Solution

However, from the point of view of corporate management, the use of budgetary slack increases
the likelihood of inefficient allocation of scarce resources, and decreases the ability to identify
potential weaknesses or trouble spots in operating activities.

3. a. Zero-based budgeting (ZBB) is a budgeting technique that evaluates all proposed operating and
administrative expenditures as though they were being initiated for the first time. Each manager
must evaluate the proposed expenditure for each activity to be undertaken during the upcoming
budget period, investigate alternative means of conducting each activity, and rank expenditures
in order of perceived importance.

b. Atlantis Laboratories could benefit from ZBB as each of the business unit managers would be
required to identify and justify all proposed expenditures for the upcoming year. This increased
evaluation of expenditures would make it difficult to include budgetary slack in the budget for
the upcoming year and likely uncover opportunities of cost savings and operational
improvements.
Requirements

1. For the months of February and March, what are the estimated cash payments for purchases of direct materials unde

Solution
Requirements

1. Calculate the budgeted total cash receipts for November and December.

2. Calculate budgeted cash payments for November and December.

Budgeted sales for January of the coming year = $200,000

Solution
Exercise 10-36: Production and Materials Purchases Budgets
Background

DeVaris Corporation's budget calls for the following sales for next year:

Quarter 1 45,000 units Quarter 3 34,000 units

Quarter 2 38,000 units Quarter 4 48,000 units

Each unit of the product requires 3 pounds of direct material. The company's policy is to be
quarter with an inventory of the product equal to 10% of that quarter's sales requirements a
of direct materials equal to 20% of that quarter's direct materials requirements for productio

Direct Materials 3
Inventory requirement as a percentage of product 10%
Direct Materials inventory as a percentage need for productio 20%

Requirements

Determine the production and materials purchases budgets for the second quarter.
Solution
s

or next year:

mpany's policy is to begin each

sales requirements and an inventory
irements for production.

pounds

the second quarter.

Exercise 10-37: Purchase Discounts

It is typically beneficial for companies to take advantage of early- payment disc

case, determine the effective rate of interest associated with not taking advantag
situations. Assume in each case that payment is made on the 30 th day of the bill

Required
1. What is the opportunity cost of not taking advantage of the discount ass
n/30?
Input Data

Discount % for early payment: 1% 2%

Discount period (no. of days) 10

Days in month beyond discount period 20

Solution
e of early- payment discounts allowed on purchases made on credit. To see why this is the
with not taking advantage of the early-payment discount for each of the following
n the 30 th day of the billing cycle.

ntage of the discount associated with purchases made under the following terms: 2/10,
Exercise 10-38: Production and Materials Budgets--Process Costing
Background

Uecker Company budgets on an annual basis. The planned beginning and ending inven
(in units) for the fiscal year of July 1, 2010 through June 30, 2011, for one of its product
are as follows:

July 1, 2010 June 30, 2011

Raw materials 40,000 50,000
Work in process 10,000 20,000
Finished goods 80,000 50,000

Two units of raw materials are needed to complete one unit of finished product. All mate
at the beginning of production. The company completes are WIP before starting a new
to sell 480,000 units during the 2010-2011 fiscal year.

Number of units of raw materials per one unit of finished product

Planned production

Requirements

1. How many units of XPL30 must Uecker Company complete in fiscal 2

2. How many units of XPL30 must Uecker Company start into production

Solution
cess Costing

beginning and ending inventory levels

2011, for one of its products, XPL30,

of finished product. All materials are added

WIP before starting a new batch and plans

nished product 2
480,000

ompany complete in fiscal 2010?

ompany start into production during the 2010–2011 fiscal
Exercise 10-39: Cash Budget--Financing Effects

You are a relatively recent hire to the Hartz & Co., a local manufacturer of
have been asked to prepare for a presentation to the company’s management a
for the months of November and December, 2010.

The cash balance at November 1st was $75,000. It is the company’s polic
balance of $50,000 at the end of each month. Cash receipts (from cash s
receivable) are projected to be $525,000 for November and $450,000 for
(sales commissions, advertising, delivery expense, wages, utilities, etc.),
scheduled to be $450,500 in November and $550,000 in December.

Borrowing, when needed, is done at the beginning of the month—in incremen

rate on any such loans is estimated to be 12%. Interest on any outstanding lo
the month. Interest on any outstanding loans is paid in cash at the end of the
(if any) are assumed to occur at the end of the month. As of November 1 st, th
Data Input
Cash balance, November 1st $75,000
Minimum eom cash balance $50,000
Budgeted cash receipts:
November $525,000
December $450,000
Budgeted cash disbursements:
November $450,500
December $550,000
Interest rate on borrowings 12.00%
Short-term loan payable, as of November 1st $50,000
Borrowings in increments of

Solution
local manufacturer of plumbing supply products. You
mpany’s management a condensed cash-flow statement

the company’s policy to maintain a minimum cash

receipts (from cash sales and collection of accounts
ber and $450,000 for December. Cash disbursements
ages, utilities, etc.), prior to financing activity, are
December.

e month—in increments of $1,000. The annual interest

on any outstanding loans is paid in cash at the end of
cash at the end of the month. Repayments of principal
As of November 1 st, the company has a $50,000 short-

per year
Exercise 10-40: Cash Budget
Background

Carla, Inc.: Budget Data

Cash balance, beginning $10,000
Collections from customers $150,000
Expenses:
Direct materials purchases $25,000
Operating expenses $50,000
Payroll $75,000
Income taxes $6,000
Machinery purchases $30,000

NOTE: Operating expenses include depreciation =

Minimum cash balance =
Requirements

Compute the amount the company needs to finance or excess cash available f

Solution
 $20,000
$20,000

e or excess cash available for Carla to invest.

Exercise 10-41: Cash Budget

Bill Joyce, CEO of Joyce and Associates, expects the firm to have $6,000 c
estimates the total revenues in 2010 to be $250,000, of which $175,000 will
and fringe benefits constitute the bulk of the firm’s expenditures and will a
operating expenses, including $5,000 for depreciation and $3,000 for proper
Required

Can Bill meet the minimum cash balance? Show calculations.

Input Data
Expected opening cash balance, 2010
Estimated revenues, 2010
Collections of revenues, 2010
Payroll & Fringe Benefits, 2010
Other operating expenses, 2010:
Depreciation expense
Property taxes
Other (misc.)
Projected 2010 increase in property taxes
Purchase of office equipment (fixed assets)
Payment in 2010 for office equipment puchase
Property tax payment %, prior to end of year
Minimum cash balance required

Solution
cts the firm to have $6,000 cash on hand at the end of 2009. He
000, of which $175,000 will be collected during the year. Payroll
irm’s expenditures and will amount to $160,000 in 2010. Other
ciation and $3,000 for property taxes, are $18,000. The property-

$6,000
$250,000
$175,000
$160,000

$5,000
$3,000
$10,000
$500
$24,000
$6,000
50%
$6,000
Requirements

Answer the following questions and complete the cash budget statements in the form below.

Solution
Exercise 10-43: Accounts Receivable Collections
Background

Esplanade Company's credit sales have the following historical pattern:

70% Collected in the month of sale

15% Collected in the first month after sale
10% Collected in the second month after sale
4% Collected in the third month after sale
1% Uncollectible

These sales on open account (credit sales) have been budgeted for the last si

July $60,000 October $90,000

August $70,000 November $100,000
September $80,000 December $85,000

Requirements

1) Determine the estimated total cash collections from accounts receivable durin
2) Compute the estimated total cash collections during the fourth quarter
fourth quarter.

Solution
ng historical pattern:

en budgeted for the last six months in 2010:

accounts receivable during October 2010.

the fourth quarter from credit sales of the
Requirements

Determine for Doreen Company for the month of May:

1. Estimated cash receipts from accounts receivable collections.
2. The gross amount of accounts receivable at the end of the month.
3. The net amount of accounts receivable at the end of the month.
4. Recalculate requirements (1) and (2) under the assumption that estimated collections in month of sale
= 60% and in first month following month of sale = 25%.
5. What are the benefits and likely costs of moving to the situation described about in (4)?

