Solution manual cost accounting by LauderbachOPERATIONAL AND FINANCIAL BUDGETING

CHAPTER 6
OPERATIONAL AND FINANCIAL BUDGETING
6-1 Sales Forecasting
(a) The most critical factors for a high-fashion clothier are the state of
the economy and the tastes of consumers. Sales for this type of company are
probably hardest to forecast because changes in taste are so hard to
forecast. Athletic shoes were selling very well into 1998, then slowed
considerably as the "brown shoes" typified by Timberland's offerings became
more fashionable.
(b) A manufacturer of carpeting must pay special attention to leading
indicators such as housing starts and building permits issued. Carpet is a
derived demand product, though the replacement market is certainly
significant.
(c) A grocery chain is concerned about the growth of areas it serves, whether
competitors are moving in, and general economic conditions. The grocery
business holds up in bad times, but the sales of other items typically
stocked by a grocery chain will fall off during recessions.
(d) Advertising revenues for a TV station depend on such factors as the
ratings of its programs and economic conditions, both national and local.
Some advertising is national, some local, so both matter.
6-2

Sales Forecasting−Effects of External Events

Note to the Instructor: Answering this question is complicated somewhat
because the indicated event may (1) affect the sales forecast in quantity,
(2) prompt a change in prices or a change in sales mix, or (3) produce some
combination of these changes. The following answers emphasize the effects on
the forecast of quantities.
(a) You would revise the forecast downward because the cut in the government
program will result in fewer families buying homes and, therefore,

appliances.
(b) The forecast would probably be revised upward. Jewelry is a luxury
item, and spending on luxury items is likely to increase as disposable
personal income increases. Some individuals will enter the market who
previously would not have, and some individuals will purchase more expensive
jewelry than they might have before.
(c) You would revise the sales forecast upward. Decreases in computer
prices will lead to people buying more computers, and to your selling more
parts to the makers.
(d) Two possibilities arise. First, the higher the prices of energy, the
more likely people and businesses will replace old, inefficient equipment.
This effect will increase your sales. However, to the extent that heating
(say in Miami) and air conditioning (say in Minnesota) are luxury items and
bought at the margin, sales might decline.
(e) The sales forecast should probably be adjusted upward. Improved
insulation should reduce the requirements for energy to heat (or cool), and
the rising energy costs should generate some additional insulation sales.

6- 1


(f) Sales forecasts for future years should be revised downward. High
school students are an important group of prospective college students.
However, the decline could be partially offset if a larger proportion of high
school graduates continues in education and/or there is an increase in the
number of persons entering college after several years away from school. (If
the forecasted number of total students declines, the company might be
expected to adopt higher prices to partially offset the smaller market.)
6-3

What's Happening Here?

Cal probably went through the year
expenditures, then saw that he would be
same pace. Fearing a cut the following
allowance, Cal sent people all over the
6-4

being careful about travel
under budget if he continued at the
year if he did not spend his
place in December.

Cash Budgeting−Effects of New Information

(a) A slowdown in collections can be expected, so cash receipts expectations
must be revised. Perhaps, in those months where projected cash balances are
relatively close to the desired minimum, borrowing will be indicated. The
cash disbursements budget may also need revision if interest rates have risen
beyond those expected at the time of the original budget.
(b) The effects of an increase in the sales budget would be a lagged
increase in the cash receipts budget, revision of the production and
purchases budgets, and a corresponding revision of the cash disbursements
budgets.
(c) The cash disbursements budget must be revised to speed up the payments
to suppliers. This revision may indicate the need for additional short-term
financing.
(d) The change in inventory policy will affect the purchases budget and,
therefore, the cash disbursements budget. It is not possible, however, to be
specific about the direction of the change without some idea of the

month-to-month swings in sales levels.
6-5 Relationships of Profit and Cash
This question draws attention to normal lead/lag situation for cash
flows. The stated changes in cash balances are in line with the stated
changes in sales volumes, given the normal expectations about cash outflows
for merchandise purchases preceding cash inflows from sales. As a company
grows, its cash receipts tend to lag behind its cash disbursements as long as
the time to pay for purchases is less than the time a unit spends in
inventory plus the time that customers take to pay. Only exceptional terms
from suppliers will allow receipts to keep pace with disbursements.
The reverse is true when sales are declining. The company is then paying
for fewer units than it is collecting for, so receipts do not fall as fast as
disbursements.
6-6

Are Budgets Bad at GE?

Welch apparently believes that sales budgets are set without regard to
conditions in a particular industry and followed despite changes in external
circumstances. Nothing in the chapter suggests that budgets should follow
such principles. Rather the chapter points out that one benefit of budgets
is that they help managers to determine whether changes during the period

6- 2


indicate permanent or temporary differences.
not believe that participation is important.

It also appears that Welch does

Welch’s views were reported by Thomas J. Martin, “Managing: Ideas %
Solutions,” Fortune, May 29, 1995, 145-7.
6-7

Budgeted Income Statements and Purchases Budget

(15 minutes)

Sales
Cost of goods sold at 60%
Gross profit
Other variable costs at 10%
Contribution margin
Fixed costs
Income

May
$250,000
150,000
100,000
25,000
75,000
22,000
$ 53,000

Cost of goods sold ($250,000 x 60%)
Desired ending inventory ($220,000 x 60%)
Total requirements
Beginning inventory

Purchases

$150,000
132,000
282,000
95,000
$187,000

6-8

Cash Budget, Continuation of 6-7

June
$220,000
132,000
88,000
22,000
66,000
22,000
$ 44,000

(20 minutes)

Cash receipts budget
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

Cash disbursements budget
Purchases of prior month (6-7)
Variable costs at 10% of sales
Fixed costs ($22,000 - $3,000)
Total cash disbursements

May
$180,000
25,000
19,000
$224,000

June
$187,000
22,000
19,000

$228,000

May
$ 30,000
272,000
302,000
224,000
$ 78,000

June
$ 78,000
232,000
310,000
228,000
$ 82,000

Cash budget
Beginning balance
Receipts
Total available
Disbursements (requirement 1)
Ending balance
6-9
1.

