PROBLEM FOR SELF·STUDY

D

Total co.ts

4,427,024$ 3244126

$22,422,40014,751,2507,671,150

$ 250,000 $ 586,336

290,000 2,083,792

220,000 780,560

240,000 531,491

400,000 444,845$1 400000 $4427024

C D

$ 586,3362,083,792

780,560531,491444,845

Schedule 8Schedule 8Schedule 8Schedule 8Schedule 8

Schedule 1Schedule 7

1,793,792

291,491

560,560

44,845$3027024

$ 336,336

Fixed Costs(as in Schedule 8,

Variable Co.ts , 192)

Selling Units TotalPrice Sold Revenues

$431.20 52,000 $22,422,400

A BStylistic Furniture Bud;<

For th •. Year Endi I!D,.

45 Coffee tables

ABCSrMdul,. 8: No~!U'uf;\rtu.riJt; _~f:I~tsBu~~t

For ih •. Ynl F.ndin; D,.r.- {herH,_ 'fl07

1234 Revenues5 Cost of goods sold6 Gross~1 Operating costs8 R&DlProducl design9 Marketing costs10 Distnbution costs11 Customer-service costs12 AdministratM costs13 Operating income14

123

4 BusinessFunctionR&DlProduct design

5 (Variable cost: $22,422,400 x 0.Dl5)Marketing

6 (Variable cost: $22,422,400 x 0.08)Distnbution

7 (Variable cost: $22,422,400 x 0.025)Customer service

8 (Variable cosl: $22,422,400 x 0.013)Administrative

9 (Variable cost: $22,422,400 x 0.002)10

ABC1 Schedule I: Revenue B~et:2 For the YtU Endi.n.:!:Dett]' n 31,200'3

If we had also assumed that the price of the pal1icle board had increased to $4.20 per board footand the price of the red oak had increased to $6.30 per board foot (as in Scenario 3 in Exhibit 6-4,p. 193), Schedules 3A, 30, GA, GO, and 7 would also have changed.

SOLUTIONSchedules 1 and 8 will change. Schedule 1 changes because a change in selling price affects rev-enues. Schedule 8 changes because revenues are a cosl driver of variable non manufacturing costs.The remaining schedules will not change because a change in selling price has no effect on manu-facturing costs. The revised schedules and the new budgeted income statement follow.

Consider the Stylistic Furniture example described earlier. Suppose the selling price perlable is $431.20,a 10% increase over the $392 selling price used in the chapter illustration. All other data are undlanged.

RequiredPrepare a budgeted income statement, including all necessary detailed supporting budget schedulesthat are different from the schedules presented in the chapter. Indicate those schedules that willremain unchanged.

DECISION POINTS

The following question-and-answer format summarizes the chapter's learning objectives. Each decisionpresents a key question related to a learning objective. The guidelines are the answer to that question.

Decision Guidelines

APPENDIX: THE CASH BUDGET

Thechapter illustrated the operating budget, 'vvhich is one pan of the master budget. The other partisthe financial budget, which comprises the capital expenditures budget, the cash budget, the bud-getedbalance sheet, and the budgeted statement of cash tlmvs. This appendix focuses on the cashbudgetand the budgeted balance sheet. Capital budgeting is discussed in Chapter 21. The budgetedstatement of cash flows is beyond the scope of this book (and generally is covered in financialaccounting and corporate finance courses).

'"c"-'"!!.c,"-'"••."C::~~.l>

~, If you have studied the ~W\ statement of cash flows ginafinancialaccountingcourse. :;.be aware thatthe directmethod :;.ofdeterminingcash flowscorre· (Q

sponds to the approach used inpreparingthe cash budget. 203

The master budget summarizes the financial projections of all the company's budgets. Itexpresses management's operating and financing plans-the formalized outline of the com-pany's financial objectives and how they will be attained. Budgets are tools that, by them-selves, are neither good nor bad, Budgets are useful when administered skillfully.

Budgets should be prepared when their expected benefits exceed their expected costs.The advantages of budgets include: lal they compel strategic analysis and planning.lb) they promote coordination and communication among subunits of the company, (c) theyprovide a framework for judging performance, and {dl they motivate managers and otheremployees.

The operating budget is the budgeted income statement and its supporting budget schedules.The starting point for the operating budget is generally the revenues budget. The followingsupporting schedules are derived from the revenues budget: production budget, direct mate-rial usage budget, direct material purchases budget, direct manufacturing labor budget,manufacturing overhead costs budget, ending inventories budget, cost of goods sold budget,R&D/product design budget, marketing budget, distribution budget, customer-service budget,and administrative budget.

Managers should use computer~based financial planning models-mathematical statementsof the relationships among operating activities, financing activities, and other factors thataffect the budget. These models make it possible for management to conduct what-if(sensitivity) analysis of the effects on the master budget of changes in the original predicteddata or changes in underlying assumptions and to develop plans to respond to changedconditions.

Kaizen budgeting is based on the idea that it is possible to continuously reduce costs overtime. Costs in kaizen budgeting are based on improvements that are yet to be implementedrather than on current practices or methods.

Activity-based budgeting focuses on the budgeted costs of activities needed to produceand sell products and services. It is linked to activity-based costing but differs in its empha-sis on future costs and future use of activity areas.

A responsibility center is a part, segment, or subunit of an organization whose manager isaccountable for a specified set of activities. Four types of responsibility centers are costcenters, revenue centers, profit centers, and investment centers. Responsibility accountingsystems are useful because they measure the plans, budgets, actions, and actual results ofeach responsibility center.

Controllable costs are costs primarily subject to the influence of a given responsibilitycenter manager for a given time period. Performance reports of responsibility centermanagers often include costs, revenues, and investments that the managers cannot control.Responsibility accounting associates financial items with managers on the basis of whichmanager has the most knowledge and information about the specific items, regardless of themanager's abilityto exercise full control.

8. Shouldpertormance reports ofresponsibility center managers onlyinclude costs the manager can control?

6. How can a company prepare a budgetbased on costs of different activities?

5, How can budgets include the effectsof future improvements?

7. How do companies use responsibilitycenters and responsibility accounting?

4. How should managers considerwhat might happen if the assumptionsunderlying the budget change?

3. What is the operating budget andwhy is it useful?

2. When should a company preparebudgets?What are the advantagesof preparing budgets?

1. What is the master budget andwhy is it useful?

204

EXHIBIT 6-5

Balance Sheel lorSlylislic Furnilure,December 31, 2006

A B DI As.ets2 Current Assets3 Cash $ 500,0004 Accounts receivable 1,881,6005 Direct materials inventory 223,0006 Finished goods inwntory 1,375,000 $3,979,6007 Property, plant and equipment8 Land 1,200,0009 Building and equipment $2,300,00010 Accumulated depreciation (800,000) 1,500,000 2,700,00011 Total $6.6796001213 Liabilitie. and Stockholders' ui14 Cmrent Liabilities15 Accounts payable $ 384,00016 Income t8JreSpayable 20,46017 Total cmrent liabilities 404,46018 Long-term debt (interest at 10% per year) 2,400,00019 Total cmrent and long-term liabilities $2,804,46020 Stockholders' equity21 Common stock, $0.01 parvalue, 300,000 sheres outstanding 3,00022 Retained earnings 3,872,140 3,875,14023 Total $6.67960024

Suppose Stylistic Furniture had the balance sheet for the year ended December 31,2006, shownin Exhibit 6-5. The budgeted cash nows for 2007 are:

A C D EI QWIrlers2 I 2 3 43 Collections from customers $5,331,200 $4,704,000 $4,704,000 $6,272,0004 Disb1ll'Sements5 Direct materials 960,000 1,152,000 1,152,000 T 1,536,0006 Payroll 1,626,300 I 1,626,300 1,888,600 1,626,3007 Other costs 1,580,460 1,580,460 1,580,460 1,580,4608 Machinery pun:hese 0 0 1,800,000 09 Interest expense on long-term debt 60,000 60,000 60,000 60,00010 Income taxes 100,000 120,460 100,000 100,000

The quanerly data are based on the budgeted cash effects of the operations formulated in Sd1cdules1 through 8 in the chapter, but the details of that formulation are not shown here to keep this illus-tration as brief and as focused as possible.