Solution
Exercise 10-45 Budgeting: Not-for Profit Context

Catholic Charities Regional Agency serves several contiguous counties in Oh

monitors financial activity for the agency. This oversight includes decision
management of endowment funds. These decisions are relevant to the annual bu
a source of needed funds and/or a use of excess funds.

As a Catholic Charities agency, the regional organization must adhere to guidel

Visit the council’s web site at http://www.usccb.org/finance/srig.htm and review
discuss basic principles for investments, and the stated Investment Policy of the o

Required:

1. What is the meaning of the word “stewardship”? Should the religious or ph

that are made as part of the budgeting process?

2. How should a board of directors for this organization apply these princip
budget?

Solution
 guous counties in Ohio. The finance committee of its Board of Directors
ght includes decisions regarding the investment of excess funds and the
evant to the annual budget preparation since the investment accounts serve as

must adhere to guidelines adopted by the U. S. Council of Catholic Bishops.

ce/srig.htm and review its Socially Responsible Investment Guidelines
estment Policy of the organization.

uld the religious or philosophical position of an organization affect decisions

n apply these principles in making investment decisions tied to the annual

Requirements

1) Prepare a schedule of cash receipts for September and October.

2) What is the approprirate accounting treatments for the bank service fees and the cash discounts
allowed on collection of receivables?

Solution
Requirements

1. What is the total budgeted cost for each activity and for the Business Services Division in January 2010?

2. What is the budgeted cost per delivered carton and the total budgeted cost for the Business Services Division if the firm uses
a single cost rate (based on the number of cartons delivered) to estimate cost?

3. Dories Supply Chain Management Company offers to install an electronic order-processing system that transmits customer
requisitions via the Internet to the Business Services Division for immediate pick, packing, and delivery. No requisition handling
and data entry will be needed once the system is fully functional. How much savings can the Business Services Division expec
from switching to the new system before considering the payment to Dories? Can you estimate the amount if the firm uses a
single cost rate based on the number of cartons delivered to determine the budgeted cost for the division?

Solution
Exercise 10-49 Activity-Based Budgeting (ABB) with Continuous Improvements

OFC Company (Exercise 10–48) has decided to implement a continuous

careful study, management and employees agree that the firm will be able to
activities by 1 percent per month during the first year of the program starting
the program for customer-sustaining and facility-level activities until 2010.
two months to be the same as those in January
Required
Input Data
Cost-reduction rate, batch-level activities = 2%
Cost-reduction rate, unit-level activities = 1%
Monthly
Activity Rates Activity
Activity January Volume
Requisition handling $12.50 30,000
Pick packing $1.50 800,000
Data entry--lines $0.80 800,000
Data entry--requisitions $1.20 30,000
Desktop deliveries $30.00 12,000
Solution
inuous Improvements

implement a continuous improvements program to improve operational efficiency. After a

at the firm will be able to reduce cost rates for batch-level activities by 2 percent and unit-level
ar of the program starting February 2009. The firm has decided to delay the implementation of
vel activities until 2010. The firm expects the amount of cost-driver usage in each of the next
those in January. (Use 4 decimal points for all cost rates.)

per month
per month
Requirements

1) Budgeted cash collections in December 2009 from November 2009 credit sales
2) Budgeted total cash receipts in January 2010
3) Budgeted total cash payments in December 2009 for inventory purchases

Solution
Requirements

1) What is the budgeted total cost for overtime hours worked by senior consultants?
2) How many full-time consultants should be budgeted?
3) Determine the manager's total compensation and total pre-tax operating income for the firm assuming that the
revenues from preparing tax returns remain unchanged.

Solution
 expenses, but not on capital expenditures. Gonzales planned to capitalize (rather than expense) the cost of per
supplies and then include them with the “Equipment” account on the balance sheet. In this way, Gonzales coul
the recognition of expenses to a later year. This procedure would increase reported earnings, which in turn wou
to higher bonuses (in the short run). Wilson agreed to do as Gonzales had asked.
While analyzing the second quarter financial statements, Gary Wood, Belco’s director of cost acco
noticed a large decrease in supplies expense from a year ago. Wood reviewed the “Supplies Expense” accou
noticed that only equipment buy no supplies had been purchased from P&R, a major source for such supplies.
who reports to Gonzales, immediate brought this to the attention of Gonzales.
Gonzales told Wood of Lin’s high expectations and of the arrangement made with Wilson (from P&R)
told Gonzales that her action was an improper accounting treatment for the supplies purchased from P&R.
requested that he be allowed to correct the accounts and urged that the arrangement with P&R be discon
Gonzales refused the request and told Wood not to become involved in the arrangement with P&R.
After clarifying the situation in a confidential discussion with an objective and qualified peer within
Wood arranged to meet with Lin, Belco’s division manager. At that meeting, Wood disclosed the arran
Gonzales had made with P&R.

Required
1. Explain why the use of alternative accounting methods to manipulate reported earnings is unethical, if n
illegal.
2. Is Gary Wood, Belco’s director of cost accounting, correct in saying that the supplies purchased from P
Inc. were accounted for improperly? Explain.
Solution
Exercise 10-53: Scenario Analysis

Background

As part of the process of preparing the master budget for the coming year, you've been asked to perform
"what-if" analyses, in the form of scenarios, on the original planning assumptions regarding Product A
produced by your company. The following are the baseline planning data for the coming year for this prod

Data

Sales volume (annual, in units) 1,000

Selling price per unit $750
Variable cost per unit $500
Fixed costs (per year) $100,000

Requirements

1. Define what is meant by the terms "what-if analysis" and "scenario analysis."
2. Based on the baseline planning data, what is the budgeted operating income
for Product A for the coming year?
3. Determine the estimated operating income under each of the following scenarios:
(for each scenario you should report both the new budgeted operating income and
the percentage change in operating income from the baseline budgeted result):
a. selling price per unit is 10% higher than planned, while fixed costs per year
are also 10% higher than planned
b. variable cost per unit is 5% higher than planned, while fixed costs are lower
by this same percentage
c. selling price per unit is 10% higher than planned, while volume is decreased by 8%

Solution
u've been asked to perform
ons regarding Product A
he coming year for this product:

eased by 8%
Ex 10-54: Profit Planning & Sensitivity Analysis

Background

You are currently trying to decide between two cost structures for your business, one that has a greater
proportion of short-term fixed costs, the other that is more heavily weighted to variable costs. Estimated
revenue and cost data for each alternative is as follows:

Data
Cost Structure
Alternative 1
Selling Price per Unit $100.00
Variable Costs per Unit $85.00
Total Fixed Costs (per Year) $40,000

Requirements

1. What sales volume, in units, is needed for the total costs in each cost-structure alternative to be the sam
2. Suppose your profit goal for the coming year is 5% on sales (i.e., operating profit/sales = 5%).
What sales level, in units, is needed under each alternative to achieve this goal?
3. Suppose again that your profit goal for the coming year is 5% on sales.
What sales volume in dollars is needed under each alternative to achieve this goal?

Solution
r business, one that has a greater
ghted to variable costs. Estimated

Cost Structure
Alternative 2
$100.00
$80.00
$45,000

st-structure alternative to be the same?

erating profit/sales = 5%).
ve this goal?

chieve this goal?

