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7 Chapter Planning for Profit and Cost Control Answers to Questions 1. Budgets are useful for large companies with complex activities as well as small companies. Budgets act as a vehicle for communication by formalizing managements plans in a document that communicates company objectives. The benefits associated with this kind of planning apply to all sizes of companies operating at all levels of complexity. The budget represents the companywide plans stated in financial terms as to how to coordinate operating activities to accomplish goals and objectives. Accordingly, its success depends upon the combined effort of all of the parties involved. A committee that includes representatives from all pertinent departments is necessary to formulate the master budget. The three levels of planning are as follows: (1) Strategic planning the long-run planning activities that address issues such as overall company goals and objectives. (2) Capital budgeting the intermediate financial planning activities of the entire company that concern investments, product selection, and desired profitability. (3) Operations budgeting the short-run financial planning for the companys different departments that culminates in the formation of a master budget. The span of time is the primary factor that distinguishes the three levels of planning from each other. Strategic planning involves long-range decisions; capital budgeting is associated with intermediate-range plans; and operational budgeting is concerned with short-range plans. The perpetual budget has the advantage of keeping management involved in the budget process. Too often budgets are prepared and forgotten. The perpetual budget forces management to maintain a constant focus on the companys goals and objectives. 2. 3. 4. 5. 6. The primary advantages associated with budgeting are as follows: Planning formalizes managements plans in a document that communicates company objectives. 7-1 Chapter 7 Planning for Profit and Cost Control Coordination forces departments to coordinate their activities in a manner that ensures the attainment of the objectives of the whole company. Performance measurement represents specific, quantitative standards that can be used to evaluate performance. Corrective action acts as an early warning system that promotes corrective action. 7. Budgeted amounts represent managements expectations regarding how the firm as a whole and individual departments within the firm should perform. By comparing actual performance with the expected performance (i.e., the budgeted amounts), managers can be effectively evaluated. Mr. Shilovs failure with budgets seems to stem from his misunderstanding of the human element. He states that he made budgets. Experience shows that, in general, employees are more willing to accept budget standards if they participate in the budgeting process. Further, Mr. Shilov appears to have used the budget as a tool for punishment a basis for reprimanding employees. As a result, employees would resent the budget and would be unmotivated to accomplish budget standards. A master budget consists of a series of detailed schedules and budgets that describe the overall financial plans for the forthcoming accounting period. The sales forecast normally functions as the starting point for the development of the master budget. Clearly, production and other related activities depend upon the level of sales. 8. 9. 10. 7-2 Chapter 7 Planning for Profit and Cost Control 11. The desired level of ending inventory must be added to projected sales in order to determine the amount of goods that are needed during the period. The beginning inventory is subtracted from the amount of goods needed in order to determine the amount of goods to be produced. Managing inventory is important because an inventory shortage can result in customer dissatisfaction and loss of sales. Conversely, excess inventory ties up capital investment, creates unnecessary storage cost, and is subject to obsolescence or spoilage. Finding the balance between too much and too little inventory is essential to the profitability of a company. The cash budget is composed of three major components: (1) (2) Cash receipts expected cash inflows from sales, sale of investments, and borrowing activities, etc. Cash payments expected cash outflows for inventory purchases, selling and administrative costs, and purchases of investments, etc. Financing activities expected borrowing and repayment activities. 12. (3) 13. Determining the amount of the cash balance to include on the budgeted balance sheet is an insignificant reason for preparing a cash budget. The real purpose of preparing a cash budget is to enable a company to effectively manage its financing and investing activities. If the company can foresee a cash surplus then investment opportunities can be investigated to earn interest or debt can be repaid to reduce interest. If the company anticipates a cash shortage, appropriate sources of financing can be investigated to avoid possible bankruptcy. When dealing with large amounts of money, investing, borrowing, and repayment activities that involve interest can be critical to profitability. 7-3 Chapter 7 Planning for Profit and Cost Control 14. The pro forma income statement provides information about the expected profitability of the company. The completion of this statement is dependent on the departmental operating budgets. For example, the sales budget provides information about projected sales revenues, the purchases budget provides information as to projected cost of goods sold, the selling and administrative budget provides information about projected operating expenses, and the cash budget provides information as to expected interest revenue and expense. The cash budget, like the pro forma statement of cash flows, provides information as to expected cash receipts and cash payments, but in addition it shows how a firm plans to effectively manage its cash through financing and investing activities. 15. Exercise 7-1A Ms. Whitlaw appears to be a person with an attitude problem. She does not understand how to involve her colleagues in the budgeting process. She degrades their input and uses the budget as a tool for criticism. In so doing, Ms. Whitlaw has failed to gain the support of upper-level management. The attitudes of upper-level management will have a significant impact on the effectiveness of the budget. Subordinates develop a keen awareness of management's expectations. If upper-level managers degrade, make fun of, or ignore the budget, subordinates will rapidly follow suit. If budgets are used to humiliate or embarrass subordinates, they will resent the treatment and the budgeting process that enables it. To be effective, upper-level management must accept and portray the budget as a sincere effort to express realistic goals that employees will be expected to accomplish. The proper atmosphere is essential to budgeting success. Once a negative pattern has been established, it is difficult to change. Perhaps the most effective solution in this case is to replace Ms. Whitlaw. 