PROBLEM FOR SELFSTUDY

Consider the Stylistic Furniture example described earlier. Suppose the selling price perlable is $431.20,
a 10% increase over the $392 selling price used in the chapter illustration. All other data are undlanged.
Required
Prepare a budgeted income statement,
that are different from the schedules
remain unchanged.

including
presented

all necessary detailed supporting budget schedules

in the chapter. Indicate those schedules that will

SOLUTION
Schedules 1 and 8 will change. Schedule 1 changes because a change in selling price affects revenues. Schedule 8 changes because revenues are a cosl driver of variable non manufacturing
costs.
The remaining schedules will not change because a change in selling price has no effect on manufacturing costs. The revised schedules and the new budgeted income statement follow.
ABC
Schedule I: Revenue

:2

For the

YtU

Endi.n.:!:
Dett]'

B~et
n

31,200'

3
Selling

Units

Total

Price Sold Revenues

5 Coffee tables $431.20 52,000 $22,422,400

4
5
6
7
8
9
10

ABC
SrMdul,. 8: No~!U'uf;\rtu.riJt; _~f:I~ts
Bu~~t
For ih . Ynl F.ndin; D,.r.- {herH,_ 'fl07

1
2
3

BusinessFunction
R&DlProduct design
(Variable cost: $22,422,400 x 0.Dl5)
Marketing
(Variable cost: $22,422,400 x 0.08)
Distnbution
(Variable cost: $22,422,400 x 0.025)
Customer service
(Variable cosl: $22,422,400 x 0.013)
Administrative
(Variable cost: $22,422,400 x 0.002)

1
2
3
4
5
6
1
8
9
10
11
12
13

Fixed Costs
(as in Schedule 8,
Variable Co.ts
, 192)

$ 336,336

$ 250,000

$ 586,336

1,793,792

290,000

2,083,792

560,560

220,000

780,560

291,491

240,000

531,491

44,845
$3027024

400,000
$1 400000

444,845
$4427024

A
B
Stylistic Furniture Bud;<
For th . Year Endi I! D,.
Revenues
Cost of goods sold
Gross~
Operating costs
R&DlProducl design
Marketing costs
Distnbution costs
Customer-service costs
AdministratM costs
Operating income

Total co.ts

$22,422,400
14,751,250
7,671,150

Schedule 1
Schedule 7

Schedule 8
Schedule 8
Schedule 8
Schedule 8
Schedule 8

$ 586,336
2,083,792
780,560
531,491
444,845

4,427,024
$ 3244126

14
If we had also assumed that the price of the pal1icle board had increased to $4.20 per board foot
and the price of the red oak had increased to $6.30 per board foot (as in Scenario 3 in Exhibit 6-4,
p. 193), Schedules 3A, 30, GA, GO, and 7 would also have changed.

DECISION

POINTS

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

Decision

Guidelines

1. What is the master budget and

why is it useful?

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

2. When should a company prepare

budgets? What are the advantages
of preparing budgets?

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

3. What is the operating budget and

why is it useful?

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

4. How should managers consider

what might happen if the assumptions
underlying the budget change?

Managers should use computer~based financial planning models-mathematical

statements
of the relationships among operating activities, financing activities, and other factors that
affect the budget. These models make it possible for management to conduct what-if
(sensitivity) analysis of the effects on the master budget of changes in the original predicted
data or changes in underlying assumptions and to develop plans to respond to changed
conditions.

5, How can budgets include the effects

of future improvements?

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

6. How can a company prepare a budget

based on costs of different activities?

Activity-based budgeting focuses on the budgeted costs of activities needed to produce

and sell products and services. It is linked to activity-based costing but differs in its emphasis on future costs and future use of activity areas.

7. How do companies use responsibility

centers and responsibility accounting?

A responsibility center is a part, segment, or subunit of an organization whose manager is

accountable for a specified set of activities. Four types of responsibility centers are cost
centers, revenue centers, profit centers, and investment centers. Responsibility accounting
systems are useful because they measure the plans, budgets, actions, and actual results of
each responsibility center.

8. Shouldpertormance reports of
responsibility center managers only
include costs the manager can control?

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

'"

'""-!c!.

,
"-

'"
."C

APPENDIX:

THE

CASH

BUDGET

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

::
~
~.
l>

~,
If you have studied the ~
W\ statement of cash flows g
in afinancial accountingcourse. :;.
be aware thatthe direct method :;.
of determiningcash flowscorre (Q
sponds to the approach used in
preparingthe cash budget.
203

EXHIBIT

6-5

Balance Sheel lor

Slylislic Furnilure,
December 31, 2006

I
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24

As.ets
Current Assets
Cash
Accounts receivable
Direct materials inventory
Finished goods inwntory
Property, plant and equipment
Land
Building and equipment
Accumulated depreciation
Total

$ 500,000
1,881,600
223,000
1,375,000

$3,979,600

1,200,000
$2,300,000
(800,000)

Liabilitie. and Stockholders'

Cmrent Liabilities
Accounts payable
Income t8JreSpayable
Total cmrent liabilities
Long-term debt (interest at 10% per year)
Total cmrent and long-term liabilities
Stockholders' equity
Common stock, $0.01 parvalue, 300,000 sheres outstanding
Retained earnings
Total

1,500,000

2,700,000
$6.679600

ui
$ 384,000
20,460
404,460
2,400,000
$2,804,460
3,000
3,872,140

3,875,140
$6.679600

Suppose Stylistic Furniture had the balance sheet for the year ended December 31,2006, shown
in Exhibit 6-5. The budgeted cash nows for 2007 are:
A
I
2
3 Collections from customers
4 Disb1ll'Sements
Direct materials
5
6
Payroll
7
Other costs
8
Machinery pun:hese
9
Interest expense on long-term debt
10 Income taxes

3
$4,704,000

4
$6,272,000

QWIrlers
I
$5,331,200

2
$4,704,000

960,000
1,152,000
1,626,300 I 1,626,300
1,580,460
1,580,460
0
0
60,000
60,000
100,000
120,460

1,152,000
1,888,600
1,580,460
1,800,000
60,000
100,000

1,536,000
1,626,300
1,580,460
0
60,000
100,000

The quanerly data are based on the budgeted cash effects of the operations formulated in Sd1cdules
1 through 8 in the chapter, but the details of that formulation are not shown here to keep this illustration as brief and as focused as possible.