10-55: Time-Driven Activity-Based Budgeting

Background

The company for which you work recently implemented Time-Driven Activity-Based Costin
system. Management is pleased with the revised product and customer cost information th
now wondering how this system can be used for budgeting purposes. You have been aske
driven activity-based budgeting, given the following information:

1. There are two resources (departments): Indirect Labor and Computer Support.

2. There are two primary activities that these resources support: Handling Production Runs

3. Indirect Labor support is consumed as follows:

a. To Handle Production Runs: 10 hours/run
b. To Suppport Products: 500 hours/product

4. Computer Support is consumed as follows:

a. To handle production runs: 0.4 hr./run
b. To Support Products: 50 hours/product

5. Resource practical capacity levels:

a. Indirect Labor: 20,000 hours per quarter
b. Computer Support: 500 hours per quarter

6. Cost of supplying resources:

a. Indirect labor: $1,000,000 per quarter
b. Computer Support: $500,000 per quarter

Required:

1. Calculate the budgeted resource cost per hour (at practical capacity) for each of the two
Computer Support.

2. Determine the budgeted cost-driver rates for each of two activities, Handle Production R

3. Suppose that the total cost of resources supplied for the quarter just ended was exactly
only 18,000 indirect labor hours were used along with 450 computer hours. Calculate, for e
capacity. How should this cost be handled for internal reporting purposes?

4. After implementing a TQM program, the company was able to implement process-efficie
was a 10% reduction in the indirect labor time associated with the activity "handling produc
cost component of the cost to handle a production run. Also, recalculate the cost of unused
original facts but the 10% efficiency gain. Assume that in the original case facts, 16,000 of
production runs.
4. After implementing a TQM program, the company was able to implement process-efficie
was a 10% reduction in the indirect labor time associated with the activity "handling produc
cost component of the cost to handle a production run. Also, recalculate the cost of unused
original facts but the 10% efficiency gain. Assume that in the original case facts, 16,000 of
production runs.

Data

Resource costs (per quarter):

Indirect labor $1,000,000
Computer $500,000

Practical capacity (resources supplied), in hours/qtr.:

Indirect labor 20,000
Computer 500
Budgeted
Unit Times
Activities: (hours)
Handle production runs:
Indirect labor 10.00
Computer support 0.40
Product-level support:
Indirect labor 500.00
Computer support 50.00

Actual activity consumption during the quarter:

Indirect labor hours used 18,000 hours
Computer hours used 450 hours

Solution
Driven Activity-Based Costing (TDABC) in conjunction with its ERP
customer cost information that the TDABC system produces. It is
poses. You have been asked to provide an example of using time-
:

Computer Support.

t: Handling Production Runs and Product-Level Support.

capacity) for each of the two resources, Indirect Labor Support and

ivities, Handle Production Runs, and Support Products.

rter just ended was exactly as budgeted (viz., $1,500,000), but that
puter hours. Calculate, for each resource, the cost of unused
purposes?

o implement process-efficiency changes, the end result of which

the activity "handling production runs." Reestimate the indirect labor
calculate the cost of unused capacity for indirect labor assuming the
iginal case facts, 16,000 of the 18,000 hours related to handling
 o implement process-efficiency changes, the end result of which
the activity "handling production runs." Reestimate the indirect labor
calculate the cost of unused capacity for indirect labor assuming the
iginal case facts, 16,000 of the 18,000 hours related to handling
10-56: Rolling Financial Forecasts

Background

You are given the following budgeted and actual data for the Grey Company for each of t
through June of the current year.

In December of the prior year, sales were forecasted as follows: January, 100 units; Febr
March, 100 units; April, 110 units; May, 120 units; June, 125 units. In January of the curre
months February through June were reforecasted as follows: February, 90 units; March, 1
units; May, 110 units; June, 120 units. In February of the current year, sales for the month
June were reforecasted as follows: March, 95 units; April, 105 units; May, 105 units; June
of the current year, sales for the months April through June were reforecasted as follows:
May, 100 units; June, 110 units. In April of the current year, sales for the months May and
reforecasted as follows: May, 90 units; June, 105 units. In May of the current year, sales f
reforecasted as 105 units.

Actual sales for the six month period were as follows: January, 98 units; February, 95 unit
April, 108 units; May, 98 units; June, 100 units.

Required

1. For each of the months January through June, inclusive, prepare a "rolling foreacast" of sales volume.
(Hint: there will be only one forecasted number for January--the forecast done in December. For
February, there will be two forecasts: one done in December, and a second one done in January. For Ju
there will be six forecasts, one done in each of the preceding six months.

2. For each of the months March through June, determine the three-month error rate, defined as 1 minus
the absolute % forecast error. For example, the forecast error rate for March's sales is found by dividing
absolute value of the forecast error for this month by the actual sales volume for the month. The forecas
month (e.g., March) is defined as the difference between the actual sales volume for the month and the
volume for that month provided three months earlier (e.g., December).

Solution
 Company for each of the months January

anuary, 100 units; February, 95 units;

In January of the current year, sales for the
ruary, 90 units; March, 100 units; April, 105
ear, sales for the months March through
s; May, 105 units; June, 120 units. In March
eforecasted as follows: April, 105 units;
or the months May and June were
the current year, sales for June were

units; February, 95 units; March, 92 units;

reacast" of sales volume.

e in December. For
one done in January. For June,

r rate, defined as 1 minus

's sales is found by dividing the
for the month. The forecast error for any
ume for the month and the sales
10-57: Profit Planning and Sensitivity Analysis

Background

As a newly hired management accountant, you have been asked to prepare a profit plan for the company
this task, you've been asked to do some "what-if" analyses. Following is budgeted information regarding

Data
Selllng price per unit =
Variable cost per unit =
Fixed costs, per year =
Requirements

1. What is the break-even volume, in units and dollars, for the coming year?

2. Assume that the goal of the company is to earn a pre-tax (operating) profit of $180,000 for the coming y
company have to sell to achieve this goal?

3. Assume that the labor-cost component of the $32.00 is $10.00. Current negotiations with the employee
uncertainty regarding the labor-cost component of the variable cost figure presented above. What is the ef
units if selling price and fixed costs are as planned, but the labor cost for the coming year is 4% higher tha
are 6% higher than anticipated? What if labor costs turn out to be 8% higher than anticipated? (Show calc

4. Assume now that management is convinced that labor costs will be 5% higher than originally planned w
put together. What selling price per unit must the company charge to maintain the budgeted ratio of contrib
the Goal-Seek function in Excel to answer this question.)

5. Explain the role of “what-if” analysis in the budgeting process.

Solution
profit plan for the company for which you work. As part of
ted information regarding the coming year:

$40.00
$32.00
$450,000

$180,000 for the coming year. How many units would the

tiations with the employees of the company indicate some

nted above. What is the effect on the break-even point in
ming year is 4% higher than anticipated? What if labor costs
n anticipated? (Show calculations.)

er than originally planned when the budget for the year was
he budgeted ratio of contribution margin to sales? ( Hint: Use
10-58: Profit Planning and Strategic Considerations

Background

Because of competitive pressure and potential increases in product quality, your company is evaluating w
replace an existing piece of machinery that is used in the manufacture of a key product produced by the c
of anticipated decreases in manufacturing cycle time and increases in product quality, you anticipate that
purchase the new machine it would be able to increase the selling price of the product. Baseline budgete

Data Existing
Product-Related Information Machine
Selllng price per unit = $15.00
Variable cost per unit = $12.00
Fixed costs, per month = $100,000

Targeted operating profit ratio

(operating profit/sales) = 12.00%
Requirements

1. What is the monthly break-even volume for each of the two decision alternatives?

2. Assume that in the past the company's targeted ratio of operating profit to sales was 12%. What sales le
month, would the company have to generate in order to meet this stated profitability target?

3. In evaluating this investment proposal, management is interested in knowing the monthly sales volume
the two decision alternatives yield the same operating profit (in dollars). Determine what this monthly vol
graph to depict the operating profit equation for each decision alternative. Be sure to fully lable the graph
profit equation for each alternative, the break-even point for each alternative, and the volume level at wh
would be indifferent between the two alternatives.