7-4 Chapter 7 Planning for Profit and Cost Control Exercise 7-2A a. Sales Budget Sales Cash sales Sales on account Total budgeted sales January $ 40,000 60,000 $100,000 February $ 44,000 66,000 $110,000 March $ 48,400 72,600 $121,000 b. The amount of sales revenue appearing on the 1st quarter income statement is the sum of the monthly amounts (i.e., $100,000 + $110,000 + $121,000 = $331,000). Exercise 7-3A a. Schedule of Cash Receipts Current cash sales Plus collections from accounts receivable Total budgeted collections July August September $ 40,000 $ 44,000 $ 48,400 120,000 90,000 99,000 $160,000 $134,000 $147,400 b. The current months sales on account will be collected in the following month. Accordingly, the amount of accounts receivable at the end of September is equal to Septembers sales on account (i.e., $108, 900). Exercise 7-4A a. East Div. West Div. South Div. Total b. Total 1st Quarter 2nd Quarter 3rd Quarter $260,000 $265,200 $270,504 370,000 381,100 392,533 170,000 178,500 187,425 $800,000 $824,800 $850,462 4th Quarter $275,914 404,309 196,796 $877,019 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $800,000 $824,800 $850,462 $877,019 Exercise 7-5A 7-5 Chapter 7 Planning for Profit and Cost Control a. Sales for January are expected to be $406,000 (i.e., $580,000 x .7) Beginning accounts receivable balance January sales on account Available for collection Less: ending accounts receivable balance Cash collected $ 90,400 406,000 496,400 (67,600) $428,800 b. It is reasonable to assume that sales will decline in January. Customers tend to buy merchandise in December for Christmas gifts and to cut back on buying in January immediately after Christmas. Exercise 7-6A Sales would likely be highest in late January or early February because of Valentines Day sales. October may also produce higher sales due to buying for Halloween. Other holiday seasons are also likely to boost sales. Accordingly, sales would be high in April for Easter, and November and December for Christmas. Months that would be lower would be May and June. Summer months may pick up due to children being out of school and in the malls. Similarly, sales would be expected to drop off in August and September when school reopens. 7-6 Chapter 7 Planning for Profit and Cost Control Exercise 7-7A a. Inventory Purchases Budget Budgeted cost of goods sold Plus desired ending inventory Inventory needed Less beginning inventory Required purchases (on account) b. Jan. $75,000 8,000 83,000 16,000 $67,000 Feb. $ 80,000 8,600 88,600 8,000 $ 80,600 Mar. $86,000 9,000 95,000 8,600 $86,400 The amount of cost of goods sold appearing on the first quarter income statement is the sum of the monthly amounts (i.e., $75,000 +$80,000 + $86,000 = $241,000). Since the quarter ends on March 31, the ending inventory for March is also the ending inventory for the quarter (i.e., $9,000). c. Exercise 7-8A a. Schedule of Cash Payments for Inventory Purchases April May June Payment for current accounts payable $54,000 $72,000 $90,000 Payment for previous accounts payable 4,000 6,000 8,000 Total budgeted payments for inventory $58,000 $78,000 $98,000 b. Since 90% of the current purchases on account are paid in cash during the month of purchase, 10% will remain payable at the end of the month (i.e., $100,000 x .10 = $10,000). Exercise 7-9A a. Budgeted cost goods sold for July is $373,800 (i.e., $356,000 x 1.05) 7-7 Chapter 7 Planning for Profit and Cost Control Ending inventory balance Budgeted cost of goods sold Inventory needed Less: beginning inventory balance Budgeted purchases b. $ 31,800 373,800 405,600 (36,800) $368,800 $ 44,000 295,040 $339,040 Junes payables balance paid in July Cash paid for July purchases ($368,800 x .8) Projected cash payments for July Exercise 7-10A a. Schedule of Cash Disbursements for Operating Expenses Oct. Nov. Equipment lease expense $7,000 $ 7,000 100% prior month's salary expense 0 6,400 Cleaning supplies 2,600 2,860 Insurance premium 6,000 0 Rent 1,800 1,800 Miscellaneous expenses 600 600 Total payments for operating expenses $18,000 $18,660 Depreciation is a noncash charge. Dec. $ 7,000 6,800 3,146 0 1,800 600 $19,346 b. Since salaries expense is paid in the month following the month it is incurred, the amount payable at the end of December will be the amount of salary expense incurred in December (i.e., $6,900). c. Since the insurance premium is prepaid for 6 months on October 1, the amount of prepaid insurance at the end of December will be $3,000 ($6,000 $1,000 x 3). 7-8 Chapter 7 Planning for Profit and Cost Control Exercise 7-11A a. An inventory purchases budget prepared with the sales manager's estimate: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Sales $500,000 $400,000 $360,000 $640,000 Cost of goods sold $350,000 $280,000 $252,000 $448,000 Plus: desired ending inventory 28,000 25,200 44,800 32,000 Inventory needed 378,000 305,200 296,800 480,000 Less: beginning inventory 30,000 28,000 25,200 44,800 Required purchases $348,000 $277,200 $271,600 $435,200 b. An inventory purchases budget prepared with the consultant's estimate: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Sales $550,000 $480,000 $400,000 $600,000 Cost of goods sold $385,000 $336,000 $280,000 420,000 Plus: desired ending inventory 33,600 28,000 42,000 32,000 Inventory needed 418,600 364,000 322,000 452,000 Less: beginning inventory 30,000 33,600 28,000 42,000 Required purchases $388,600 $330,400 $294,000 $410,000 Exercise 7-12A a. Budgeted payments for January: Sales commissions $20,000 Rent 15,000 Miscellaneous 2,000 Total* $37,000 *The amount of utilities is not included because the cash payment will be made in February. The amount of depreciation is not included because the depreciation does not require a cash payment. Recall that cash is paid at the time of purchase rather than when the depreciation is recognized. b. The full $5,000 balance for the utilities charge will remain payable at the end of January. c. The problem implies that the monthly charge for depreciation is $4,000. Accordingly, the amount of depreciation to be recognized on an annual income statement would be $48,000 (i.e., $4,000 x 12). Exercise 7-13A a. 7-9 Chapter 7 Planning for Profit and Cost Control Cash Budget Section 1: Cash receipts Beginning cash balance Add cash receipts Total cash available (a) Sections 2: Cash Payments For inventory purchases For S&A expenses For interest exp at 2% per month Total budgeted disbursements (b) Sections 3: Financing Activities Cash surplus (shortage) (a b=c) Borrowing (repayment) (dc) Ending cash balance (d) 1 2 July $ 42,500 180,000 222,500 165,526 54,500 0 220,026 2,474 11,526 $ 14,000 August $ 14,000 200,000 214,000 140,230 60,560 2311 201,021 12,979 1,021 $ 14,000 September $ 14,000 240,600 254,600 174,152 61,432 2512 235,835 18,765 (4,765) $ 14,000 11,526 x 2% = 231 (rounded) (11,526+1,021) x 2% = 251 (rounded). Note that $4,765 is repaid at the end of month in addition to interest that still has to be paid in September. b. Cash flow from operating activities is equal to total (i.e., sum of the monthly amounts) cash receipts from customers minus the total (i.e., sum of the monthly amounts) of cash payments for inventory, S&A expense, and interest [i.e., $620,600 ($220,026 + $201,021 + $235,835) = ($36,282) net cash outflow.] c. Cash flow from financing activities is the amount borrowed less repayments (i.e., $11,526 + $1,021 $4,765 = $7,782 net cash inflow.) 7-10 Chapter 7 Planning for Profit and Cost Control Exercise 7-14A a. Cash Collections Collections from Mays receivables balance Collections from Junes credit sales ($500,000 x .9) Cash sales from June Total cash receipts Desired cash balance Cash disbursements Total cash needs Cash shortage (amount needed to be borrowed) $ 50,000 450,000 100,000 20,000 620,000 $600,000 640,000 $40,000 b. The interest expense for June is $0 because the loan is taken at the end of June. c. The interest expense for July is $300 ($40,000 x 9% 12). 