Chapter 3 End of Chapter Materials Solutions

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Chapter 3 End of Chapter Materials Solutions

REVIEW QUESTIONS

Q3-1A budget is a formal estimate of the resources that an organization plans to expend, for a given purpose or over a given period, and the proposed means of acquiring these resources. It informs the reader of what activities the organization plans to undertake and how the organization expects to finance these activities. In addition to serving as a framework for operations, the budget often acts as a legal document for certain types of organizations, principally governmental units.

Q3-2State and local governments prepare operating budgets, capital budgets, and cash budgets, also referred to as cash forecasts.

Q3-3Approaches to budget preparation include object-of-expenditure budgeting, performance budgeting, planning-program budgeting, and zero-based budgeting. The object of expenditure approach is the most common in practice.

Q3-4A cash forecast is a plan of the actual monies expected to be received and expended during a particular period. It assists the smooth functioning of the organization by enabling the organization to anticipate cash shortages and surpluses before they occur. As a result, the organization can obtain more favorable interest rates than an organization that borrows or invests on a "crash" basis.

Q3-5The steps in preparing a budget are:

1.Prepare budgetary policy guidelines.

2.Prepare a budget calendar.

3.Prepare and distribute budget instructions.

4.Prepare revenue estimates.

5.Prepare departmental (or program) expenditure requests:

a.Personal services work sheet

b.Travel work sheet

c.Operating expense work sheet

d.Equipment work sheet

6.Prepare nondepartmental expenditure and interfund transfer requests.

7.Prepare a capital outlay request summary (if appropriate)

8.Consolidate departmental expenditure requests, nondepartmental expenditure and interfund transfer requests, capital outlay requests and revenue estimates. Submit to the CEO for review and revision.

9.Prepare the budget document.

10.Present the budget document to the legislative body.

11.Record the approved budget in the accounts.

12.Determine the property tax (millage) rate.

Q3-6Types of supplementary information that should be included with budget requests are:

a.Departmental budget request worksheets

b.Departmental work programs

c.Pro forma balance sheets for each fund, as of the beginning and the end of the budget year

d.A cash forecast

e.A schedule of interest payments, sinking fund contributions, and bond issues and retirements

Any three of these could be listed.

Q3-7In addition to copies of forms and worksheets to be used, a set of budget instructions should contain the following:

1.A budget calendar,

2.A copy of the budgetary policy guidelines,

3.A statement summarizing the organization's anticipated fiscal condition for the following year,

4.A statement of specific policies to be followed when preparing expenditure requests,

5.A set of inflationary guidelines to be used in estimating future costs of equipment, supplies, etc.,

6.Specific instructions on how each form and work sheet should be completed, and

7.Instructions on where to seek help and clarification of any ambiguities that might arise.

Q3-8The purpose of a budget calendar is to ensure that each person knows when his or her (and everyone else's) part of the budgetary process is due. A budget calendar formalizes all key dates in the budgetary process. The calendar itself can be a simple listing of dates or it can be in the form of a complex flowchart.

Q3-9A capital budget is a supplement to the capital outlay request summary which presents information on the capital improvements desired over a long period of time (e.g., five years). It lists projects planned, estimated cost of each project and the proposed source or sources of funding for each project. It should be prepared several years in advance so that more realistic estimates can be made of the useful life of existing assets, the possibility of "unexpected" large expenditures can be minimized, and the organization can formulate a sound, long-range revenue raising plan.

Q3-10The purposes of a budgetary review are to make certain that expenditure request documents have been properly prepared and that each requested item is justified, realistic and appropriate. This part of the budgetary review is performed by the budget officer. A final budgetary review is performed by the CEO. The purposes of this review are to (1) obtain input of the CEO into the budgetary process, (2) act as a "court of last resort" for disputes between the budget officer and the persons preparing expenditure requests, and (3) to enable the CEO to prepare specific budget recommendations before submitting them to the legislative body.

Q3-11A millage rate is a tax rate that, when applied to the assessed valuation of property being taxed, will provide the desired amount of revenue. It is determined by dividing the amount of money to be raised (the required tax levy) by the net assessed value of the property being taxed. The net assessed value of the property being taxed is the total value of the property, less the value of exempt property (e.g., religious institutions) and the value of the various exemptions granted from property taxes (e.g., old age, homestead, etc.).

