 12 x $16,000 (5,000) $20,000 $15,000 (900) $15,000 x .06 42,100

(15,000)

given

5,000 given 15,000 given 20,000 47,100 0 $47,100

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ATC 7-1 (continued) Budgeted Financial Statements (continued) Balance Sheet Cash Trailer cart Acc. depreciation Total assets Note payable Contributed capital Retained earning Total liabilities & Equity

Amounts Computations $47,100 from SCF 15,000 given (2,000) ($15,000 $5,000) 5 $60,100 $15,000 given 5,000 given 40,100 from Inc. Statement $60,100

b. The budget financial statements above assume sales for each month of the year will be approximately equal to sales for September and October. Most likely, sales will be lower during periods between semesters, during the colder months, and during the summer session. On the plus side, some of the initial expenses of $5,000 may not have to be incurred every year. Also, the presentation above assumes the owners do not take any money out of the business. Obviously, they would need to use some of the earnings from the business to pay their living expenses.

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ATC 7-2 a. Group Tasks

Pro Forma Data $169,400 595,800 Accounts Rec. Sales Rev.

Task 1
Cash sales Sales on account Total budgeted sales October November December $ 40,000 $ 44,000 $ 48,400 140,000 154,000 169,400 $180,000 $198,000 $217,800

Schedule of Cash Receipts Cash sales Collections from accounts receivable Total cash collections

October November $ 40,000 $ 44,000 60,000 140,000 $100,000 $184,000

December $ 48,400 154,000 $202,400

Task 2
Pro Forma Oct. Nov. Dec. Data $72,000 $79,200 $87,120 $238,320 Cost of Goods Sold 14,400 15,840 17,424 17,424 Ending Inventory 86,400 95,040 104,544 40,000 14,400 15,840 $46,400 $80,640 $88,704 22,176 Accounts Payable

Budgeted cost of goods sold Plus: Desired ending inventory Inventory needed Less: Beginning inventory Required purchases (on account)

Schedule of Cash Payments Budget for Inventory Purchases October November Pmt of current month's accts. pay. $34,800 $60,480 Pmt for prior month's accts. pay. 72,000 11,600 Total budgeted pmts. for inventory $106,800 $72,080

December $66,528 20,160 $86,688

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ATC 7-2 (continued) Task 3

Oct. Nov. Dec. $ 7,200 $ 7,920 $ 8,712 1,800 1,980 2,178 2,200 2,200 2,200 1,600 1,600 1,600 34,000 34,000 34,000 6,000 6,000 6,000 1,000 1,000 1,000 $53,800 $54,700 $55,690 Pro Forma Data $ 8,712 Commissions pay. 2,200 Utility payable 4,800 Accum. dep.

Sales commissions Supplies expense Utilities Depreciation on store equipment Salary expense Rent Miscellaneous Total S&A expenses

$164,190 S&A Exp.

b.

Financial Statements Income Statement Sales revenue Cost of goods sold Gross margin Operating expenses Operating income Interest expense Net income $595,800 (238,320) 357,480 (164,190) 193,290 (2,530) $190,760

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ATC 7-2 (continued) Balance Sheet Assets Cash Accounts receivable Inventory Store equipment Accumulated depreciation store equipment Book value of store equipment Total assets Liabilities Accounts payable Utilities payable Sales commissions payable Line of credit Equity Common stock Retained earnings Total liabilities and equity c. Havel will need to borrow money in October. Cash Budget for October Beginning cash balance Add: Cash receipts Cash available Less: Payments For inventory purchases For S&A expenses Total budgeted payments Payments minus receipts = shortage $ 16,000 100,000 (1) 116,000 106,800 (2) 42,800 (3) 149,600 $ 33,600

$ 9,760 169,400 17,424 $200,000 (81,600) 118,400 $314,984 $ 22,176 2,200 8,712 23,936 50,000 207,960 $314,984

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Chapter 07 - Planning for Profit and Cost Control

ATC 7-2 (continued) (1) $40,000 cash sales + $60,000 collection on September accounts receivable. (2) $34,800 payment for Oct. Inventory + $72,000 payment on September accounts payable. (3) $53,800 October S&A expenses $7,200 sales commissions $2,200 utilities expense $1,600 depreciation = $42,800 ATC 7-3 a. There was a budgeted surplus in 6 years and a deficit in the 51 years from 1960 to 2010: 1960, 1969, 1998, 1999, 2000, 2001. Thus, a deficit was reported in 45 years. 2009 had a deficit of 12.9 % of GDP 2010 had a deficit of 8.5 % of GDP 1983 had a deficit of 6.0 % of GDP. 2000 had a surplus of 2.4 % of GDP. For 2009: Deficit Revenues = d. $1,841,188 $2,156,654 85.4%

b.

c.

