Chapter 23

operational budgeting

Overview of Exercises, Problems, Cases,and internet assignment

Exercises /
Topic / Learning
Objectives / Characteristics
23–1 / Budgeting purchases and payments / 4, 5 / Mechanical
23–2 / Estimating direct materials inventory / 4, 5 / Mechanical
23–3 / Production budgets / 4, 5 / Mechanical
23–4 / Direct materials budget / 4, 5 / Mechanical, conceptual
23–5 / Budgeting for prepayments / 4, 5 / Mechanical
23–6 / Budgeting for interest expense / 4, 5 / Mechanical
23–7 / Operating expense budget / 4, 5 / Mechanical
23–8 / Budgeting cash receipts / 4, 5 / Mechanical
23–9 / Budgeting ending cash / 4, 5 / Mechanical
23–10 / Preparing a flexible budget / 6 / Mechanical, conceptual
23–11 / Preparing a flexible budget / 6 / Mechanical, conceptual, ethics
23–12 / Budget estimates / 2, 3 / Conceptual
Problems
23–1 / Budgeting manufacturing overhead / 4, 5 / Mechanical
23–2 / Budgeting labor costs / 4, 5 / Mechanical
23–3 / Budgeting manufacturing costs and cost of sales / 4, 5 / Mechanical, analytical
23–4 / Budgeting manufacturing costs and cost of sales / 4, 5 / Mechanical, analytical
23–5 / Budgeting for cash / 4, 5 / Mechanical
23–6 / Estimating borrowing requirements / 1, 2, 4, 5 / Mechanical, conceptual
23–7 / Income and cash comparisons / 1, 2, 4, 5 / Mechanical, conceptual
23–8 / Budgeting for cash / 1, 2, 4, 5 / Mechanical, conceptual
23–9 / Preparing and using flexible budgets / 2, 4, 5, 6 / Mechanical, conceptual
23–10 / Preparing and using flexible budgets / 2, 4, 5, 6 / Mechanical, conceptual
Cases
23–1 / Interrelationships among budget estimates / 2, 5 / Mechanical, analytical
23–2 / Distorting budget estimates and the CPA’s role / 1–3 / Conceptual, ethics, group
Business Week Assignment /
Topic / Learning
Objectives / Characteristics
23–3 / Business Week assignment: Yahoo! Japan / 2, 6 / Conceptual, writing, real
Internet
Assignment
23–1 / Budgeting Shareware / 2, 6 / Conceptual

Descriptions of problems, cases, and internet assignment

Below are brief descriptions of each problem, case, and the Internet assignment. These descriptions are accompanied by the estimated time (in minutes) required for completion and by a difficulty rating. The time estimates assume use of the partially filled-in working papers.

Problems

23–1 / Fargo Enterprises
Prepare a budget for manufacturing overhead costs for one month.
/ 15 Easy
23–2 / Sun Mountain Foods
Prepare a budget for direct labor cost for one month.
/ 15 Easy
23–3 / Renfrow International
Budget such quantities and amounts as the planned production of finished goods, cost of goods manufactured, finished goods inventory, and the cost of goods sold.
/ 25 Medium
23–4 / Harmony Corporation
Budget such quantities and amounts as the planned production of finished goods, cost of goods manufactured, finished goods inventory, and the cost of goods sold.
/ 20 Medium
23–5 / Barnum Distributors
Prepare a cash budget for one month.
/ 50 Strong
23–6 / Potter Corporation
Analyze collection patterns for accounts receivable and accounts payable. Assess the company’s ability to generate adequate cash flow to service additional debt.
/ 40 Strong
23–7 / Rizzo’s
Analyze a budgeted income statement and a cash budget, and determine why income recognition differs from cash flow.
/ 30 Strong
23–8 / Marley Wholesale
Prepare a monthly cash budget for three months in support of a loan application. Determine whether a scheduled loan repayment can be met at the end of the period.
/ 60 Strong
23–9 / Four Flags
Prepare a statement comparing actual results with a flexible budget and comment on the company’s performance.
/ 50 Medium
23–10 / Braemar Saddlery
An excellent problem for demonstrating the importance of flexible budgeting. Due to an increase in production, the production department exceeds its budget by large amounts. Student is asked to prepare a flexible budget showing that the company actually did very well in controlling costs.
/ 45 Medium