Budgeted Income Statement and Purchases Budget

(20 minutes)

Budgeted income statement for first three months of 20X9

Sales ($70,000 + $70,000 + $90,000)
Cost of sales at 60%
Gross profit
Fixed costs ($12,000 x 3)

6- 3

$230,000
138,000
92,000
36,000


Income

$ 56,000

6- 4


2.

Purchases budget
Cost of sales*
Desired ending inventory**
Total requirements
Beginning inventory
Purchases

January

$ 42,000
63,000
105,000
55,000
$ 50,000

February
$ 42,000
81,000
123,000
63,000
$ 60,000

March
$ 54,000
72,000
126,000
81,000
$ 45,000

Total
$138,000
72,000
210,000
55,000
$155,000

* 60% of month's sales
**1.5 x coming month's cost of sales; $63,000 = 1.5 x $42,000; $81,000 =
1.5 x $54,000; $72,000 = 1.5 x $80,000 x .60 (April cost of sales)

Note to the Instructor: We urge stressing that inventory, and hence
purchases, must be stated in cost dollars, not selling prices. Despite the
attention paid to this point in the chapter, some students will insist on
interpreting "one and one-half times the coming month's budgeted sales" as
meaning that inventory is 1.5 times sales for the coming month, not cost of
sales.
6-10 Cash Budget and Pro Forma Balance Sheet (Continuation of 6 -9)
minutes)
1.

Cash receipts budget

Sales budget
Collections from:
Current month (60%)
Prior month (40%)
Total
2.

January
$ 70,000

February
$ 70,000

March
$ 90,000

Total

$ 42,000
30,000
$ 72,000

$ 42,000
28,000
$ 70,000

$ 54,000
28,000
$ 82,000

$138,000
86,000
$224,000

January
$ 50,000

February
$ 60,000

March
$ 45,000

Total

$ 20,000
18,000
12,000

$ 50,000

$ 24,000
30,000
12,000
$ 66,000

$ 18,000
36,000
12,000
$ 66,000

$ 62,000
84,000
36,000
$182,000

January
February
$ 20,000 $ 42,000
72,000
70,000
92,000
112,000
50,000
66,000
$ 42,000 $ 46,000

March
$ 46,000

82,000
128,000
66,000
$ 62,000

Total
$ 20,000
224,000
244,000
182,000
$ 62,000

Cash disbursements budget

Purchases (6-9)
Payments for purchases:
Current month (40%)
Prior month (60%)
Fixed costs
Total
3.

(20-25

Cash budget

Beginning balance
Receipts
Available
Disbursements

Ending balance

4. Pro Forma Balance Sheet as of March 31, 20X9
Assets
Cash (cash budget)
Accounts receivable (40% of March sales of $90,000)
Inventory (6-9 purchases budget)
Total assets
Equities
Accounts payable (60% x $45,000 March purchases)
Stockholders' equity
143,000*
Total equities

6- 5

$ 62,000
36,000
72,000
$170,000
$ 27,000
$170,000


* $87,000 beginning balance + $56,000 income, from 6-9
6-11 Budgeted Income Statement and Purchases Budget (20 minutes)
1.

Budgeted income statements
January

$100,000
40,000
60,000
30,000
30,000
22,000
$ 8,000

Sales
Cost of sales at 40%
Gross profit
Other variable costs at 30%
Contribution margin
Fixed costs
Income
2.

February
$130,000
52,000
78,000
39,000
39,000
22,000
$ 17,000

March
$160,000
64,000
96,000

48,000
48,000
22,000
$ 26,000

Total
$390,000
156,000
234,000
117,000
117,000
66,000
$ 51,000

Purchases budget

Cost of sales
Desired ending inventory*
Total requirements
Beginning inventory
Purchases

January
$ 40,000
104,000
144,000
50,000
$ 94,000

February

$ 52,000
128,000
180,000
104,000
$ 76,000

March
$ 64,000
120,000
184,000
128,000
$ 56,000

Total
$156,000
120,000
276,000
50,000
$226,000

* Inventories are twice cost of sales for the coming month, $104,000 =
$52,000 x 2, etc. The $120,000 is $150,000 (April budgeted sales) x 40% x 2.
Note to the Instructor: In their entirety, these assignments are a bit
more challenging than 6-9 and 6-10. The latter do not have depreciation,
those of this exercise do. The cash balance in 6-12 drops in the face of
positive income, giving you the opportunity to pursue the important point
that cash and income are not the same.
The same point about cost dollars versus sales that is discussed in the
Note to the Instructor in 6-9 also applies here.
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

352,000
402,000
401,000
$ 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

$

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
6-13

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

Budget for Service Company
April

Sales of merchandise
Cost of sales at 90%
Gross profit
Design fees
Total
Fixed expenses
Income

$14,000
12,600
1,400
6,000

7,400
4,100
$ 3,300

May
$17,000
15,300
1,700
9,500
11,200
4,100
$ 7,100

June
$13,000
11,700
1,300
7,500
8,800
4,100
$ 4,700

Total
$44,000
39,600
4,400
23,000
27,400
12,300
$15,100

Other formats for the income statements are possible. Ms Davis might
want a two-column income statement showing the two types of sales separately.
6-14 Purchases Budget−Units and Dollars
1.