Long-term debt is $2.4 million at an annual interest rate of 10%, with $60,000 interest payableevery quarter. The company "vants to maintain a $100,000 minimum cash balance at the end ofeach quarter. The company can borrow or repay money at an interest rate of 12% per year.Management does not want to borrow any more short-term cash than is necessary. By specialarrangement, interest is computed and paid when the principal is repaid. Assume, for simplicity,that borrowing takes place (in multiples of $1,000) at the beginning and repayment at the end ofthe quarter under consideration. Interest is computed to the nearest dollar.

Suppose the management accountant at Stylistic is given the preceding data and the other datacontained in the budgets in the chapter (pp. 188-193). She is instructed as follows:

1. Prepare a cash budget for 2007 by quarter. That is, prepare a statemenl of cash receipts and dis-bursements by quarter, including details of borrowing, repayment. and interest.

2. Prepare a budgeted balance sheel on December 31, 2007.3. Prepare a budgeted income stalement for the year ended December 31, 2007. This statement

should include interest expense and income taxes (at a rate of 36% of operating income). InApril 2007, Stylistic will pay $120,640 of income taxes. This amount is the remaining paymentdue for the 2006 income tax year togelher with tlle $100,000 Stylistic pays each quarter of2007 toward its 2007 income tax bill. Any remaining amount due is paid in April 2008.

4,800,0006,161,5006,321,8401,800,000

240,000420,460

20,349,800100,000

20,449,800$ 1 061 400

$ 308,000(308,000)(18,480)

$ (8480)$1142920

6,272,0006,372,160

4$ 100,160

$ 0(308,000)(18,480)

$ (326480)$1 142920

308,000oo

308.000100.160

4,704,0006,373,220

1,152,000 1,536,0001,888,600 1,626,3001,580,460 1,580,4601,800,000 0

60,000 60,000100,000 100,000

6,581,060 4,902,160100,000 100,000

6,681,060 5,002,160$ (301 840) $1 369 400

DQuarters

J$1,669,220

C

4,704,0006,208,440

1,152,0001,626,3001,580,460

o60,000

120,4604,539,220

100,0004,639,220

$1 569.220

o $oo

$ 0 $$1.669220 $

B

5,331,2005,831,200

I 2$ 500,000 $1,504,440

$

960,0001,626,3001,580,460

o60,000

100,0004,326,160

100,0004,426,160

$1404440

o $oo

$ 0$1.504440

A123 Cash balance, beginnir1g4 Add receipts5 Collections from customers:6 Total cash available for needs (x)7 Deduct disbursements8 Du.ctmate~9 Payroll10 Other costs11 Machinery purchase12 Interest expense on long-tem debt13 Income taxes14 Total disbursements (y)15 Minimum cash balance desu.d16 Total cash needed17 CashelOCoss(defIciency)'18 Financing19 Bonowing (at beginning)20 Repayment (at end)21 Interest (at 12% per annum) b22 Total effects of fmancing23 Cash balance, ending'2425 aExcess of total cash available ow:r total ca:>h :needed before current fmancing.

-26 bNote that the short~tenn interest payn\enb pertain only to the amowtt of principal being repaid at the end27 of, -'ere $308,000 x 0.12 X 0.5 = $18,480.28 cEno:fu1g cash balance = Total cash available for needs (x) - Total disbursements (y) + Total effects offUW'LCing.

preparation of BUdgetsI.The cash budget (Exhibit 6-6) is a schedule of expected cash receipts and disbursements. It

predicts the effects on the cash position at the given level of operations. Exhibit 6-6 presentsthe cash budget by quarters to show the impact of cash flow timing on bank loans and theirrepayment. In practice, monthly-and sometimes weekly or even daily-cash budgets are crit-ical for cash planning and control. Cash budgets help avoid unnecessary idle cash and unex-pected cash deficiencies. They thus keep cash balances in line \-"ith needs. Ordinarily, the cashbudget has these main sections:a. The beginning cash balance plus cash receipts equals the total cash available before financ-

ing. Cash receipts depend on collections of accounts receivable, cash sales, and miscellaneousrecurring sources, such as rental or royalty receipts. Infonnauon on the expected colledibilityof accounts receivable is needed for accurate predictions. Keyfactors include bad-debt (uncol-lectible accounts) experience and average time lag between sales and colledions.

b. Cash disbursements by Stylistic Furniture include:i. Direa material purchases. Suppliers are paid in full three v..leeksafter the goods are

delivered.ii. Direalabor and other wage and salary outlays. All payroll-related costs are paid in the

month in which the labor effort occurs.iii. Other cos/s. These depend on timing and credil terms. Not.e, depreciation does not.

require a cash outlay.iv. Other disbllrsement.s. These include outlays for property, plant, equipment, and other

long-term investments.v. Inrerest on long-term borrowing.vi. Income tax payment.s.

c. Shan-term financing requirements depend on how the total cash available for needs [keyedas (x) in Exhibit 6-61compares with the total cash disbursements !keyed as (y)J, plus theminimum ending cash balance desired. The financing plans ,"viIIdepend on the relationshipbetween total cash available for needs and total cash needed. If there is a deficiency of cash,loans will be obtained. If there is excess cash, any oUlslanding loans will be repaid.

d. The ending cash balance.

~~ There's no need to memo-IIi!l rizethe format of the cashbudget ifvou remember that it'ssimilar to the way your bankstatement works: beginningbalance + deposits (receiptsl-disbursements=ending balance(before financingl. This endingbalance reveals how muchmust be borrowed or can berepaid/invested.

~~ Keep in mind three points~aboutcashbudgets:(l1The ending balance fEB)ofcashin one quarter is the beginningbalance(BBiofcash inthe nextquarter. m In the "Year as aWhole" column. receipts anddisbursements are totaled forthe four quarters. However, theSS in that column is the BB forquarter 1, and the EB is the EBfor quarter4.(3) Depreciation isnota cash disbursement.

205

ARevenuesCost of goods soldGross marginOpemting costs

R&Dil'roduct designMarketing costsDistnbution costsCustomer·setvice costsAdministrative costs

Operating Uu:omeInterest expenseIncome before income taxesIncome taxesNet Income

B CSchedule 1Schedule 7

Schedule 8 $ 555,760 'Schedule 8, 1,920,720

] Schedule 8 729,600Schedule 8 504,992Schedule 8 440,768

D$20,384,000

14,751,2505,632,750

4,151,8401,480,910

258,4801,222,430

440,075$ 782355

The cash budget in Exhibit G-G shows the pattern of short-term "self-liquidating" cash loans.In quarter 3, Stylistic budgets a $307,840 cash deficiency. Hence, it undertakes short-term bor-rowing of $308,000 for six months. Seasonal peaks of production or sales often result in heavycash disbursements for purchases, payroll, and other operating outlays as the products are pro-duced and sold. Cash receipts from customers typically lag behind sales. The loan is self-liqui-dating in the sense that the borrowed money is used to acquire resources that are used to pro-duce and sell finished goods, and the proceeds from sales are used to repay the loan. Thisself-liquidating cycle is the movement from cash to inventories to receivables and back to cash.

2. The budgeted income statement is presented in Exhibit 6-7. It is merely the budgeted operatingincome statement in Exhibit 6-3 (p. ] 93) expanded to include interest expense and income taxes.

3. The budgeted balance sheet is presented in Exhibit 6-8. Each item is projected in light of thedetails of the business plan as expressed in all the previous budget schedules. For example, theending balance of accounts receivable of $ 1,254,400 is computed by adding the budgeted rev-enues of $20,384,000 (from Schedule 1) to the beginning balance of accounts receivable of$1,881,600 (from Exhibit 6-5) and subtracting cash receipts of$21,Oll,200 (from Exhibit 6-6).

For simplicity, the cash receipts and disbursements were given explicitly in this illustration.Usually, the receipts and disbursements are calculated based on the lags bet\',,'een the items reportedon the accrual basis of accounting in an income statement and balance sheet and their related cashreceipts and disbursements. Consider accounts receivable. In the first three quarters, Stylistic esti-

$ 358,00040,075

398,0752,400,000

$2,798,075

3,0004,654,495 4,657,495

$7455570

Liahilin.. and Slotkholders' Equity

A C DABseil

Current AssetsCesh $1,142,920Accounts receivable 1,254,400Direct materials inventory 204,000Finished goods inventory 854,250 $3,455,570

Property, plant end equipmentLand 1,200,000Building end equipment $4,100,000Accumulated depreciation (1,300.000) 2,800,000 4,000,000

Total $7.455,570

Current LiabilitiesAccounts payableIncome taxes payable

TotaI current liabilitiesLong-term debt (interest at 10% per year)Total current end long-term liabilitiesStockholders' equity

Common stock, $0.01 parvalue, 300,000 shares outstendingRetained earnings

Total206

mates that 70% of all sales made in a quarter are collected in the same quarter and 30% are col-lected in the following quarter. In the fourth quarter, Stylistic anticipates, based on its prior history,that it will collect slightly less than 80% of sales (79.445%). Estimated collections from customerseach quarter are calculated in the following table (assuming sales by quarter of $4,928,000,$4,608,000, $4,745,143, and $6,102,857 that equal 2007 budgeted sales of $20,384,000).

