Solution manual cost management measuring monitoring and motivating performance 1st by wolcott ch10

10.5 The master budget is a particular application of the flexible budget for the specific level of operations that management expects during the next period.. The flexible budget can b

Chapter 10 Static and Flexible Budgets

LEARNING OBJECTIVES

Chapter 10 addresses the following questions:

Q1 What are the relationships among budgets, long-term strategies, and short-term

operating plans?

Q2 What is a master budget, and how is it prepared?

Q3 What are budget variances, and how are they calculated?

Q4 What are the differences between static and flexible budgets?

Q5 How are budgets used to monitor and motivate performance?

Q6 What are other approaches to budgeting?

Q7 How is the cash budget developed? (Appendix 10A)

These learning questions (Q1 through Q7) are cross-referenced in the textbook to individual exercises and problems

COMPLEXITY SYMBOLS

The textbook uses a coding system to identify the complexity of individual requirements in the exercises and problems

Questions Having a Single Correct Answer:

No Symbol This question requires students to recall or apply knowledge as shown in the

textbook

e This question requires students to extend knowledge beyond the applications

shown in the textbook

Open-ended questions are coded according to the skills described in Steps for Better Thinking (Exhibit 1.10):

 Step 1 skills (Identifying)

 Step 2 skills (Exploring)

 Step 3 skills (Prioritizing)

 Step 4 skills (Envisioning)

QUESTIONS 10.1 The revenue budget determines the volume of units sold This amount, less beginning

inventories plus desired ending inventories determines the amount of units for the

production budget The production budget determines the amount of direct materials needed If there are any constraints in the production process or for direct materials, these relationships could change

10.2 An organization would like the right people to be available at the right place and at the

right time This includes having the necessary talent in marketing to produce sales, and

in production to provide the product The various staff functions should be able to

perform their assigned tasks in an effective and efficient manner The budget provides advance guidance about personnel requirements during specific time periods

10.3 If individuals who are affected by some aspect of the budget participate in that budget’s

construction, there should be greater acceptance of the stated goals and the means to their attainment If a manager has not had input to setting goals or to the resources required to attain them, there is a possibility that the budget may not be taken seriously as the formal financial expression of that individual's responsibility and authority

10.4 Zero based budgeting does not take a prior period's performance and budget as given It

requires that each budget be justified by first demonstrating that the projected level of output (of goods or services) justifies the budget submitted The projected level of output needs to be consistent with the goals of the organization This means that under zero based budgeting, managers ignore prior period results and proceed as if they were

developing budgets for the first time

10.5 The master budget is a particular application of the flexible budget for the specific level

of operations that management expects during the next period The flexible budget can

be readily adapted to any level of activity within the relevant range; the master budget is one particular level of activity

10.6 To minimize budgetary slack, organizations ask outside consultants or market specialists

to make forecasts for the next period and compare their forecasts to those generated internally In addition, bonuses are paid for accuracy in budgeting as well as for meeting

or beating budgets

10.7 Static budgets need the following adjustments for performance evaluation:

* Use flexible budget to adjust for actual volumes

* Remove allocated costs

* Update costs for anticipated price changes

10.8 Here are some of the challenges that organizations face when they allocate budget

authority and responsibility; students might have thought of others Sometimes managers feel that they are held responsible for costs over which they have little or no control, and they begin to feel resentful When there is interdependency among divisions and

departments, it is difficult to separate the effects of individual manager’s efforts

Sometimes a new manager replaces someone who leaves, and the new manager is held

responsible for whatever budget decisions were made previously Sometimes

uncontrollable external or internal factors alter budgets unexpectedly For example, a few key employees could leave for better jobs Unanticipated changes could occur in the organization’s prices and costs

10.9 Cash budgets help managers plan their short term borrowing needs to meet payroll,

accounts payable, and other cash obligations In a seasonal business, there are times when cash levels are quite high, but also times when very little cash is flowing into the company Managers need to plan ahead for times of reduced cash flow so that employees and vendors are unaffected by these cycles

10.10 Managers use many different types of information to develop budgets Often they use

last year’s results to determine a base level of costs and revenues They also estimate future sales volumes, prices, and costs Information for these estimates can be obtained from very specific sources, such as trade journals that provide total market share

information, to very general sources such as economic trends described in business

publications such as The Wall Street Journal Information is also obtained from

individuals throughout the organization For example, engineers might provide estimates

of cost changes resulting from expected changes to production processes Individual department managers submit plans and budget requests In addition, information is obtained from suppliers, companies from whom they rent, and others who might know whether cost changes are expected during the period for which the budget is developed