Cases

23–1 / Budgeting in a Nutshell
A short budgeting case that shows the interrelationships among budgeted financial statements. but more importantly, it provides an opportunity for students to review the relationships between cash flows and accrual accounting. A real favorite.
/ 30 Medium
23–2 / An Ethical Dilemma
A company in need of bank financing has inflated its master budget figures due to a large receivable with a questionable likelihood of being collected. The company’s CPA is aware of the problem and knows that if the company is denied credit, his accounting firm will not be paid. Students must decide whether the role of a CPA is to serve the client or to serve the client’s creditors.
/ 20 Medium

Business Week Assignment

23–3 / Business Week Assignment: Yahoo! Japan
The case describes an unusual business strategy of the Japanese Yahoo subsidiary and asks students to speculate about the role of budgeting. / 20 Easy

Internet Assignment

23–1 / Budgeting Shareware
Student is asked to explore free software available on the Internet to help companies with budgeting. / 30 Medium

suggested answers to discussion questions

1. / Planning is the process of setting financial and operational goals, including cost levels, and deciding upon the actions that will achieve these goals. Exercising control over costs means monitoring actual results, comparing those results to the plan, and taking corrective action when actual results fall below expectations. In short, control is the function of keeping actual results in line with the plan.
2. / A business may expect to benefit from preparing a formal budget in several ways, including (three required):
a. / The process of preparing the budget forces management to consider all aspects of the company’s activities and also many aspects of the external business environment. Thus, budgeting should make managers more aware of the company’s resources, problems, and environment.
b. / A budget is a forecast of the outcome of future events. Thus, it may give advance warning of impending problems, such as cash shortages.
c. / The preparation of a budget provides an opportunity to coordinate the efforts of the various departments in the business so that all are working efficiently toward common goals.
d. / The budgeted levels of performance provide a yardstick for evaluating the actual performance of company personnel.
3. / The most widely used budgeting “philosophy” is to set budgeted amounts at reasonable and achievable levels. A second approach is to set these amounts at levels achievable only under ideal conditions. When budgeted amounts are set at levels that cannot be achieved under any conditions, however, the budget loses much of its potential value. If failure to meet the budget becomes a normal and acceptable condition, the budget provides neither a sound basis for evaluating departments nor a means of drawing attention to areas of potential improvement.
4. / Budgets and schedules included in the master budget of a manufacturing company include (five required): sales budgets, production budgets (in units), unit cost estimates, manufacturing budgets, operating expense budgets, estimates of inventory levels, a budgeted income statement, capital expenditures budgets, cash budgets, and a budgeted balance sheet.
5. / The steps in preparing a master budget are:
a. / Prepare a sales forecast.
b. / Prepare budgets for production, manufacturing costs, and operating expenses.
c. / Prepare a budgeted income statement.
d. / Prepare a cash budget.
e. / Prepare a budgeted balance sheet.
6. / Preparation of the sales budget is an early step in the budgeting process because many budgeted amounts, such as production levels, manufacturing costs, operating expense, and cash payments and receipts, are dependent upon the projected level of sales volume.
7. / Responsibility budgets are subsections of the master budget showing only the business activities that are under the control of a particular manager. In a large retail store, responsibility sales budgets would be organized around the individual sales departments, such as men’s clothing, women’s clothing, shoes, appliances, and automotive products. Each of these departments should have a budgeted monthly sales level.
8. / A flexible budget may be geared to any volume level and therefore can be based on the actual (as distinguished from the planned) level of volume attained during a budget period. A thorough knowledge of cost-volume-profit behavior enables management to determine what costs should have been at the volume of activity actually attained. A comparison between a flexible budget for any responsibility center and actual results achieved becomes a reasonable basis for evaluating performance because differences between planned and actual volume (which may not be within the control of the person being evaluated) are eliminated from consideration.
9. / If a budgeted expenditure can be directly influenced by the manager responsible for such an expenditure, it is known as a controllable expenditure. Most variable expenses, for example, are controllable.
The federal budget includes a multitude of expenditures, some of which are not controllable by government officials to any significant extent. Some examples (two required) of such uncontrollable government expenditures are interest payments on national debt, social security payments, veterans’ benefits, and commitments outstanding on firm contracts.
10. / Companies that experience rapid growth sometimes undergo cash flow problems because, as demand for their product increases, cash becomes tied up in direct materials, work in process, and finished goods inventories. Furthermore, as finished goods are sold, cash remains tied up in accounts receivable until it is ultimately collected. Meanwhile, as cash is tied up in inventory and receivables, expenditures must be made to pay vendors, employees, interest, taxes, etc. This can put a great deal of strain on a company and cause severe cash flow problems.