Schedule of Cash CollectionsQuarters

2 3 4

!'-..., Study Tip: To check~yourunderstandingofcash budgeting, see FeaturedExercise 2,multiple-choice ques-tion 8, and Review Exercise 3(Student Guide, beginning p. 65).Fully explained answers begin onpage 71.

$1,382,400

3,321,600 $1,423,543

4,848,457$4,704,000 $6,272,000

3,225,600

$1,478,400

$4,704,000

A B C D E F G H1 Diretl Malerial2 Purc:hase Co./J Budgeled. Short-Ten" Bo3 Sellin; Partide Red Operating Quarto ••4 Scenario Prke Board I Oak lru;ome I 2 J 45 1 $431.20 $3.80 $5.70 $3,458,226 $0 $0 $ 0 $ 06 2 431.20 4.00 6.00 3,244,126 0 0 0 07 3 431.20 4.20 6.30 3,030,026 0 0 0 08 4 392.00 3.80 5.70 1,695,010 o ~ 0 145,000 0 ;::

~9 5 392.00 4.00 6.00 1,4&0,910 0 0 308,000 0 'i10 6 392.00 4.20 6.30 1,266,810 ' 0 0 472,000 0 to11 7 352.80 3.80 5.70 (68,206) I 0 0 1,413,000 717,000

cQ.

'"12 8 352.80 4.00 6.00 (282,306) 0 0 1,576,000 997,000 !!-13 9 352.80 4.20 6.30 (496,406) 0 0 1,739,000 1,276,000 Q~

"-'"~TERMS TO LEARN ~."Q

;:Thechapter and the Glossary at the end of the book contain definitions of:

~activity-based budgeting (ABB) (p. 186) financial budget (p. 1861 pro forma statements (p. 1821 .;rbudgetaryslack (p. 1991 financial planning models (p. 1931 profit center (p. 197) ,.

ncashbudget (p. 2051 investment center (p. 197) responsibility accounting (p. 1971 n

0ccontinuousbudget (p. 1841 kaizen budgeting (p. 1951 responsibility center Ip. 1971 "-controllability (p. 188) master budget (p. 1821 revenue center (p. 1971,.'"controllable cost(p. 1981 operating budget (p. 186) rolling budget (p. 1841

costcenter (p. 187) organization structure (p. 197) 201

sensitivity Analysis and Cash FlowsExhibit 6-4 (p. 195) shows how differing assumptions about selling prices of coffee tables anddirect material prices led to differing amounts for budgeted operating income for Stylistic Furniture.Akey use of sensitivity analysis is to budget cash flow. Exhibit 6-9 outlines the short-term borrow-ingimplications of the nine combinations examined in Exhibit GA. Scenarios 7 to 9, with the lov,ferselling price per table ($352.80), require large amounts of short-term borrowing in quarters 3 and4. Scenario 9, with the combination of a 10% lower selling price and 5% higher direct 111aterialcosts,requires the largest amount of borrowing by Stylistic Furniture. Sensitivity analysis helps man-agersanticipate such outcomes and take steps to minimize the effects of expected reductions in cashflowsfrom operations.

Accounts receivable balance on 1-1-2007(p. 2041 $1,881,600(Fourth quarter sales from prior yearcollected in first quarter of 2007)

Fromfirst-quarter 2007 sales(84,828,000x 0.70; $4,928,000 x 0.30) 3,448,600

Fromsecond-quarter 2007 sales184,608,000x 0.70; $4,608,000 x 0.301

Fromthird-quarter 2007 sales184,745,143x 0.70; $4,745,143 x 0.301

Fromfourth-quarter 2007 sales(estimated collections from sales of $6,102,8571

Totalcollections $5,331,200

Note that the quarterly cash collections from customers calculated in this schedule equal the cashcollections by quarter shown on page 204. Purthermore, the difference betv.'een fourth-quarter salesand the cash collected from fourth-quarter sales, $6,102,857 - $4,848,457 '= $1,254,400 appears asaccounts receivable in the budgeted balance sheet as of December 31, 2007 (see Exhibit 6-8).

ASSIGNMENT MATERIAL

Questions

6-1 What are the four elements of the budgeting cycle?6-2 Define master budget.

6-3 "Strategy, plans, and budgets are unrelated to one another." Do you agree? Explain.6-4 "Budgeted performance is a better criterion than past performance for judging managers." Do

you agree? Explain.6-5 "Production managers and marketing managers are like oil and water. They just don't mix."

How can a budget assist in reducing battles between these two areas?6-6 "Budgets meet the cost-benefit test. They force managers to act differently." Do you agree?

Explain.6-7 Define rolling budget. Give an example.

6-8 Outline the steps in preparing an operating budget.

6-9 "The sales forecast is the cornerstone for budgeting." Why?6-10 How can sensitivity analysis be used to increase the benefits of budgeting?6-11 Define kaizen budgeting.

6-12 Describe how nonoutput-based cost drivers can be incorporated into budgeting.

6-13 Explain how the choice of the type of responsibility center least, revenue, profit, or invest-mentl affects behavior.

6-14 What are some additional considerations that arise when budgeting in multinational companies?6-15 "Cash budgets must be prepared before the operating income budget." Do you agree? Explain.

Prentice Hall Grade Assist IPHGAIYour professor may ask you to complete selected exercises and problems in Prentice HallGrade Assist (PHGA). PHGA is an online tool that can help you master the chapter's topics.It provides you with multiple variations of exercises and problems designated by the PHGAicon. You can rework these exercises and problems-each time with new data-as manytimes as you need. You also receive immediate feedback and grading.

PH Grade Assist

Required

Exercises

6-16 Sales budget, service setting_ In 2006, McGrath & Sons, a small environmental-testing firm, per-formed 11,000 radon tests for S250 each and 15,200 lead tests for $200 each. Because newer homes arebeing built with lead-free pipes, lead-testing volume is expected to decrease by 10% next year. However,awareness of radon-related health hazards is expected to result in a 5% increase in radon·test volume eachyear in the near future. Jim McGrath feels that if he lowers his price for lead testing to $190 per test, he willhave to face only a 5% decline in lead-test sales in 2007.

-------

1. Prepare a 2007 sales budget for McGrath & Sons assuming that they hold prices at 2006 levels_2. Prepare a 2007 sales budget for McGrath & Sons assuming that they lower the price of a lead test to

$190. Should McGrath lower the price of a lead test in 2007 if its goal is to maximize sales revenue?

6-17 Sales and production budget. The Mendez Company expects sales in 2007 of 100,000 units of serv-ing trays. Mendez's beginning inventory for 2007 is 7,000 trays; target ending inventory, 11,000 trays.Compute the number of trays budgeted for production in 2007.

6-18 Direct material budget Inglenook Co. produces wine. The company expects to produce 1,500,000two-liter bottles of Chablis in 2007. Inglenook purchases empty glass bottles from an outside vendor. Its tar-get ending inventory of such bottles is 50,000; its beginning inventory is 20,000. For simplicity, ignore break-age_ Compute the number of bottles to be purchased in 2007.

Budgeting material purchases, The Mahoney Company has prepared a sales budget of 42,000 fin-~...•units for a three-month period. The company has an inventory of 22,000 units of finished goods on

hand at December 31 and has a target finished goods inventory of 24,000 units at the end of the succeedingquarter.

Ittakes three gallons of direct materials to make one unit of finished product. The company has an inven-tory of 90,000 gallons of direct materials at December 31 and has a target ending inventory of 110,000 gal-lons at the end of the succeeding quarter. How many gallons of direct materials should be purchased dur-ing the three months ending March 31?

209

1.5

May

9,000$51.50

1.5

April

9,000$51.50

1.5

8,000$51.50

2.0

12,000$51.50

20

10,000$54.00

Januarv February March

Estimated sales in unitsSelling priceDirect manufacturing labor-

hours per unitWage per direct manufacturing

labor-hour $10.00 $10.00 $10.00 Sl1.00 $11.00

Besides wages, direct manufacturing labor-related costs include pension contributions of $0.50 perhour,worker's compensation insurance of $0.15 per hour, employee medical insurance of $0.40 per hour, andsocialsecurity taxes. Assume that as of January 1, 2007, the social security tax rates are 7.5% for employ-ersand7.5% for employees. The cost of employee benefits paid by Roletter on its employees is treated asadirect manufacturing labor cost.

