Solution manual cost accounting by LauderbachOPERATIONAL AND FINANCIAL BUDGETING

6 - 2 Sales Forecasting− Effects of External Events Note to the Instructor: Answering this question is complicated somewhatbecause the indicated event may 1 affect the sales forecast i

forecast Athletic shoes were selling very well into 1998, then slowed

considerably as the "brown shoes" typified by Timberland's offerings became more fashionable

(b) A manufacturer of carpeting must pay special attention to leading

indicators such as housing starts and building permits issued Carpet is a derived demand product, though the replacement market is certainly

significant

(c) A grocery chain is concerned about the growth of areas it serves, whethercompetitors are moving in, and general economic conditions The grocery business holds up in bad times, but the sales of other items typically

stocked by a grocery chain will fall off during recessions

(d) Advertising revenues for a TV station depend on such factors as the ratings of its programs and economic conditions, both national and local Some advertising is national, some local, so both matter

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- 2 Sales Forecasting− Effects of External Events

Note to the Instructor: Answering this question is complicated somewhatbecause the indicated event may (1) affect the sales forecast in quantity, (2) prompt a change in prices or a change in sales mix, or (3) produce some combination of these changes The following answers emphasize the effects onthe forecast of quantities

(a) You would revise the forecast downward because the cut in the governmentprogram will result in fewer families buying homes and, therefore,

appliances

(b) The forecast would probably be revised upward Jewelry is a luxury item, and spending on luxury items is likely to increase as disposable

personal income increases Some individuals will enter the market who

previously would not have, and some individuals will purchase more expensive jewelry than they might have before

(c) You would revise the sales forecast upward Decreases in computer prices will lead to people buying more computers, and to your selling more parts to the makers

(d) Two possibilities arise First, the higher the prices of energy, the more likely people and businesses will replace old, inefficient equipment This effect will increase your sales However, to the extent that heating (say in Miami) and air conditioning (say in Minnesota) are luxury items and bought at the margin, sales might decline

(e) The sales forecast should probably be adjusted upward Improved

insulation should reduce the requirements for energy to heat (or cool), and the rising energy costs should generate some additional insulation sales

(f) Sales forecasts for future years should be revised downward High school students are an important group of prospective college students However, the decline could be partially offset if a larger proportion of highschool graduates continues in education and/or there is an increase in the number of persons entering college after several years away from school (Ifthe forecasted number of total students declines, the company might be

expected to adopt higher prices to partially offset the smaller market.) 6

- 3 What's Happening Here?

Cal probably went through the year being careful about travel

expenditures, then saw that he would be under budget if he continued at the same pace Fearing a cut the following year if he did not spend his

allowance, Cal sent people all over the place in December

6-4 Cash Budgeting− Effects of New Information

(a) A slowdown in collections can be expected, so cash receipts expectationsmust be revised Perhaps, in those months where projected cash balances are relatively close to the desired minimum, borrowing will be indicated The cash disbursements budget may also need revision if interest rates have risenbeyond those expected at the time of the original budget

(b) The effects of an increase in the sales budget would be a lagged

increase in the cash receipts budget, revision of the production and

purchases budgets, and a corresponding revision of the cash disbursements budgets

(c) The cash disbursements budget must be revised to speed up the payments

to suppliers This revision may indicate the need for additional short-term financing

(d) The change in inventory policy will affect the purchases budget and, therefore, the cash disbursements budget It is not possible, however, to bespecific about the direction of the change without some idea of the

month-to-month swings in sales levels

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- 5 Relationships of Profit and Cash

This question draws attention to normal lead/lag situation for cash flows The stated changes in cash balances are in line with the stated changes in sales volumes, given the normal expectations about cash outflows for merchandise purchases preceding cash inflows from sales As a company grows, its cash receipts tend to lag behind its cash disbursements as long asthe time to pay for purchases is less than the time a unit spends in

inventory plus the time that customers take to pay Only exceptional terms from suppliers will allow receipts to keep pace with disbursements

The reverse is true when sales are declining The company is then payingfor fewer units than it is collecting for, so receipts do not fall as fast asdisbursements

6-6 Are Budgets Bad at GE?