(a)

Purchases budget−units

6- 7

(20 minutes)


Sales
Desired ending inventory*
Total requirements
Beginning inventory
Purchases

February
1,900
1,100
3,000
1,000
2,000

March
2,200

1,150
3,350
1,100
2,250

April
2,300
1,050
3,350
1,150
2,200

May
2,100
850
2,950
1,050
1,900

June
1,700

* 50% of budgeted sales for the following month: 1,100 = 2,200 x .50, 1,150
= 2,300 x .50, 1,050 = 2,100 x .50,
850 = 1,700 x .50
(b)

Purchases budget−dollars

February

Cost of sales at $4
$ 7,600
Desired ending inventory*
4,400
Total requirements
12,000
Beginning inventory
4,000
Purchases
$ 8,000

March
$ 8,800
4,600
13,400
4,400
$ 9,000

April
$ 9,200
4,200
13,400
4,600
$ 8,800

May
$ 8,400
3,400
11,800
4,200

$ 7,600

June
$ 6,800

* budgeted cost of sales for the next month x 50%, or $4 times desired units
from requirement (a).
2. We stop with May. Determining June purchases requires knowing July
sales.
Note to the Instructor: Some students will determine dollar purchases
for requirement 1b by multiplying the answers in requirement 1a by the $4
unit cost. The resulting dollar amounts for purchases are correct, of
course.
6-15

Budgeted Income Statement for a Manufacturer

Sales (50 units x $40)
Variable costs:
Manufacturing, materials (50 x $12)
other
(50 x $14)
Commissions, 15% of sales
Contribution margin
Fixed costs, manufacturing
other
Profit

(5-10 minutes)
$2,000

$ 600
700
300

1,600
400

$ 150
70

6-16 Production Budget for a Manufacturer (Continuation of 6-15)
minutes)
Variable manufacturing costs (50 units):
Materials (50 units x 4 lbs. per unit x $3 per lb.)
Other variable manufacturing cost
[50 units x ($26 - $12)]
Fixed manufacturing costs
Total production cost

220
180

$
(5-10

$

600
700
150

$1,450

6-17 Purchases Budget for a Manufacturer (Continuation of 6 -15 and 6-16)
(10 minutes)
Dollars
Pounds
Pounds x
$3
Material needed for production (50 units x 4 lbs.)
200
$ 600
Material needed for ending inventory
55 units x 4 lbs. x 20%
44
132

6- 8


Total required
Material in beginning inventory, given
Required purchases
6-18

Expense Budgets and Variances

244
34
210

$

732
102
630

(5 minutes)

Note to the Instructor: We do not wish to introduce the difference
between flexible budgets based on output and on those based on input at this
stage. We used both input and output, and had no efficiency variance, in the
assignment so that students would not be confused by overuse or underuse of
the resource.
The budget variance is $450 unfavorable
Flexible budget allowance, $22,700 + ($1.815 x 14,000 hours)
Actual cost
Flexible budget variance, unfavorable

$48,110
48,550
$
450

The flexible budget allowance is much more useful than the original
budget of $49,925 because it reflects the actual activity and the cot that
should have been incurred based on the work done during the period. The
responsible manager did not save $1,375 on utilities, given that he worked
less than the originally budgeted amount.
Note to the Instructor: Because they have seen cost-prediction formulas
in Chapter 3, students usually have little trouble with the concept of a

flexible-budget allowance in Chapter 6. Nevertheless, we developed this
simple exercise to emphasize the budgeted/actual distinction because students
often err in determining a flexible-budget allowance in Chapter 11 (on
standard costs) and in the chapters on product costing (Chapters 12-14).
6-19

Budgeted Income Statements

Sales, monthly base
Variable at $0.052 x value of
permits in prior month
Total sales
Cost of sales at 45%
Gross profit
Other variable costs at 8%
Contribution margin
Fixed costs
Income (loss)

(25 minutes)
April
$136.0

May
$136.0

June
$136.0

July

$136.0

156.0
292.0
131.4
160.6
23.4
137.2
140.0
($ 2.8)

247.0
383.0
172.4
210.6
30.6
180.0
140.0
$ 40.0

358.8
494.8
222.7
272.1
39.6
232.5
140.0
$ 92.5

369.2

505.2
227.3
277.9
40.4
237.5
140.0
$ 97.5

Note to the Instructor: This exercise can be used to explain a lag
relationship. In this case, building permits precede sales, which is
reasonable given that permits are issued prior to the start of construction.
The one-month lag is not necessarily realistic because it assumes that all
materials will be bought in the month after the permit is secured. It is
more likely that there would be several months of permits in the equation,
with differing weights assigned to the various months. The resulting
equation would be a multiple regression equation as illustrated in the
appendix to Chapter 3. If we suppose that materials bought by builders are
spread over a three-month period, we would have an equation of the form
$ Sales = a + b1X1

+

b2X2

+

bnXn

where the b's are the coefficients for each month and the X's are months
following the issuances of permits.

6- 9


Finally, it is convenient to think of the $136,000 intercept as the
company's business that does not depend on new construction. Replacements,
repairs, do-it-yourself work, and other such sources of demand fit this
category. It should be noted that the intercept (zero building permits) is
outside the relevant range, so that it is not warranted to assume that sales
are likely to be $136,000 if there is no building activity.
6-20
1.