Q3-12A budget appropriation is a legal authorization for a government to spend a certain amount money for a specific purpose(s).

Q3-13Three typical types of departmental expenditures are those for current operating, capital outlay, and debt service items.

Q3-14The legal level of budgetary control refers to the organizational unit or budgetary unit at which expenditures legally must not exceed the appropriation. Examples of the legal level of budgetary control, from highest to lowest, are fund, function, department, and object of expenditure.

Q3-15No, the balance in the estimated revenues account does not represent an asset. The estimated revenues account is a budgetary account against which actual revenues are compared for budget administration.

Q3-16The budgetary fund balance account predicts the effect (increase or decrease) on actual fund balance during the budget period (usually a fiscal year) assuming that actual revenues will equal estimated revenues and expenditures will equal appropriations.

Q3-17Five typical sources of revenues received by local governments are property taxes, sales taxes, charges for services, fines and forfeits, and intergovernmental (grants). Other sources include fees for licenses and permits and interest on investments.

Q3-18The subclassifications of expenditures used in governmental budgeting and accounting are fund, function/program, organizational unit or department, activity, and object of expenditures.

Q3-19The purpose of encumbrances in governmental accounting is to protect an appropriation from being overexpended. Encumbrances show the amounts of an appropriation that, in effect, have been used up by the issuance of purchase orders prior to the ordered items being received and actual expenditures and liabilities recognized.

CASES

C3-1The problem with these reports is that they are not tailored to the needs of their users. An assumption is made that all activities performed by this city are done so on a steady bases. While this is true for many activities others, such as police and flood protection, often are performed in "peaks" due to events like Carnival and hurricane season. The best approach for this city would be to adopt a form of flexible budgeting under which it would allocate more resources to activities like police, fire protection and flood control on a seasonal or "as needed" basis. Correlations between the extra costs of providing service (such as overtime for police officers) and events causing those extra costs would be developed and budgeted resources allocated accordingly. A base measure like visitors to the city might be used for police protection while past weather records and long-term forecasts might be used to plan costs of flood control on a month-to month basis. Generally the timing of events like Carnival, major sporting events and large conventions are known well in advance and, while hurricanes and floods are unpredictable, a large part of the cost of flood control is incurred even in calm seasons.

C3-2No. The purpose of allowing the use of beginning fund balance to cover appropriations is to provide a "cushion" which, of course, must eventually be replenished. For example, a city might suddenly be faced with unexpected obligations, such as federal mandates. To raise the extra revenues to cover these mandates often takes a great deal of time and effort (e.g., persuading the citizens to vote for extra taxes for something with which they might not agree). In addition, it might not always be possible to balance revenues and appropriations under ordinary circumstances. For example, a city might be undergoing an economic downturn, which will be aggravated by extra taxes. The "cushion" will allow the necessary level of services to be performed until the economy recovers and additional revenue can be raised. Rural legislatures tend to distrust their counterparts from large cities and, not having experienced the complex needs of these governmental units, feel that a misleading picture is being presented. They also tend to be more conservative then their counterparts from large cities. On the other hand, rating agencies like Moody’s and Standard & Poor look at a reasonable fund balance as key to financial solvency and a means for cushioning against future revenue shortfalls. These agencies like to see fund balances at about 3% to 5% of expenditures, depending on the economic sensitivity of the tax structure. Thus an argument can be made that nothing should be done to dilute the “cushion.” The proposal of the rural legislator would prevent a possible dilution of the “cushion.”

ETHICS CASE

EC3-1No. This is not ethical behavior. The “extra” money in the Director’s budget is money that can be used elsewhere. In order to provide this money to Streets and Parkways, the city might be underfunding a vital service in some other area. As budget director, you should compare the amounts requested by Streets and Parkways with the actual expenditures of previous years, to determine the amount of “padding” that is taking place. You should also look for frivolous expenditures and report them to the Mayor or the City Council. Finally, you should compare the expenditures of this department with those of the streets and parkways departments of some comparable-sized cities in order to establish benchmarks.

EXERCISES

E3-1A budget is a formal estimate of resources that an organization plans to expend for a given purpose or over a given period and the proposed means of acquiring these resources. A budget can be used for:

1.Planning - It forces managers to formulate goals, identify the interrelationship of various activities and to consider future events and the various means of achieving the organization's goals.