Long-term debt is $2.4 million at an annual interest rate of 10%, with $60,000 interest payable
every quarter. The company "vants to maintain a $100,000 minimum cash balance at the end of
each quarter. The company can borrow or repay money at an interest rate of 12% per year.
Management does not want to borrow any more short-term cash than is necessary. By special
arrangement, interest is computed and paid when the principal is repaid. Assume, for simplicity,
that borrowing takes place (in multiples of $1,000) at the beginning and repayment at the end of
the quarter under consideration. Interest is computed to the nearest dollar.
Suppose the management accountant at Stylistic is given the preceding data and the other data
contained in the budgets in the chapter (pp. 188-193). She is instructed as follows:

204

1. Prepare a cash budget for 2007 by quarter. That is, prepare a statemenl of cash receipts and disbursements by quarter, including details of borrowing, repayment. and interest.
2. Prepare a budgeted balance sheel on December 31, 2007.
3. Prepare a budgeted income stalement for the year ended December 31, 2007. This statement
should include interest expense and income taxes (at a rate of 36% of operating income). In
April 2007, Stylistic will pay $120,640 of income taxes. This amount is the remaining payment
due for the 2006 income tax year togelher with tlle $100,000 Stylistic pays each quarter of
2007 toward its 2007 income tax bill. Any remaining amount due is paid in April 2008.

1
2
3 Cash balance, beginnir1g
4 Add receipts
5

Quarters

$ 500,000

$1,504,440

J
$1,669,220

4
$ 100,160

5,331,200
5,831,200

4,704,000
6,208,440

4,704,000
6,373,220

6,272,000
6,372,160

960,000
1,626,300
1,580,460

1,152,000
1,626,300
1,580,460

Collections from customers:

6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

Total cash available for needs (x)

Deduct disbursements
Du.ctmate~
Payroll
Other costs
Machinery purchase
Interest expense on long-tem debt
Income taxes
Total disbursements (y)
Minimum cash balance desu.d
Total cash needed
CashelOCoss(defIciency)'
Financing
Bonowing (at beginning)
Repayment (at end)
21 Interest (at 12% per annum) b
22
Total effects of fmancing
23 Cash balance, ending'

60,000
100,000
4,326,160
100,000
4,426,160
$1404440

60,000
120,460
4,539,220
100,000
4,639,220
$1 569.220

$
$1.504440

o
o
o

0 $
$1.669220

o
o
o

1,152,000
1,536,000
1,888,600
1,626,300
1,580,460
1,580,460
1,800,000
0
60,000
60,000
100,000
100,000
6,581,060
4,902,160
100,000
100,000
6,681,060
5,002,160
$ (301 840) $1 369 400

$ 308,000

o
o

0 $ 308.000
$ 100.160

(308,000)
(18,480)
$ (326480)
$1 142920

4,800,000
6,161,500
6,321,840
1,800,000
240,000
420,460
20,349,800
100,000
20,449,800
$ 1 061 400
$

308,000
(308,000)
(18,480)
$ (8480)
$1142920

24
25 aExcess of total cash available ow:r total ca:>h :needed before current fmancing.

-26 bNote that the short~tenn interest payn\enb pertain only to the amowtt of principal being repaid at the end
27 of, -'ere $308,000 x 0.12 X 0.5 = $18,480.
28 cEno:fu1g cash balance = Total cash available for needs (x) - Total disbursements

(y) + Total effects offUW'LCing.

preparation of BUdgets
I.The cash budget (Exhibit 6-6) is a schedule of expected cash receipts and disbursements. It
predicts the effects on the cash position at the given level of operations. Exhibit 6-6 presents
the cash budget by quarters to show the impact of cash flow timing on bank loans and their

repayment. In practice, monthly-and sometimes weekly or even daily-cash budgets are critical for cash planning and control. Cash budgets help avoid unnecessary idle cash and unexpected cash deficiencies. They thus keep cash balances in line \-"ith needs. Ordinarily, the cash
budget has these main sections:
a. The beginning cash balance plus cash receipts equals the total cash available before financing. Cash receipts depend on collections of accounts receivable, cash sales, and miscellaneous
recurring sources, such as rental or royalty receipts. Infonnauon on the expected colledibility
of accounts receivable is needed for accurate predictions. Keyfactors include bad-debt (uncollectible accounts) experience and average time lag between sales and colledions.
b. Cash disbursements by Stylistic Furniture include:

i. Direa material purchases. Suppliers are paid in full three v..leeksafter the goods are
delivered.

ii. Direalabor and other wage and salary outlays. All payroll-related costs are paid in the
month in which the labor effort occurs.

iii. Other cos/s. These depend on timing and credil terms. Not.e, depreciation does not.
require a cash outlay.