Flexible Budget and Variances

(15 minutes)

Total production cost = $70,000 + [($4 + $3 + $5) x units produced]

2, 3.
Materials ($4 x 18,000)
Labor ($3 x 18,000)
Variable overhead ($5 x 18,000)
Fixed overhead
Totals

Budget
$ 72,000
54,000
90,000

70,000
$286,000

6-21 Income Statement and Purchases Budget

March
$ 80,000

April
$ 90,000

32,000
16,000
48,000
32,000
14,000
$ 18,000

36,000
18,000
54,000
36,000
14,000
$ 22,000

3,000 units
Sales
Ending inventory, 2 x May sales of 3,750
Total required
Beginning inventory, 2 x April sales of 4,500

Purchases

3.

4,500
7,500
12,000
9,000
3,000

6,250, June sales are 5,000 units, $100,000/$20
Sales
Ending inventory, 2 x June sales of 5,000
Total required
Beginning inventory, 2 x May sales of 3,750
Purchases

6-22
1.

Variance
$ 200 F
2,100 U
1,000 F
$ 900 U

(15 minutes)

Sales, 4,000 x $20, 4,500 x $20
Variable costs:

Cost of goods sold at $8
Commissions at 20%
Total variable costs
Contribution margin
Fixed costs
Income
2.

Actual
$ 71,800
56,100
89,000
70,000
$286,900

Cash Budget−Quarters

3,750
10,000
13,750
7,500
6,250

(30 minutes)

Cash budget, in thousands of dollars
Quarter

1

2
3
4
Cash receipts:
From prior quarter
$1,700
1/3 of current quarter's

.

Total
$2,400

6-10

$2,800

$3,200

$10,100


sales
Total
Cash disbursements
Excess (deficiency)
Beginning balance
Indicated ending balance
Borrowing required
Repayments

Ending balance
2.
6-23

1,200
2,900
3,350
( 450)
200
( 250)
450

1,400
3,800
4,240
( 440)
200
( 240)
440

1,600
4,400
4,520
( 120)
200
80
120

$

$

$

200

200

1,100
4,300
3,470
830
200
1,030
(
$

200

830)
200

5,300
15,400
15,580
( 180)
200
20
1,010
( 830)

$ 200

The loan outstanding is $180 thousand ($1,010 - $830).
Flexible and Static Budgets--Service Department

(15 minutes)

The memo should point out that:
1. The $13,940 unfavorable variance is based on a static budget
allowance of $155,400 ($169,340 - $155,400 = $13,940). This allowance does
not recognize that actual activity might differ from budgeted activity. Such
an allowance is appropriate for fixed costs, but not for variable or mixed
costs.
2. A better comparison is of actual costs with a flexible budget
allowance, which does consider the level of activity actually achieved. The
analysis below better shows performance, and indicates that I controlled
costs very well.
Flexible budget allowance, $12,400 + ($1.43 x 112,500) $173,275
Actual cost
169,340
Favorable budget variance
$ 3,935
6-24

Production Budget

(10-15 minutes)

Sales
Desired ending inventory*

Total requirements
Beginning inventory
Production

April
18,000
48,000
66,000
41,000
25,000

May
24,000
50,000
74,000
48,000
26,000

June
25,000

* Next month's unit sales x 2
6-25
(a)

Purchases Budget (Extension of 6-24)

(10-15 minutes)

Purchases budget in pounds

April
300,000
468,000
768,000
540,000
228,000

Used in production
Desired ending inventory
Total requirements
Beginning inventory
Purchases
(b)

25,000 x 12
26,000 x 150% x 12

Purchases budget in dollars
April
750,000
1,170,000
1,920,000
1,350,000
$ 570,000

Used in production
Desired ending inventory
Total requirements
Beginning inventory
Purchases

$

6-11

300,000 x $2.50
468,000 x $2.50
540,000 x $2.50
228,000 x $2.50


6-26
1.

JIT Manufacturing (Extension of 6-24 and 6-25)

(20 minutes)

Production budgets
April
18,000
800
18,800
800
18,000

Sales
Desired ending inventory
Total requirements
Beginning inventory

Production

May
24,000
800
24,800
800
24,000

Having constant inventory means that production equals sales every month.

6-12


Purchases budget in pounds
April
216,000
19,200
235,200
14,400
220,800

Used in production
Desired ending inventory
Total requirements
Beginning inventory
Purchases

18,000 x 12
24,000/15 x 12

18,000/15 x 12

Purchases budget in dollars
April
$540,000
48,000
588,000
36,000
$552,000

Used in production
Desired ending inventory
Total requirements
Beginning inventory
Purchases
2.

216,000 x $2.50
19,200 x $2.50
14,400 x $2.50
220,800 x $2.50

Cost-saving opportunities that might be included in the memo:

(a) Reduced floor-space requirements. This might permit subletting or
expansion without increasing floor space.
(b) Reduced investment in inventory.
Cash tied up in inventory cannot be
used for other purposes. Reducing the investment in inventory permits cash
to be used elsewhere. The cash could earn a return if invested elsewhere; or

it might be used to reduce interest costs, either by paying off debt or by
reducing borrowing requirements.
(c) Reduced storage costs. Reducing inventory should reduce handling,
insurance, personal property taxes, pilferage, shrinkage, and other costs.
(d) Reduced rework and inspection costs. Cost savings in these areas are
likely if the company's move to JIT operating conditions includes assigning
some inspection responsibilities to manufacturing personnel. Additionally,
when inventories are low, defective units cannot hide for lengthy periods.
Workers find defectives quicker and can eliminate their causes quicker.
Note to the Instructor: Some students will mistakenly assert that costs
are lower because the company produces and buys less under these policies.
This is not so, though the numbers used here create the impression. Overall
costs might go down because of increased efficiency and less waste, but the
costs of production and of purchases do not fall nearly as much as indicated
here.
6-27
1.