6~20 Revenues and production budget. Purity, Inc., bottles and distributes mineral water from the com- l1J1pany's natural springs in northern Oregon. Purity markets two products: twelve-ounce disposable plastic 01fbottles and four-gallon reusable plastic containers. PHClldlAssis1

1. For 2007, Purity marketing managers project monthly sales of 400,000 twelve-ounce bottles and 100,000 •••• ulr•••four-gallon containers. Average selling prices are estimated at $0.25 per twelve-ounce bottle and Sl.5O perfour-gallon container. Prepare a revenues budget for Purity, Inc., for the year ending December 31 f 2007.

2. Purity begins 2007 with 900,000 twelve-ounce bottles in inventory. The vice president of operationsrequests that twelve-ounce ending inventory on December 31, 2007, be no less than 600,000 bottles.Based on sales projections as budgeted above, what is the minimum number of twelve-ounce bottlesPurity must produce during 200n

3. The VP of operations requests that ending inventory of four-gallon containers on December 31, 2007,be 200,000 units. If the production budget calls for Purity to produce 1,300,000 four-gallon containersduring 2007, what is the beginning inventory of four-gallon containers on January 1, 200n

6·21 Direct material usage, unit costs, and gross margins (continuation of 6-20). Purity, Inc., bottles anddistributesmineral water from the company's natural springs in northern Oregon. Purity markets two products:12-ouncedisposable plastic bottles and 4-gallon reusable plastic containers. The 12-ounce bottles are pur-chasedfrom Plastico, a plastics manufacturer, at a cost of 6 cents per bottle. The 4-gallon containers are ster-ilizedand put back into service at a cost of 30 cents per container. Spring water is extracted at a direct laborcostof 1 cent per 8 ounces (there are 128 ounces in a gallon). Manufacturing overhead is allocated atthe rateof 15cents per unit. (Note: A unit can be a 12-ounce bottle or a 4-gallon containerl. In 2007, the productionbudgetcalls for the production of 4,500,000 12-ounce bottles and 1,300,000 4-gallon containers.

1. Assume 4-gallon containers are fully depreciated, so the only cost incurred is that of sterilization. aequl •.•dBeginning and ending inventories for 4-gallon containers are zero. There are 500,000 empty 12-ouncebottles in beginning inventory on January 1, 2007. The vice president of operations would like to end2007with 300,000 empty 12-ounce bottles in inventory. Accounting for sterilization as the only cost ofthe 4-gallon containers, prepare a direct material usage budget (relating to both bottles and contain-ersl in both units and dollars.

2. The cost of direct manufacturing labor is captured through the extraction cost as detailed above.Based on the data given, prepare a direct manufacturing labor budget for 2007.

3. Calculate the manufacturing cost per unit for each product.4. Assuming average selling prices as in Exercise 6-20, what is the expected average gross margin per

unit for each product?5. Consider Purity's choice of the cost-allocation base for manufacturing overhead. Can you suggest

alternative cost-allocation bases?

6·22 Revenues. production. and purchases budgets. The Suzuki Co. in Japan has a division that manu-facturestwo-wheel motorcycles. Its budgeted sales for Model G in 2007 is 800,000 units. Suzuki's target end-inginventory is 100,000 units, and its beginning inventory is 120,000 units. The company's budgeted sellingpriceto its distributors and dealers is 400,000 yen (¥) per motorcycle.

Suzukibuys all its wheels from an outside supplier. No defective wheels are accepted. (Suzuki's needsforextra wheels for replacement parts are ordered by a separate division of the company.) The company's~rget ending inventory is 30,000 wheels, and its beginning inventory is 20,000 wheels. The budgeted pur-chaseprice is 16,000 yen (¥) per wheel. --------------------

1. Compute the budgeted revenues in yen. Required2. Compute the number of motorcycles to be produced.3. Compute the budgeted purchases of wheels in units and in yen.

6-23 Budgets lor production and direct manufacturing labor.ICMA, adaptedl Roletter Company makes andsellsartistic frames for pictures of weddings, graduations, and other special events. Bob Anderson, the controller,isresponsiblefor preparing Roletter's master budget and has accumulated the following information for 2007:

2007

A B C D E F1 January 2008 January 2008 BwIgl!red2 BwIgl!red Amounl of Coil Driver Used

COlt-Driver Soft Fresh Pa<k:aged3 AdM CoslDriver Rare Drinks Prodw:. Food4 Ordering Number of purchase orde•• $ 90 14 24 145 Delivery Number of deliveries $ 82 12 62 196 Shelf-stocking Hours of stocking time $ 21 16 172 947 Customer support Number of items sold $0.18 4,600 34,200 10,750

R••• ul ••••

R_qulred

If you want to use Excel to solve this exercise, go to the Excel Lab at www.prenhall.com/horngren/cost12eand download the template for Exercise 6-24.

-------1. What is the total budgeted indirect cost atthe Chelsea store in January 2008? What is the total budgeted

cost of each activity at the Chelsea store for January 2008? What is the budgeted indirect cost of eachproduct category for January 200B?

2. Which product category has the largest fraction of total budgeted indirect costs?3, Given your answer in requirement 2, what advantage does FS gain by using an activity-based approach

to budgeting over, say, allocating indirect costs to products based on cost of goods sold?

6-25 Kaizen approach to activity-based budgeting (continuation of 6-24). Family Supermarkets (FS) hasa kaizen (continuous improvement) approach to budgeting monthly activity costs for each month of 2008.Each successive month, the budgeted cost-driver rate decreases by 0.2% relative to the preceding month(so, for example, February's budgeted cost-driver rate is 0.998 times January's budgeted cost·driver rate,and March's budgeted cost-driver rate is 0.99Btimes the budgeted February 200B rate I. FS assumes that thebudgeted amount of cost-driver usage remains the same each month.

If you want to use Excel to solve this exercise, go to the Excel Lab at www.prenhall.com/horngren/cost12eand download the template for Exercise 6-24.

-----1. What is the total budgeted cost for each activity and the total budgeted indirect cost for March 200B?2. What are the benefits of using a kaizen approach to budgeting? What are the limitations of this

approach, and how might FS management overcome them?

6-26 Responsibility and controllability. Consider each of the following independent situations:

1. A very successful salesman at Amcorp Computers regularly ignores the published sales catalog andoffers lowered prices to his customers in order to close sales. The VP of sales notices that revenuesare substantially lower than budgeted.

2. Every "special deal" offered to a customer by any salesperson at Amcorp Computers has to be clearedby the VP of sales. Revenues for the second quarter have been lower than budgeted.

3. The shipping department of Amcorp has limited capacity, and sales orders are being cancelled by cus·tamers because of delays in delivery. Revenues for the past month have been lower than budgeted.

4. At Planetel Corp., a manufacturer ohelecommunications equipment, the production supervisor noticesthat a significantly larger number of direct manufacturing labor-hours were used than had been bud·geted. Investigation revealed that it was due to a decline in educational standards required by the HRdepartment when they interviewed applicants for hourly production jobs six months earlier.

5. At Planetel Corp., a relatively new production supervisor finds that more direct manufacturing labor-hours were used than had been budgeted. Interviews revealed that workers were unhappy with hismanagement style and were intentionally working slowly and inefficiently.

6. At Planetel Corp., the production supervisor traces the excessive consumption of direct materials (rela-_______ tive to the budget) to the fact that waste was high on machines that had not been properly maintained.R_qulred For each situation described, determine where (that is, with whom) (a) responsibility and (b) controlla-

bility lie. Suggest what might be done to solve the problem or to improve the situation.

Roletter has a labor contract that calls for a wage increase to $11 per hour on April 1, 2007. New labor-saving machinery has been installed and will be fully operational by March t, 2007. Roletter expects to have16,000 frames on hand at December 31,2006, and it has a policy of carrying an end-of-month inventory of

______ '_00_'1<_, of the following month's sales plus 50% of the second following month's sales.Required Prepare a production budget and a direct manufacturing labor budget for Roletter Company by month

and for the first quarter of 2007. Both budgets may be combined in one schedule. The direct manufacturinglabor budget should include labor-hours, and show the details for each labor cost category.