~~

There's no need to memorizethe format of the cash

budget ifvou remember that it's
similar to the way your bank
statement
works:
beginning
balance + deposits (receiptsldisbursements=ending
balance
(before financingl. This ending
balance
reveals
how much
must be borrowed or can be
repaid/invested.

IIi!l

~~
Keep in mind three points
~aboutcashbudgets:(l1
The ending balance fEB)ofcash
in one quarter is the beginning
balance(BBiofcash
inthe next
quarter.
In the "Year as a
Whole" column. receipts and
disbursements
are totaled for
the four quarters. However, the
SS in that column is the BB for
quarter 1, and the EB is the EB
for quarter4.(3) Depreciation is
nota cash disbursement.

iv. Other disbllrsement.s. These include outlays for property, plant, equipment, and other
long-term investments.
v. Inrerest on long-term borrowing.
vi. Income tax payment.s.

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

205

A
B
C
D
Revenues
Schedule 1
$20,384,000
Cost of goods sold
Schedule 7
14,751,250
Gross margin
5,632,750
Opemting costs
R&Dil'roduct design
Schedule 8 $ 555,760 '
Marketing costs
Schedule 8, 1,920,720
Distnbution costs
] Schedule 8
729,600
Customersetvice costs
Schedule 8
504,992
Administrative costs
Schedule 8
440,768
4,151,840
Operating Uu:ome
1,480,910
Interest expense
258,480
Income before income taxes
1,222,430
Income taxes
440,075
Net Income
$ 782355

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

income statement is presented in Exhibit 6-7. It is merely the budgeted operating

income statement in Exhibit 6-3 (p. ] 93) expanded to include interest expense and income taxes.
3. The budgeted balance sheet is presented in Exhibit 6-8. Each item is projected in light of the
details of the business plan as expressed in all the previous budget schedules. For example, the
ending balance of accounts receivable of $ 1,254,400 is computed by adding the budgeted revenues of $20,384,000
(from Schedule 1) to the beginning balance of accounts receivable of
$1,881,600 (from Exhibit 6-5) and subtracting cash receipts of$21,Oll,200
(from Exhibit 6-6).

For simplicity, the cash receipts and disbursements

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

$1,142,920
1,254,400
204,000
854,250

$3,455,570

ABseil

Current Assets
Cesh
Accounts receivable
Direct materials inventory
Finished goods inventory
Property, plant end equipment
Land
Building end equipment
Accumulated depreciation
Total

1,200,000
$4,100,000
(1,300.000)

Liahilin..

and Slotkholders'

Current Liabilities
Accounts payable
Income taxes payable
TotaI current liabilities
Long-term debt (interest at 10% per year)
Total current end long-term liabilities
Stockholders' equity
Common stock, $0.01 parvalue, 300,000 shares outstending
Retained earnings
Total

206

2,800,000

4,000,000
$7.455,570

Equity

$ 358,000
40,075
398,075
2,400,000
$2,798,075
3,000
4,654,495

4,657,495
$7455570

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

Schedule of Cash Collections

Quarters

2
Accounts receivable balance on 1-1-2007(p. 2041
(Fourth quarter sales from prior year
collected in first quarter of 2007)
Fromfirst-quarter 2007 sales
(84,828,000x 0.70; $4,928,000 x 0.30)
Fromsecond-quarter 2007 sales
184,608,000x 0.70; $4,608,000 x 0.301
Fromthird-quarter 2007 sales
184,745,143x 0.70; $4,745,143 x 0.301
Fromfourth-quarter 2007 sales
(estimated collections from sales of $6,102,8571

$1,881,600

Totalcollections

$5,331,200

3,448,600

$1,478,400
3,225,600

$1,382,400

$4,704,000

3,321,600

$1,423,543

$4,704,000

4,848,457
$6,272,000

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

sensitivity Analysis and Cash Flows

!'-...,

Study Tip: To check

~yourunderstandingof
cash budgeting, see Featured
Exercise 2,multiple-choice question 8, and Review Exercise 3
(Student Guide, beginning p. 65).
Fully explained answers begin on
page 71.

Exhibit 6-4 (p. 195) shows how differing assumptions

about selling prices of coffee tables and
direct material prices led to differing amounts for budgeted operating income for Stylistic Furniture.
Akey use of sensitivity analysis is to budget cash flow. Exhibit 6-9 outlines the short-term borrowingimplications of the nine combinations
examined in Exhibit GA. Scenarios 7 to 9, with the lov,fer
selling price per table ($352.80), require large amounts of short-term borrowing in quarters 3 and
4. Scenario 9, with the combination
of a 10% lower selling price and 5% higher direct 111aterial
costs,requires the largest amount of borrowing by Stylistic Furniture. Sensitivity analysis helps managersanticipate such outcomes and take steps to minimize the effects of expected reductions in cash
flowsfrom operations.
A
1
2
3
4 Scenario
5
1
6
2
7
3
8
4
9
5
10
6
11
7
12
8
13
9

TERMS

TO

Sellin;
Prke
$431.20
431.20
431.20
392.00
392.00
392.00
352.80
352.80
352.80

C
D
E
F G
H
Diretl Malerial
Purc:hase Co./J Budgeled. Short-Ten" Bo
Partide Red Operating
Quarto
Board I Oak
lru;ome
I
2
J
$3.80
4.00
4.20
3.80
4.00
4.20
3.80
4.00
4.20

$5.70
6.00
6.30
5.70
6.00
6.30
5.70
6.00
6.30

$3,458,226
$0
3,244,126
0
3,030,026
0
1,695,010
1,4&0,910
0
1,266,810 ' 0
(68,206) I 0
(282,306)
0
(496,406)
0

o~

$0
0
0
0
0
0
0
0
0

0
0
0
145,000
308,000
472,000
1,413,000
1,576,000
1,739,000

4
$

0
0
0
0
0
0
717,000
997,000
1,276,000

;::

'ito

Q.