Welch apparently believes that sales budgets are set without regard to conditions in a particular industry and followed despite changes in external circumstances Nothing in the chapter suggests that budgets should follow such principles Rather the chapter points out that one benefit of budgets

is that they help managers to determine whether changes during the period

indicate permanent or temporary differences It also appears that Welch doesnot believe that participation is important

Welch’s views were reported by Thomas J Martin, “Managing: Ideas %

Solutions,” Fortune, May 29, 1995, 145-7

6-7 Budgeted Income Statements and Purchases Budget (15 minutes)

May June Sales $250,000 $220,000

Cost of goods sold at 60% 150,000 132,000

Cost of goods sold ($250,000 x 60%) $150,000

Desired ending inventory ($220,000 x 60%) 132,000

Total requirements 282,000

Beginning inventory 95,000

Purchases $187,000

6-8 Cash Budget, Continuation of 6-7 (20 minutes)

Cash receipts budget

Purchases of prior month (6-7) $180,000 $187,000

Variable costs at 10% of sales 25,000 22,000

- 9 Budgeted Income Statement and Purchases Budget (20 minutes)

1 Budgeted income statement for first three months of 20X9

Sales ($70,000 + $70,000 + $90,000) $230,000

Cost of sales at 60% 138,000

Gross profit 92,000

Fixed costs ($12,000 x 3) 36,000

Income $ 56,000

2 Purchases budget

January February March Total Cost of sales* $ 42,000 $ 42,000 $ 54,000 $138,000 Desired ending inventory** 63,000 81,000 72,000 72,000 Total requirements 105,000 123,000 126,000 210,000 Beginning inventory 55,000 63,000 81,000 55,000 Purchases $ 50,000 $ 60,000 $ 45,000 $155,000

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- 10 Cash Budget and Pro Forma Balance Sheet (Continuation of 6 - 9) (20-25 minutes)

1 Cash receipts budget

January February March Total Sales budget $ 70,000 $ 70,000 $ 90,000 Collections from:

Current month (60%) $ 42,000 $ 42,000 $ 54,000 $138,000 Prior month (40%) 30,000 28,000 28,000 86,000 Total $ 72,000 $ 70,000 $ 82,000 $224,000

2 Cash disbursements budget

January February March Total Purchases (6-9) $ 50,000 $ 60,000 $ 45,000

Payments for purchases:

Current month (40%) $ 20,000 $ 24,000 $ 18,000 $ 62,000 Prior month (60%) 18,000 30,000 36,000 84,000 Fixed costs 12,000 12,000 12,000 36,000 Total $ 50,000 $ 66,000 $ 66,000 $182,000

3 Cash budget

January February March Total Beginning balance $ 20,000 $ 42,000 $ 46,000 $ 20,000 Receipts 72,000 70,000 82,000 224,000 Available 92,000 112,000 128,000 244,000 Disbursements 50,000 66,000 66,000 182,000 Ending balance $ 42,000 $ 46,000 $ 62,000 $ 62,000

4 Pro Forma Balance Sheet as of March 31, 20X9

Assets

Cash (cash budget) $ 62,000 Accounts receivable (40% of March sales of $90,000) 36,000 Inventory (6-9 purchases budget) 72,000 Total assets $170,000 Equities

Accounts payable (60% x $45,000 March purchases) $ 27,000 Stockholders' equity

143,000*

Total equities $170,000

* $87,000 beginning balance + $56,000 income, from 6-9

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- 11 Budgeted Income Statement and Purchases Budget (20 minutes)

1 Budgeted income statements

January February March Total Sales $100,000 $130,000 $160,000 $390,000 Cost of sales at 40% 40,000 52,000 64,000 156,000 Gross profit 60,000 78,000 96,000 234,000 Other variable costs at 30% 30,000 39,000 48,000 117,000 Contribution margin 30,000 39,000 48,000 117,000 Fixed costs 22,000 22,000 22,000 66,000 Income $ 8,000 $ 17,000 $ 26,000 $ 51,000

* Inventories are twice cost of sales for the coming month, $104,000 =

$52,000 x 2, etc The $120,000 is $150,000 (April budgeted sales) x 40% x 2 Note to the Instructor: In their entirety, these assignments are a bit more challenging than 6-9 and 6-10 The latter do not have depreciation, those of this exercise do The cash balance in 6-12 drops in the face of positive income, giving you the opportunity to pursue the important point that cash and income are not the same

The same point about cost dollars versus sales that is discussed in the Note to the Instructor in 6-9 also applies here

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minutes)

1 Cash receipts budget

January February March Total Sales budget $100,000 $130,000 $160,000

Collections from:

Current month (20%) $ 20,000 $ 26,000 $ 32,000 $ 78,000 Prior month (80%) 90,000 80,000 104,000 274,000 Total $110,000 $106,000 $136,000 $352,000

2 Cash disbursements budget

Other variable costs (30% of sales) 30,000 39,000 48,000 117,000 Fixed costs* 18,000 18,000 18,000 54,000 Total $108,000 $151,000 $142,000 $401,000

* $22,000 - $4,000 depreciation

3 Cash budget

January February March Total Beginning balance $ 50,000 $ 52,000 $ 7,000 $ 50,000