6-24 Activity-based budgeting. The Chelsea store of Family Supermarket (FSI. a chain of small neigh·borhood grocery stores, is preparing its activity· based budget for January 200B. FS has three product cat·egories: soft drinks, fresh produce, and packaged food. The following table shows the four activities thatconsume indirect resources at the Chelsea store, the cost drivers and their rates, and the cost-driveramount budgeted to be consumed by each activity in January 2008.

'"'"~>-•.«J::u

210

6·27 Cash flow analysis, chapter appendix. ICMA, adapted) TabComp, Inc., is a retail distributor forMZB-33 computer hardware and related software and support services. TabComp prepares annual salesforecasts of which the first six months for 2006 are presented here.

Cash sales account for 25% of TabComp's total sales, 30% of the total sales are paid by bank credit card,and the remaining 45% are on open account (TabComp's own charge accounts). The cash sales and cashfrom bank credit-card sales are received in the month of the sale. Bank credit-card sales are subject to a4% discount deducted at the time of the daily deposit. The cash receipts for sales an open account are 70%inthe month following the sale and 28% in the second month after the sale. The remaining accounts receiv-able are estimated to be uncollectible.

TabComp's month-end inventory requirements for computer hardware units are 30% of the next month'ssales.A one-month lead time is required for delivery from the manufacturer. Thus, orders for computer hard-ware units are placed on the 25th of each month to assure that they will be in the store by the first day ofthe month needed. The computer hardware units are purchased under terms of n/45 (payment in full within45 days of invoice), measured from the time the units are delivered to TabComp. TabComp's purchase pricefor the computer units is 60% of the selling price.

TobComp Inc,Soles Forecosl First Six Monlhs of 2006

Hardware Sales Software TotalUnits Dollars Sales and Support Revenues

January 130 S 390,000 $160,000 $ 550,000February 120 360,000 140,000 500,000March 110 330,000 150,000 480,000April 90 270,000 130,000 400,000May 100 300,000 125,000 425,000June 125 375,000 225,000 600,000Total Jill $2025000 ~ $2955000

1. Calculate the cash that TabComp, Inc., can expect to collect during April 2006. Be sure to show all ofyour calculations.

1. TabComp, Inc., is determining how many M2B-33 computer hardware units to order on January 25, 2006.a, Determine the projected number of computer hardware units that will be ordered.b. Calculate the dollar amount of the order that TabComp will place for these computer hardware units.

3. As part of the annual budget process, TabComp prepares a cash budget by month for the entire year.Explain why a company such as TabComp prepares a cash budget by month for the entire year.

Problems6·28 Budget schedules for a manufacturer. Sierra Furniture is an elite desk manufacturer. It makes twoproducts:

• Executive desks-3' x 5' oak desks• Chairman desks-6' x 4' red oak desks

Thebudgeted direct-cost inputs for each product in 2006 are:

Executive line Chairman line

•••• ul ••••

TargetEnding Direct Materials Inventory (3/3112006)Executive Line

Unitdata pertaining to the direct materials for March 2006 are:

Actual Beginning Direct Materials Inventory (3/1JZOO6)Executive line

Oak topRed oak topOak legsRed oak legsDirect manufacturing labor

Oak top (square feet)Red oak top {square feetlOak legsRed oak legs

Oak top (square feet)Red oak top (square feet)Oak legsRed oak legs

16 square feeto4o

3 hours

320o

100o

192o

80o

o25 square feet

o4

5 hours

Chairman line

o150

o40

Chairman Line

o200

o44

'"c0-

'"!lo,0-

'"••-0o,•~~'

l>nnoC

~"'"

211

Unit cost data for direct-cost inputs pertaining to February 2006 and March 2006 are:

February 2006 March 2006lactuall (budgetedl

Oak top (per square foot) S18 $20Red oak top (per square foot) 23 25Oak legs (per legl 11 12Red oak legs (per leg) 17 18Manufacturing labor cost per hour 30 30

Manufacturing overhead (both variable and fixed) is allocated to each desk on the basis of budgeted directmanufacturing labor-hours per desk. The budgeted variable manufacturing overhead rate for March 2006 is$35 per direct manufacturing labor-hour. The budgeted fixed manufacturing overhead for March 2006 is$42,500. Both variable and fixed manufacturing overhead costs are allocated to each unit of finished goods.

Data relating to finished goods inventory for March 2006 are:

Executive Chairman line

$165$250

Price

60,00040,000

Units

ThingoneThingtwo

Product

PIl Clade Assisl

Requl ••••

Beginning inventory in units 20 5Beginning inventory in dollars (cost) $10,480 $4,850Target ending inventory in units 30 15

Budgeted sales for March 2006 are 740 units of the executive line and 390 units of the chairman line. Thebudgeted selling prices per unit in March 2006 are $1,020 for the executive-line desk and $1,600 for thechairman-line desk. Assume the following in your answer:

• Work-in-process inventories are negligible and ignored .• Direct materials inventory and finished goods inventory are casted using the FIFO method.-Unit costs of direct materials purchased and finished goods are constant in March 2006.

R••• ul •••• 1. Prepare the following budgets for March 2006:a. Revenues budgetb. Production budget in unitsc. Direct material usage budget and direct material purchases budgetd. Direct manufacturing labor budgete. Manufacturing overhead budgetI. Ending inventory budget (direct materials and finished goodslg. Cost of goods sold budget

2. Suppose Sierra Furniture decides to incorporate continuous improvement into its budgeting process.Describe two areas where Sierra could incorporate continuous improvement into the budget sched-ules in requirement 1.

6-29 Sensitivity analysis, changing budget assumptions, kaizen approach. Chaco Chips produces twobrands of chocolate chip cookies: Chippo and Chokko. The cookies are produced from only two ingredients:chocolate chips and cookie dough. Chippo is 50% chips by weight and 50% dough, whereas Chokko is 25%chips by weight and 75% dough; there is negligible loss while baking the cookies.

Packages of either brand weigh 1 pound. Chaco Chips's master budget projects sales of 500,000 packagesof each brand in 2007, at $3 per package. Forecasted 2007 ingredients' costs are $2 per pound of chocolate chipsand $1 per pound of cookie dough. A total of 5,000 direct manufacturing labor-hours-40% for Chippo and 60%for Chokko-are budgeted, at $20 per hour. Manufacturing overhead costs are expected to be $160,000, alia·cated between the two products on the basis of packages produced. There is no beginning or ending inventory.

1. Calculate budgeted gross margins for each product and for Chaco Chips in 2007.2. By working with its current suppliers, Chaco Chips estimates it could reduce the cost of ingredients by

3%. Calculate Chaco Chips's revised budgeted gross margin in 2007.3. An analysis of all activities by a cross-functional team responsible for continuous improvement shows

that if the company purchases better-quality ingredients from a different supplier costing 5% more thanthe original ingredients, there will be fewer quality-related production line stoppages, which willreduce manufacturing overhead costs and direct manufacturing labor-hours by 2%. Calculate ChacoChips's revised 2007 budgeted gross margin under this scenario.

4. Based on bu~geted gross margin alone, which of the three scenarios here do you think Chaco Chips's man-agement would prefer? What other factors would you consider before choosing between (2) and (3) above?

6-30 Revenue and production budgets. (CPA, adaptedl The Scarborough Corporation manufactures andsells two products: Thingone and Thingtwo. In July 2006, Scarborough's budget department gathered thefollowing data to prepare budgets for 2007:

2007 Projected Sales

212

2001/nventories in Units

Product

Expected Target

January 1,2007 December 31, 2007

25,0009,000

Thingone 20,000Thingtwo 8,000

The following direct materials are used in the two products:

Amount Used per Unit

Thingtwo

531

TargetInventories

December 31, 2007

ThingoneUnitDirect Material

DirectMaterial

A pound 4B pound 2C each 0

Projected data for 2007 with respectto direct materials are as follows:

Anticipated ExpectedPurchase Inventories

Price January 1, 2007

A $12 32,000 lb. 36,000 lb.B 5 29,000 lb. 32,000 lb.C 3 6,000 units 7,000 units

Projected direct manufacturing labor requirements and rates for 2007 are as follows:

Product Hours per Unit Rate per Hour

Thingone 2 $12Thingtwo 3 16

Manufacturing overhead is allocated at the rate of £20 per direct manufacturing labor-hour.Based on the preceding projections and budget requirements for Thingone and Thingtwo, prepare the

following budgets for 2007:t Revenues budget lin dollars)2, Production budget (in units)3. Direct material purchases budget (in quantities)4. Direct material purchases budget (in dollars)5. Oirect manufacturing labor budget (in dollars)6. Budgeted finished goods inventory at December 31, 2007 (in dollars)

6·31 Budgeted income statement ICMA, adapted) Easecom Company is a manufacturer of video-conferencing products. Regular units are manufactured to meet marketing projections, and specializedunitsare made after an order is received. Maintaining the video-conferencing equipment is an importantareaof customer satisfaction. With the recent downturn in the computer industry, the video-conferencingequipmentsegment has suffered, leading to a decline in Easecom's financial performance. The followingincomestatement shows results for 2007.