'"!!Q

"-~
'"

."~

LEARN

;:
Thechapter and the Glossary at the end of the book contain definitions of:
activity-based budgeting (ABB) (p. 186)
financial budget (p. 1861
budgetaryslack (p. 1991
financial planning models (p. 1931
cashbudget (p. 2051
investment center (p. 197)
continuous budget (p. 1841
kaizen budgeting (p. 1951
controllability (p. 188)
master budget (p. 1821
controllable cost(p. 1981
operating budget (p. 186)
costcenter (p. 187)
organization structure (p. 197)

pro forma statements (p. 1821

profit center (p. 197)
responsibility accounting (p. 1971
responsibility center Ip. 1971
revenue center (p. 1971
rolling budget (p. 1841

.;r~

,.

n
n

,."-

'"

201

Prentice Hall Grade Assist IPHGAI

Your professor may ask you to complete selected exercises and problems in Prentice Hall
Grade Assist (PHGA). PHGA is an online tool that can help you master the chapter's topics.
It provides you with multiple variations of exercises and problems designated by the PHGA

PH Grade Assist

icon. You can rework these exercises and problems-each

time with new data-as

many

times as you need. You also receive immediate feedback and grading.

ASSIGNMENT

MATERIAL

Questions
6-1
6-2
6-3
6-4

What are the four elements

6-5

"Production managers and marketing managers are like oil and water. They just don't mix."
How can a budget assist in reducing battles between these two areas?

6-6

"Budgets
Explain.

6-7
6-8
6-9
6-10
6-11
6-12
6-13

of the budgeting

cycle?

Define master budget.

"Strategy,

plans, and budgets are unrelated

"Budgeted performance
you agree? Explain.

is a better criterion

meet the cost-benefit

to one another."

Do you agree? Explain.

than past performance

test. They force managers

for judging managers."

to act differently."

Do

Do you agree?

Define rolling budget. Give an example.

Outline the steps in preparing

an operating

budget.

"The sales forecast

is the cornerstone

How can sensitivity

analysis be used to increase

for budgeting."

Why?

the benefits of budgeting?

Define kaizen budgeting.

Describe

how nonoutput-based

Explain how the choice

mentl affects behavior.

cost drivers can be incorporated

of the type of responsibility

into budgeting.

center least, revenue,

profit, or invest-

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

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

Required

1. Prepare a 2007 sales budget for McGrath & Sons assuming that they hold prices at 2006 levels_
2. Prepare a 2007 sales budget for McGrath & Sons assuming that they lower the price of a lead test to
$190. Should McGrath lower the price of a lead test in 2007 if its goal is to maximize sales revenue?

6-17 Sales and production budget. The Mendez Company expects sales in 2007 of 100,000 units of serving trays. Mendez's beginning inventory for 2007 is 7,000 trays; target ending inventory, 11,000 trays.
Compute the number of trays budgeted for production in 2007.
6-18 Direct material budget Inglenook Co. produces wine. The company expects to produce 1,500,000
two-liter bottles of Chablis in 2007. Inglenook purchases empty glass bottles from an outside vendor. Its target ending inventory of such bottles is 50,000; its beginning inventory is 20,000. For simplicity, ignore breakage_ Compute the number of bottles to be purchased in 2007.
Budgeting material purchases, The Mahoney Company has prepared a sales budget of 42,000 fin~...units for a three-month period. The company has an inventory of 22,000 units of finished goods on
hand at December 31 and has a target finished goods inventory of 24,000 units at the end of the succeeding
quarter.
Ittakes three gallons of direct materials to make one unit of finished product. The company has an inventory of 90,000 gallons of direct materials at December 31 and has a target ending inventory of 110,000 gallons at the end of the succeeding quarter. How many gallons of direct materials should be purchased during the three months ending March 31?

6~20

Revenues and production

budget. Purity, Inc., bottles and distributes

mineral water from the com-

pany's natural springs in northern Oregon. Purity markets two products: twelve-ounce
bottles and four-gallon reusable plastic containers.

disposable

plastic

l1J1

01f

PHClldlAssis1

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

ulr

2. Purity begins 2007 with 900,000 twelve-ounce

bottles in inventory.

The vice president

of operations

requests that twelve-ounce ending inventory on December 31, 2007, be no less than 600,000 bottles.
Based on sales projections as budgeted above, what is the minimum number of twelve-ounce bottles
Purity must produce during 200n
3. The VP of operations requests that ending inventory of four-gallon containers on December 31, 2007,
be 200,000 units. If the production budget calls for Purity to produce 1,300,000 four-gallon containers
during 2007, what is the beginning inventory of four-gallon containers on January 1, 200n
621 Direct material usage, unit costs, and gross margins (continuation of 6-20). Purity, Inc., bottles and
distributesmineral water from the company's natural springs in northern Oregon. Purity markets two products:
12-ouncedisposable plastic bottles and 4-gallon reusable plastic containers. The 12-ounce bottles are purchasedfrom Plastico, a plastics manufacturer, at a cost of 6 cents per bottle. The 4-gallon containers are sterilizedand put back into service at a cost of 30 cents per container. Spring water is extracted at a direct labor
costof 1 cent per 8 ounces (there are 128 ounces in a gallon). Manufacturing overhead is allocated atthe rate
of 15cents per unit. (Note: A unit can be a 12-ounce bottle or a 4-gallon containerl. In 2007, the production
budgetcalls for the production of 4,500,000 12-ounce bottles and 1,300,000 4-gallon containers.
1. Assume 4-gallon containers are fully depreciated, so the only cost incurred is that of sterilization.
Beginning and ending inventories for 4-gallon containers are zero. There are 500,000 empty 12-ounce
bottles in beginning inventory on January 1, 2007. The vice president of operations would like to end
2007with 300,000 empty 12-ounce bottles in inventory. Accounting for sterilization as the only cost of
the 4-gallon containers, prepare a direct material usage budget (relating to both bottles and containersl in both units and dollars.
2. The cost of direct manufacturing labor is captured through the extraction cost as detailed above.
Based on the data given, prepare a direct manufacturing labor budget for 2007.
3. Calculate the manufacturing cost per unit for each product.
4. Assuming average selling prices as in Exercise 6-20, what is the expected average gross margin per
unit for each product?
5. Consider Purity's choice of the cost-allocation base for manufacturing overhead. Can you suggest
alternative cost-allocation bases?