Cash Budget--Nursery School

(15-25 minutes)

Cash disbursements budget

Payroll:
Teacher's salary, $21,000 x 1.15
Teacher's assistant
Total payroll
Payroll-related cost, $28,150 x [$2,144/($21,000 + $4,000)]
Supplies, $3,240 x 105%

Food, $2,162 x 105%
Equipment-related costs
Licenses, $285 + $50
Miscellaneous
Total
2.

About $110 per child per month

6-13

$24,150
4,000
28,150
2,414
3,402
2,270
1,650
335
1,226
$39,447


Revenue
divided
Monthly
divided
Monthly
6-28

required
by number of months
revenue required
by enrollment
fee

$39,447
9
$ 4,383
40
$109.58

Preparing Flexible Budgets

Cost
Supplies
Repairs
Power
Depreciation
Supervision
Totals

(10-15 minutes)
Direct Labor Hours
12,000
$28,800
12,460
30,000
14,700
11,000

$96,960

10,000
$28,000
12,300
27,600
14,700
8,000
$90,600

14,000
$29,600
12,620
32,400
14,700
14,000
$103,320

For the first four costs, the allowances are the fixed costs, plus the
variable component multiplied by direct labor hours. Supervision is $8,000
plus $3,000 for each 2,000-hour increase beyond 10,000 hours.
Note to the Instructor: This basic assignment permits you to discuss
some points of flexible budgeting. For example, determining the total budget
allowances for all costs except supervision is simply a matter of multiplying
the direct labor hours by the variable rate and adding the fixed amount.
Thus, one could group the first four costs into a single formula for a
flexible budget allowance. That formula is: $1.68 DLH plus $65,800.
Supervision can't be included in this formula because the variable portion is
not $1.50 per DLH ($1,500 increase for 1,000 DLH), but $1,500 for each 1,000
DLH above 10,000. Note, however, that budgeting the first four items as a

group is not advantageous for two reasons. First, the company is likely to
want to compare actual and budgeted costs for each cost element. Second, the
cash-payment patterns of the costs might differ.
6-29

Relationships

(30 minutes)

1. 900 units, because inventories are to remain constant.
2. $15,300 (material costs of $5,400 + labor costs of $6,300 + $3,600
variable overhead costs of manufacturing)
3.

$420

Selling price
Variable costs ($6 + $7 + $4 + $1)
Contribution margin
Contribution margin on extra units (10 x $42)
4.

$ 60
18
$ 42
$420

$34,480

Variable costs

Fixed costs
Total costs

(910 x $18)

$16,380
18,100
$34,480

We could also add current budgeted costs and incremental costs, as follows.
Costs, as budgeted for 900 units ($16,200 + $18,100)
Variable costs for 10 extra units (10 x $18)
Total costs

6-14

$34,300
180
$34,480


5.
6.

About 431 units, $18,100/$42
$17,900

New contribution margin (current less additional variable cost)
$40
Number of units planned

900
Total contribution margin using new variable costs
$36,000
Fixed costs
18,100
Income
$17,900
We can also compute the decline in contribution margin, as follows:
Current income
Reduction in contribution, 900 units x $2
New income
7.

About 1,014 units

8.

$24,810

$19,700
1,800
$17,900

[($18,100 + $4,800 + $19,700)/$42]

Materials (930 x $6)
Labor (930 x $7)
Variable overhead (930 x $4)
Total variable costs
Fixed manufacturing costs

Total manufacturing costs with production of 930 units
6-30

Relationships Among Sales and Production Budgets

$ 5,580
6,510
3,720
15,810
9,000
$24,810
(30 minutes)

Sales budget (units)
January
3,000
(20)

February
3,400

March
4,200 (7)

April
4,600 (12)

May
6,200 (14)

June
5,800 (21)

July
5,400

Production budget (units)
EI
(19)
Sales
Total
(18)
BI
(17)
Prod

January
February
5,100 (1) 6,300

March
6,900 (8)

April
9,300 (13)

May
8,700

June

8,100

3,000
8,100 (2)

3,400 (4) 4,200 (7)
9,700 (5) 11,100 (9)

4,500 (3)

5,100

6,300 (10)

6,900

9,300 (13)

8,700

3,600

4,600 (6)

4,800 (11)

7,000

5,600 (16)

5,200

1.
2.
3.

150% of February sales
1 + January sales
2 - January production

4.

February sales forecast

5.
6.
7.
8.
9.
10.

4 + February ending inventory
5 - beginning inventory
2/3 of February EI
April beginning inventory
7 + 8
February ending inventory

4,600 (12) 6,200 (14) 5,800
13,900

14,900 (15) 13,900

11.
12.
13.

9 - 10
2/3 of 8
April total requirements minus
April sales

14.
15.
16.
17.
18.
19.
20.

2/3 of April ending inventory
14 + May ending inventory
15 - 13
May ending inventory
17 + June production
18 - June sales
2/3 of June ending inventory

6-15

21.

2/3 of May ending inventory

Note to the Instructor:
Many students find this problem quite
difficult. In any case, the order in which the blanks are filled in will
differ among individuals.