7-11 Chapter 7 Planning for Profit and Cost Control Exercise 7-15A a. Pro forma income statement prepared with Mr. Tamerons estimate: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Sales Revenue $137,500 $132,000 $145,200 $245,300 Cost of Goods Sold 82,500 79,200 87,120 147,180 Gross Profit 55,000 52,800 58,080 98,120 S. & Adm. expenses 27,500 26,400 29,040 49,060 Net Income $ 27,500 $ 26,400 $ 29,040 $ 49,060 Total $660,000 396,000 264,000 132,000 $132,000 b. Pro forma income statement prepared with Ms. Chance's estimate: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Sales Revenue $131,250 $126,000 $138,600 $234,150 Cost of Goods Sold 78,750 75,600 83,160 140,490 Gross Profit 52,500 50,400 55,440 93,660 S. & Adm. expenses 26,250 25,200 27,720 46,830 Net Income $ 26,250 $ 25,200 $ 27,720 $ 46,830 Total $630,000 378,000 252,000 126,000 $126,000 c. Forecasting is not likely to be 100% accurate. Therefore, different executive officers within the same company may have different estimates about the future. In addition to legitimate differences caused by honest opinions, self-interest may also contribute to differences. For example, Anita Chance may want to establish low budgetary figures for sales because these figures will become the standards for the evaluation of June's future performance. With low standards, she would have a better chance of reaching the standards. Problem 7-17A a. 7-12 Chapter 7 Planning for Profit and Cost Control Inventory Purchases Budget Budgeted cost of goods sold Plus desired ending inventory Inventory needed Less beginning inventory Required purchases (on account) April May $40,000 $50,000 5,000 8,000 45,000 58,000 3,600 5,000 $41,400 $53,000 June $80,000 8,600 88,600 8,000 $80,600 b. Since the quarter ends on June 30, the ending inventory for June is also the ending inventory for the quarter (i.e., $8,600). c. Schedule of Cash Payments Payment of current accounts payable Payment of previous accounts payable Total budgeted payments for inventory April May $24,840 $31,800 14,800 16,560 $39,640 $48,360 June $48,360 21,200 $69,560 d. Since 60% of the current purchases on account are paid in cash during the month of purchase, 40% will remain payable at the end of the month (i.e., $80,600 x .40 = $32,240). 7-13 Chapter 7 Planning for Profit and Cost Control Problem 7-18A This is a typical problem for what-if analysis. Students can use a computerized spreadsheet to try different possible scenarios. a. The budgeted net income for the next year: $340,000 x 115%= $391,000 Assume X = Desired sales Sales Cost of goods sold S&A = NI X 0.7 X ($60,000 + .10 X) = $391,000 .20 X $60,000 = $391,000 X = $2,255,000 Alternatively, you can use the contribution margin ratio to determine sales. Contribution margin ratio = Sales (100%) Variable costs (80%) = 20% (Net income + Fixed cost) CM ratio = ($391,000+$60,000) 20% = $2,255,000 Pro Forma Income Statement Sales Revenue Cost of Goods Sold Gross Profit Selling & Admin. Expenses Net Income $2,255,000 1,578,500 676,500 285,500* $ 391,000 *($2,255,000 x 10% + $60,000) = $285,500 % increase required: ($2,255,000 $2,000,000) $2,000,000 = 12.75% 7-14 Chapter 7 Planning for Profit and Cost Control Problem 7-18A (continued) b. Budgeted cost of goods sold with a 2% cut: $1,400,000 x 98% = $1,372,000 Budgeted gross profit: $2,000,000 $1,372,000= $628,000 The budgeted level of selling and administrative expenses: $628,000 $391,000 = $237,000 Pro Forma Income Statement Sales Revenue Cost of Goods Sold Gross Profit Selling & Admin. Expenses Net Income $2,000,000 1,372,000 628,000 237,000* $ 391,000 *The figure means that management has to cut the selling and administrative expenses by $23,000 ($237,000 $260,000) in order to reach the presidents goal. c. Projected sales revenue to increase by 15%: $2,000,000 x 115%= $2,300,000 Projected cost of goods sold: $2,300,000 x 70% = $1,610,000 Pro Forma Income Statement Sales Revenue Cost of Goods Sold Gross Profit Selling & Admin. Expenses Net Income $2,300,000 1,610,000 690,000 340,000 $ 350,000 Since the projected net income under the original scenario will be only $350,000, which is short of the original $391,000, the company cannot reach its goal. Problem 7-19A a. 7-15 Chapter 7 Planning for Profit and Cost Control Schedule of Cash Payments for S&A Expenses July Salary expense $10,000 100% prior month's sales commissions 0 Supplies expense 360 100% prior month's utilities 0 Rent 6,600 Miscellaneous 720 Total payments for S&A expenses $17,680 Depreciation is a noncash charge. August $10,000 1,440 400 1,200 6,600 720 $20,360 September $10,000 1,600 440 1,200 6,600 720 $20,560 b. Since utilities are paid in the month following the month they are incurred, the amount payable at the end of September will be the amount of utilities expense incurred in September (i.e., $1,200). c. Since sales commissions are paid in the month following the month they are incurred, the amount payable at the end of September will be the amount of sales commissions expense incurred in September (i.e., $1,760). 7-16 Chapter 7 Planning for Profit and Cost Control Problem 7-20A Cash Budget Beginning cash balance Add cash receipts Cash available (a) Less cash payments For inventory purchases For S&A expenses Interest exp at 1% per month Total budgeted payments (b) Payments minus receipts Surplus (Shortage) (a b) Financing Activity Borrowing (repayment) (c) Ending cash balance (a b + c) 1 2 January $ 8,000 100,000 108,000 90,000 31,000 4001 121,400 (13,400) 19,000 $ 5,600 February $ 5,600 106,000 111,600 72,000 32,000 5902 104,590 7,010 (2,010) $ 5,000 March $ 5,000 126,000 131,000 85,000 27,000 5703 112,570 18,430 (13,430) $ 5,000 ($40,000) x 1% = $400 ($40,000 + $19,000) x 1% = $590 3 ($40,000 + $19,000 $2,010) x 1% = $570 (rounded). 7-17 Chapter 7 Planning for Profit and Cost Control Problem 7-21A a. 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Peaches $252,000 $262,500 $315,000 $262,500 Oranges 440,000 495,000 627,000 418,000 Total $692,000 $757,500 $942,000 $680,500 Total $1,092,000 1,980,000 $3,072,000 b. Budgeted cost of goods sold: $3,072,000 x 60% = $1,843,200 Budgeted Annual Income Statement Sales Revenue $3,072,000 Cost of Goods Sold 1,843,200 Gross Profit 1,228,800 Selling & Admin. expenses 700,000 Net Income $528,800 c. Inventory purchases budget for peaches 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Sales $252,000 $262,500 $315,000 $262,500 Cost of goods sold $151,200 $157,500 $189,000 $157,500 Plus: desired ending inventory 31,500 37,800 31,500 34,000 Inventory needed 182,700 195,300 220,500 191,500 Less: beginning inventory 30,240 31,500 37,800 31,500 Required purchases $ 152,460 $163,800 $182,700 $160,000 Inventory purchases budget for oranges 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Sales $440,000 $495,000 $627,000 $418,000 Cost of goods sold $264,000 $297,000 $376,200 $250,800 Plus: desired ending inventory 59,400 75,240 50,160 56,000 Inventory needed 323,400 372,240 426,360 306,800 Less: beginning inventory 52,800 59,400 75,240 50,160 Required purchases $270,600 $312,840 $351,120 $256,640 Problem 7-22A (Note: All computations are rounded to the nearest whole dollar.) 7-18 Chapter 7 Planning for Profit and Cost Control a. & b. Sales Budget Sales Cash sales Sales on account Total budgeted sales Schedule of Cash Receipts Current cash sales Plus collections from A/R Total collections Oct. $ 48,000 72,000 $120,000 $48,000 0 $48,000 Nov. $ 60,000 90,000 $150,000 $ 60,000 72,000 $132,000 Dec. $ 75,000 112,500 $187,500 $ 75,000 90,000 $165,000 Pro Forma $112,500(a) 457,500(b) $345,000 (c) (a) Ending accounts receivable balance appearing on balance sheet. (b) Sales rev. appearing on income statement (i.e., sum of monthly amounts). (c) Cash receipts from customers on statement of cash flows (i.e. sum of monthly amounts). c. and d. Inventory Purchases Budget Budgeted cost of goods sold Plus desired ending inventory Inventory needed Less beginning inventory Required purchases (on Acct.) Oct. Nov. $72,000 $ 90,000 9,000 11,250 81,000 101,250 0 9,000 $81,000 $ 92,250 Dec. $112,500 12,000 124,500 11,250 $113,250 Pro Forma Data $274,500(a) 12,000(b) 33,975(c) Schedule of Cash Payments Budget for Inventory Purchases Pmt of current month's accts. pay. $56,700 $64,575 $ 79,275 Pmt for prior month's accts. pay. 0 24,300 27,675 Total budgeted pmts for inventory $56,700 $88,875 $106,950 252,525(d) (a) Cost of goods sold appearing on pro forma Income statement (i.e., sum of monthly amounts). (b) Ending inventory balance appearing on pro forma balance sheet. (c) Ending accounts payable balance appearing on pro forma balance sheet (i.e., $113,250 -$79,275). (d) Cash payments for inventory purchases (i.e., sum of monthly amounts). 