4. What strategic factors or considerations might affect the decision as to whether the company should kee
existing equipment?
Solution
ur company is evaluating whether it should
product produced by the company. Because
quality, you anticipate that should the company
product. Baseline budgeted data are as follows:

New
Machine
$17.50
$12.00
$200,000

es was 12%. What sales level, in units per

ability target?

he monthly sales volume (in units) at which

mine what this monthly volume is. Construct a
ure to fully lable the graph, to include the
and the volume level at which the company

er the company should keep or replace the

Problem 10-59: Ethics in Budgeting/Budgetary Slack

Norton Company, a manufacturer of infant furniture and carriages, is

for 2010. Scott Ford recently joined Norton’s accounting staff and is in
company’s budgeting process. During a recent lunch with Marge Atkin
manager, Scott initiated the following conversation:
Scott: Since I’m new around here and am going to be involved with th
interested to learn how the two of you estimate sales and production
Marge: We start out very methodically by looking at recent history, di
potential customers, and the general state of consumer spending. Th
with the best forecast we can.
Pete: I usually take the sales projections as the basis for my projectio
what this year’s closing inventories will be, and that sometimes is diffi
Scott: Why does that present a problem? There must have been an e
current year.
Pete: Those numbers aren’t always reliable since Marge makes some
them on to me.
Scott: What kind of adjustments?
Marge: Well, we don’t want to fall short of the sales projections so we
lowering the initial sales projection anywhere from 5 to 10 percent.
Pete: So you can see why this year’s budget is not a very reliable sta
production rates as the year progresses and, of course, this changes
make similar adjustments to expenses by adding at least 10 percent t
the same thing.
Required

1. Marge Atkins and Pete Granger have described the use of budgeta
a. Explain why Marge and Pete might behave in this manner, and
the use of budgetary slack.
b. Explain how the use of budgetary slack can adversely affect Ma
2. As a management accountant, Scott Ford believes that the behavio

Solution
e and carriages, is in the initial stages of preparing the annual budget
nting staff and is interested in learning as much as possible about the
ch with Marge Atkins, sales manager, and Pete Granger, production
:
be involved with the preparation of the annual budget, I’d be
es and production numbers.
t recent history, discussing what we know about current accounts,
umer spending. Then, we add that usual dose of intuition to come up

sis for my projections. Of course, we have to make an estimate of

t sometimes is difficult.
ust have been an estimate of closing inventories in the budget for the

Marge makes some adjustments to the sales numbers before passing

s projections so we generally give ourselves a little breathing room by

5 to 10 percent.
a very reliable starting point. We always have to adjust the projected
urse, this changes the ending inventory estimates. By the way, we
t least 10 percent to the estimates; I think everyone around here does

the use of budgetary slack.

this manner, and describe the benefits they expect to realize from

dversely affect Marge and Pete.

es that the behavior described by Marge and Pete may be unethical
Problem 10-60: Comprehensize Profit Plan
Background
Spring Manufacturing Company makes two components identified as C12 and D57. Selec
follow:

Requirements for each finished component:

RM1
RM2
RM3
Direct labor
Product information:
Sales price
Sales units
Estimated beginning inventory (units)
Desired ending inventory (units)

Cost per pound

Estimated beginning inventory in pounds
Desired ending inventory in pounds

The firm expects the average wage rate to be $25 per hour in 2010. Spring Manufacturing
year the firm determines the overhead application rate for the year based on the budgeted
maintains negligible WIP inventory and expects the cost per unit for both beginning and en
be identical.

Factory Overhead Information

Indirect materials-variable
Miscellaneous supplies and tools-variable
Indirect labor-variable
Supervision-fixed
Payroll taxes and fringe benefits-variable
 Maintenance costs-fixed
Maintenance costs-variable
Depreciation-fixed
Heat, light, and power-fixed
Heat, light, and power-variable
Total

Advertising
Sales salaries
Travel and entertainment
Depreciation-warehouse
Office salaries
Executive salaries
Supplies
Depreciation-office
Total

Income Tax Rate 40%

Requirements

Prepare the following schedules or statements for 2010:

1. Sales budget
2. Production budget
3. Direct materials purchases budget (units and dollars)
4. Direct labor budget
5. Factory overhead budget
6. Cost of goods sold and ending inventory budgets
7. Selling and administrative expense budget
8. Budgeted Income Statement

Solution
 C12 and D57. Selected budgetary data for 2010

Finished Components
C12 D57

10 pounds 8 pounds
0 4 pounds
2 pounds 1 pound
2 hours 3 hours

$150 $220
12,000 9,000
400 150
300 200

Direct Materials Information

RM1 RM2 RM3
$2.00 $2.50 $0.50
3,000 1,500 1,000
4,000 1,000 1,500

Spring Manufacturing uses DLHs to apply overhead. Each

ased on the budgeted ouput for the year. The company
oth beginning and ending finished products inventories to

ad Information

$10,000
$5,000
$40,000
$120,000
$250,000
 $20,000
$10,080
$71,330
$43,420
$11,000
$580,830

Selling and Administrative Expense

Information

$60,000
$200,000
$60,000
$5,000
$60,000
$250,000
$4,000
$6,000
$645,000
Problem 10-61: Comprehensize Profit Plan
Background

(Use information in Prob. 10-60 for Spring Manufacturing Company, amended as explaine

Requirements for each finished component:

RM1
RM2
RM3
Direct labor
Product information:
Sales price
Sales units
Estimated beginning inventory (units)
Desired ending inventory (units)

Cost per pound

Estimated beginning inventory in pounds
Desired ending inventory in pounds

C12 is a mature product. The sales manager believes that the price of C12 can be raised t
no effect on sales quantity. D57 is a new product introduced last year. Management believ
great potential and is considering lowering the price to $180 to expand market size and ga
lowering of D57's selling price is likely to double the total units of D57 sold.

Variable:
Indirect materials-variable
Miscellaneous supplies and tools-variable
Indirect labor-variable
Maintenance costs-variable
Heat, light, and power-variable
Payroll taxes and fringe benefits-variable
Fixed:
 Supervision-fixed
Maintenance costs-fixed
Depreciation-fixed
Heat, light, and power-fixed
Total

Advertising
Sales salaries
Travel and entertainment
Depreciation-warehouse
Office salaries
Executive salaries
Supplies
Depreciation-office
Total

Income Tax Rate 40%

Requirements

1. Amend the spreadsheet constructed in 10-60 to incorporate the changes outlined above
on the firm's after-tax operating income?
2. Would you recommend that the firm execute the strategy?

Solution
amended as explained below.)

Finished Components
C12 D57

10 pounds 8 pounds
0 4 pounds
2 pounds 1 pound
2 hours 3 hours

$160 $180
12,000 18,000
400 150
300 200

Direct Materials Information

RM1 RM2 RM3
$2.00 $2.50 $0.50
3,000 1,500 1,000
4,000 1,000 1,500

f C12 can be raised to $160 per unit with

. Management believes that D57 has a
d market size and gain market share. The

Factory Overhead Information

$10,000
$5,000
$40,000
$10,080
$11,000
$250,000
 $120,000
$20,000
$71,330
$43,420
$580,830

Selling and Administrative Expense

Information

$60,000
$200,000
$60,000
$5,000
$60,000
$250,000
$4,000
$6,000
$645,000

anges outlined above. What effect do the changes have

Problem 10-62: Comprehensize Profit Plan (Kaizen Budgeting)
Background--Use Data from Prob. 10-60, as amended.

Spring Manufacturing Company has had a continuous improvement (kaizen) program for t
kaizen program, the company is expected to manufacture C12 and D57 with the following

Requirements for each finished component:

RM1
RM2
RM3
Direct labor

The company also anticipates the following changes:

Decrease in variable factory overhead
Decrase in total fixed overhead costs
Hourly wage rate, direct labor

Product information:
Sales price
Sales units
Estimated beginning inventory (units)
Desired ending inventory (units)

Cost per pound

Estimated beginning inventory in pounds
Desired ending inventory in pounds

Variable:
Indirect materials-variable
 Miscellaneous supplies and tools-variable
Indirect labor-variable
Payroll taxes and fringe benefits-variable
Heat, light, and power-variable
Maintenance costs-variable
Fixed:
Supervision-fixed
Maintenance costs-fixed
Heat, light, and power-fixed
Depreciation-fixed
Total

Advertising
Sales salaries
Travel and entertainment
Depreciation-warehouse
Office salaries
Executive salaries
Supplies
Depreciation-office
Total

Income Tax Rate 40%

Requirements

1. What is the budgeted after-tax operating income if the firm can attain the expected oper
the kaizen program?
2. What are the benefits of Spring Manufacturing Company adopting a continuous improve
limitations?