solutions to exercises

Ex. 23–1 / a. / Direct materials budgeted for use during the year / $250,000
Budgeted direct materials inventory at December 31 / 80,000
Total direct materials budgeted to be available / $330,000
Less: Direct materials inventory at January 1 / 65,000
Budgeted direct materials purchases for the year / $265,000
b. / Amount owed to suppliers at January 1 / $50,000
Budgeted purchases of direct materials (part a) / 265,000
Total owed to suppliers during the year / $315,000
Less: Amount owed to suppliers at December 31 / 75,000
Budgeted cash payments to materials suppliers during the year / $240,000
Ex. 23–2 / Direct materials used during the period (10,000 pounds ´ 10) / 100,000 pounds
Add: Desired ending inventory / 6,500
Total pounds of inventory needed / 106,500
Less: Estimated purchases required / 10,000
Beginning materials inventory / 96,500 pounds
Ex. 23–3 / a. / Sales forecast:
Budgeted sales (in cases) / 1,200
Selling price per case / $ 240
Budgeted sales (in dollars) / $ 288,000
Production schedule:
Budgeted sales (cases) / 1,200
Target ending inventory / 100
Cases budgeted to be available for sale / 1,300
Less: Beginning inventory / (150)
Planned production / 1,150 cases
b. / Budgeted variable manufacturing cost per case:
Direct materials / $8
Direct labor (2 hours/case ´ $10/hour) / 20
Variable overhead / 6
Total variable cost per case / $34
c. / Manufacturing cost budget:
Variable manufacturing costs:
Direct materials (1,150 cases ´ $8/case) / $ 9,200
Direct labor (1,150 cases ´ $20/case) / 23,000
Variable overhead (1,150 cases ´ $6/case) / 6,900
Total variable manufacturing costs / $ 39,100
Fixed manufacturing overhead / $ 220,000
Total cost of finished goods manufactured / $ 259,100
Manufacturing cost per unit ($259,100/1,150 units) / $225.30
d. / Ending inventory value:
Target ending inventory (cases) ´ Manufacturing cost per unit = 100 cases ´ $225.30/case
Ending inventory value = $22,530
Ex. 23–4 / a. / Production schedule:
Budgeted sales (units) / 5,500
Target ending inventory / 480
Units budgeted to be available for sale / 5,980
Less: Beginning inventory / (620)
Planned production / 5,360 doors
b. / Materials requirements based on planned production of 5,360 doors:
Steel: (5,360 doors ´ 20 pounds/door) / 107,200 pounds
Glass: (5,360 doors ´ 6 square feet/door) / 32,160 square feet
Materials purchases budget:
Steel / Glass
Direct materials used / 107,200 lbs. / 32,160 sq. ft.
Target ending inventory / 80,000 lbs. / 4,000 sq. ft.
Direct materials available for use / 187,200 lbs. / 36,160 sq. ft.
Less: Beginning inventory / (40,000) lbs. / (6,000) sq. ft.
Raw materials to be purchased (units) / 147,200 lbs. / 30,160 sq. ft.
´ Budgeted purchase price per unit / ´ $4 / ´ $2
Budgeted direct materials purchases / $ 588,800 / $ 60,320
c. / Safe ’n Bright may wish to increase its ending inventory level of steel if the price of steel this year is expected to be much lower than the price next year. However, the cost savings must be greater than the increased storage and capital costs associated with carrying a large amount of inventory. A decrease in glass inventory may be required to accommodate the storage requirements of the increased amount of steel. Also, glass is fragile and often difficult to store. Safe ’n Bright may simply be following a policy of trying to lower the inventory of glass to minimize the amount of losses due to breakage and the costs associated with storage.
Ex. 23–5 / First, calculate prepayments to be expired during the period:
Total costs and expenses / $325,000
Less: / Amount financed with current payables / 300,000
Depreciation expense / 20,000
Prepayments to be expired during the period / $5,000
Next, let X equal the beginning prepayments balance and 2X equal the ending prepayments balance. We may then solve for the ending prepayments balance as follows:
Beginning Prepayments + Cash Payments - Expired Prepayments = Ending Prepayments
X + $8,000 - $5,000 = 2X
X = Beginning Prepayments = $3,000
2X = Ending Prepayments = $6,000
Ex. 23–6 / a. / Budgeted interest expense reported on the February income statement is computed as follows:
$100,000 principal ´ 1% per month = $1,000
b. / In part a, February interest expense is computed as $1,000. The remaining $200 is used to reduce the note’s principal to $99,800. Interest expense in March can now be computed as follows:
$99,800 principal ´ 1% per month = $998