7-19 Chapter 7 Planning for Profit and Cost Control Problem 7-22A (continued) e. and f. Selling and Administrative Expense Budget Salary expense Sales commissions 5% of sales Supplies expense 2% of sales Utilities Depreciation on store equipment Rent Miscellaneous Total S&A expenses before Interest Oct. Nov. $18,000 $18,000 6,000 7,500 2,400 3,000 1,400 1,400 4,000 4,000 4,800 4,800 1,200 1,200 $37,800 $39,900 Dec. $18,000 9,375 3,750 1,400 4,000 4,800 1,200 $42,525 Pro Forma Data $ 9,375(a) 1,400(b) 12,000(c) 120,225(d) The determination of interest expense is shown in the cash budget. Schedule of Cash Payments for S&A Expenses Salary expense $18,000 $18,000 100% prior month's sales comm. 0 6,000 Supplies expense 2,400 3,000 100% prior month's utilities 0 1,400 Depreciation on store equipment 0 0 Rent 4,800 4,800 Miscellaneous 1,200 1,200 Total payments for S&A exp. $26,400 $34,400 Depreciation is a noncash charge. $18,000 7,500 3,750 1,400 0 4,800 1,200 $36,650 $97,450 (e) (a) Ending sales commissions payable account balance shown on pro forma balance sheet. (b) Ending utilities payable account balance shown on pro forma balance sheet. (c) Accumulated depreciation appears on the pro forma balance sheet (i.e., sum of monthly amounts). (d) S&A expense appearing on pro forma income statement (i.e., sum of monthly amounts). (e)Cash payments for S&A expenses (i.e., sum of monthly amounts). 7-20 Chapter 7 Planning for Profit and Cost Control Problem 7-22A (continued) g. Cash Budget Beginning cash balance Add cash receipts Cash available (w) Less payments For inventory purchases For S&A expenses Purchase of store fixtures Interest expense* (z) Total budgeted payments (x) Payments minus receipts Surplus (Shortage) (wx) Financing Activity Borrowing (repayment) (y) Ending cash bal. (w x+ y) Oct. $ 0 48,000 48,000 56,700 26,400 164,000 0 247,100 (199,100) 212,000 $ 12,900 Nov. $ 12,900 132,000 144,900 88,875 34,400 0 2,120 125,395 19,505 Dec. $ 12,000 165,000 177,000 106,950 36,650 0 2,045 145,645 31,355 185,140(e) 12,000(g) Pro Forma Data $345,000(a) 252,525(b) 97,450(c) 164,000(d) 4,165 (f) (7,505) (19,355) $ 12,000 $ 12,000 *Oct. ($0 x .01); Nov. ( $212,000 x .01); Dec. [( $212,000 $7,505) x.01] (a) Operating activities section of pro forma Statement of Cash Flows (i.e., sum of monthly amounts). (b) Operating activities section of pro forma Statement of Cash Flows (i.e., sum of monthly amounts). (c) Operating activities section of pro forma Statement of Cash Flows (i.e., sum of monthly amounts). (d) Investing activities section of pro forma Statement of Cash Flows. The investment in store fixtures also appears on the pro forma balance sheet. (e) Financing activities section of pro forma Statement of Cash Flows (i.e., sum of monthly amounts). (f) Operating activities section of pro forma Statement of Cash Flows (i.e., sum of monthly amounts). (g) The ending cash balance appears on the pro forma balance sheet and as the last item in the statement of cash flows. 7-21 Chapter 7 Planning for Profit and Cost Control Problem 7-22A (continued) h. Thigpen Company Pro Forma Income Statement For the Quarter Ended December 31, 2007 Sales Revenue $457,500 Cost of Goods Sold (274,500) Gross Margin 183,000 S&A Expenses (120,225) Operating Income 62,775 Interest Expense (4,165) Net Income $ 58,610 i. Thigpen Company Pro Forma Balance Sheet As of December 31, 2007 $ 12,000 112,500 12,000 $164,000 (12,000) 152,000 $288,500 $ 33,975 1,400 9,375 185,140 58,610 $288,500 Assets Cash Accounts Receivable Inventory Store Equipment Accumulated Depreciation Book Value of Equipment Total Assets Liabilities Accounts Payable Utilities Payable Sales Commissions Payable Line of Credit Liability Equity Retained Earnings Total Liabilities and Equity Problem 7-22A (continued) 7-22 Chapter 7 Planning for Profit and Cost Control j. Thigpen Company Pro Forma Statement of Cash Flows For the Quarter Ended December 31, 2007 Cash Flow From Operating Activities Cash receipts from Customers Cash payments for Inventory Cash payments for S&A Expenses Cash payments for Interest Expense Net cash Flow from Operating Activities Cash Flow From Investing Activities Cash Outflow to Purchase Fixtures Cash Flow From Financing Activities Net Inflow from Line of Credit Net Change in Cash Plus Beginning Cash Balance Ending Cash Balance $ 345,000 (252,525) (97,450) (4,165) $ (9,140) (164,000) 185,140 12,000 0 $ 12,000 Problem 7-23A a. Pro forma income statement assuming 5% growth: Sales Revenue Cost of Goods Sold Gross Profit Selling & Admin. Expenses Net Income Budget $3,780,000 2,268,000 1,512,000 756,000 $ 756,000 7-23 Chapter 7 Planning for Profit and Cost Control Problem 7-23A (continued) b. Pro forma income statement assuming 10% growth: Sales Revenue Cost of Goods Sold Gross Profit Selling & Admin. Expenses Net Income Actual Result $3,960,000 2,376,000 1,584,000 792,000 $ 792,000 Excess of actual net income over budget: $792,000 $756,000 = $36,000 Bonus: $36,000 x 20% = $7,200 c. Pro forma income statement assuming 15% growth: Sales Revenue Cost of Goods Sold Gross Profit Selling & Admin. Expenses Net Income d. e. Zero The process of participative budgeting is recommended. This process requires two-way communication between the president and divisional vice presidents. Any disagreement about the budget assumptions should be fully discussed and pros and cons well considered. If the president believes that the divisional budget is unrealistic, he should tell the vice president directly and explain the reasons. Participative budgeting is more than just a budget proposal from a subordinate and a review and final decision by the superior. The process described in the problem is nothing but gamesmanship. Budget $4,140,000 2,484,000 1,656,000 828,000 $ 828,000 Exercise 7-1B 7-24 Chapter 7 Planning for Profit and Cost Control The primary deficiencies in Howards budgeting process are the absence of leadership and top management participation and the failure of the controller and department managers to coordinate their efforts. As a result of these flaws, department managers proposed budgets that would satisfy their individual needs at the expense of the companys best interests. Ms. Pruett should have established general corporate goals early in the budgeting process. She neednt dictate company goals based on her personal ambitions; rather, she could have created a high-level committee to evaluate the companys long-term competitive position in the market and to advise her regarding possible alternative future company goals. Once top management establishes company goals, individual departments should propose department-level goals and budgets to support the companys general goals. Mr. Snowden should have coordinated the budgeting process among the different departments to ensure that they would propose individual budgets in support of the companys overall goals. Exercise 7-2B a. Revenues Budget Food sales Beverage and liquor sales Total budgeted revenues b. Jul $20,000 12,000 $32,000 Aug Sep $21,000 $22,050 12,600 13,230 $33,600 $35,280 The total revenue Addisons will report on the 3rd quarter pro forma income statement is the sum of the monthly amounts, $32,000 + $33,600 + $35,280 = $100,880. 