10.11 Both types of budgets forecast revenues and costs using information about past, present,

and future operations Annual budgets forecast for next year while rolling budgets

forecast for shorter or longer periods Annual budgets are developed once a year while rolling budgets are updated more frequently, often on a monthly basis

10.12 Budgets are prepared in light of organizational strategies and are a method to

communicate strategies and objectives throughout the organization Operating plans are developed from organizational strategies, and these are communicated from top levels throughout the organization Sub-units then develop budgets considering organizational objectives and communicate their budget goals to top management After the budgeting process is complete, actual operations are compared to budgets and any differences are investigated This process leads to re-evaluation of the organization’s vision and

strategies as shown in Exhibit 10.2

EXERCISES 10.13 Seer Manufacturing

A Production Budget

B Direct Materials Unit Forecast

a

Current production x 3 units direct materials x 0.5 to reflect 3 direct materials units per product, and half of this month’s production for ending inventory balance

b

Current production x 3

c

Prior month's production x 3 x 5;

January production was change in finished goods inventory plus January sales, or (100 + 90) - (40 + 90) + 40 = 100 units

C Labor Requirements Budget

a

Current production x 10

10.14 Bullen & Company

Notice that the first quarter is the first three months April’s information is needed for some of

March’s budget calculations

A

(1) Production budget (units)

January February March Quarter

Total units to be produced 22,000 20,000 17,000 59,000 (a) Current month's sales

(b) 50% of following month's sales (2) Direct labor budget (hours)

Direct labor hours per unit 4.0 4.0 3.5

(3) Direct materials budget (dollars)

Cost per unit $10 $10 $10

Total direct material cost $220,000 $200,000 $170,000 $590,000 (4) Sales budget (dollars)

Sales price per unit $80 $80 $75

Total sales revenue budget $1,600,000 $1,920,000 $1,200,000 $4,720,000

B

Bullen & Company Budgeted Contribution Margin First Quarter, 20X5

$4,720,000

Direct materials cost 200,000 240,000 160,000 600,000 Contribution margin $ 200,000 $ 240,000 $ 144,000 $ 584,000

C At least three behavioral considerations in the profit-planning and budgeting process

include the following

Goal alignment is critical The individual manager’s goals may conflict with the firm’s goals Setting targets in a budget process helps focus and motivate

managers to achieve the firm’s objectives

Participation from lower-level managers and other employees has two benefits It uses information from those closest to the process, and the mangers have a

stronger commitment to the budget itself

The entire budget process is a form of communication Feedback and other forms

of improving communication are essential throughout the process

10.15 Appliances Now

A

Flexible

The following computations are short-cuts that can be used to calculate variable costs under a flexible budget, with revenues as the cost driver

Flexible budget for variable costs = Static budget variable cost/Revenues in static budget * Actual Revenues:

(a) $5,892/$16,491 * $17,480 (b) $456/$16,491 * $17,480

B If market share is 20% and revenues are $17,480, then the following equation estimates the total market:

20% * Market = $17,480 Market = $17,480/0.20 = $87,400

If market share of 22% had been obtained, revenues would have been:

$87,400 * 22% = $19,228 Thus, foregone revenue is:

Revenue at 22% Market Share – Actual Revenues

= $19,228 - $17,480 = $1,748

The foregone profit is equal to the marginal profit that would have been earned on

foregone revenues Thus, the marginal profit is equal to the contribution margin on foregone revenues (Remember: Fixed costs would not be affected by higher revenues.) The contribution margin per dollar of revenue from the original (static) budget follows:

Foregone profit is equal to the contribution margin on foregone revenues:

Foregone Revenues * Contribution Margin Ratio

= $1,748 * 61.51% = $1,075

10.16 The Zel Company

A Cost of goods sold = (0.8*sales)

= (0.8*$1,700,000)

= $1,360,000

B Beginning inventories are 30% of that month’s cost of goods sold Therefore, July

Beginning Inventory = (0.3*cost of goods sold)

= (0.3*0.8*$1,810,000)

= $434,400

C Ending inventory for July is the beginning inventory for August

Ending inventory (0.3*0.8*1,920,000) $ 460,800 + July cost of goods sold (0.8*1,810,000) 1,448,000

- Beginning inventory (part B) (434,400)

D 40% of receivables are collected in the month sold, and 50% are collected the next

month For July:

First, determine the purchases budget for the 1st quarter:

January February March April

Raw materials needed per unit x 2 x 2 x 2 x 2

Ending inventory requirement

(25% of next month's production requirement) 25,000 35,000 35,000

Less: Beginning inventory (0) (25,000) (35,000)