aequl .d

622 Revenues. production. and purchases budgets. The Suzuki Co. in Japan has a division that manufacturestwo-wheel motorcycles. Its budgeted sales for Model G in 2007 is 800,000 units. Suzuki's target endinginventory is 100,000 units, and its beginning inventory is 120,000 units. The company's budgeted selling
priceto its distributors and dealers is 400,000 yen () per motorcycle.
Suzuki buys all its wheels from an outside supplier. No defective wheels are accepted. (Suzuki's needs
forextra wheels for replacement parts are ordered by a separate division of the company.) The company's
~rget ending inventory is 30,000 wheels, and its beginning inventory is 20,000 wheels. The budgeted purchaseprice is 16,000 yen () per wheel.

--------------------

1. Compute the budgeted revenues in yen.

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

Required

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

Estimated sales in units

Selling price
Direct manufacturing laborhours per unit
Wage per direct manufacturing
labor-hour

Januarv

February

March

April

May

10,000
$54.00

12,000
$51.50

8,000
$51.50

9,000
$51.50

9,000
$51.50

20

2.0

1.5

1.5

1.5

$10.00

$10.00

$10.00

Sl1.00

$11.00

Besides wages, direct manufacturing labor-related costs include pension contributions of $0.50 per
hour,worker's compensation insurance of $0.15 per hour, employee medical insurance of $0.40 per hour, and
socialsecurity taxes. Assume that as of January 1, 2007, the social security tax rates are 7.5% for employersand7.5% for employees. The cost of employee benefits paid by Roletter on its employees is treated as
adirect manufacturing labor cost.

209

______
Required

Roletter has a labor contract that calls for a wage increase to $11 per hour on April 1, 2007. New laborsaving machinery has been installed and will be fully operational by March t, 2007. Roletter expects to have
16,000 frames on hand at December 31,2006, and it has a policy of carrying an end-of-month inventory of
'_00_'1<_, of the following month's sales plus 50% of the second following month's sales.
Prepare a production budget and a direct manufacturing labor budget for Roletter Company by month
and for the first quarter of 2007. Both budgets may be combined in one schedule. The direct manufacturing
labor budget should include labor-hours, and show the details for each labor cost category.

6-24 Activity-based

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

C
January 2008
BwIgl!red

1
2

COlt-Driver

3
4
5
6
7

------R_qulred

-----

R ul

AdM
Ordering
Delivery
Shelf-stocking
Customer support

.
>-

J::
u

210

_______
R_qulred

Rare
$ 90
$ 82
$ 21
$0.18

If you want to use Excel to solve this exercise, go to the Excel Lab at www.prenhall.com/horngren/cost12e
and download the template for Exercise 6-24.
1. What is the total budgeted indirect cost atthe Chelsea store in January 2008? What is the total budgeted
cost of each activity at the Chelsea store for January 2008? What is the budgeted indirect cost of each
product category for January 200B?
2. Which product category has the largest fraction of total budgeted indirect costs?
3, Given your answer in requirement 2, what advantage does FS gain by using an activity-based approach
to budgeting over, say, allocating indirect costs to products based on cost of goods sold?

6-25 Kaizen approach to activity-based budgeting (continuation of 6-24). Family Supermarkets (FS) has
a kaizen (continuous improvement) approach to budgeting monthly activity costs for each month of 2008.
Each successive month, the budgeted cost-driver rate decreases by 0.2% relative to the preceding month
(so, for example, February's budgeted cost-driver rate is 0.998 times January's budgeted costdriver rate,
and March's budgeted cost-driver rate is 0.99Btimes the budgeted February 200B rate I. FS assumes that the
budgeted amount of cost-driver usage remains the same each month.
If you want to use Excel to solve this exercise, go to the Excel Lab at www.prenhall.com/horngren/cost12e
and download the template for Exercise 6-24.
1. What is the total budgeted cost for each activity and the total budgeted indirect cost for March 200B?
2. What are the benefits of using a kaizen approach to budgeting? What are the limitations of this
approach, and how might FS management overcome them?

6-26 Responsibility

'~
"
'"

CoslDriver
Number of purchase orde
Number of deliveries
Hours of stocking time
Number of items sold

D
E
F
January 2008 BwIgl!red
Amounl of Coil Driver Used
Soft
Fresh
Pa<k:aged
Drinks
Prodw:.
Food
14
24
14
12
62
19
16
172
94
34,200
10,750
4,600

and controllability.