7-25 Chapter 7 Planning for Profit and Cost Control Exercise 7-3B a. Schedule of Cash Receipts Current cash sales Plus collections from accounts receivable Total budgeted collections April $120,000 430,000 $550,000 May $132,000 480,000 $612,000 June $124,000 568,000 $692,000 b. Since the current months sales on account will be collected in the following month, the amount of accounts receivable at the end of June is equal to Junes credit sales of $500,000. Exercise 7-4B a. This Quarter 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Falcon $ 250,000 $ 260,000 $ 270,400 $ 281,216 $ 292,465 Ammons 350,000 353,500 357,035 360,605 364,211 Ocean 450,000 463,500 477,405 491,727 506,479 Total $1,050,000 $1,077,000 $1,104,840 $1,133,548 $1,163,155 b. Corporate Budget Budgeted 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Annual $1,077,000 $1,104,840 $1,133,548 $1,163,155 $4,478,543 Income Exercise 7-5B a. The expected cash collections in July are 50% of that months expected sales revenues. The computation follows: $100,000 x 50% = $50,000 b. The expected cash collections in August are the sum of 50% of Julys expected revenues and 50% of Augusts expected revenues. The computation $100,000 follows: x 50% + $120,000 x 50% = $110,000 Exercise 7-6B Sales would likely be high in February because of Valentines Day sales, in May because of Mothers Day sales, in June because of Fathers Day sales, and in December because of Christmas sales. Sales should be 7-26 Chapter 7 Planning for Profit and Cost Control relatively stable in other months since birthdays and other personal events occur in a normal distribution pattern. Exercise 7-7B a. Inventory Purchases Budget January February Budgeted cost of goods sold $40,000 $35,000 Plus desired ending inventory 7,000 9,600 Inventory needed 47,000 44,600 Less beginning inventory 8,000 7,000 Required purchases (on account) $39,000 $37,600 March $48,000 10,000 58,000 9,600 $48,400 b. The amount of cost of goods sold reported on the first quarter income statement is the sum of the monthly amounts, $40,000 + $35,000 + $48,000 = $123,000. c. Since the quarter ends on March 31, the ending inventory for March is also the ending inventory for the quarter, $10,000. Exercise 7-8B a. Schedule of Cash Payments for Inventory Purchases Oct. Nov. Dec. Payment for current accounts payable $17,500 $16,800 $21,700 Payment for previous accounts payable 6,000 7,500 7,200 Total budgeted payments for inventory $23,500 $24,300 $28,900 Since 70% of current accounts payable are paid in cash in the month of purchase, 30% will remain payable at the end of any month ($31,000 x .30 = $9,300 at the end of December). Exercise 7-9B b. a. Budgeted cost goods sold for February is $410,000 ($400,000 x 1.025). Desired February ending inventory balance Budgeted cost of goods sold Inventory needed in February Less: beginning inventory balance (January) 7-27 $ 25,000 410,000 435,000 (22,000) Chapter 7 Planning for Profit and Cost Control Budgeted February purchases b. Januarys payables balance paid in February Cash paid for February purchases ($413,000 x .6) Projected cash payments for February Exercise 7-10B a. $413,000 $ 30,000 247,800 $277,80 0 Schedule of Cash Payments for Selling and Administrative Expenses January February March Equipment depreciation* $ 0 $ 0 $ 0 100% of prior month's salary expense 0 2,900 2,700 Cleaning supplies 1,000 940 1,100 Insurance premium 7,200 0 0 Equipment maintenance expense 500 500 500 Leases expense 1,600 1,600 1,600 Miscellaneous expenses 400 400 400 Total payments for S&A expenses $10,700 $6,340 $6,300 *Depreciation is a noncash charge. b. Since salary expense is paid in the month following the month it is incurred, the amount payable at the end of March will be the amount of salary expense incurred in March ($3,050). c. Since the annual insurance premium is prepaid on January 1, the amount of prepaid insurance at the end of March will be $5,400 [$7,200 ($600 x 3)]. Exercise 7-11B a. An inventory purchases budget prepared with Jennys estimate: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Sales $320,000 $400,000 $280,000 $360,000 Cost of goods sold $192,000 $240,000 $168,000 $216,000 Plus: ending inventory 36,000 25,200 32,400 35,000 Inventory needed 228,000 265,200 200,400 251,000 Less: beginning inventory 25,000 36,000 25,200 32,400 7-28 Chapter 7 Planning for Profit and Cost Control Required purchases $203,000 $229,200 $175,200 $218,600 b. An inventory purchases budget prepared with Haley's estimate: 1st Quarter 2nd Quarter Sales $280,000 $300,000 Cost of goods sold $168,000 $180,000 Plus: ending inventory 27,000 28,800 Inventory needed 195,000 208,800 Less: beginning inventory 25,000 27,000 Required purchases $170,000 $181,800 3rd Quarter 4th Quarter $320,000 $400,000 $192,000 $240,000 36,000 35,000 228,000 275,000 28,800 36,000 $199,200 $239,000 Exercise 7-12B a. Budgeted payments for January 2008: Office lease Utilities Office supplies Miscellaneous Total* $ 5,000 1,600 2,400 1,000 $10,000 *The referral fees are not included because cash payment for them will be made in February. The depreciation is not included because depreciation does not require a cash payment. Cash for depreciable assets is paid when the assets are purchased rather than when depreciation is recognized. b. The full $5,000 balance for the referral fees will remain payable at the end of January. c. Since the office lease is $5,000 each month, the annual lease expense will be $60,000 ($5,000 x 12). Exercise 7-13B a. Cash Budget Beginning cash balance Add cash receipts Cash available (a) Less disbursements For inventory purchases For S&A expenses Interest exp. at 1% per month Total budgeted disbursements (b) July $ 16,000 180,000 196,000 158,000 37,000 0 195,000 August $ 4,000 192,000 196,000 153,000 36,000 301 189,030 September $ 4,000 208,000 212,000 171,000 39,000 0 210,000 7-29 Chapter 7 Planning for Profit and Cost Control Cash surplus (shortage) (ab) Financing activity Borrowing (repayment) (c) Ending cash balance (a b + c) 1 2 1,000 6,970 $ 2,000 2,000 4,000 3,000 (2,970) $ 4,000 $ 4,000 $3,000 x 1 % = $30 ($3,000 $2,970) x 1% = 0 (rounded) b. Net cash flows from operating activities equals total (sum of the monthly amounts) cash receipts from customers minus total (sum of the monthly amounts) cash payments for inventory, S&A expenses, and interest. The computation follows: ($180,000 + $192,000 + $208,000) ($195,000 + $189,030 + $210,000) = $580,000 $594,030 = $(14,030) Net cash Outflow c. Cash flow from financing activities is the amount borrowed less repayments. The computation follows: $3,000 $2,970 + $2,000 = $2,030 Net cash Inflow 7-30 Chapter 7 Planning for Profit and Cost Control Exercise 7-14B a. Cash Collections Collections from June 30 receivables balance Collections from Julys credit sales ($320,000 x .75) July cash sales Total cash receipts in July Desired cash balance Cash disbursements in July Total July cash needs Cash shortage (amount to borrow) $ 40,000 240,000 74,000 15,000 400,000 $354,000 415,000 $ 61,000 b. There will be no interest reported on July pro forma income statement because money was borrowed on the last date of the month. c. Estimated Interest expense for August is $610 [$61,000 x (12% Exercise 7-15B a. Pro forma income statement prepared with Mr. Stulls estimate: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Sales Revenue $252,000 $210,000 $226,800 $329,700 Cost of Goods Sold 126,000 105,000 113,400 164,850 Gross Margin 126,000 105,000 113,400 164,850 S&A Expenses 31,500 26,250 28,350 41,213* Net Income $ 94,500 $ 78,750 $ 85,050 $123,637 *rounded Total $1,018,500 509,250 509,250 127,313 $ 381,937 12)]. b. Pro forma income statement prepared with Ms. Simpsons estimate: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Sales Revenue $259,200 $216,000 $233,280 $339,120 Cost of Goods Sold 129,600 108,000 116,640 169,560 Gross Margin 129,600 108,000 116,640 169,560 S&A Expenses 32,400 27,000 29,160 42,390 Net Income $ 97,200 $ 81,000 $ 87,480 $127,170 Total $1,047,600 523,800 523,800 130,950 $ 392,850 7-31 Chapter 7 Planning for Profit and Cost Control Exercise 7-15B (continued) c. Forecasting is not likely to be 100% accurate. It is based on inexact factors such as judgment and economic predictions. Different executive officers in the same company will probably have different future expectations. In addition to legitimate differences of opinion, self-interest may also contribute to disagreement. For example, Brian Stull, who deals with customers credit problems and uncollectible accounts, may want stricter criteria for granting customer credit, which would naturally result in lower sales growth. On the other hand, May Simpson, who deals with market potential and sales commissions, may want looser criteria for customer credit, which would result in greater sales growth. Problem 7-16B a. Sales Budget Sales on Account January $840,000 February Total $924,000 $1,764,000 b. Sales revenue for January and February is equal to the sum of the monthly amounts (i.e., $840,000 + $924,000 = $1,764,000). c. Schedule of Cash Receipts Receipts from December Sales Receipts from January Sales Receipts from January Sales Receipts from February Sales Receipts from February Sales Total January $140,000 672,000 February $168,000 739,200 $812,000 $907,200 d. The accounts receivable as of February 28, 2007 is equal to the amount due to be collected in March, $184,800 (i.e., $924,000 x 20%). Problem 7-17B a. 7-32 Chapter 7 Planning for Profit and Cost Control Inventory Purchases Budget Budgeted cost of goods sold Plus desired ending inventory Inventory needed Less beginning inventory Required purchases (on account) *$800,000 x .75 x .20 = 120,000 Oct. $480,000 115,200 595,200 90,000 $505,200 Nov. Dec. $576,000 $720,000 144,000 120,000* 720,000 840,000 115,200 144,000 $604,800 $696,000 b. Since the quarter ends on December 31, the ending inventory for December is also the ending inventory for the quarter (i.e., $120,000). c. Schedule of Cash Payments Payment of current accounts payable Payment of previous accounts payable Total budgeted payments for inventory Oct. $353,640 90,000 $443,640 Nov. Dec. $423,360 $487,200 151,560 181,440 $574,920 $668,640 d. Since the quarter ends on December 31, the ending accounts payable balance for December is the balance in accounts payable that will appear on the end of quarter pro forma balance sheet. 