Raw materials purchases (units) 65,000 110,000 140,000 Raw material unit cost x $7 x $7 x $7

Raw materials purchases $455,000 $770,000 $980,000

Next compute cash disbursements for purchases of raw materials:

January purchases (a) $163,800 $273,000

March purchases (c) 352,800 Total cash payments $163,800 $550,200 $814,800

(a) January: ($455,000 x 0.4).9 = $163,800 February: ($455,000 x 0.6) = $273,000

(b) February: ($770,000 x 0.4).9 = $277,200 March: ($770,000 x 0.6) = $462,000 (c) March: ($980,000 x 0.4).9 = $352,800

10.18 Myrna Manufacturing

Cash receipts for February are

From February (30,000 x €18 x 25 x 97) 130,950

Production requirements are

Less: Beginning inventory (units) 0 (7,500) (8,000) Production requirement (units) 32,500 30,500 32,750 Materials Purchases Budget

Plus: Ending inventory (units) 12,200 13,100

Less: Beginning inventory (units) 0 (12,200)

Raw materials cost per unit €0.75 €0.75

Labor costs in February are

Overhead costs in February are

The February cash budget is thus:

10.19 Play Time Toys

[Note about problem complexity: Items A and B are coded as ―Extend‖ instead of ―Step 2‖

because a similar example was provided in the chapter.]

A Play Time Toys is using a static budget It does not reflect the activity levels, so it is not

a good measure of performance The variable costs need to be related to actual

production volumes It also includes division, marketing and headquarters overhead costs and managers are not responsible for those They should be eliminated Managers and their departments should be evaluated relative to costs they can control Any costs they cannot control should be removed

B and C The following schedule eliminates costs that are not under the dolls production

department manager’s control These include production division costs, headquarters costs, and marketing costs Revenues and volume are included only because provide information about activity levels Variable costs are adjusted for actual volume

D The direct material variance is favorable and about 5% of the benchmark Perhaps

materials of lower quality than usual were purchased, or perhaps there was a price

decrease that should be reflected through a new standard If lower quality materials were purchased, more labor time might have been needed to produce the dolls, resulting in a negative labor variance If there was no change in the quality of materials, then other reasons need to be investigated for the negative labor variance (11% of the benchmark) Perhaps there was unusually high turnover or other factors, resulting in lower

productivity It is also possible that the standard labor cost is too low, particularly if there was an unanticipated labor rate increase The unfavorable fixed overhead variance is very large (28% of benchmark) Perhaps there were large discretionary expenditures, such as painting the production facility Or, perhaps there was an unexpected increase in one or more fixed overhead cost categories It is also possible that the budgeted cost is too low

Cash sales (a) $2,160 $3,960 $ 5,760 $ 7,200$ 0 $ 0 $ 0

Three months later (e) 0 0 0 240 440 640 800

(a) Cash sales: Unit sales x $50 x 40% x (1-10%)

(b) Credit card sales: Unit sales x $50 x 30% x (1-5%)

(c) Collected one month later: Unit sales last month x $50 x 15%

(d) Collected two months later: Unit sales two months ago x $50 x 6%

(e) Collected three months later: Unit sales three months ago x $50 x 4%

Cash Disbursements

Purchases:

Less beginning inventory (b) (50) (154) (224) (280)

(a) Next month’s unit sales x 70%

(b) Prior month’s ending inventory (c) Zero for Sept; other months: units purchased x $32 x 50% x (1-6%) (d) September: 50 units purchased during August x $32; October: units purchased during Sept x $32; other months: prior month units purchased x $32 x 50%

Summary of Budgeted Cash Receipts and Disbursements

Cash receipts $3,870 $ 7,995 $12,330 $16,200 $ 4,400 $ 1,840$ 800 Cash disbursements (1,600) (11,530) (10,295) (7,821) (1,920) ( 0) (0) Net cash flow $2,270 $ (3,535) $ 2,035 $ 8,379 $ 2,480 $ 1,840$ 800 Cumulative cash flow $2,270 $ (1,265)$ 770 $ 9,149 $11,629 $13,460 $14,269

B Although the problem does not require this calculation, the total amount of uncollectible accounts can be estimated as follows:

(120+220+320+400) x $50 x 5% = $2,650 Because the only option under consideration is to write off the accounts, Brad could

allow the collection agency to keep 100% of collections and still be no worse off

PROBLEMS 10.21 Patricia’s Reconciliation

A Many accounting tasks are nonroutine and involve unpredictable activities For example,

a reconciliation could require investigation of unusual items or uncover problems with the mathematical accuracy of other accounting records Unforeseen problems make it difficult to establish an accurate time budget