The departments whose budgets changed the most from the Clinton years to the Bush years were: Health and Human Services DefenseMilitary Other Independent Agencies (On-budget) Treasury Social Security Administration (Off-budget) See the table below for complete data. 2.3 increase 2.2 increase 0.9 increase 3.9 decrease 1.9 decrease

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ATC 7-3 (continued)

Comparison of Average Budget Percentages by Department for 1994 - 2001 (Clinton Years) to 2002 2009 (Bush Years) Average Average for for Clinton Bush Years Years Difference Legislative Branch 0.2 0.2 0.0 The Judiciary 0.2 0.2 0.0 Agriculture 3.7 3.2 -0.5 Commerce 0.3 0.3 0.0 DefenseMilitary 16.2 18.4 2.2 Education 1.9 2.5 0.6 Energy 1.0 0.8 -0.2 Health and Human Services 20.9 23.2 2.3 Homeland Security 0.7 1.5 0.8 Housing and Urban Development 1.8 1.7 -0.1 Interior 0.4 0.4 -0.1 Justice 0.8 1.0 0.2 Labor 2.1 2.4 0.3 State 0.4 0.5 0.1 Transportation 2.3 2.4 0.0 Treasury 22.4 18.5 -3.9 Veterans Affairs 2.5 2.6 0.1 Corps of Engineers 0.2 0.2 0.0 Other DefenseCivil Programs 1.9 1.7 -0.2 Environmental Protection Agency 0.4 0.3 -0.1 Executive Office of the President 0.2 0.2 General Services Administration 0.1 -0.1 International Assistance Programs 0.6 0.5 -0.1 National Aeronautics and Space Administration 0.9 0.6 -0.2 National Science Foundation 0.2 0.2 0.0 Office of Personnel Management 2.7 2.3 -0.4 Small Business Administration 0.1 0.1 0.0 Social Security Administration (On-budget) 2.2 2.1 -0.1 Social Security Administration (Off-budget) 22.1 20.3 -1.8 Other Independent Agencies (On-budget) 0.3 1.1 0.8 Other Independent Agencies (Off-budget) 0.1 0.0 -0.1 Allowances 0.1 0.1 Undistributed offsetting receipts -9.4 -9.1 0.3 (On-budget) -6.2 -5.0 1.2 (Off-budget) -3.2 -4.1 -1.1

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ATC 7-4 HON could use a technique known as perpetual or continuous budgeting. This technique utilizes a twelve-month budgeting period. However, at the completion of the current month, a new month is added to the end of the budget period. The result is a continuous twelve-month budget. The advantage of the perpetual budget is that it keeps management involved in the budget process. The traditional approach often leads to a frenzied stop-andgo mentality. The annual budget is prepared in a year-end rush, and the assumptions underlying its formation are forgotten shortly thereafter. Changing conditions are not likely to be discussed until the next year-end review cycle. The perpetual budget overcomes these shortcomings by keeping management involved with the budget. Each month a new monthly budget is prepared to replace the budget of the ending month. Management is thereby forced into a constant twelve-month think-ahead process.

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ATC 7-5 a. Mr. Cleavers behavior could be construed to be in violation of the objectivity standards. The failure to disclose the lack of need for computers to the Board of Education would violate (1) the standard to communicate information fairly and objectively and (2) the standard to disclose fully all relevant information that could reasonably be expected to influence an intended users understanding of the reports, comments, and recommendations presented. However, Mr. Cleaver could have disclosed all information fairly to the board. He is correct in his assessment that neither he nor Ms. Simmons has the right to establish policy. Also, it should be noted that Mr. Cleaver may not be a member of the Institute of Management Accountants and is therefore not bound by the organizations code of ethics. b. Sarbanes-Oxley Act requires management of public companies to report accurately the financial statements to external users such as investors and creditors. This case does not involve external reporting, and, consequently, the law is not applicable. However, with recent school board scandals abound in the past ten years, many principles of Sarbanes-Oxley have been adopted by school districts. c. As its name implies, participative budgeting encourages participation by subordinates as well as upper level managers in the budget process. Information flows from the bottom up as well as from the top down during the preparation of the budget. Accordingly, the Board of Education members would be in a position to gain insight as to the true needs of the schools and would thereby be more likely to allocate funds where they would produce the greatest benefit.

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ATC 7-6 Screen capture of cell values:

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Chapter 07 - Planning for Profit and Cost Control

ATC 7-6 (continued) Screen capture of cell formulas:

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Chapter 07 - Planning for Profit and Cost Control

ATC 7-7 Screen capture of cell values:

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Chapter 07 - Planning for Profit and Cost Control

ATC 7-7 Screen capture of cell formulas:

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Chapter 07 - Planning for Profit and Cost Control

ATC 7-7 Screen capture of cell formulas (continued):

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Chapter 07 - Planning for Profit and Cost Control

Chapter 7 Comprehensive Problem Growth Rate of Sales Sales Budget Cash sales Sales on account Total budgeted sales Schedule of Cash Receipts Current cash sales Plus: Collections from accts. rec. Total budgeted collections Growth Rate of Sales Sales Budget Cash sales Sales on account Total budgeted sales Schedule of Cash Receipts Current cash sales Plus: Collections from accts. rec. Total budgeted collections Growth Rate of Sales Sales Budget Cash sales Sales on account Total budgeted sales Schedule of Cash Receipts Current cash sales Plus: Collections from accts. rec. Total budgeted collections Jan $10,000 48,000 $58,000 Feb $10,400 50,000 $60,400 Mar $10,816 52,000 $62,816 Jan $10,000 50,000 $60,000 Jan $10,000 48,000 $58,000 Feb $10,200 50,000 $60,200 0.04 Feb $10,400 52,000 $62,400 Mar $10,816 54,080 $64,896 Mar $10,404 51,000 $61,404 Jan $10,000 50,000 $60,000 Jan $10,000 48,000 $58,000 Feb 10,100 50,000 60,100 0.02 Feb $10,200 51,000 $61,200 Mar $10,404 52,020 $62,424 Mar 10,201 50,500 60,701 Jan $10,000 50,000 $60,000 0.01 Feb $10,100 50,500 $60,600 Mar $10,201 51,005 $61,206

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