Inventory (purchases budget from 6-11) 120,000

Fixed assets ($150,000 - $12,000 depreciation) 138,000 Total assets $387,000 Equities

Accounts payable (March purchases, from 6-11) $ 56,000 Stockholder's equity 331,000* Total equities $387,000

* $280,000 Beginning balance + $51,000 income

Note to the Instructor: You might ask the class why cash is budgeted to dive to $1,000, a decrease of $49,000, when budgeted income for the quarter was $51,000 An analysis appears below The reasons are that cash

collections were $38,000 less than sales ($390,000 sales - $352,000 cash receipts), payments to suppliers were $74,000 higher than cost of sales

($230,000 from cash budget - $156,000 cost of sales), and depreciation was

$12,000 The $74,000 difference between payments for merchandise and cost of sales was a $70,000 ($120,000 - $5,000) increase in inventory less a $4,000 increase in payables ($56,000 March A/P from pro forma balance sheet, or Marchpurchases budget, less $60,000 beginning balance)

6-13 Budget for Service Company

April May June Total Sales of merchandise $14,000 $17,000 $13,000 $44,000Cost of sales at 90% 12,600 15,300 11,700 39,600Gross profit 1,400 1,700 1,300 4,400Design fees 6,000 9,500 7,500 23,000 Total 7,400 11,200 8,800 27,400Fixed expenses 4,100 4,100 4,100 12,300Income $ 3,300 $ 7,100 $ 4,700 $15,100

Other formats for the income statements are possible Ms Davis might want a two-column income statement showing the two types of sales separately.6

- 14 Purchases Budgetư Units and Dollars (20 minutes)

1 (a) Purchases budgetưunits

February March April May June Sales 1,900 2,200 2,300 2,100 1,700

Desired ending inventory* 1,100 1,150 1,050 850

Total requirements 3,000 3,350 3,350 2,950 Beginning inventory 1,000 1,100 1,150 1,050 Purchases 2,000 2,250 2,200 1,900 * 50% of budgeted sales for the following month: 1,100 = 2,200 x 50, 1,150 = 2,300 x 50, 1,050 = 2,100 x 50, 850 = 1,700 x 50 (b) Purchases budget−dollars February March April May June Cost of sales at $4 $ 7,600 $ 8,800 $ 9,200 $ 8,400 $ 6,800 Desired ending inventory* 4,400 4,600 4,200 3,400 Total requirements 12,000 13,400 13,400 11,800 Beginning inventory 4,000 4,400 4,600 4,200 Purchases $ 8,000 $ 9,000 $ 8,800 $ 7,600 * budgeted cost of sales for the next month x 50%, or $4 times desired units from requirement (a) 2 We stop with May Determining June purchases requires knowing July sales Note to the Instructor: Some students will determine dollar purchases for requirement 1b by multiplying the answers in requirement 1a by the $4 unit cost The resulting dollar amounts for purchases are correct, of course 6 - 15 Budgeted Income Statement for a Manufacturer (5-10 minutes)

Sales (50 units x $40) $2,000 Variable costs: Manufacturing, materials (50 x $12) $ 600

other (50 x $14) 700

Commissions, 15% of sales 300 1,600 Contribution margin 400

Fixed costs, manufacturing $ 150

other 70 220

Profit $ 180

6 - 16 Production Budget for a Manufacturer (Continuation of 6 - 15) (5-10 minutes) Variable manufacturing costs (50 units): Materials (50 units x 4 lbs per unit x $3 per lb.) $ 600

Other variable manufacturing cost [50 units x ($26 - $12)] 700

Fixed manufacturing costs 150

Total production cost $1,450 6 - 17 Purchases Budget for a Manufacturer (Continuation of 6 - 15 and 6 - 16) (10 minutes) Dollars Pounds Pounds x $3 Material needed for production (50 units x 4 lbs.) 200 $ 600

Material needed for ending inventory

55 units x 4 lbs x 20% 44 132

Total required 244 732 Material in beginning inventory, given 34 102 Required purchases 210 $ 6306

- 18 Expense Budgets and Variances (5 minutes)

Note to the Instructor: We do not wish to introduce the difference between flexible budgets based on output and on those based on input at this stage We used both input and output, and had no efficiency variance, in theassignment so that students would not be confused by overuse or underuse of the resource

The budget variance is $450 unfavorable

Flexible budget allowance, $22,700 + ($1.815 x 14,000 hours) $48,110Actual cost 48,550Flexible budget variance, unfavorable $ 450 The flexible budget allowance is much more useful than the original budget of $49,925 because it reflects the actual activity and the cot that should have been incurred based on the work done during the period The responsible manager did not save $1,375 on utilities, given that he worked less than the originally budgeted amount