Consider each of the following independent situations:

1. A very successful salesman at Amcorp Computers regularly ignores the published sales catalog and
offers lowered prices to his customers in order to close sales. The VP of sales notices that revenues
are substantially lower than budgeted.
2. Every "special deal" offered to a customer by any salesperson at Amcorp Computers has to be cleared
by the VP of sales. Revenues for the second quarter have been lower than budgeted.
3. The shipping department of Amcorp has limited capacity, and sales orders are being cancelled by cus
tamers because of delays in delivery. Revenues for the past month have been lower than budgeted.
4. At Planetel Corp., a manufacturer ohelecommunications
equipment, the production supervisor notices
that a significantly larger number of direct manufacturing labor-hours were used than had been bud
geted. Investigation revealed that it was due to a decline in educational standards required by the HR
department when they interviewed applicants for hourly production jobs six months earlier.
5. At Planetel Corp., a relatively new production supervisor finds that more direct manufacturing laborhours were used than had been budgeted. Interviews revealed that workers were unhappy with his
management style and were intentionally working slowly and inefficiently.
6. At Planetel Corp., the production supervisor traces the excessive consumption of direct materials (relative to the budget) to the fact that waste was high on machines that had not been properly maintained.
For each situation described, determine where (that is, with whom) (a) responsibility and (b) controllability lie. Suggest what might be done to solve the problem or to improve the situation.

627 Cash flow analysis, chapter appendix. ICMA, adapted) TabComp, Inc., is a retail distributor for
MZB-33 computer hardware and related software and support services. TabComp prepares annual sales
forecasts of which the first six months for 2006 are presented here.
Cash sales account for 25% of TabComp's total sales, 30% of the total sales are paid by bank credit card,
and the remaining 45% are on open account (TabComp's own charge accounts). The cash sales and cash
from bank credit-card sales are received in the month of the sale. Bank credit-card sales are subject to a
4% discount deducted at the time of the daily deposit. The cash receipts for sales an open account are 70%
inthe month following the sale and 28% in the second month after the sale. The remaining accounts receivable are estimated to be uncollectible.
TabComp's month-end inventory requirements for computer hardware units are 30% of the next month's
sales. A one-month lead time is required for delivery from the manufacturer. Thus, orders for computer hardware units are placed on the 25th of each month to assure that they will be in the store by the first day of
the month needed. The computer hardware units are purchased under terms of n/45 (payment in full within
45 days of invoice), measured from the time the units are delivered to TabComp. TabComp's purchase price
for the computer units is 60% of the selling price.
TobComp Inc,
First Six Monlhs of 2006

Soles Forecosl
Hardware Sales

January
February
March
April
May
June
Total

Units

Dollars

130
120
110
90
100
125

S 390,000

Software
Sales and Support

Total
Revenues

$160,000
140,000
150,000
130,000
125,000
225,000

$ 550,000
500,000
480,000
400,000
425,000
600,000
$2955000

360,000
330,000
270,000
300,000
375,000
$2025000

Jill

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

ul

1. TabComp, Inc., is determining how many M2B-33 computer hardware units to order on January 25, 2006.
a, Determine the projected number of computer hardware units that will be ordered.
b. Calculate the dollar amount of the order that TabComp will place for these computer hardware units.
3. As part of the annual budget process, TabComp prepares a cash budget by month for the entire year.
Explain why a company such as TabComp prepares a cash budget by month for the entire year.

Problems
628 Budget schedules for a manufacturer.
products:
Executive desks-3' x 5' oak desks
Chairman desks-6' x 4' red oak desks
Thebudgeted direct-cost

Sierra Furniture is an elite desk manufacturer.

inputs for each product in 2006 are:

Executive line

Oak top
Red oak top
Oak legs
Red oak legs
Direct manufacturing

16 square feet

o
25 square feet

o
labor

Chairman line

3 hours

4
5 hours

Unitdata pertaining to the direct materials for March 2006 are:

Actual Beginning Direct Materials

Oak
Red
Oak
Red

It makes two

Inventory (3/1JZOO6)
Executive line

top (square feet)

oak top {square feetl
legs
oak legs

TargetEnding Direct Materials

320

o
100

Inventory (3/3112006)
Executive Line

Oak top (square feet)

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

192

o
80

'"c0-

Chairman line

o
150

o
40

'"!l
o
,
0-

'"
,

-0

~
~'

Chairman Line

l>
n
n

o
C

'""

44

211

200

Unit cost data for direct-cost

inputs pertaining to February 2006 and March 2006 are:

March 2006
(budgetedl

February 2006
lactuall
Oak top (per square foot)
Red oak top (per square foot)
Oak legs (per legl
Red oak legs (per leg)
Manufacturing labor cost per hour

S18
23
11
17
30

$20
25
12
18
30

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

Beginning inventory in units

Beginning inventory in dollars (cost)
Target ending inventory in units

Executive

Chairman line

20
$10,480
30

5
$4,850
15

Budgeted sales for March 2006 are 740 units of the executive line and 390 units of the chairman line. The
budgeted selling prices per unit in March 2006 are $1,020 for the executive-line desk and $1,600 for the
chairman-line desk. Assume the following in your answer:
Work-in-process inventories are negligible and ignored .
Direct materials inventory and finished goods inventory are casted using the FIFO method.
-Unit
costs of direct materials purchased and finished goods are constant in March 2006.

R ul

PIl Clade Assisl

Requl

1. Prepare the following budgets for March 2006:

a. Revenues budget
b. Production budget in units
c. Direct material usage budget and direct material purchases budget
d. Direct manufacturing labor budget
e. Manufacturing overhead budget
I. Ending inventory budget (direct materials and finished goodsl
g. Cost of goods sold budget
2. Suppose Sierra Furniture decides to incorporate continuous improvement into its budgeting process.
Describe two areas where Sierra could incorporate continuous improvement into the budget schedules in requirement 1.