6-31

One-Month Cash Budget−Discounts

(30 minutes)

Beginning balance
Collections:
June sales ($260,000 x 80% x 45%)
July sales ($300,000 x 80% x 30%)
August cash sales ($340,000 x 20%)
August credit sales ($340,000 x 80% x 20%)
Cash available
Disbursements:
July purchases ($210,000 x 98% x 1/3)
August purchases*
S & A expenses ($102,000 - $21,000)
Budgeted balance, end of August

$ 73,000
$ 93,600

72,000
68,000
54,400
$ 68,600
123,480
81,000

288,000
361,000

273,080
$ 87,920

* 2/3 x August purchases (below)
Cost of sales (gross = $340,000 x 60%)
Desired ending inventory (gross =
$300,000 x 60% x 2.5)
Required
Beginning inventory (gross = $455,700/98%)
Purchases

Gross
$204,000

Net
$199,920

450,000
654,000
465,000

$189,000

441,000
640,920
455,700
$185,220

Note to the Instructor: The 2% purchase discount will give some
students difficulty. The subject is usually mentioned in the first financial
accounting course, but the coverage of the gross and net methods varies among
schools.
We believe that the better interpretation of the inventory policy is that
the company should have enough goods to cover 2.5 times the coming month's
budgeted sales, so we do not solve the problem assuming that the dollar
amount of inventory, net of purchase discounts, should be $450,000, which
would make the ending inventory at gross $459,184 ($450,000/98%). However,
department stores frequently treat purchase discounts as revenue, and you
might wish to take the opportunity to discuss this practice.
Another point that is illustrated in this problem, and in others in the
chapter, is that the beginning inventory is not always equal to the budgeted
amount. If the firm did have 2.5 times August sales on hand at July 31, it
would have $510,000 (gross, or net of $499,800), which is $340,000 x 60% x
2.5. Students seem to need constant reminding that budgets are based on
expectations and that actual results will not always equal budgeted results.
Moreover, because of the timing of purchases or temporary shortages of cash
or a host of other causes, the firm may not reach a budgeted level of
inventory even if its sales expectations are realized. In this problem, the
firm could have had higher sales in July than expected and, if it could not
respond quickly and change its purchasing, could easily have wound up short
of what would have been its budgeted inventory level at July 31.

6-32

Budgeting in a CPA Firm

(25 minutes)

6-16


January
through
April
$143,200
64,400
$ 78,800

Revenues (1)
Expenses ($16,100 monthly)
Income

6-17

May
through
December
$190,800
128,800
$ 62,000

Total

$334,000
193,200
$140,800


(1)

Schedule of revenues
January
through
April
(4 months)

Ms. Watson
40% x 1,400 hrs. x $100
60% x 1,400 hrs. x $100
Staff accountants:
200 hrs. x 2 people x 4 months x $50
120 hrs. x 2 people x 8 months x $50
Clerical:
40% x 600 hrs. x 2 people x $15
60% x 600 hrs. x 2 people x $15
Total
6-33

May
through
December
(8 months)

$ 56,000
$ 84,000
80,000
96,000
7,200
$143,200

Sales Forecasting−Scatter Diagram and Regression

10,800
$190,800
(35 minutes)

1. A scatter diagram is easy to construct, but the formulas for predicting
sales will differ among students. Regression analysis yields the formula:
Sales = $437,500 + ($1,542 x thousands of housing units built).
2. $3,213,100 [($437,500 + ($1,542 x 1,800)]
The results here will differ because slightly different formulas will be
developed. The high r2 of the regression (.9986) indicates that considerable
confidence can be placed in the forecast provided that underlying conditions
do not change. The standard error is also low, indicating a good fit. Lotus
1-2-3 output appears below. We rounded the fixed component.
Regression Output:
Constant
437.4892
Std Err of Y Est
18.21279
R Squared
0.998565
No. of Observations

6
Degrees of Freedom
4
X Coefficient(s) 1.542274
Std Err of Coef. 0.029226
6-34

Flexible Budget, Multiple Drivers

(20 minutes)

Case A
Variable
Component
Inspection
$120.00
Maintenance
2.40
Data processing
0.25
Purchasing
180.00
Other
2.20

x

Level of
Total Variable
Fixed

Total
Activity =
Amount
+ Component =
Cost
110
$13,200
$72,500
$ 85,700
15,000
36,000
61,200
97,200
220,000
55,000
9,700
64,700
120
21,600
63,600
85,200
7,000
15,400
278,800
294,200
$627,000

Case B
Variable
Component

Inspection
$120.00
Maintenance
2.40
Data processing
0.25
Purchasing
180.00
Other
2.20

x

Level of
Total Variable
Fixed
Total
Activity =
Amount
+ Component =
Cost
75
$ 9,000
$72,500
$ 81,500
22,000
52,800
61,200
114,000
360,000

90,000
9,700
99,700
40
7,200
63,600
70,800
11,000
24,200
278,800
303,000
$669,000

6-18


6-35

Budgeting and Behavior

(15 minutes)

1. A-1303, because of the higher contribution margin (in dollars per unit
and
percentage) and potential for growth.
2. D-165, because they are easier to sell and the sales quota is based on
dollars of sales, not contribution margin produced.
3. The salespeople should be judged by other factors besides dollar sales.
Contribution margin should play some part. Possibly, separate quotas could
be established for each product. A special commission might be offered on A1303 sales. If salespeople are not well acquainted with the advantages and

uses of A-1303, the company should undertake an educational program. In any
case,
suggestions for promotional plans could be solicited from the salespeople.
6-36