B Patricia’s time might exceed the budget because of unforeseen items, as discussed in Part

A Alternatively, her time could exceed the budget because she is inexperienced or is distracted by other matters (such as worrying about her performance)

C Patricia is probably concerned that asking for more help will lead Ron to believe that she

is incompetent or lacks confidence, which could in turn lead to a poor performance

evaluation She also might want to avoid interrupting Ron from performing his work

D It is uncertain how Ron would respond to either situation Although he has told Patricia that ―All new-hires are slow to begin with,‖ he probably has some unspoken expectation for how long it should take her to complete the task He probably also has some

expectation about the number and types of questions that are appropriate for a hired staff member

newly-1 If Ron thinks that Patricia’s questions are reasonable and she completes the

assignment in 4 hours, he will probably consider her performance to be acceptable for

a new-hire However, he will probably expect her to perform more quickly on future tasks On the other hand, he might view her performance as poor if he believes that her questions involved issues about which she should already know

2 Ron will probably give Patricia a poor performance review if she does not seek his help and completes the assignment in 8 hours He will probably assume that she wasted time by failing to ask him questions However, he might consider this amount

of time reasonable if Patricia adequately explains to him legitimate reasons for the reconciliation taking twice as long as expected—such as unanticipated reconciliation problems

E

1 Assuming that there were no unusual problems causing the reconciliation to be

significantly more complex than expected, Patricia has probably prioritized reliance and worry about her performance as more important than meeting the job’s time budget In addition, she has placed a low priority on communicating her work status with her supervisor

self-2 The ethics in this problem involve Patricia’s responsibilities to her supervisor, her firm, and her client Her supervisor and firm are both responsible for Patricia’s

professional development and the quality of her job performance If failing to ask questions hindered her development or job performance, then Patricia has not acted

ethically Her supervisor is probably evaluated at least in part on Patricia’s

performance, so her poor performance would also reflect poorly on Ron’s

performance In addition, the firm and client have a financial stake in this situation Time is money to a CPA firm; either the firm absorbs the cost of the additional time,

or the time will be billed to the client A failure to ask questions might have

increased the length of time to complete Patricia’s tasks, and a failure to provide timely communication about problems with the reconciliation might prevent the firm from billing the client for legitimate cost overruns Ethical behavior in this situation would require Patricia to focus on what is best overall—for herself, her supervisor, her firm, and her client In this case, her personal concerns appeared to override the interests of other stakeholders Thus, Patricia did not appear to act ethically

F Because of Patricia’s lack of experience, it was difficult for her to gauge the quality of her work and the appropriateness of questions she might ask her supervisor

Nevertheless, once the job is completed she has an opportunity to reflect upon what occurred and to consider things she might have done differently For example, she might identify a different way to sequence the work she performed to reduce the overall time

Or, she might think about how the work was similar to what she had learned in school, how it was different, and why She might also ask Ron for suggestions about ways to improve her work By reflecting on her work and asking for suggestions, Patricia can more readily recognize problems and solutions in future assignments

G and H There is no one answer to these parts Sample solutions and a discussion of typical student responses will be included in assessment guidance on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg)

10.22 Helping a Friend

A A friend would need to prepare budgets for revenues and for costs that vary per month such as rent, food, and entertainment An additional budget should be prepared for things that vary per semester, like books and tuition Because personal costs tend to vary by month, these budgets are prepared for monthly costs by category instead of direct cost budgets that are used in manufacturing Finally, she needs to prepare a cash budget to estimate her cash needs throughout the semester so that she does not run short

B Monthly information that is known for certain includes rent, insurance (if monthly), and car payments Tuition and fees are known for certain Other costs that must be estimated include food, books, and entertainment

C Assumptions may need to be made about tuition and fees Do they vary with credit hours? If so, how many credit hours are expected? Assumptions also need to be made about the frequency and cost of events such as eating in restaurants and entertainment If

a lease has not been signed, an assumption needs to be made about the cost of rent She will make assumptions about the amount and cost of food she will eat, entertainment costs, car and travel related costs She will not have to make assumptions about costs that she knows ahead, for example tuition (if fixed) and rent However she will have to make assumptions about other costs that are not known ahead These assumptions include the

amount that will be spent, the frequency and timing of the expenditures She will need to make similar assumptions about cash inflows that she does not know ahead If she works

a variable schedule at a restaurant, she cannot know the amount of tips she will receive and will have to make assumptions about the amounts and timing of these cash inflows Similarly, there may be uncertainties with regard to the money that she receives from her parents She may know for certain the amounts and timing of scholarship funds