Solution
ng)

(kaizen) program for the last two years. According to the

D57 with the following specifications:

C12 D57

9 pounds 7 pounds
0 3.6 pounds
1.8 pounds 0.8 pound
1.5 hours 2 hours

10.00%
5.00%
$30.00

C12 D57

$150 $220
12,000 9,000
400 150
300 200

Direct Materials Information

RM1 RM2 RM3
$2.00 $2.50 $0.50
3,000 1,500 1,000
4,000 1,000 1,500

(Prior to Planned Decreases)

Factory Overhead Information

$10,000
 $5,000
$40,000
$250,000
$11,000
$10,080

$120,000
$20,000
$43,420
$71,330
$580,830

Selling and Administrative

Expense Information

$60,000
$200,000
$60,000
$5,000
$60,000
$250,000
$4,000
$6,000
$645,000

ain the expected operating level as prescribed by

a continuous improvement program? What are the

Problem 10-63 Retailer Budget
Background

D. Tomlinson Retail seeks your assistance in developing cash and other budget informatio
store expects tobalances at the end of April:

Cash
Accounts receivable
Inventories
Accounts payable

The company follows these guidelines in budget preparations:

Collection of credit sales:

Within discount period in month of sale
Outside of discount period, but before eom
Second month following month of sale
Uncollectible accounts

Cash discount allowed for collections within discount period

Purchases and expenses:
Paid in month incurred
Paid in month following month of purchase

Target ending inventory, as % of next month's sales (in units)

Cost per unit of inventory
SG&A Expenses:
Total (as % of current month's sales)
Portion of total expense represented as depreciation

Actual and projected sales follow:

Month
 March
April
May
June
July
August

Requirements

1. Prepare schedules showing budgeted purchases for May and June.

2. Prepare a schedule showing budgeted cash disbursements during June.
3. Prepare a schedule showing budgeted cash collections during May.
4. Determine gross and net balances of accounts receivable on May 31.

Solution
et

ssistance in developing cash and other budget information for May, June, and July. The
nd of April:

these guidelines in budget preparations:

riod in month of sale 60%

t period, but before eom 25%
owing month of sale 9%
6% (written off at end of 3rd month follow
100%
d for collections within discount period 3%

54%
wing month of purchase 46%

ntory, as % of next month's sales (in units) 130%

$20.00

urrent month's sales) 15.00%

expense represented as depreciation $2,000

sales follow:

Dollars
 $354,000
$363,000
$357,000
$342,000
$360,000
$366,000

dgeted purchases for May and June.

dgeted cash disbursements during June.
dgeted cash collections during May.
ces of accounts receivable on May 31.
June, and July. The

$5,500
$437,000
$309,400
$133,055

en off at end of 3rd month following sale)

Units
11,800
12,100
11,900
11,400
12,000
12,200
Problem 10-64: Sales Budget and Pro-Forma Financial Statements
Background

Mark Dalid founded Molid Company three years ago. The comp
most operating systems including Palm, MS Windows, and Linus wit
company’s inception its business has expanded rapidly.

MOLID COMPANY
Pro Forma Statement of Income (in thousands)
For the budget year ended August 31, 2011

Net sales
Cost of goods sold
Gross Profit
Operating expenses:
Selling $3,200
General administrative $2,200
Income from operations before income taxes

MOLID COMPANY
Pro Forma Statement of Cost of Goods Sold (in thousands)
For the budget year ended August 31, 2011

Direct materials:
Materials inventory, 9/1/2010 $1,360
Materials purchases $14,476
Materials available for use $15,836
Materials inventory, 8/31/2011 $1,628
Cost of direct materials used
Direct labor
Factory overhead:
 Indirect materials $1,421
General factory overhead $3,240
Cost of goods manufactured
Finished goods inventory, 9/1/2010
Cost of goods available for sales
Finished goods inventory, 8/31/2011
Cost of goods sold

On December 10, 2010, Mark and Maria met to discuss the first-quarter operating results (
November 30, 2010). Maria believed that several changes should be made to the original b
been used to prepare the pro-forma statements. She prepared the following notes summar
not become known until the first-quarter results had been compiled. She submitted the follo

Original output volume for the year =

Revised output volume for the entire year =
Actual first-quarter production =
Balance of planned production spread evenly over this many months
Planned end-of-year inventory (units) =
Finished goods inventory:
September 1, 2010
November 30, 2010
Planned DL rate increase
Quarters in new year for which new labor rate will be in effect
Eq Units of DM on hand, beginning of the year
Eq Units of DM, forecasted end of the year
Purchases of DM, first-quarter:
Eq units
Dollars
Projected DM price increase
No. of quarters for which new DM rate will be in effect
Indirect materials cost, as a percentage of direct materials consumed in p
Portion of fixed costs:
General factory overhead
Selling and general expenses
Requirements

1. Based on the revised data that Bob presented, calculate Molid Company's sales for the
and (b) dollar volume of sales.

2. Prepare the pro-forma statement of cost of goods sold for the year ending August 31, 20

3. Maria suggests that the firm adopt a JIT strategy to better serve customers and to reduc
out that the firm needs to incorporate new manufacturing technologies to maintain its co
to make changes because he does not want to upset the proven successful business. H
and he does not want to commit fresh capital just to change the business procedures. M
be needed to fund the changes. She points out that a JIT system maintains no finished g
than those needed to produce 100 units of the finished products.

a. How much will the firm save by changing to JIT? (Hint: estimate the cost savings pe
of capital, say 10%, and the estimated reduction in net working capital under JIT.)
b. Should the firm follow Maria's suggestion?
c. What other factors should be considered in making the decision?

Solution
ncial Statements

pany three years ago. The company produces PDAs that are compatible with the
m, MS Windows, and Linus with UBS connection and WiFi capability. Since the
expanded rapidly.

MPANY
Income (in thousands)
ded August 31, 2011

$31,248
$20,765
$10,483

$5,400
$5,083

MPANY
f Goods Sold (in thousands)
ded August 31, 2011

$14,208
$1,134
 $4,661
$20,003
$1,169
$21,172
$407
$20,765

he first-quarter operating results (September 1 through

s should be made to the original budget assumptions that had
pared the following notes summarizing the changes that had
compiled. She submitted the following data to Mark:

162,000
170,000
35,000
over this many months 9
3,300

9,300
9,000
8.00%
will be in effect 1
16,000
18,500

37,500
$3,300,000
5.00%
2
ct materials consumed in p 10.00%

50.00%
100.00%
 e Molid Company's sales for the year ending August 31, 2011 in (a) number of units sold,

for the year ending August 31, 2011, that Mark Dalid had requested.

ter serve customers and to reduce obsolescence costs. She points

ng technologies to maintain its competitive advantage. Mark is reluctant
he proven successful business. He knows that any changes cost money,
ange the business procedures. Maria argues that no additional capital will
IT system maintains no finished goods inventory and no more materials
products.