2.Evaluating Performance- It provides a "standard" with which to compare actual results and to analyze causes of variances from standard. It also provides an objective basis for measuring superior or inferior performance.

3.Coordinating Activities - It encourages thinking about the over-all objectives of the organization and how each activity contributes to the overall effort. It forces managers to subdivide work in an organized manner among their subordinates.

4.Implementing Plans - It communicates management's expectations of subordinates as to what must be accomplished. It establishes responsibilities for meeting goals and provides a guide for performance.

5.Communicating Plans - It is a means of expressing the goals of the organization, and the means of attaining them, in a concise, quantitative manner. It also helps managers communicate to subordinates, in many areas, the expected level of performance.

6.Motivation - If presented properly, it can motivate employees to work more effectively and efficiently, since it provides a goal for the employees to meet (or beat) and the means by which the employees can measure their own performance. It should be possible to "beat" the budget occasionally and, when this happens, the employee(s) should be rewarded.

7.Authorizing Actions - In the case of governmental units, budgets are legal documents which can be used to control the release of monies for designated activities. In such instances, budgets are used to establish ceilings on spending and to provide legal guidance as to how and, in many cases, when monies can be spent.

E3-2July payments for July purchases, $650,000 x .50 = $325,000

July payments for June purchases $400,000 x .70 =$280,000

July payments for items purchased prior to June 50,000

Estimated cash disbursements for July$655,000

Note: Items purchased and vouchered in June but returned in July, before payment was made, are not relevant in a cash budget.

E3-3May collections of sales taxes collected by merchants in May:

$2,000,000 x .05 x .20 = $20,000

May collections of sales taxes collected by merchants in April:

$l,500,000 x .05 x .70 = 52,500

May collections of sales taxes collected by merchants

prior to April: 10,000

Estimated cash receipts from sales taxes collected by

the City in May: $82,500

E3-4Budgeted revenues from property taxes$800,000

Amount of property taxes to be levied in order

to collect $800,000 ($800,000/.97)$824,742

Property tax base:

Assessed valuation of all property $ 50,000,000

Less: Assessed value of property not subject to tax 10,000,000

Assessed value of property subject to tax$ 40,000,000

Less exemptions:

Homestead$2,500,000

Veterans 1,000,000

Old age, blindness, etc. 500,000

Net assessed value of property $ 36,000,000

a.Property tax rate: $824,742 / $36,000,000 = .02291

or $22.91 per $1,000 of assessed valuation

b.$2,291 ($100,000 x .02291)

E3-5Surplus from prior year$ 800,000

Year-to-Estimated

DateRemainderTotal

Actualof YearRevenues

Property taxes$1,250,000$500,000$ 1,750,000

Out-of-township tuition 50,00020,00070,000

Lottery receipts 100,00050,000150,000

State grants500,000 ---500,000$2,470,000

$3,270,000

Expenditures:

Salaries$875,000$450,000$1,325,000

Fringe benefits90,00040,000130,000

Operating expenses588,000240,000828,000

Equipment110,00050,000160,000

Transportation 15,00010,00025,000

Debt service100,000100,000200,000 2,668,000

Projected year-end fund balance$ 602,000

E3-6(Multiple-choice)

1.b5.d

2.d6.b

3.d7.d

4.d

E3-71.The behavioral benefits of a budget lie in the ability of the budget and the budgetary process to motivate managers to accomplish the organization's objectives. This is done by using the budget as a vehicle to communicate the organization's objectives, establishing sub-objectives in accordance with the legislative body's objectives and providing a thoroughly-understood common basis for performance measurement and feedback.

2.The budgetary process has been subject to criticism by behavioral scientists and others on several counts:

a.The most serious charge is that the budgetary process fails to recognize that individuals may not accept the organization's objectives as their own. The result is lack of effort by the individual to achieve the organization's objectives.

b. The level of objectives set may be established without regard to how this will motivate managers to achieve the objectives. Results may include underachievement of potentially obtainable levels of performance and/or destruction of morale.

c. The budget is used as a pressure device to force conformity with and acceptance of objectives established in the budget. This often results in personnel finding ways to "beat" the budget, rather than actually improving performance.

d.The budget is administered by individuals, not directly involved in the operating activity of the organization, who are not particularly skillful in dealing with people.