70% of the current purchases on account are paid in cash during the month of purchase; therefore, 30% will remain payable at the end of the month (i.e., $696,000 x .30 = $208,800). 7-33 Chapter 7 Planning for Profit and Cost Control Problem 7-18B This is a typical problem for what-if analysis. Students can use a computerized spreadsheet to try different possible scenarios. Budgeted net income for the next year: $60,000 x 120%= $72,000 Budgeted cost of goods sold for the next year: $350,000 $500,000 = 70% of sales Budgeted selling and administrative expenses for the next year: $68,000 +10% of sales. a. The budgeted sales that meet the goal: If sales = X Sales Cost of goods sold S&A expenses = NI 1X .70X ($68,000 + .10X) = $72,000 .20X $68,000 = $72,000 .20X = $140,000 X = $700,000 ($700,000 $500,000) $500,000 = 40% increase in sales Pro Forma Income Statement Sales Revenue Cost of Goods Sold Gross Profit Selling & Admin. Expenses Net Income $700,000 490,000 210,000 138,000* $ 72,000 *($700,000 x 10% + $68,000) = $138,000 b. Budgeted cost of goods sold with a 3% cut: $350,000 x 97% = $339,500 Budgeted gross profit: $500,000 $339,500= $160,500 The budgeted level of selling and administrative expenses: If X = S&A expenses Gross Profit X = $72,000 $160,500 X = $72,000 X = $88,500 7-34 Chapter 7 Planning for Profit and Cost Control Problem 7-18B (continued) Pro Forma Income Statement Sales Revenue $500,000 Cost of Goods Sold 339,500 Gross Profit 160,500 Selling & Admin. Expenses 88,500* Net Income $ 72,000 *The figure means that management has to cut the selling and administrative expenses by $1,500 in order to reach Mr. Lowerys goal. c. Projected sales revenue to increase by 25%: $500,000 x 125%= $625,000 Projected cost of goods sold: $625,000 x 70% = $437,500 Pro Forma Income Statement Sales Revenue $625,000 Cost of Goods Sold 437,500 Gross Profit 187,500 Selling & Admin. Expenses 150,000 Net Income $ 37,500 Since the projected net income under the given scenario will be only $37,500, which is far short of the original $60,000 and the desired $72,000, the company cannot reach its goal. 7-35 Chapter 7 Planning for Profit and Cost Control Problem 7-19B a. Schedule of Cash Payments for S&A Expenses Jan. Salary expense $ 8,000 Prior month's sales commissions 0 Prior month's advertising expense 0 Prior month's telephone expense 0 Rent 10,000 Miscellaneous 800 Total payments for S&A expenses $18,800 Depreciation is a noncash charge. Feb. Mar. $ 8,000 $ 8,000 600 640 500 500 1,000 1,080 10,000 10,000 800 800 $20,900 $21,020 b. Since telephone expense is paid in the month following the month it is incurred, the amount payable at the end of March will be the amount of telephone expense incurred in March (i.e., $1,100). c. Since sales commissions are paid in the month following the month they are incurred, the amount payable at the end of February will be the amount of sales commissions expense incurred in February (i.e., $640). 7-36 Chapter 7 Planning for Profit and Cost Control Problem 7-20B Cash Budget Beginning cash balance Add cash receipts Cash available (a) Less cash payments For inventory purchases For S&A expenses Interest exp at 1% per month Total budgeted payments (b) Payments minus receipts Surplus (shortage) (ab) Financing Activity Borrowing (repayment) (c) Ending cash balance (a b + c) 1 2 April $ 36,000 320,000 356,000 410,000 80,000 01 490,000 (134,000) 194,000 $ 60,000 May $ 60,000 470,000 530,000 420,000 106,000 2,9102 528,910 1,090 59,000 $ 60,090 June $ 60,090 624,000 684,090 464,000 132,000 3,7953 599,795 84,295 (24,295) $ 60,000 $0 x 1.5% = $0 194,000 x 1.5% = $2,910 3 ($194,000 + $59,000) x 1.5% = $3,795 Problem 7-21B When necessary, all computations are rounded to the nearest dollar. a. 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Total Computer $550,000 $605,000 $682,000 $ 803,000 $2,640,000 Calculator 260,000 286,000 301,600 338,000 1,185,600 Total $810,000 $891,000 $983,600 $1,141,000 $3,825,600 7-37 Chapter 7 Planning for Profit and Cost Control Problem 7-21B (continued) b. Budgeted cost of goods sold: $3,825,600 x 75% = $2,869,200 Budgeted Annual Income Statement Sales Revenue $3,825,600 Cost of Goods Sold 2,869,200 Gross Profit 956,400 Selling & Admin. expenses 500,000 Net Income $ 456,400 c. Inventory purchases budget for palm-size computers: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Sales Cost of goods sold Plus: desired ending inventory Inventory needed Less: beginning inventory Required purchases $550,000 $412,500 45,375 457,875 78,000 $379,875 $605,000 $453,750 51,150 504,900 45,375 $459,525 $682,000 $511,500 60,225 571,725 51,150 $520,575 $803,000 $602,250 88,000 690,250 60,225 $630,025 Inventory purchases budget for programmable calculators: 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Sales Cost of goods sold Plus: desired ending inventory Inventory needed Less: beginning inventory Required purchases $260,000 $286,000 $195,000 21,450 216,450 32,000 $184,450 $214,500 22,620 237,120 21,450 $215,670 $301,600 $226,200 25,350 251,550 22,620 $228,930 $338,000 $253,500 42,000 295,500 25,350 $270,150 7-38 Chapter 7 Planning for Profit and Cost Control Problem 7-22B (Note: All computations are rounded to the nearest whole dollar.) a. & b. Sales Budget Sales Cash sales Sales on account Total budgeted sales Schedule of Cash Receipts Current cash sales Plus collections from accts. rec. Total collections Jan. $ 75,000 175,000 $250,000 $ 75,000 0 $75,000 Feb. $ 82,500 192,500 $275,000 $ 82,500 175,000 $257,500 Mar. $ 90,750 211,750 $302,500 $ 90,750 192,500 $283,250 Pro Forma Data $211,750(a) 827,500(b) $615,750 (c) (a) Ending accounts receivable balance appearing on balance sheet. (b) Sales Rev. appearing on income statement (i.e., sum of monthly amounts). (c) Cash receipts from customers on statement of cash flows (i.e., sum of monthly amounts). c. and d. Inventory Purchases Budget Budgeted cost of goods sold Plus desired ending inventory Inventory needed Less beginning inventory Required purchases (on Acct.) Jan. $125,000 27,500 152,500 0 $152,500 Feb. Mar. $137,500 $151,250 30,250 33,000 167,750 184,250 27,500 30,250 $140,250 $154,000 Pro Forma Data $413,750(a) 33,000(b) 61,600(c) Schedule of Cash Payments Budget for Inventory Purchases Pmt of current month's A/P $91,500 $ 84,150 $ 92,400 Pmt for prior month's A/P 0 61,000 56,100 Total budgeted Pmts for Invent. $91,500 $145,150 $148,500 $385,150(d) (a) Cost of goods sold appearing on pro forma income statement (i.e., sum of monthly amounts). (b) Ending inventory balance appearing on pro forma balance sheet. (c) Ending accounts payable balance appearing on pro forma balance sheet (i.e., $154,000 x .4). (d) Cash payments for inventory purchases on statement of cash flows (i.e., sum of monthly amounts). 