6-29 Sensitivity analysis, changing budget assumptions, kaizen approach. Chaco Chips produces two
brands of chocolate chip cookies: Chippo and Chokko. The cookies are produced from only two ingredients:
chocolate chips and cookie dough. Chippo is 50% chips by weight and 50% dough, whereas Chokko is 25%
chips by weight and 75% dough; there is negligible loss while baking the cookies.
Packages of either brand weigh 1 pound. Chaco Chips's master budget projects sales of 500,000 packages
of each brand in 2007, at $3 per package. Forecasted 2007 ingredients' costs are $2 per pound of chocolate chips
and $1 per pound of cookie dough. A total of 5,000 direct manufacturing labor-hours-40%
for Chippo and 60%
for Chokko-are budgeted, at $20 per hour. Manufacturing overhead costs are expected to be $160,000, alia
cated between the two products on the basis of packages produced. There is no beginning or ending inventory.
1. Calculate budgeted gross margins for each product and for Chaco Chips in 2007.
2. By working with its current suppliers, Chaco Chips estimates it could reduce the cost of ingredients by
3%. Calculate Chaco Chips's revised budgeted gross margin in 2007.
3. An analysis of all activities by a cross-functional team responsible for continuous improvement shows
that if the company purchases better-quality ingredients from a different supplier costing 5% more than
the original ingredients, there will be fewer quality-related production line stoppages, which will
reduce manufacturing overhead costs and direct manufacturing labor-hours by 2%. Calculate Chaco
Chips's revised 2007 budgeted gross margin under this scenario.
4. Based on bu~geted gross margin alone, which of the three scenarios here do you think Chaco Chips's management would prefer? What other factors would you consider before choosing between (2) and (3) above?

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

212

Product

Units

Price

Thingone
Thingtwo

60,000
40,000

$165
$250

2001/nventories in Units
Expected Target
Product

January 1,2007

December 31, 2007

Thingone
Thingtwo

20,000
8,000

25,000
9,000

The following direct materials are used in the two products:

Amount Used per Unit
Direct Material

Unit

Thingone

Thingtwo

A
B
C

pound
pound
each

4
2
0

Projected data for 2007 with respectto

3
1

direct materials are as follows:

Direct
Material

Anticipated
Purchase
Price

Expected
Inventories
January 1, 2007

Target
Inventories
December 31, 2007

A
B
C

$12
5
3

32,000 lb.
29,000 lb.
6,000 units

36,000 lb.
32,000 lb.
7,000 units

Projected direct manufacturing

labor requirements and rates for 2007 are as follows:

Product

Hours per Unit

Rate per Hour

Thingone
Thingtwo

$12

16

Manufacturing overhead is allocated at the rate of 20 per direct manufacturing labor-hour.

Based on the preceding projections and budget requirements for Thingone and Thingtwo, prepare the
following budgets for 2007:

R ul

t Revenues budget lin dollars)

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

631

Budgeted income statement ICMA, adapted) Easecom Company is a manufacturer of videoconferencing products. Regular units are manufactured to meet marketing projections, and specialized
unitsare made after an order is received. Maintaining the video-conferencing equipment is an important
areaof customer satisfaction. With the recent downturn in the computer industry, the video-conferencing
equipmentsegment has suffered, leading to a decline in Easecom's financial performance. The following
incomestatement shows results for 2007.
Easecom Company
Income 5talement
For the Year Ended December 31. 2007 (in tbousands)
Revenues:
Equipment
$6,000
Maintenance contracts
1,800
Total revenues
$7,800
Cost of goods sold
4,600
Gross margin
3,200
Operating costs
Marketing
600
Distribution
150
Customer maintenance
1,000
Administration
900
Total operating costs
2,650
Operating income
$ 550
Easecom'smanagement team is in the process of preparing the 2008 budget and is studying the following
infDrmati~
1. Sellin
ces of equipment are expected to increase by 10% as the economic recovery begins. The
sellir
ce of each maintenance contract is expected to remain unchanged from 2007.
2. EqIt sales in units are .expected to increase by 6%, with a corresponding 6% growth in units of
maintenance contracts.
3. Cost of each unit sold is expected to increase by 3% to pay for the necessary technology and quality
improvements.

213

4. Marketing costs are expected to increase by $250,000, but administration costs are expected to remain
at 2007 levels.
5. Distribution costs vary in proportion to the number of units of equipment sold.
6. Two maintenance technicians are to be hired at a total cost of 130,000, which covers wages and
related travel costs. The objective is to improve customer service and shorten response time.
7. There is no beginning or ending inventory of equipment.
-------

Reulred

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

6-32 Responsibility

_____
Re'lulred

of purchasing agent.IAdapted from a description by R. Villers) Mark Richards is the

purchasing agent for the Hart Manufacturing Company. Kent Sampson is head of the Production Planning
and Control Department. Every six months, Sampson gives Richards a general purchasing program.
Richards gets specifications from the Engineering Department. He then selects suppliers and negotiates
prices. When he took this job, Richards was informed very clearly that he bore responsibility for meeting the
general purchasing program once he accepted it from Sampson.
During week 24, Richards is advised that Part No. 1234-a critical part-would
be needed for assembly
on Tuesday morning of week 32. He found that the regular supplier could not deliver. He called everywhere
and finally found a supplier in the Midwest who accepted the commitment.
He followed up bye-mail. Ves, the supplier assured him, the part would be ready. The matter was so
important that on Thursday of week 31, Richards checked by phone. Yes, the shipment had left in time.
Richards was reassured and did not check further. But on Tuesday of week 32, the part had not arrived.
In_q~uiryrevealed that the shipment had been misdirected by the railroad and was still in Chicago.
What department should bear the costs of time lost in the plant due to the delayed shipment? Why? As
purchasing agent, do you think it is fair that such costs be charged to your department?