Conflicts in Policy

(30 minutes)

It is not possible to keep inventory within the limits. There are two
solutions that violate the desired limits in only one month. In one month
(February), Plan 1 produces an inventory that is 6,000 units below the
desired minimum. Plan 2 produces an inventory that is 11,000 units above the
desired
maximum in April. Both plans offer relatively stable production, which might
be important in maintaining good labor relations.
Of some importance is the accuracy of the sales forecasts. For example,
if the forecasts are likely to be optimistic, Plan 1 is preferable because it
yields an inventory shortage but still offers a cushion to cover problems
with suppliers. But the most important quantitative factor in choosing
between the two plans is the relative cost of being over and under the
desired levels. The manager should know the additional contribution margin
per unit and the added cost of carrying a unit in excess of 40,000. Without
information about costs, it is impossible to choose among the many plans that
would meet the sales, but not the inventory objectives.
Month
Production
January
72,000
February

72,000
March
72,000
April
72,000
May
90,000
June
72,000

Plan 1
Ending Inventory
27,000
9,000*
21,000
33,000
23,000
15,000

Production
72,000
90,000
72,000
72,000
72,000
72,000

Plan 2
Ending Inventory
27,000

27,000
39,000
51,000*
23,000
15,000

* Outside stated limits
6-37

Budgeting Administrative Expenses

(35 minutes)

1.
Eight order clerks and three data entry clerks are required and the
slack times available are 13 hours and 25 hours, respectively.
Order
Data Entry
Clerks
Clerks
Calculation of persons needed:
Orders that can be processed per hour
3
10
Hours per week
35
35
Orders per week, per person
105
350

Required for 800 orders per week
8
3

6-19


Order
Clerks

Data Entry
Clerks

3
267*
280
13

10
80
105
25

Calculation of slack time:
Orders per hour
Time required for 800 orders
Time available (number of persons x 35 hours)
Slack time, in hours
* Rounded
2. The likely flexible budget formula is: Total costs = $500 + ($2.90 x

orders processed). The typical week is likely to produce an unfavorable
budget variance of $205.
Calculation of components of budget formula:
Fixed cost - purchasing agent's salary of $500
Variable costs:
Supplies
$0.40
Data entry
0.50 ($5.00/10 orders per hour)
Order clerks
2.00 ($6.00/3 orders per hour)
Variable cost per order
$2.90
Calculation of likely budget variance:
Flexible budget allowance of $500 + ($2.90 x 800)
Total costs incurred:
Purchasing agent
$ 500
Supplies
320 (800 x $0.40)
Data entry
525 (3 x $5.00 x 35
Order clerks
1,680 (8 x $6.00 x 35
Total
Budget variance
3.

$2,820

hours)
hours)
3,025
205U

$

840 orders
Data Entry
Clerks
Number of persons
3
Hours worked per week
35
Total hours of work
105
Orders that can be completed per hour
10
Total number of orders that can be handled
1,050

Order
Clerks
8
35
280
3
840

Although the data entry clerks could handle 1,050 orders, the current

capacity of the department is set by the lower capacity of the order clerks.
4. $2,705 + ($0.40 x orders processed)
Fixed costs would be all the costs
listed in requirement 2, except the cost of supplies.
6-38

Reporting Budget Variances

(50 minutes)

1.
Budget
Cost
Material
Direct
labor
Indirect
labor

Change/
2,000 =
Variable
Portion
$2.00

Total
Variable
Cost at
Cost at
8,000 - 8,000

$16,000
$16,000

At
10,000
$20,000

At
8,000
$16,000

Change
$ 4,000

30,000

24,000

6,000

3.00

24,000

24,000

0

5,000

4,000

1,000

0.50

4,000

4,000

0

6-20

Fixed
Amount
0


Power
8,000
Maintenance
6,000
Supplies,
other
5,000
Totals
$74,000

7,000

5,200

1,000
800

0.50
0.40

7,000
5,200

4,000
3,200

$3,000
2,000

4,600
$60,800

400
$13,200

0.20
$6.60

4,600
$60,800

1,600

$52,800

3,000
$8,000

The memo should say that the reports currently provided do not help
managers because the reports do not focus on the behavior of costs when
activity changes. Unless budgeted production equals actual production, it is
hard to tell whether operations went well or poorly. The memo could include
a revised report, as shown below.
The current confusion is understandable,
as witnessed by changes in direction of most of the variances.
2.
Budget
Unit production 7,000
Costs:
Material
$14,000
F
Direct labor
21,000
F
Indirect labor 3,500
U
Power
6,500
U
Maintenance
4,800
Supplies, etc

4,400
F
Total costs
$54,200
F

April
Actual
7,000

Variance
-0-

Budget
10,500

May
Actual
Variance
10,500
-0-

$14,600

$ (600) U

$21,000

$20,800

$200

21,600

(600) U

31,500

31,300

200

3,900

(400) U

5,250

5,300

(50)

6,700

(200) U

8,250

8,400

(150)

4,700
4,580

100 F
(180) U

6,200
5,100

6,200
5,050

0
50

$56,080

($1,880) U

$77,300

$77,050

$250

The reporting method might be partly to blame for some of the variances.
For example, a manager who knows that production for a month will be lower
than budgeted could be tempted to exercise less control over costs because

the variances will still probably be favorable. In months when production is
higher than budgeted, it is difficult to decide what a manager might do
because the variances (based on the original budget of costs) will probably
be unfavorable anyway. A manager who has learned to "play the game" could be
tempted to move costs, and production, from one period to another to reduce
variances. We do not know whether managers in this case can shift costs from
period to period, but they can almost certainly do so with production.
Note to the Instructor: A point worth mentioning now, although it is
taken up in greater depth later, is the interpretation of the variance in
units of production. The question here is whether the variances occurred
because of factors not controllable by the production manager, or whether
they were the result of lack of effectiveness. The possibility of
manipulation is also present, as discussed above.
6-39
1.