7-39 Chapter 7 Planning for Profit and Cost Control Problem 7-22B (continued) e. and f. Selling and Administrative Expense Budget Salary expense Sales commissions 8% sales Supplies expense 4% sales Utilities Depreciation on store equipment Rent Miscellaneous Total S&A expenses before interest Jan. $25,000 20,000 10,000 1,800 5,000 7,200 2,000 $71,000 Feb. Mar. $25,000 $25,000 22,000 24,200 11,000 12,100 1,800 1,800 5,000 5,000 7,200 7,200 2,000 2,000 $74,000 $77,300 Pro Forma Data $24,200(a) 1,800(b) 15,000(c) 222,300(d) The determination of interest expense is shown in the cash budget. Schedule of Cash Payments for S&A Expenses Salary expense $25,000 $25,000 $25,000 100% prior month's sales comm. 0 20,000 22,000 Supplies expense 10,000 11,000 12,100 100% prior month's utilities 0 1,800 1,800 Depreciation on store equipment 0 0 0 Rent 7,200 7,200 7,200 Miscellaneous 2,000 2,000 2,000 Total payments for S&A exp. $44,200 $67,000 $70,100 $181,300(e) Depreciation is a noncash charge. (a) Ending sales commissions payable account balance shown on pro forma balance sheet. (b) Ending utilities payable account balance shown on pro forma balance sheet. (c) Accumulated depreciation appears on the pro forma balance sheet (i.e., sum of monthly amounts). (d) S&A expense appearing on pro forma income statement (i.e., sum of monthly amounts). (e) Cash payments for S&A expenses on statement of cash flows (i.e., sum of monthly amounts). Problem 7-22B (continued) 7-40 Chapter 7 Planning for Profit and Cost Control g. Cash Budget Jan. Beginning cash balance Add cash receipts Cash available (w) Less payments For inventory purchases For S&A expenses Purchase of store fixtures Interest expense* Total budgeted payments (x) Payments minus receipts Surplus (shortage) (wx) Financing activity Borrowing (repayment) (y) Ending cash balance (w x+ y) $ 0 75,000 75,000 91,500 44,200 350,000 0 485,700 (410,700) 461,000 $ 50,300 Feb. Mar. $ 50,300 $ 50,000 257,500 283,250 307,800 333,250 145,150 67,000 0 6,915 219,065 88,735 (38,735) $ 50,000 148,500 70,100 0 6,334 224,934 108,316 (58,316) $50,000 Pro Forma Data $615,750(a) 385,150(b) 181,300(c) 350,000(d) 13,249(f) 363,949(e) 50,000(g) *Jan. ($0 x .015); Feb. ($461,000 x .015); Mar. [($461,000 $38,735) x .015] (a) Operating activities section of pro forma statement of cash flows (i.e., sum of monthly amounts). (b) Operating activities section of pro forma statement of cash flows (i.e., sum of monthly amounts). (c) Operating activities section of pro forma statement of cash flows (i.e., sum of monthly amounts). (d) Investing activities section of pro forma statement of cash flows. The investment in store fixtures also appears on the pro forma balance sheet. (e) Financing activities section of pro forma statement of cash flows (i.e., sum of monthly amounts). (f) Operating activities section of pro forma statement of cash flows (i.e., sum of monthly amounts). (g) The ending cash balance appears on the pro forma balance sheet and as the last item in the statement of cash flows. 7-41 Chapter 7 Planning for Profit and Cost Control Problem 7-22B (continued) h. World Gifts Corporation Pro Forma Income Statement For the Quarter Ended March 31, 2008 Sales Revenue $827,500 Cost of Goods Sold (413,750) Gross Margin 413,750 S&A Expenses (222,300) Operating Income 191,450 Interest Expense (13,249) Net Income $178,201 i. World Gifts Corporation Pro Forma Balance Sheet March 31, 2008 $ 50,000 211,750 33,000 $350,000 (15,000) 335,000 $629,750 $ 61,600 24,200 1,800 363,949 178,201 $629,750 Assets Cash Accounts Receivable Inventory Store Equipment Accumulated Depreciation Book Value of Equipment Total Assets Liabilities Accounts Payable Sales Commissions Payable Utilities Payable Line of Credit Equity Retained Earnings Total Liabilities and Equity 7-42 Chapter 7 Planning for Profit and Cost Control Problem 7-22B (continued) j. World Gifts Corporation Pro Forma Statement of Cash Flows For the Quarter Ended March 31, 2008 Cash Flow From Operating Activities Cash Receipts from Customers Cash Payments for Inventory Cash Payments for S&A Expenses Cash Payments for Interest Expense Net Cash Flow from Operating Activities Cash Flow From Investing Activities Cash Outflow to purchase Fixtures Cash Flow From Financing Activities Net Inflow from Line-of-Credit Net Change in Cash Plus Beginning Cash Balance Ending Cash Balance $615,750 (385,150) (181,300) (13,249) $ 36,051 (350,000) 363,949 50,000 0 $ 50,000 Problem 7-23B a. Pro forma income statement assuming a 4% annual growth rate: Sales Revenue Cost of Goods Sold Gross Profit Selling & Admin. Expenses Net Income Problem 7-23B (continued) b. Pro forma income statement assuming a 8% annual growth rate: 7-43 Budget $9,984,000 5,491,200 4,492,800 1,996,800 $2,496,000 Chapter 7 Planning for Profit and Cost Control Sales Revenue Cost of Goods Sold Gross Profit Selling & Admin. Expenses Net Income c. Budget $10,368,000 5,702,400 4,665,600 2,073,600 $2,592,000 Excess of actual net income over budget: 2,592,000 $2,496,000 = $96,000 Bonus: $96,000 x 10% = $9,600 d. The process of participative budgeting is recommended. This process requires two-way communication between the president and divisional directors. Any disagreement on budget assumptions should be fully discussed and pros and cons well considered. If the president believes that the divisional budget is unrealistic, he/she should tell the vice president directly and explain the reasons. Participative budgeting is more than just a submission of a budget proposal from a subordinate and a review and final decision by the superior. The process described in the problem is nothing but gamesmanship. It would be unethical if Ms. Pender proposes only a 4% growth rate because it not only reflects a dishonest estimate but also results in Ms. Penders personal gain at the expense of her employer. On the other hand, the company's plan to use the excess of actual income over budget as the basis for bonuses is an invitation for unethical behavior. 7-44 Chapter 7 Planning for Profit and Cost Control ATC 7-1 a. Budgeted Financial Statements Income Statement Sales Revenue Cost of Goods Sold Depreciation Expense Other Expense Operating Income Interest Expense Net Income Statement of Cash Flows Operating Activities: Inflows from sales Outflows for: Purchase of food, etc. Other initial expenses Interest Expense NCF Operating Activities Investing Activities: Outflow for purchase of cart Financing Activities: Inflows from: Contribution by owners Loan from parents Financing Act. Net Change in Cash Plus beginning cash Ending cash balance Amounts $76,800 (46,800) (1,667) (1,200) 27,133 (270) $26,863 Computations 12 x $6,400 12 x $3,900 ($4,000 $500) 3 $5,200 $4,000 $4,500 x .06 $76,800 (46,800) (1,200) (270) 28,530 12 x $6,400 12 x $3,900 $5,200 $4,000 $4,500 x .06 (4,000) given 700 4,500 5,200 29,730 0 $29,730 given given ATC 7-1 (continued) Budgeted 7-45 Chapter 7 Planning for Profit and Cost Control Financial Statements continued Balance Sheet Cash Food cart Acc. Depreciation Total Assets Note Payable Contributed Capital Retained Earn. Total Liab. & Equity b. Amounts Computations $29,730 from SCF 4,000 given (1,667) ($4,000 $500) 3 $32,063 $ 4,500 700 26,863 $32,063 given given from Inc. Statement The budget financial statements above assume sales for each month of the year will be approximately equal to sales for September and October. Most likely, sales will be lower during periods between semesters, during the colder months, and during the summer session. Also, the presentation above assumes the owners do not take any money out of the business. Obviously, they would need to use some of the earnings from the business to pay their living expenses. 