R••• ul ••••

213

$7,8004,6003,200

$6,0001,800

Easecom CompanyIncome 5talement

For the Year Ended December 31. 2007 (in tbousands)Revenues:

EquipmentMaintenance contracts

Total revenuesCost of goods soldGross marginOperating costs

Marketing 600Distribution 150Customer maintenance 1,000Administration 900

Total operating costs 2,650Operating income $ 550

Easecom'smanagement team is in the process of preparing the 2008 budget and is studying the followinginfDrmati~

1. Sellin ces of equipment are expected to increase by 10% as the economic recovery begins. Thesellir ce of each maintenance contract is expected to remain unchanged from 2007.

2. Eq- It sales in units are .expected to increase by 6%, with a corresponding 6% growth in units ofmaintenance contracts.

3. Cost of each unit sold is expected to increase by 3% to pay for the necessary technology and qualityimprovements.

Re••ulred

4. Marketing costs are expected to increase by $250,000, but administration costs are expected to remainat 2007 levels.

5. Distribution costs vary in proportion to the number of units of equipment sold.6. Two maintenance technicians are to be hired at a total cost of £130,000, which covers wages and

related travel costs. The objective is to improve customer service and shorten response time.7. There is no beginning or ending inventory of equipment.

-------Prepare a budgeted income statement for the year ending December 31,2008.

6-32 Responsibility of purchasing agent.IAdapted from a description by R. Villers) Mark Richards is thepurchasing agent for the Hart Manufacturing Company. Kent Sampson is head of the Production Planningand Control Department. Every six months, Sampson gives Richards a general purchasing program.Richards gets specifications from the Engineering Department. He then selects suppliers and negotiatesprices. When he took this job, Richards was informed very clearly that he bore responsibility for meeting thegeneral purchasing program once he accepted it from Sampson.

During week 24, Richards is advised that Part No. 1234-a critical part-would be needed for assemblyon Tuesday morning of week 32. He found that the regular supplier could not deliver. He called everywhereand finally found a supplier in the Midwest who accepted the commitment.

He followed up bye-mail. Ves, the supplier assured him, the part would be ready. The matter was soimportant that on Thursday of week 31, Richards checked by phone. Yes, the shipment had left in time.Richards was reassured and did not check further. But on Tuesday of week 32, the part had not arrived.

_____ In_q~uiryrevealed that the shipment had been misdirected by the railroad and was still in Chicago.Re'lulred What department should bear the costs of time lost in the plant due to the delayed shipment? Why? As

purchasing agent, do you think it is fair that such costs be charged to your department?6-33 Activity-based budgeting. Anderson Manufacturing, Inc., manufactures two types of valves,300,000 simple valves ISV2) and tOO,OOOcomplex valves (CL9). Anderson uses activity-based costing andactivity-based budgeting. The following table contains cost-driver and budgeted indirect-cost informationfor 2007 for the different activities.

Activitv

Machining

Setups andquality assurance

Procurement

DesignMaterials handling

Cost Driver

Machine hours

Production runs

Purchase orders

Engineering hoursSquare feet of materials

handled

Items in Cost Pool (fixed cost +cost per unit of cost driver)

Indirect materials SO+ $10 per machine-hourIndirect labor S20,000 + $15 per machine-hourUtilities SO+ 55 per machine-hourIndirect materials SO+ Sl,OOO per prod. runIndirect labor $0 + $1,200 per prod. runInspection $80,000 + $2,000 per prod. runIndirect materials $0 + S4 per purch. orderIndirect labor $45,000 + $0 per purch. orderEngineering $75,000 + $50 per engg.-hourIndirect materials $0 + $2 per sq ftIndirect labor $30,000 + $0 per sq ft

Additional budget data for 2007, describing the amount of activity resources used by the two types of valvesfollows:

Quantity of Cost Driver Used By

Activity

a. Machiningb. Setups and quality assurancec. Procurementd. Designe. Materials handling

SV2

6,50020

8,00025

60,000

Cl9

3,50020

7,00075

40,000

Total Budgeted Volnme of Cost Driver

10,000 machine-hours40 production runs15,000 purchase orders100 engineering-hours100,000 square feet

5 board feet Ib.f.) per snowboard6 yards per snowboard5 hours per snowboard214

Required 1. Calculate the total budgeted cast for each activity in 2007 and the cost-driver rate for each activity.2. Use the cost-driver rates calculated in requirement 1 to calculate budgeted indirect costs allocated to

each product in total and per unit.3. What advantages might Anderson gain by using an activity-based budgeting approach over, say, an

approach that allocates the cost of these activities to products as a percentage of the cost of goods sold.

6-34 Comprehensive operating budget, budgeted balance sheet. Slopes, Inc., manufactures and sellssnowboards-"-lP..ees manufactures a single model, the Pipex. In the summer of 2006, Slopes's managementaccountant g red the following data to prepare budgets for 2007:

Materials a !JorrequirementsDirect materials

WoodFiberglass

Direct manufacturing labor

Slopes's CEO expects to sell 1,000 snowboards during 2007 at an estimated retail price of $450 per board.Further,he expects 2007 beginning inventory of 100 boards and would like to end 2007 with 200 snowboardsin stock.

Direct materials inventories

WoodFiberglass

BeginningInventorv1/1/2007

2,0001,000

EndingInventory12/31/2007

1,5002,000

Variable manufacturing overhead is $7 per direct manufacturing labor-hour. There are also S66,000 infixed manufacturing overhead costs budgeted for 2007. Slopes combines both variable and fixed manufac-turing overhead into a single rate based on direct manufacturing labor-hours. Variable marketing costs areallocated at the rate of $250 per sales visit. The marketing plan calls for 30 sales visits during 2007. Finally,there are $30,000 in fixed nonmanufacturing costs budgeted for 2007.

Other data includes:

WoodFiberglassDirect manufacturing labor

2006 Unit Price

$28.00 per b.t.$ 4.80 per yard$24.00 per hour

2007 Unit Price

$30.00 per b.f.$ 5.00 per yard$25.00 per hour

The inventoriable unit cost for ending finished goods inventory on December 31,2006, is $374.80. AssumeSlopesuses a FIFO inventory method for both direct materials and finished goods. Ignore work in processinyour calculations.

8udgeted balances at December 31, 2007, in the selected accounts are:

Cash S 10,000Properly, plant, and equipment Inetl 850,000Current liabilities 17,000Long-term liabilities 178,000Stockholders' equity 800,000

1. Prepare the 2007 revenues budget lin dollars) .2, Prepare the 2007 production budget (in units).3. Prepare the direct material usage and purchases budgets.4, Prepare a direct manufacturing labor budget.5. Prepare a manufacturing overhead budget.6. What is the budgeted manufacturing overhead rate?7. What is the budgeted manufacturing overhead cast per output unit?8, Calculate the cost of a snowboard manufactured in 2007.9. Prepare an ending inventory budget for bath direct materials and finished goods.

10. Prepare a cost of goods sold budget.11. Prepare the budgeted income statement for Slopes, Inc., for the year ending December 31, 2007.12. Prepare the budgeted balance sheet for Slopes, Inc., as of December 31,2007.

6·35 Cash budgeting, chapter appendix. Retail outlets purchase snowboards from Slopes, Inc., through-out the year. However, in anticipation of late summer and early fall purchases, outlets ramp up inventoriesfromMay through August. Outlets are billed when boards are ordered. Invoices are payable within 60 days.Frompast experience. Slopes's accountant projects 20% of invoices are paid in the month invoiced, 50% arepaidin the following month, and 30% of invoices are paid two months after the month of invoice. The aver-ageselling price per snowboard is $450.

To meet demand, Slopes increases production from April through July, because the snowboardsareproduced a month prior to their projected sale. Direct materials are purchased in the month of produc-tionand are paid for during the fallowing month Iterms are payment in full within 30 days of the invoice date).Duringthis period there is no production for inventory, and no materials are purchased for inventory.