3.The most serious problem that must be overcome in order to solve problems identified by the criticisms in part (2) is the lack of understanding of forces that cause managers to act as they do. There must be recognition that the traditional assumptions which underlie the budget process are not entirely valid. Such assumptions include:

a.Managers accept organizational objectives as their own objectives.

b.Tight standards are best because they represent hard-to-reach goals and people will strive to reach hard-to-reach goals.

c.Upper levels of management are best equipped to establish operating sub-objectives.

It is necessary to recognize behavioral influences (psychological and sociological) on managers in the work that they do.

The most common specific recommendation is to use participative budgeting. This approach is considered desirable because it provides for an opportunity to identify the objectives of operating personnel and the organization. This increases the ability of both to develop operating activities to reach those objectives. It also increases the likelihood that objectives will be set at levels which will be effective in motivating personnel toward the organization's goals.

E3-8Students' answers to this exercise will be specific to the state in which their school is located.

E3-9(Budgetary Fund Balance)

a.0. Estimated revenues equal appropriations.

b.$2,000,000 debit. Appropriations exceed estimated revenues by this amount.

c. $2,000,000 credit. Estimated revenues exceed appropriations by this amount.

E3-10(Budgetary accounting)

Total estimated revenues = $2,000,000 + 720,000 + 120,000 + 8,500 = $2,848,500.

Total appropriations = $425,000 + 1,300,000 + 630,000 + 367,000 = $2,722,000.

Estimated revenues - Appropriations = $2,848,500 - $2,722,000 = $126,500 surplus.

Estimated revenues 2,848,500

Appropriations2,722,000

Budgetary fund balance126,500

To record 2009 budget.

E3-11(Relationship between budgetary fund balance and actual fund balance)

a. Revenues - Expenditures = $5,000,000 - [$4,950,000 - 7,000] = $57,000 increase.

b.Revenues - Expenditures = $5,000,000 - $4,950,000 = $50,000 increase.

c.Revenues - Expenditures = [$5,000,000 + $4,000] - $4,950,000 = $54,000 increase.

d.Revenues - Expenditures = [$5,000,000 - $3,000] - [$4,950,000 - $3,000] = $50,000 increase.

e.Revenues - Expenditures = [$5,000,000 + $2,000] - [$4,950,000 - $6,000] = $58,000 increase.

E3-12(Encumbrance Journal Entries)

Encumbrances16,700

Budgetary fund balance reserved for encumbrances16,700

To record encumbrance for goods ordered.

Budgetary fund balance reserved for encumbrances16,700

Encumbrances16,700

To reverse encumbrance for goods received.

Expenditures16,700

Cash16,700

To record expenditure for purchased goods.

E3-13(Encumbrance Journal Entries)

Encumbrances--public safety16,700

Budgetary fund balance reserved for encumbrances16,700

To record encumbrance for goods ordered.

Budgetary fund balance reserved for encumbrances16,700

Encumbrances–public safety16,700

To reverse encumbrance for goods received.

Expenditures–public safety17,000

Cash17,000

To record expenditure for purchased goods.

E3-14 (Encumbrance Journal Entries)

Encumbrances–public safety16,700

Budgetary fund balance reserved for encumbrances16,700

To record encumbrance for goods ordered.

Budgetary fund balance reserved for encumbrances16,700

Encumbrances–public safety16,700

To reverse encumbrance for goods received.

Expenditures–public safety16,500

Cash16,500

To record expenditure for goods purchased.

E3-15(Encumbrance and partial orders)

October 1Encumbrances--Road Maintenance 10,000

Budgetary fund balance reserved for encumbrances10,000

To record encumbrance.

October 20Budgetary fund balance reserved for encumbrances8,000

Encumbrances--Road Maintenance 8,000

To record partial reversal of encumbrance.

Expenditures--Road Maintenance 8,000

Cash8,000

To record expenditure.

November 1Budgetary fund balance reserved for encumbrances2,000

Encumbrances--Road Maintenance 2,000

To record partial reversal of encumbrance.

Expenditures--Road Maintenance 2,000

Cash2,000 To record expenditure.

E3-16(Budgetary interchange)

Appropriations--Public Safety500,000

Appropriations--Streets and Bridges500,000

To record budgetary interchange.

PROBLEMS

P3-1

STATEMENT OF ACTUAL AND ESTIMATED REVENUES

Fund: General

Date: October 15, 2008

Prepared by ______

Approved by ______

Source: Fines and forfeits