7-46 Chapter 7 Planning for Profit and Cost Control ATC 7-2 a. Group Tasks Pro Forma Data $169,400 Accounts Rec. $595,800 Sales Rev. Task 1 Sales Cash sales Sales on account Total budgeted sales Oct $ 40,000 140,000 $180,000 Nov $ 44,000 154,000 $198,000 Dec $ 48,400 169,400 $217,800 Schedule of Cash Receipts Cash sales Collections from accounts receivable Total cash collections October November December $ 40,000 $ 44,000 $ 48,400 60,000 140,000 154,000 $100,000 $184,000 $202,400 Task 2 Oct $72,000 14,400 86,400 40,000 $46,400 Pro Forma Nov Dec Data $79,200 $87,120 $238,320 Cost of Goods Sold 15,840 17,424 17,424 Ending Inventory 95,040 104,544 14,400 15,840 $80,640 $88,704 22,176 Accounts Payable Budgeted cost of goods sold Plus desired ending inventory Inventory needed Less beginning inventory Required purchases (on account) Schedule of Cash Payments Budget for Inventory Purchases October November December Pmt of current month's accts. pay. $34,800 $60,480 $66,528 Pmt for prior month's accts. pay. 72,000 11,600 20,160 Total budgeted pmts for inventory $106,800 $72,080 $86,688 7-47 Chapter 7 Planning for Profit and Cost Control ATC 7-2 (continued) Task 3 Oct $ 7,200 1,800 2,200 1,600 34,000 6,000 1,000 $53,800 Pro Forma Nov Dec Data $ 7,920 $ 8,712 $ 8,712 Commissions pay 1,980 2,178 2,200 2,200 2,200 Utility pay 1,600 1,600 4,800 Accum. dep. 34,000 34,000 6,000 6,000 1,000 1,000 $54,700 $55,690 $164,190 S&A Exp. Sales commissions Supplies expense Utilities Depreciation on store equipment Salary expense Rent Miscellaneous Total S&A expenses before interest b. Financial Statements Income Statement Sales Revenue Cost of Goods Sold Gross Margin Operating Expenses Operating Income Interest Expense Net Income $595,800 (238,320) 357,480 (164,190) 193,290 (2,530) $190,760 7-48 Chapter 7 Planning for Profit and Cost Control ATC 7-2 (continued) Balance Sheet Assets Cash Accounts Receivable Inventory Store Equipment Accumulated Depreciation Store Equipment Book Value of Equipment Total Assets Liabilities Accounts Payable Utilities Payable Sales Commissions Payable Line of Credit Equity Common Stock Retained Earnings Total Liabilities and Equity c. Havel will need to borrow money in October. Cash Budget for October Beginning cash balance Add cash receipts Cash available Less disbursements For inventory purchases For S&A expenses Total budgeted disbursements Payments minus receipts = Shortage ATC 7-2 (continued) (1) $40,000 cash sales + $60,000 collection on September accounts receivable. $ 16,000 100,000 (1) 116,000 106,800 (2) 42,800 (3) 149,600 $33,600 $ 9,760 169,400 17,424 $200,000 (81,600) 118,400 $314,984 $ 22,176 2,200 8,712 23,936 50,000 207,960 $314,984 7-49 Chapter 7 Planning for Profit and Cost Control (2) $34,800 payment for Oct. Inventory + $72,000 payment on September accounts payable. (3) $53,800 October S&A expenses $7,200 sales commissions $2,200 Utilities expense $1,600 depreciation = $42,800 ATC 7-3 a. The five steps of budgeting identified by the author are: planning controlling coordinating motivation evaluation The article defines the Three Cs of motivation for those preparing a budget as: b. Choice of employees who make decisions relevant to the budget. Collaboration of employees from different areas, i.e., multifunctional teams. Content of what is to be accomplished. That is, employees involved in the budgeting process should be given meaningful tasks to accomplish, not just small parts of a bigger budgeting objective. Activity budgeting is an outgrowth of activity based costing. Under activity budgeting a budget is organized by expected costs of activities rather than products, services, or resources Global budgeting has nothing to do with international issues. Rather, it relates to preparing a budget that is easier to read and use. To accomplish this, the author recommends preparing a budget with a few, relevant spending lines rather than one with a lot of detail. The author suggests that more budget categories be devoted to variable-cost categories. c. d. e. ATC 7-4 HON could use a technique known as perpetual or continuous budgeting. This technique utilizes a twelve-month budgeting period. However, at the completion of the current month, a new month is added to the end of the budget period. The result is a continuous twelve-month budget. The advantage of the perpetual budget is that it keeps management involved 7-50 Chapter 7 Planning for Profit and Cost Control in the budget process. The traditional approach too often leads to a frenzied stop-and-go mentality. The annual budget is prepared in a yearend rush, and the assumptions underlying its formation are forgotten shortly thereafter. Changing conditions are not likely to be discussed until the next year-end review cycle. The perpetual budget overcomes these shortcomings by keeping management involved with the budget. Each month a new monthly budget is prepared to replace the budget of the ending month. Management is thereby forced into a constant twelvemonth think-ahead process. 7-51 Chapter 7 Planning for Profit and Cost Control ATC 7-5 a. Mr. Cleavers behavior could be construed to be in violation of the objectivity standards. The failure to disclose the lack of need for computers to the Board of Education would violate (1) the standard to communicate information fairly and objectively and (2) the standard to disclose fully all relevant information that could reasonably be expected to influence an intended users understanding of the reports, comments, and recommendations presented. However, Mr. Cleaver could have disclosed all information fairly to the board. He is correct in his assessment that neither he nor Ms. Simmons has the right to establish policy. Also, it should be noted that Mr. Cleaver may not be a member of the Institute of Management Accountants and is therefore not bound by the organizations code of ethics. b. Sarbanes-Oxley Act requires management of public companies to report accurately the financial statements to external users such as investors and creditors. This case does not involve external reporting, and, consequently, the law is not applicable. c. As its name implies, participative budgeting encourages participation by subordinates as well as upper level managers in the budget process. Information flows from the bottom up as well as from the top down during the preparation of the budget. Accordingly, the Board of Education members would be in a position to gain insight as to the true needs of the schools and would thereby be more likely to allocate funds where they would produce the greatest benefit. 7-52 Chapter 7 Planning for Profit and Cost Control ATC 7-6 Screen capture of cell values: 7-53 Chapter 7 Planning for Profit and Cost Control ATC 7-6 (continued) Screen capture of cell formulas: 7-54 Chapter 7 Planning for Profit and Cost Control ATC 7-6 Screen capture of cell formulas (continued): 7-55 Chapter 7 Planning for Profit and Cost Control ATC 7-7 Screen capture of cell values: ATC 7-7 7-56 Chapter 7 Planning for Profit and Cost Control Screen capture of cell formulas: 7-57 Chapter 7 Planning for Profit and Cost Control ATC 7-7 Screen capture of cell formulas (continued): 7-58 Chapter 7 Planning for Profit and Cost Control ATC 7-7 Screen capture of cell formulas (continued): 7-59 Chapter 7 Planning for Profit and Cost Control Chapter 7 Comprehensive Problem Growth Rate of Sales Sales Budget Sales Cash sales Sales on account Total budgeted sales Schedule of Cash Receipts Current cash sales Plus collections from accts. rec. Total budgeted collections Growth Rate of Sales Sales Budget Sales Cash sales Sales on account Total budgeted sales Schedule of Cash Receipts Current cash sales Plus collections from accts. rec. Total budgeted collections Growth Rate of Sales Sales Budget Sales Cash sales Sales on account Total budgeted sales Schedule of Cash Receipts Current cash sales Plus collections from accts. rec. Total budgeted collections 0.01 Jan $10,000 50,000 $60,000 $10,000 48,000 $58,000 Feb $10,100 50,500 $60,600 10,100 50,000 60,100 0.02 Jan $10,000 50,000 $60,000 $10,000 48,000 $58,000 Feb $10,200 51,000 $61,200 $10,200 50,000 $60,200 0.04 Jan Feb $10,000 $10,400 50,000 52,000 $60,000 $62,400 $10,000 $10,400 48,000 50,000 $58,000 $60,400 Mar $10,816 54,080 $64,896 $10,816 52,000 $62,816 Mar $10,404 52,020 $62,424 $10,404 51,000 $61,404 Mar $10,201 51,005 $61,206 10,201 50,500 60,701 7-60 ... View Full Document

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