Direct manufacturing labor and manufacturing overhead are paid monthly. Variable manufacturing over-headis incurred at the rate of $7 per direct manufacturing labar-hour. Variable marketing costs are drivenby the number of sales visits. However, there are no sales visits during the months studied. Slopes, Inc., alsoincursfixed manufacturing overhead costs of $5,500 per month and fixed nonmanufacturing overhead costsof$2,500per month.

Projected Sales

MayJuneJuly

80 units120 units200 units

AugustSeptemberOctober

100 units60 units40 units

•• "ul••••

215

216

Required

A C1 Sbuport, Inc.2 C•• h Budget for 1he Vear Ending Deeemher 31, 2007 (in thousands)34 Quarton Vearas a5 1 2 J 4 Whole6 Cash balance, beginning $ 15,000 ? ? ? ?7 Add receipts8 Collections from customers 385,000 ? ? $365,000 $1,360,0009 Total cash available for needs ? $347,000 $310,000 ? ?10 Deduct disbursements11 Direct materials 175,000 125,000 ? 155,000 ?12 Payroll ? 110,000 95,000 118,000 448,00013 Other costs 50,000 45,000 40,000 49,000 ?14 Machine>y purchese 0 ? 0 0 85,00015 Interest costs (bond) ? ? ? ? ?

16 Income taxes 15,000 14,000 12,000 ? 61,00017 Total disbursements 368,000 ? 260,000 345,000 ?18 Minimum cash balance desired ? ? ? ? 15,00019 Total cash needed ? ? ? ? 1,370,00020 Cash ",:ess (defICiency) ? $ (50.000) ? ? $ 500021 Financing ---22 Borrowing (at be!9nning) $ 0 ? $ 0 $ 0 ?23 Repayment (at end) 0 $ 0 0 (50,000) $ (50,000)24 Interest (at 12% per annum) 0 0 0 (4,500) (4,500)25 Total effects of fmancing L-.Q ? $ 0 $ (54 500) $ (4500)26 Cash balance, ending $ 32 000 ? ? $ 15.500 ?.27

$15,800

$ 12,00010,00063,600

100,000None

6-37 Cash budgeting, chapter appendix. On December 1, 2007, the Itami Wholesale Co. is attempting toproject cash receipts and disbursements through January 31,2008. On this latter date, a note will be payablein the amount of $100,000. This amount was borrowed in September to carry the company through the sea-sonal peak in November and December.

Selected general ledger balances on December 1 are:

Cash $ 10,000Accounts receivable 280,000Allowance for bad debtsInventory 87,500Accounts payable 92,000

Sales terms call for a 2% discount if payment is made within the first 10 days of the month after sale, withthe balance due by the end of the month after sale. Experience has shown that 70% of the billings will becollected within the discount period, 20% by the end of the month after purchase, and 8% in the followingmonth. The remaining 2% will be uncollectable. There are no cash sales.

The average selling price of the company's products is $100 per unit. Actual and projected sales are:

October actual $ 180,000November actual 250,000December estimated 300,000January estimated 150,000February estimated 120,000Total estimated for year ending June 30, 2008 $1,500,000

All purchases are payable within 15 days. Thus, approximately 50% of the purchases in a month are due andpayable in the next month. The average unit purchase cost is $70. Target ending inventories are 500 unitsplus 25% of the next month's unit sales.

Total budgeted marketing, distribution, and customer-service costs for the year are S400,000. Of thisamount,$150,000 are considered fixed land include depreciation of $30,000). The remainder vary with sales.Both fixed and variable marketing, distribution, and customer-service costs are paid as incurred .

Prepare a cash budget for December 2007 and January 2008. Supply supporting schedules for collec-tions of receivables; payments for merchandise; and marketing, distribution, and customer-service costs.

6-38 Comprehensive budget, fill in schedules. The manager of Newport Stationery Store is working onthe final quarter's budget for 2007. She has the following information:

1. A B

I N""1'ort Stationery Store2 BalaJu:e Sheet as of Sep1emberJO, 20073 CurrentAssets4 Cash5 Accounts ReceNoble6 Inventory7 Equipment .. net8 Liabilities as of September 30

•• qul ••••

2. I DIE I F GRecent and anticipated sales:September October November Dec:ember

$40,000 $48,000 $60,000 $80,000

H

January$36,000

3. Credit sales: Sales are 75% cash, 25% on credit. Credit accounts are all collected within 30 days of sale.The accounts receivable on September 30 are the result of September's credit sales (25% of $40,000).

4. Gross margin averages 30% of revenues. Newport treats cash discounts on purchases as "otherincome" in the income statement.

5. Monthly operating costs: Salaries and wages average 15% of revenues; rent 5%; other operating costs,excluding depreciation, 4%. These costs are paid in cash each month. Depreciation is $',000 per month.

6. Inventory purchases: Newport always keeps a basic minimum inventory of $30,000. Each month it pur-chases just enough inventory to cover the following month's sales. The inventory on September 30 is theS30,000minimum inventory plus cost of sales equal to 70% (100% - gross margin of 30%) of October'santicipated sales of $48,000 [$30,000 + 10.7x $48,0001= $63,600]. Terms on inventory purchases are 2110,n130.(Payments on purchases are to be made in 30 days; a 2% discount is available if full payment is madewithin 10days of purchase.) Newporttakes all available discounts by paying in the month of the purchase.

1. Equipment purchases: In October, Newport will spend $600 on light fixtures, and in November, $400;these amounts will be capitalized.

8. A minimum cash balance of $8,000 must be maintained. All borrowing-in multiples of $1,OOo-occursatthe beginning of the month; all repayments are made at month-end. Loans are repaid when sufficientcash is available, and interest is paid only at the time of repaying the principal. The interest rate is 18% 217

•••• ul •• d

per year. Management does not want to borrow any more cash than is necessary and wants to repayas soon as cash is available.

II you want to use Excel to solve this problem, go to the Excel Lab at www.prenhall.com/horngren/costlZeand download the template lor Problem 6-38.

-------1. Complete the lollowing schedules A through F.2. What do you think is the mostlogical type of loan lor Newport to take when it needs cash? Explain your

reasoning.3. Prepare a budgeted income statement for the fourth quarter and a budgeted balance sheet as of

December 31, 2007. Ignore income taxes.4. Some simplifications have been made in the design of this problem. What complicating factors may

arise in compiling cash and financing budgets in a business such as Newport Stationery Store?

A B1 Schedule A2 Budgeted Monthly Cash Receipts3 Item 's tember October November December4 Total sales $40,000 $48,000 $60,000 $80,0005 Credit ,ales 10,000 12,0006 Cash sales7 -- -- -- --~ceipts:8 Cash sales $36,0009 Collections on accounts receivable 10,00010 Total $46 000 -- --II Schedule B12 Budgeted Monthly Cash Disbursements for Purchases\3 Item October November December 4th uarter14 Purchases (70% of next month', sales) $42,00015 Deduct 2% cash discount t 84016 Total disbursement, $41.160

Schedule C -- -- --1718 Budgeted Monthly Cas». Disbursements for Operations19 Item October November December 4th. uarter20 Salaries and wages $ 7,20021 Rent ut

, 2,40022 Other cash operating costs ~23 Total disbursement, $11 520 -- -- --24 Schedule D25 Budgeted Total Monthly Cash Disbursements26 Item - October November 1December 4th uarter27 Purchases $41,16028 Cash operating costs 11,52029 Light fIxtures 600 t-30 Total disbursement, $53280 -- --31 Schedule E32 Budgeted Cash Receipts and Disbursements33 Item October November IDecember 4th wu1er34 Total receipts $46,00035 Total disbursements 53,28036 Net cash increase (decrease) $ (7 280) -- -- --37 Schedule F38 Financing Required39 Item October November IDecember' 4th uarter40 Beginning cash baleru:e $12,00041 Net cash increase (decrease) (7,280)42 Cash position before borrowing 4,72043 Mincmurn cash baleru:e required 8,000..,

'" 44 Cash excess (defu:iency) (3,280)w1- 45 Borrowing required 4,000•••-<: 46 Interest payments:r:u 47 Borrowing repaid

218 48 Ending cash baleru:e $ 8720 -- -- --

6-39 Budgetary slack and ethics.ICMAllt is fall 2006 and Marge Atkins, the new management accountantat Norton Company, a manufacturer of baby furniture, is working on the 2007 budget. Scott Ford, the northeastsales manager, whose sales team will easily meet its $2,000,000 sales budget this year, has projected sales ofS2,200,000in 2007. But, in conversations with individual salespeople, Atkins learns that each salesperson isexpecting to make sales of at least 20% more in 2007 than in the current year. When Atkins asks Ford about this,he says, "Well, not meeting projections is so bad for the morale of the sales team ... and you know how the topbrass froths at the mouth when we miss our target by even a little bit ... so, we give ourselves a little breathingroom." Intrigued, Atkins investigates further and finds that Pete Granger, the production manager, makes similaradjustments, padding estimated costs by about 10% to come up with the budgeted costs.