Understanding Budgets

(20 minutes)

$41,000
Receivable at December 31, 20X0
Collected on January sales ($50,000 x 20%)
Total

2.

$78,000

[($60,000 + $70,000) x 60%]

6-21

$ 31,000
10,000
$ 41,000


3.

$49,000
January cost of sales, $50,000 x 60%
Required ending inventory, requirement 2
Total requirements
Beginning inventory, given
Purchases

6-22

$ 30,000
78,000
108,000
59,000
$ 49,000


4.

$3,000
Sales, given

Cost of sales (60%)
Gross profit
Other variable costs (20%)
Contribution margin
Fixed costs, given
Income before taxes
Taxes, at 25%
Net income

5.

$ 50,000
30,000
20,000
10,000
10,000
6,000
4,000
1,000
$ 3,000

$2,800

Balance, 12/31 (given in balance sheet)
$ 33,000
Receipts from sales, requirement 1
41,000
Total
74,000
Disbursements:

December purchases (accounts payable at 12/31) $ 9,000
January purchases (80% of requirement 3)
39,200
Variable cost for January (20% of January sales) 10,000
January fixed costs, cash only
5,000
Taxes on December income (liability at 12/31)
8,000
71,200
Balance
$ 2,800
6.

$48,000

($60,000 x 80%)

7.

$99,000

[$102,000 - (3 x $1,000)]

8.

$7,800
(20% x $39,000)
March cost of sales (60% x $70,000)
Inventory 3/31 [60% x ($66,000 + $65,000)]
Required

Inventory 2/28 [60% x ($70,000 + $66,000)]
Purchases

$ 42,000
78,600
120,600
81,600
$ 39,000

$29,800
Retained earnings, 12/31
Budgeted net income (requirement 4)
Total
Dividend
Budgeted retained earnings, 1/31

$ 28,000
3,000
31,000
1,200
$ 29,800

9.

10. $2,000, from March tax accrual.
accrual per item g.

Taxes are paid in the month after

Sales

Cost of sales at 60%
Gross profit
Other variable costs at 20%
Contribution margin
Fixed costs
Income before taxes
Income taxes at 25%
6-40

Cash Budget for a Student

$ 70,000
42,000
28,000
14,000
14,000
6,000
$ 8,000
$ 2,000
(15 minutes)

Phelps must work about 81 hours in September and about 62 hours in the
other two months to meet his expenses and maintain a minimum balance of $100.

6-23


Beginning balance
Scholarship check
Cash available

Disbursements:
Tuition, books, and rent
Meals
Clothing
Dates and miscellaneous
Total disbursements
Indicated balance (deficit)
Funds required from working1
1

September
$1,250
2,000
3,250
3,280
300
50
100
3,730
( 480)
($580)

October
$ 100

November
$ 100

100

100

0
300
50
100
450
( 350)
($450)

0
300
50
100
450
( 350)
($450)

62.5

62.5

Deficit plus $100 minimum required balance

Hours required:
$580 / $7.20*
80.6
$450 / $7.20*
* $8 hourly wage - 10% withholding tax
6-41

Analysis of Budgets of a Manufacturing Firm

(35 minutes)

1.

$0.80 ($8,000 total variable manufacturing costs divided by 10,000 units)

2.

$600, as given in the cash disbursements budget.

3. Collections are expected to be 25% in the month of sale and 75% in the
month after sale. The cash receipts budget shows that each month's sales are
so collected. (January sales collections are $1,500 in January, $4,500 in
February, and so on.)
4. $1,000, because collections in January on December sales are to be $750,
which is 75% of December sales.
5. $11,250, which is 75% of $15,000 budgeted sales in March ($3,750 cash
collections/25%).
6. 40% in the month of sale and 60% in the following month. The "current
month" portion of variable S&A expenses in the cash budget is always 40% of
the total of the S&A associated with that month. For example, $600 paid in
January is 40% of the January total ($600 + $900).
7.

$2,250
March sales (5,000 x $3)
Variable cost, at 25% of sales

Unpaid portion, at 60% of variable cost

8.

9.

$900
Beginning balance
Budgeted receipts ($2,250 + $6,750 + $10,500)

$15,000
$ 3,750
$ 2,250

Budgeted disbursements ($5,350 + $8,000 + $7,050)
Budgeted ending balance

$ 1,800
19,500
21,300
20,400
$
900

$13,200
Revenue increase
Cost increase [($6,000 x 25%) + (2,000 x $0.80)]
Increased contribution margin

$ 6,000

3,100
2,900

6-24


Current profit budgeted
10,300
Revised profit
$13,200
10. Inventory is equal to one and one-half times the budgeted sales of the
coming month. (The desired ending inventory in January is 4,500, one and
one-half times February's budgeted sales of 3,000, and so on.)
11. No, because only 2,500 units are on hand at January 1. If the policy
were followed, there would be 3,000 units (2,000 units x 1 1/2).
12. 4,000 units, since the desired inventory at March 31 is 6,000 units.
Dividing 6,000 by 1.5 gives 4,000.

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