Hint: estimate the cost savings per year as the product of the firm's cost
net working capital under JIT.)

g the decision?
of units sold,
Problem 10-65: Budgeting for a Merchandising Firm
Background

Budgeted sales:
December $220,000
January $200,000
Collections of A/R:
Collected in month of sale 60.00%
Collected following month 38.00%
Est B/D expense 2.00%
Discount for early payment 1.00%
Gross margin % 25%
Target End Inv, as % of following month's sales 80.00%
Merchandise payments:
% paid in month following month of purchase 100.00%
Other operating expenses (cash) = $22,600
Annual depreciation expense = $216,000

Kelly Company's statement of financial position at the close of business o

KELLY COMPANY
Statement of Financial Position
November 30, 2010
Assets
Cash
Accounts receivable (net of $4,000 allowance for doubtful accounts)
Inventory
Property, plant, and equipment (net of $680,000 accumulated depreciat
Total assets
Liabilities and Stockholders' Equity
Accounts payable
Common stock
Retained earnings
Total liabilities and equity
Requirements

1. What is the total of budgeted cash collections for December?

2. How much is the book value of accounts receivable at the end of December?
3. How much is the income (loss) before income taxes for December?
4. What is the projected balance in inventory on December 31, 2010?
5. What are budgeted purchases for December?
6. What is the projected balance in accounts payable on December 31, 2010?

Solution
 he close of business on November 30th follows:

Y COMPANY
f Financial Position
mber 30, 2010

$22,000
doubtful accounts) $76,000
$132,000
accumulated depreciation) $870,000
$1,100,000

$162,000
$800,000
$138,000
$1,100,000
December?

31, 2010?
Problem 10-66: Budgeting for a Service Firm
Background

Triple-F Health Club (Family, Fitness, and Fun) is a not-for-profit family-oriented health clu
developing plans to acquire more equipment and to expand club facilities. The boad plans
equipment each year and wants to establish a fund to purchase the adjoining property in fo
has a market value of about $300,000.

The club manager, Jane Crowe, is concerned that the board has unrealistic goals in light o
She has sought the help of a club member with an accounting background to assist her in
supporting her concerns.

The member reviewed the club's records, including this cash-basis income statement:

TRIPLE-F HEALTH CLUB

Income Statement (Cash Basis)
For Years Ended October 31

Cash revenues:
Annual membership fees
Lesson and class fees
Miscellaneous
Total cash revenues

Cash expenses:
Manager's salary and benefits
Regular employees' wages and benefits
Lesson and class employees' wages and benefits
Towels and supplies
Utilities (heat and light)
Mortgage interest
Miscellaneous
Total cash expenditures
Increase in cash
 Other financal information as of October 31, 2011:
Cash in checking account $7,000
Petty cash $300
Outstanding mortgage balance $360,000
A/P, purch of supplies and utilities $2,500

Purchase of exercise equipment during the year $25,000

Portion of purchase price paid in cash $10,000
Balance outstanding as of Oct 31, 2011 $15,000

Planned purchase of equipment, coming year $25,000

Acquisition costs (2007):

Land and building $600,000
Cash payment, at time of acquisition $120,000
Financing:
Annual princ payment, Nov 1st $30,000
Plus: interest on unpaid balance, b-o-y 9.00%
Years of mortgage amort to date 4

Anticipated annual membership growth rate 3.00%

Membership fees increases:

2011 (actual) 15.00%
2012 (est.) 10.00%

Lesson and class fees growth in 2012 = same as growth rate experienced in 2011

Miscellaneous revenue growth rate, 2012 = same as growth rate in 2011

Expected increases in operating expenses:

Hourly wage rates and the manager's salary 15.00%
Towels and supplies, ultilities, and misc 25.00%

Requirements
1. Prepare a cash budget for 2012 for the Triple-H Health Club.
2. Indentify any operating problems that this budget discloses for the Triple-H Health Club.
3. Is Jane Crowe's concern that the board's goals are unrealistic justified? Explain your an

Solution
 family-oriented health club. The club's board of directors is
facilities. The boad plans to purchase about $25,000 new
he adjoining property in four or five years. The adjoining property

unrealistic goals in light of the club's recent financial performance.

ackground to assist her in preparing a report to the board

sis income statement:

EALTH CLUB
ment (Cash Basis)
ded October 31
2011 2010

$355,000 $300,000
$234,000 $180,000
$2,000 $1,500
$591,000 $481,500

$36,000 $36,000
$190,000 $190,000
$195,000 $150,000
$16,000 $15,500
$22,000 $15,000
$35,100 $37,800
$2,000 $1,500
$496,100 $445,800
$94,900 $35,700
 (due in November)

(cash)

years

experienced in 2011

ate in 2011
 the Triple-H Health Club. Explain your answer.
justified? Explain your answer.
Problem 10-67: Budgeting for Marketing Expenses; Strategy
Background

You have been recruited by a former classmate, Susanna Wu, to join the fin
company produces a unique product-line of hypo-allergenic cosmetics and relie
company is in a start-up phase and therefore has no significant history of expe
planning purposes. Given the restriction on available funds (most of the availab
to recruit a management team), the control of costs, including marketing costs,
short-term viability of the company.

Cost
Sales commissions
Sales staff salaries
Telephone and mailing
Rental--Office building
Gas (utility)
Delivery charges
Depreciation--office furniture
Marketing consultants
TOTAL marketing costs

Changes/Assumptions

(1) Sales volume increase/month

(2) Sales price change
(3) Monthly % increase in staff salaries
(4) Percentage increase in price for:
Telephone and Mailing Costs
Delivery expense
(5) Percentage increase in rent
(6) Utility rate increase
 (7) Purchase of new furniture:
Cost
Estimated salvage
Life (months)
(8) Monthly increase in consulting costs

Requirements

1. Use the preceding information to develop an Excel spreadsheet that can be used to gen
expenses. (Use the built-in function "SLD" to calculate monthly depreciation charges for
What is the percentage change, by line item and in total, for items in your budget?

2. The management team is worried about the short-term financial position of the new com
the president has expressed a desire to keep marketing expenses over the new few mo
Discussions with the marketing department indicate that telephone and mailing costs are
can reasonably bear the planned-for reduction in marketing costs. The budget you have
increase in telephone and mailing costs. What must this percentage change (positive or
monthly marketing costs? (Hint: Use the "goal seek" function in Excel, which is found un

3. Comment on the use of the budget in this situation for cost-control purposes.

Solution
 trategy

, Susanna Wu, to join the finance team of a company that she founded recently. The
o-allergenic cosmetics and relies for its success on an aggressive marketing program. The
s no significant history of expenses and revenues upon which to rely for budgeting and
able funds (most of the available capital has been used for new-product development and
sts, including marketing costs, is thought by the management team to be essential for the

Amount
$120,000
$40,000
$38,000
$25,000
$12,000
$70,000
$8,000
$25,000
$338,000

ptions

10%
-5.00%
10%

6.00%
6.00%
0.00%
15%
 $30,000
$0
60
$5,000

sheet that can be used to generate a monthly budget for marketing

nthly depreciation charges for the new equipment to be purchased.)
or items in your budget?

ancial position of the new company. Given the strain on available cash,
xpenses over the new few months to a maximum of $350,000.
lephone and mailing costs are the only category, in the short run, that
g costs. The budget you have prepared includes an assumed 6 percent
ercentage change (positive or negative) be in order to achieve targeted
on in Excel, which is found under "Data Tools," then "What-If Analysis.")

t-control purposes.
Problem 10-68: Strategy, Product Life-Cycle, and Cash Flow

Burke Company manufactures various electronic assemblies that it sells pr

Burke has built its reputation on quality, timely delivery, and products that
technology. Burke’s business is fast paced: A typical product has a short li
about a year and in the growth stage, with spectacular growth sometimes, f
experiences a rapid decline in sales as new products become available.

Burke has just hired a new vice president of finance, Devin Ward. Shortly
a conversation with Andrew Newhouse, Burke’s president. A portion of th
Andrew: The thing that fascinates me about this business is that change is
started out that a reliable stream of new products was one of our key variab
the threat of product obsolescence. You see, our products go through only
cycle—the development stage and then the growth stage. Our products nev
stage or the declining product stage. Toward the end of the growth stage, p

Devin: I suppose your other key variables are cost controls and efficient pr

Andrew: Getting the product to market on schedule, whether efficiently o

business announce a new product in March to be delivered in June, and the
a year from March, or sometimes, never. Our reputation for delivering on s
much as anything.