D Here is a plan for monitoring your budget

Each month, compare actual costs to the budgeted costs by budget category The

differences between actual and budgeted costs are called variances If you have spent more than budgeted, a variance is considered unfavorable If you have spent less than budgeted, the variance is favorable At the end of each month, calculate a variance for each budget category and then add all of the variances together to see if you are over or under budget that month

To calculate these variances, you need to track your costs using the same categories included in the budget I recommend you use one category to track monthly fixed costs like rent, utilities, car payment, and utilities Keep two separate categories for

discretionary costs, one for food and one for entertainment You can cut back on

discretionary costs more easily than the fixed costs For example, if utilities are high one month, you could cut back on entertainment the next month to avoid having an overall variance from the budget at the end of the semester

If you have unfavorable variances for several months, you will need to find additional sources of revenue or cut back on discretionary expenditures If you have favorable variances for several months you may want to wait until the end of the semester to adjust the budget, to make certain you have not overlooked anything

10.23 Central County Public Clinic

A The prior year’s actual results can be used as a static budget for the next period The

2004 results can be used as the basis for a benchmark for 2005, adjusting for activity levels and any price changes

B To convert the 2004 results to a benchmark for 2005, adjust 2004 variable costs to reflect activity levels in 2005 In addition, adjust 2004 amounts for any known price changes The following costs are most likely variable To create an estimate for 2005, divide each cost by the level of activity in 2004 and then multiply by the level of activity in 2005 Home visits can be used to measure activity levels Adjust for known cost increases, using information given in the problem

Homemakers: ($60,046 / 4,312 visits * 5,101 visits) $71,033 Medical supplies: ($18,197 / 4,312 visits * 5,101 visits) 21,527 Cleaning supplies ($6,894 / 4,312 visits * 5,101 visits) 8,155 Transportation ($9,068 / 4,312 visits * 5,101 visits) 10,727

The following costs are most likely fixed To create an estimate for 2005, these costs are adjusted for known cost increases, using information given in the problem

Nurses:

Two thirds year’s salary (($135,378 * 105%) / 3) x 2 94,765

Average cost per visit $53.24 $49.27 $50.63

C It seems there is a large variance in cleaning supplies Are employees taking supplies home? The homemakers did not get a raise but the nurses did, are homemakers taking home cleaning supplies because they feel they are underpaid? Why are nurses’ salaries

so high? Did you add hours, or are some nurses getting larger raises? Do patients live further away or are errands being run using clinic car expense?

D If costs had been in control, there would have been no variances Thus, this question calls for the number of home visits that could have been made for the extra $6,948 in unfavorable variances The benchmark average cost of $49.27 cannot be used in the calculations because average cost includes fixed costs that do not change with changes in volume Therefore, a benchmark variable cost per unit is calculated:

Variable costs per visit:

Benchmark Variable Cost Per Visit ($111,442/5,101) $21.85

Now the additional number of visits that could have been made is calculated for the variance:

$6,948 / $21.85 variable cost per visit = 318 visits Total visits that could have been made if costs had been in control:

5,101 actual visits + 318 additional visits = 5,419 visits

10.24 Fighting Kites Part 1

A sample spreadsheet showing the calculations for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg)

A Below is the input section of the sample spreadsheet for this problem The data input box shown here includes only the input for Part 1 The solution for later parts will show additional input items

Data Input

DIRECT LABOR: Assembly Packing DIRECT MATERIALS PER KITE:

Hours 0.5 0.1 Nylon $10

Cost per hour $30.00 $15.00 Ribs $5

Cost per kite $15.00 $1.50 String $2

Target INVENTORIES: Beginning Ending REVENUE ASSUMPTIONS:

Direct materials: Selling price $75

Nylon $5,000 $7,000 Volume of sales 80,000

Selling price Units sold Revenues

C Estimated sales volumes and anticipated inventory levels are used to predict the number

of units to produce as follows

PRODUCTION BUDGET (UNITS)

DIRECT MATERIALS USAGE AND PURCHASES BUDGET

Add target ending inventory:

E The direct labor budget can now be prepared

10.24 Fighting Kites Part 2

A sample spreadsheet showing the calculations for this problem is available on the Instructor’s web site for the textbook (available at www.wiley.com/college/eldenburg) Here is an excerpt from the spreadsheet showing the additional input area for Part 2:

Fixed overhead rate per labor hour $20.00

Variable manufacturing overhead costs

Fixed manufacturing overhead costs

G Using information above, determine the cost of ending inventories

COST OF ENDING FINISHED GOODS INVENTORY