Note to the Instructor: Because they have seen cost-prediction formulas

in Chapter 3, students usually have little trouble with the concept of a flexible-budget allowance in Chapter 6 Nevertheless, we developed this simple exercise to emphasize the budgeted/actual distinction because studentsoften err in determining a flexible-budget allowance in Chapter 11 (on

standard costs) and in the chapters on product costing (Chapters 12-14) 6

- 19 Budgeted Income Statements (25 minutes)

April May June July Sales, monthly base $136.0 $136.0 $136.0 $136.0 Variable at $0.052 x value of

permits in prior month 156.0 247.0 358.8 369.2 Total sales 292.0 383.0 494.8 505.2 Cost of sales at 45% 131.4 172.4 222.7 227.3 Gross profit 160.6 210.6 272.1 277.9 Other variable costs at 8% 23.4 30.6 39.6 40.4 Contribution margin 137.2 180.0 232.5 237.5 Fixed costs 140.0 140.0 140.0 140.0 Income (loss) ($ 2.8) $ 40.0 $ 92.5 $ 97.5 Note to the Instructor: This exercise can be used to explain a lag relationship In this case, building permits precede sales, which is

reasonable given that permits are issued prior to the start of construction The one-month lag is not necessarily realistic because it assumes that all materials will be bought in the month after the permit is secured It is more likely that there would be several months of permits in the equation, with differing weights assigned to the various months The resulting

equation would be a multiple regression equation as illustrated in the

appendix to Chapter 3 If we suppose that materials bought by builders are spread over a three-month period, we would have an equation of the form $ Sales = a + b1X1 + b2X2 + bnXn

where the b's are the coefficients for each month and the X's are months following the issuances of permits

Finally, it is convenient to think of the $136,000 intercept as the company's business that does not depend on new construction Replacements, repairs, do-it-yourself work, and other such sources of demand fit this category It should be noted that the intercept (zero building permits) is outside the relevant range, so that it is not warranted to assume that sales are likely to be $136,000 if there is no building activity

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- 20 Flexible Budget and Variances (15 minutes)

1 Total production cost = $70,000 + [($4 + $3 + $5) x units produced]

2, 3

Budget Actual Variance Materials ($4 x 18,000) $ 72,000 $ 71,800 $ 200 F Labor ($3 x 18,000) 54,000 56,100 2,100 U Variable overhead ($5 x 18,000) 90,000 89,000 1,000 F Fixed overhead 70,000 70,000 - Totals $286,000 $286,900 $ 900 U6-21 Income Statement and Purchases Budget (15 minutes)

March April Sales, 4,000 x $20, 4,500 x $20 $ 80,000 $ 90,000

- 22 Cash Budget− Quarters (30 minutes)

1 Cash budget, in thousands of dollars

sales 1,200 1,400 1,600 1,100 5,300 Total 2,900 3,800 4,400 4,300 15,400 Cash disbursements 3,350 4,240 4,520 3,470 15,580 Excess (deficiency) ( 450) ( 440) ( 120) 830 ( 180) Beginning balance 200 200 200 200 200 Indicated ending balance ( 250) ( 240) 80 1,030 20 Borrowing required 450 440 120 1,010 Repayments ( 830) ( 830) Ending balance $ 200 $ 200 $ 200 $ 200 $ 200

2 The loan outstanding is $180 thousand ($1,010 - $830)

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- 23 Flexible and Static Budgets Service Department (15 minutes)

The memo should point out that:

1 The $13,940 unfavorable variance is based on a static budget

allowance of $155,400 ($169,340 - $155,400 = $13,940) This allowance does not recognize that actual activity might differ from budgeted activity Such

an allowance is appropriate for fixed costs, but not for variable or mixed costs

2 A better comparison is of actual costs with a flexible budget allowance, which does consider the level of activity actually achieved The analysis below better shows performance, and indicates that I controlled costs very well

Flexible budget allowance, $12,400 + ($1.43 x 112,500) $173,275

Actual cost 169,340

Favorable budget variance $ 3,935

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- 24 Production Budget (10-15 minutes)

April May June

- 25 Purchases Budget (Extension of 6 - 24) (10-15 minutes)

(a) Purchases budget in pounds

Beginning inventory 1,350,000 540,000 x $2.50 Purchases $ 570,000 228,000 x $2.50

- 26 JIT Manufacturing (Extension of 6 - 24 and 6 - 25) (20 minutes)

1 Production budgets

April May Sales 18,000 24,000 Desired ending inventory 800 800