Devin: Where I previously worked, we also recognized the importance of

system set 93 percent on time as a standard.

Andrew: The key variable that is your responsibility is cash management.

first, we thought that profit was the key and that cash would naturally follo
and the profits naturally follow. Still, we don’t manage cash well. Improvi
thing we expect from you.
Required
1. Discuss the cash-generating and cash usage characteristics of products in
of the product life cycle—development, growth, maturity, and decline.
2. Describe the cash management problems confronting Burke Company.
 thing we expect from you.
Required
1. Discuss the cash-generating and cash usage characteristics of products in
of the product life cycle—development, growth, maturity, and decline.
2. Describe the cash management problems confronting Burke Company.
Solution
w

semblies that it sells primarily to computer manufacturers.

very, and products that are consistently on the cutting edge of
al product has a short life; the product is in development for
ar growth sometimes, for about a year. Each product then
become available.

, Devin Ward. Shortly after reporting for work at Burke, he had

esident. A portion of the conversation follows.
siness is that change is its central ingredient. We knew when we
as one of our key variables, in fact, the only way to cope with
oducts go through only the first half of the traditional product life
stage. Our products never reach the traditional mature product
d of the growth stage, products dies as new ones are introduced.

controls and efficient production scheduling?

e, whether efficiently or not, is important. Some firms in this

livered in June, and they make the first shipment in October, or
ation for delivering on schedule could account for our success as

ized the importance of on-time deliveries. Our absorption cost

y is cash management. It took us a while to recognize that. At

h would naturally follow. But now we know that cash is the key
age cash well. Improving our cash management is the main

acteristics of products in general in each of the four

turity, and decline.
ting Burke Company.
acteristics of products in general in each of the four
turity, and decline.
ting Burke Company.
10-69: Budgeting Customer Retention and Insurance-Policy Renewal; Sensitivity Ana

Background

National Insurance company underwrites property insurance for homeowners. You have b
of the monthly budget for the coming 12-month period for the company.
 
You have collected the following driver volumes, consumption rates, unit resource costs, a
those policyholders whose policy runs from January to December:

Data

Number of active policy holders, beginning of month #1 100,000

Average monthly premium per policy $100.00
Monthly mid-term cancellation rate 0.50%
Policy renewal rate 85.00%

Required

1. Prepare, in good form, a monthly budget for customer retention and insurance premium
December. Columns in your budget should represent months, while the rows in your bud
No. of policyholders, beginning of the month; mid-term cancellation rate (%); number of a
average number of active policyholders during the month; average monthly premium per
month from active policyholders. How many policies are projected to be renewed at the e

2. Within the context of budgeting, what is meant by the term "what-if" analysis?

3. Re-do the original 12-month budget you created above in (1) to reflect a decrease in the
in the mid-term cancellation rate to 0.75%. Of what potential value is the analysis you jus

4. What other informatin or data would be included in a full budget prepared each month fo

Solution
 l; Sensitivity Analysis

wners. You have been charged with the responsibility of developing a portion

resource costs, and other data needed to prepare your 12-month budget for

surance premium revenue for the period January through

e rows in your budget should consist of the following:
e (%); number of active policyholders, end of the month;
nthly premium per policy; and, total premiums earned per
e renewed at the end of the year?

a decrease in the policy-renewal rate to 80.0% and a change

e analysis you just performed?

ed each month for this insurance company?

10-70: Budgeting Insurance Policy Volume and Monthly Revenues

Background

National Auto Insurance company underwrites automobile coverage for the consumer mar
estimates for number of policies in force and the amount of premium revenue associated w
estimates for the coming six-month period. Past experience indicates that number of polic
factors (e.g., market size [total number of households] and market growth rate) and comp
 
At the beginning of January for the new budget year, the number of households is estimat
approximately 0.05% per month. Your own research indicates that approximately 80% of h
2.2 cars. Because of legal requirements, the average percentage of cars insured is high—
month. Current market share of National Auto in the consumer market is approximately 10
National has been 0.005% per month. Because of aggressive levels of customer service,
average, to approximately 0.125%. Average monthly premium paid per auto insured for th

Data

Macroeconomic Data:
Estimated number of households, beginning of January =
Estimated monthly growth rate in number of households =
% of households with car ownership (one or more autos) =
average number of cars per household =
current % of autos that are insured =
estimated monthly increase in % of insured autos =
Company-Specific Data:
No. of autos insured, beginning of the year =
Current market share of National Auto Insurance Co. =
Recent monthly increase in market share =
Current monthly cancellation rate (%) =
Average monthly insurance premium, coming year =

Requirements
1. Prepare, for each of the mnths January-June in the coming year, a budget broken do

a. Market Size and Volume

b. Volume for National Auto Insurance (# of policies outstanding)
c. Premium revenues generated
For (a) above, you should have six rows of data, as follows: total number of households
 1. Prepare, for each of the mnths January-June in the coming year, a budget broken do

a. Market Size and Volume

b. Volume for National Auto Insurance (# of policies outstanding)
c. Premium revenues generated
For (a) above, you should have six rows of data, as follows: total number of households
cars owned per household; % of car owners with insurance; total number of insured car
insured by National Auto, end of the month. For (b) above, your budget should have fou
cancellations during the month; number of insured autos, end of month; and, average n
have the following three rows: average number of cars insured during the month; avera
2. What additional real-life refinements do you envision for the budgets you prepared a
company if you were in charge of the budget-preparation process?
3. The budgets you prepared above in (1) can be referred to as “driver-based budgets.
budgeting practices.

Solution
age for the consumer market. As part of the annual planning process, National requires monthly
um revenue associated with this volume of business. You have been asked to prepare these
ates that number of policies outstanding during a given month is influenced both by macro
et growth rate) and company-specific factors (e.g., market share, cancellation rate experience).

of households is estimated as 100 million; further, past experience indicates that this will grow by
at approximately 80% of households have one or more cars. On average, each household owns
of cars insured is high—your best estimate is that this number is 85% and growing by 0.1% per
arket is approximately 10%. Over the past 24 months, the rate of increase in market share for
els of customer service, National has been able to keep its monthly cancellation rate below
id per auto insured for the coming year is assumed to be $100.00.

100,000,000
0.050%
80.00%
2.2
85.00%
0.100%

14,940,000
10.000%
0.005%
0.125%
$100.00

year, a budget broken down in three parts:

ding)

al number of households (i.e., market size), % of households owning one or more cars; number of
year, a budget broken down in three parts:

ding)

al number of households (i.e., market size), % of households owning one or more cars; number of
tal number of insured cars (market-wide); market share of National Auto; and, number of autos
r budget should have four rows, as follows: number cars insured, beginning of the month;
of month; and, average number of autos insured during the month. For (c) above, you budget should
during the month; average insurance premium per car per month; total monthly premiums revenue.
budgets you prepared above in (1)? What additional budgets would you anticipate preparing for the
ess?
s “driver-based budgets.” List some of the pros and the cons of such budgets, relative to traditional
 tional requires monthly
ked to prepare these
ced both by macro
cellation rate experience).

ates that this will grow by

, each household owns
nd growing by 0.1% per
se in market share for
cellation rate below

e or more cars; number of

e or more cars; number of
and, number of autos
ing of the month;
c) above, you budget should
monthly premiums revenue.
u anticipate preparing for the

dgets, relative to traditional

Problem 10-71: Comprehensive Budget; Strategy
Background NOTE: Other than depreciation,
all operating expenses are CASH
expenses, paid before the EOM.