1. As a management accountant, should Marge Atkins take the position that the behavior described byScott Ford and Pete Granger is unethical? Refer to the Standards of Ethical Conduct for ManagementAccountants described in Chapter lip. 16).

2. How would you suggest Marge Atkins handle this situation?

Re••ulred

Collaborative Learning Problem

6-40 Comprehensive Review 01 Budgeting, Cash Budgeting, Chapter Appendix. Wilson Beverages bot-tles two soft drinks under license to Cadbury Schweppes at its Manchester plant. All inventory is in directmaterials and finished goods at the end of each working day. There is no work-in-process inventory.

The two soft drinks bottled by Wilson Beverages are lemonade and diet lemonade. The syrup for bothsoh drinks is purchased from Cad bury Schweppes.

Wilson Beverages uses a lot size of 1,000 cases as the unit of analysis in its budgeting. (Each case con-tains 24 bottles.) Direct materials are expressed in terms of lots, in which one lot of direct materials is theinput necessary to yield one lot (1,000 cases) of beverage. The following purchase prices are forecast fordirect materials in 2005:

lemonade Diet lemonade

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SI,100 per lot$1,000 per lot$ 800 per lot

$550,000300,000100,000

• Diet lemonade, 50 lots at $5,200 per lot

• Containers, 100 lots• Packaging, 200 lots

• Diet lemonade, 540 lots atSS,500 selling price per lot

$1,200 per lot$1,000 per lot$ 800 per lot

SyrupContainers (bottles, caps, etc.)Packaging

All direct material purchases are on account.The two soft drinks are bottled using the same equipment. The only difference in the bottling process for

thetwo soft drinks is the syrup.Summary data used in developing budgets for 2005 are

1. Sales• Lemonade, 1,080 lots at $9,000 selling price per lotAll sales are on account.

1. Beginning (January I, 20051 inventory of direct materials• Syrup for lemonade, 80 lots at $1,100 purchase price per lot • Containers, 200 lots at S950 purchase price per lot• Syrup for diet lemonade, 70 lots at $1,000 purchase price per lot • Packaging, 400 lots at $900 purchase price per lot

3. Beginning IJanuary I, 2005) inventory of finished goods• Lemonade, 100 lots at $5,300 per lot

4. Target ending IDecember 31, 2005) inventory of direct materials• Syrup for lemonade, 30 lots• Syrup for diet lemonade, 20 lots

5. Target ending (December 31, 20051 inventory of finished goods• Lemonade, 20 lots • Diet lemonade, 10 lots

6. Each lot requires 20 direct manufacturing labor-hours at the 2005 budgeted rate of $25 per hour. Directmanufacturing labor costs are paid atthe end of each month.

7. Variable manufacturing overhead is forecast to be $600 per hour of bottling time; bottling time is thetime the filling equipment is in operation. Ittakes two hours to bottle one lot of lemonade and two hoursto bottle one lot of diet lemonade. Assume all variable manufacturing overhead costs are paid duringthe same month when incurred.

Fixed manufacturing overhead is forecast to be $1,200,000for 2005. Included in the fixed manufacturingoverhead forecast is $400,000 for depreciation. All manufacturing overhead costs are paid as incurred.

8. Hours of budgeted bottling time is the sale cost~allocation base for all fixed manufacturing overhead.9. Administration costs are forecast to be 10% of the cost of goods manufactured for 2005. Marketing

costs are forecast to be 12% of revenues for 2005. Distribution costs are forecast to be 8% of revenuesfor 2005. All these costs are paid during the month when incurred. Assume there are no depreciationor amortization expenses.

10. Budgeted beginning balances on January I, 2005:

Accounts receivable (from sales)Accounts payable Ifor direct materials)Cash

g. Ending finished goods inventory budgeth, Cost of goods sold budgeti. Marketing costs budgetj. Distribution costs budgetI. Budgeted income statement

m, Cash budget

lI.qulre"

11. Budgeted ending balances on December 31, 2005:

Accounts receivable (from sales) $600,000Accounts payable (for direct materials) 400,000

12. Budgeted equipment purchase in May $1,350,00013. Estimated income tax expense for 2005 $ 625,000-------

Assume Wilson Beverages uses the first-in, first-out method for costing all inventories. On the basis of thepreceding data, prepare the following budgets for 2005:

•. Revenues budget (in dollars)b, Production budget (in unitslc. Direct materials usage budget (in units and dollars)d. Direct materials purchases budgetk. Administration costs budget (in units and dollars)e. Direct manufacturing labor budgetf. Manufacturing overhead costs budget

revisions provided as needed. Managers of each hotel meet dailyto review performance to date, and have the ability to adjustprices in the reservation system if they so choose. Adjustingprices can be particularly important if a large group cancels atthe last minute or if other unforeseen events cause occupancy todrop suddenly, as happened after the World Trade Center terror-ist attacks in 2001.

Meeting the monthly budgeted goals is primarily theresponsibility of each hotel's controller. The controller of eachhotel receives a monthly report from corporate headquartersthat shows how the hotel performed against budget, as well asagainst the actual performance of other Ritz-Carlton hotels.Ideas for boosting revenues and reducing costs are regularlyshared among hotel controllers, who recognize the value ofcontributing to the entire organization's success, not just thesuccess of their own hotel properties.

1. The Ritz-Carlton gives all employees at each of its hotelsthe chance to meet with their hotel's controller to reviewbudgets and reports on actual performance, as a form ofparticipatory budgeting. What advantages or disadvan-tages do you see with this approach?

2. What factors might affect the Ritz-Carlton's annual salesforecast for room occupancy, restaurants, and use ofmeetings rooms and conference facilities?

3. How is uncertainty handled in Ritz-Carlton's budgetingprocess?

4. The Ritz-Carlton uses responsibility accounting for its world·wide hotel and resort operations. What levels of responsibil-ity reports would you expectto see throughoutthe company?

QUESTIONS

Get Connected: Cost Accounting in the NewsGo to wwworenhall.com/hornaren/cost12eforadditional online exercise!s) that explore issues affecting theaccounting world today. These exercises offer you the opportunity to analyze and reflect on how costaccounting helps managers to make better decisions and handle the challenges of strategic planning andimplementation.

Video Case

RITZ-CARLTON HOTELS: Budgets and Responsibility Accounting

"ladies and gentlemen serving ladies and gentlemen." That'sthe motto of the Ritz-Carlton. With locations ranging from theUnited States to Bahrain to China, the grand 58-hotel chain isknown for its indulgent luxury and sumptuous surroundings.This aura of old-world elegance stands in stark contrast to itsrather heavy emphasis, behind the scenes of course, on costcontrol and budgets. Yet it is this very approach that makes itpossible for the Ritz-Carlton to offer the legendary grandeur allguests expect during their stay.

A hotel's performance is the responsibility of the generalmanager and controller at each location worldwide. local fore-casts and budgets are prepared annually and are the basis ofsubsequent performance evaluations. Preparation of the annualbudget begins with the sales budget, prepared by the hotel'ssales director. Budgeted sources of revenue include hotelrooms; convention, wedding, and meeting facilities; merchan-dise; and food and beverage. The controller then seeks inputfrom all employees-from maintenance staff to kitchen work-ers-about anticipated payroll changes, operating costs, andplanned events or promotions that might affect costs. Standardcosts, based on cost per occupied room, are used to build thebudget for guest room stays. Other standards are used for meet-ing rooms and food and beverages. The completed sales budgetand annual operating budget are sent to corporate headquar-ters. From there, actual monthly performance against plan ismonitored.

Onthe 25th of each month, budgets for the next three monthsare reviewed to be sure goals are still accurate. Accuracy can becritical for a business whose occupancy can fluctuate signifi-cantly from day to day, depending on group or company bookings,special events, or changes in local competition. Any changes arecommunicated to corporate headquarters, with explanations of

CHAPTER 6

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