Gold Sporting Equipment (GSE) is in the process of preparing its budget for the third quarter of 2010. The budgeting staff has gathered the following data:

Account balances, June 30th Recent and forecasted sales Monthly Operating Expenses
Cash $25,000 June (actual) $75,000 Fixed:
A/R $15,000 July $80,000 Salaries & wages $8,000
Inventory $47,520 August $82,000 Rent/Property Taxes $1,000
Bldg./Equip (net) $200,000 September $90,000 Depreciation $800
Short-term payable (equip) $0 October $100,000
Bank loan payable $0 Variable:
Income taxes payable $0 Salaries & wages 5%
Sales Breakdown (on average): Other cash oper. Expe 2%
Cash 80%
Credit 20% (ALL collected in month following sale) Income tax rate (combined) 25%

Gross margin % 40% (based on gross, not net, purchase price)

Purchases Information:
Each month, on the 15th, purchases equal the following month's projected sales (@ COST)
Terms of purchase, 1/10, n/30 ("1% discount if paid within 10 days; net amount is due in 30 days")
Purchases discount 1%
% of purchases for which the "early payment" discount is taken 100%

Planned equipment purchase, August: Cash-related information:

Cost $127,000 Minimum cash balance $30,000
% paid Aug. 50% Interest rate/year 15% (paid EOM)
% paid Oct. 50% Borrowing/Repayments $10,000 increments
Borrowings occur @ BOM, repayments occur EOM

3. Sales are 80 percent cash and 20 percent on credit. Credit accounts are all collected 30 days after sale.

4. At gross purchase prices of inventories, GSE’s gross margin averages 40 percent of revenues. GSE records all inventory purchases at net prices.

5. Operating expenses: Salaries and wages, $8,000 per month plus 5 percent of revenue; rent and property tax, $1,000 per month; other operating expenses,
excluding depreciations, 2 percent of revenues; depreciations $800 per month. All cash operating expenses are paid before the end of the month.

6. GSE has no minimum inventory requirement. The policy is to purchase each month on the 15th the expected sales for the following month. Terms on
purchases are 1/10, n/30. Purchases usually arrive on or before the 20th. GSE’s policy is to take all cash discounts offered.

7. GSE is negotiating the purchase of new equipment for $127,000 to be installed in September. Terms are 50 percent in the month before and 50 percent
after the month of installation.

8. Minimum cash balance is $30,000. All borrowings are effective at the beginning of the month and all repayments are made at the end of the month of
repayment. Loans are repaid when sufficient cash is available. The interest rate is 15% per year, payable at the end of each month. Both borrowings and
repayments are in multiple of $10,000. Management does not want to borrow any more cash than is necessary and wants to repay whenever the cash on
hand exceeds the minimum requirement.

Requirements

1. Complete schedules A through E.

2. Prepare a budgeted income statement for the third quarter and beginning and end-of-quarter balance sheets. GSE estimates its income tax rate at 25 percent,
payable in the second quarter of the following year. (Hint: Cost of good sold percentage is 59.4%.)

3. Gold Sporting Equipment has been using the loan described in Item 8 to meet its needs for funds. Alternatively, Gold can issue long-term bonds at no more than
12% annual interest rate to incrase funds available for expansion. What is the most sensible type of loan GSE should use to meet its needs? Explain your answer.

4. The underlying business situation has been greatly simplyfied. List at least three complicating factors that may exist in a real business setting.

Solution
Problem 10-72: Cash Budgeting; Sensitivity Analysis
Background

CompCity, Inc., sells computer hardware. It also markets related software and software-s
The company prepares annual sales forecasts for sales, of which the first six month of 20
In a typical month, total sales are broken down as follows: cash sales, 25%; VISA
55%; and, 20% open account (the company's own charge accounts). For budgeting purp
cash sales plus bank credit-card sales are received in the month of sale; bank credit-card
to a 3% processing fee, which is deducted daily at the time of deposit into CompCity's cas
the bank. Cash receipts from collection of accounts receivable are typically collected as fo
month of sale, 45% in the month following the month of sale, and 27% in the second mon
of sale. The remaining receivable generally turn out to be uncollectible.
CompCity's month-end inventory requirements for computer hardware units are 30% o
estimated sales. A one-month lead time is required for delivery from the hardware distribu
computer hardware units are generally placed by CompCity on the 25th of each month to
the store on the first day of the month needed. These units are purchases on credit, unde
n/45, measured from the time the units are delivered to CompCity. Assume that CompCit
amount of time to pay its invoices. On average, the purchase price for hardware units run

COMPCITY, Inc.
Forecasted Sales (units and dollars)
January-June, 2010
Hardware Hardware Software/Support Total
Sales (Units) Revenue Services Revenue Revenue
January 120 $360,000 $140,000 $500,000
February 130 $390,000 $160,000 $550,000
March 90 $270,000 $130,000 $400,000
April 100 $300,000 $125,000 $425,000
May 110 $330,000 $150,000 $480,000
June 120 $360,000 $140,000 $500,000
Totals 670 $2,010,000 $845,000 $2,855,000

Sales Breakdown Information:

Cash Sales = 25.00%
Bank Credit-card (VISA) Sales 55.00%
 Open Account (CompCity) = 20.00%
Bank collection fee/service charge = 3.00%
Collection of Open Accounts:
Month of Sale = 25.00%
Following Month = 45.00%
2nd Month Following Sale = 27.00%
Uncollectible accounts = 3.00%
CGS Percentage, Hardware Sales = 65.00%
Desired eom Inventory percentage = 30.00%

Requirements

1. Calculate estimated cash receipts for April 2010 (show details).

2. The company wants to estimate the number of hardware units to order on January 25th:
a. Determine the estimated number of units to be ordered
b. Calculate the dollar cost (per unit and total) for these units
3. Cash planning in this line of business is critical to success. Management feels that the a
($3,000) is firm--at least for the foreseeable future. Also, it is comfortable with the 30% r
is not so sure, however, about (a) the CGS rate (because of the state of flux in the supp
sales in March 2010. Discussions with marketing and purchasing suggest that three out
two variables, as follows:
March
Outcome Sales CGS%
Optimistic 100 60%
Expected 90 65%
Pessimistic 80 70%

The preceding outcomes are assumed to be independent, which means that there are n
You are asked to conduct a sensitivity analysis to determine the range of possible cash
different combinations of the above. Assume, for simplicity, that slaes volume for April is
Prepare a table disclosing each of the nine possible scenarios that could exist regarding

4. As part of the annual budgeting process, CompCity, Inc. prepares a cash budget by mon
company such as CompCity would prepare monthly cash-flow budgets for the entire yea
in the monthly planning process.
Solution
ftware and software-support services.
e first six month of 2010 are given below.
sales, 25%; VISA® credit-card sales,
). For budgeting purposes, assume that
sale; bank credit-card sales are subject
sit into CompCity's cash account with
ypically collected as follows: 25% in the
7% in the second month following the month

dware units are 30% of the following month's

the hardware distributor. Thus, orders for
25th of each month to assure availability in
hases on credit, under the following terms:
Assume that CompCity takes the maximum
or hardware units runs 65% of selling price.
 rder on January 25th:

ement feels that the assumption of selling price per unit

ortable with the 30% rate for end-of-month inventories. It
ate of flux in the supplier market), and (b) the level of predicted
suggest that three outcomes are possible for each of these

means that there are nine possible combinations (3 x 3).

nge of possible cash outflows for April 10th, under
aes volume for April is considered known (i.e., is fixed).
could exist regarding the cash outflow on April 10th.

a cash budget by month for the entire year. Explain why a

gets for the entire year. Explain the role of senstivity analysis
10-73: Criticisms of Traditional Budgeting/Incentive Issues

Background

As noted in the chapter, some individuals allege that the practice of tying managerial
rewards to budgeted performance has dysfunctional consequences, including (but not
limited to) “gaming behavior.”

Required

Search the Internet and pertinent literature (e.g., Michael C. Jensen, “Corporate
Budgeting Is Broken—Let’s Fix It,” Harvard Business Review (November 2001), pp. 94-
101) to further explore the issue of negative incentive effects associated with traditional
budgeting practices. What alternatives are suggested to correct these negative
consequences?

Solution