6-33 Activity-based budgeting. Anderson Manufacturing, Inc., manufactures two types of valves,
300,000 simple valves ISV2) and tOO,OOOcomplex valves (CL9). Anderson uses activity-based costing and
activity-based budgeting. The following table contains cost-driver and budgeted indirect-cost information
for 2007 for the different activities.
Items in Cost Pool (fixed cost +
cost per unit of cost driver)

Activitv

Cost Driver

Machining

Machine hours

Setups and
quality assurance

Production runs

Procurement

Purchase orders

Design
Materials handling

Engineering hours
Square feet of materials
handled

Indirect materials SO + $10 per machine-hour

Indirect labor S20,000 + $15 per machine-hour
Utilities SO + 55 per machine-hour
Indirect materials SO + Sl,OOO per prod. run
Indirect labor $0 + $1,200 per prod. run
Inspection $80,000 + $2,000 per prod. run
Indirect materials $0 + S4 per purch. order
Indirect labor $45,000 + $0 per purch. order
Engineering $75,000 + $50 per engg.-hour
Indirect materials $0 + $2 per sq ft
Indirect labor $30,000 + $0 per sq ft

Additional budget data for 2007, describing the amount of activity resources used by the two types of valves
follows:
Quantity of Cost Driver Used By
Activity
a.
b.
c.
d.
e.
Required

Machining
Setups and quality assurance
Procurement
Design
Materials handling

SV2

Cl9

6,500

3,500

20

20

8,000

7,000

25

75

60,000

40,000

Total Budgeted Volnme of Cost Driver

10,000 machine-hours
40 production runs
15,000 purchase orders
100 engineering-hours
100,000 square feet

1. Calculate the total budgeted cast for each activity in 2007 and the cost-driver rate for each activity.
2. Use the cost-driver rates calculated in requirement 1 to calculate budgeted indirect costs allocated to
each product in total and per unit.
3. What advantages might Anderson gain by using an activity-based budgeting approach over, say, an
approach that allocates the cost of these activities to products as a percentage of the cost of goods sold.

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

214

!Jorrequirements
Direct materials
Wood
Fiberglass
Direct manufacturing

labor

5 board feet Ib.f.) per snowboard

6 yards per snowboard
5 hours per snowboard

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

Direct materials inventories

Wood
Fiberglass

Beginning
Inventorv
1/1/2007

Ending
Inventory
12/31/2007

2,000
1,000

1,500
2,000

Variable manufacturing overhead is $7 per direct manufacturing labor-hour. There

fixed manufacturing overhead costs budgeted for 2007. Slopes combines both variable
turing overhead into a single rate based on direct manufacturing labor-hours. Variable
allocated at the rate of $250 per sales visit. The marketing plan calls for 30 sales visits
there are $30,000 in fixed nonmanufacturing costs budgeted for 2007.
Other data includes:

Wood
Fiberglass
Direct manufacturing

labor

are also S66,000 in

and fixed manufacmarketing costs are
during 2007. Finally,

2006 Unit Price

2007 Unit Price

$28.00 per b.t.

$ 4.80 per yard
$24.00 per hour

$30.00 per b.f.

$ 5.00 per yard
$25.00 per hour

The inventoriable unit cost for ending finished goods inventory on December 31,2006, is $374.80. Assume
Slopes uses a FIFO inventory method for both direct materials and finished goods. Ignore work in process
inyour calculations.
8udgeted balances at December 31, 2007, in the selected accounts are:
Cash
Properly, plant, and equipment Inetl
Current liabilities
Long-term liabilities
Stockholders' equity

S 10,000
850,000
17,000
178,000
800,000

1. Prepare the 2007 revenues budget lin dollars) .

2, Prepare the 2007 production budget (in units).
3. Prepare the direct material usage and purchases budgets.
4, Prepare a direct manufacturing labor budget.
5. Prepare a manufacturing overhead budget.
6. What is the budgeted manufacturing overhead rate?
7. What is the budgeted manufacturing overhead cast per output unit?
8, Calculate the cost of a snowboard manufactured in 2007.
9. Prepare an ending inventory budget for bath direct materials and finished goods.
10. Prepare a cost of goods sold budget.
11. Prepare the budgeted income statement for Slopes, Inc., for the year ending December 31, 2007.
12. Prepare the budgeted balance sheet for Slopes, Inc., as of December 31,2007.

635

"ul

Cash budgeting, chapter appendix. Retail outlets purchase snowboards from Slopes, Inc., through-

out the year. However, in anticipation of late summer and early fall purchases, outlets ramp up inventories
fromMay through August. Outlets are billed when boards are ordered. Invoices are payable within 60 days.
Frompast experience. Slopes's accountant projects 20% of invoices are paid in the month invoiced, 50% are
paidin the following month, and 30% of invoices are paid two months after the month of invoice. The averageselling price per snowboard is $450.
To meet demand, Slopes increases production from April through July, because the snowboards
are produced a month prior to their projected sale. Direct materials are purchased in the month of productionand are paid for during the fallowing month Iterms are payment in full within 30 days of the invoice date).
Duringthis period there is no production for inventory, and no materials are purchased for inventory.
Direct manufacturing labor and manufacturing overhead are paid monthly. Variable manufacturing overheadis incurred at the rate of $7 per direct manufacturing labar-hour. Variable marketing costs are driven
by the number of sales visits. However, there are no sales visits during the months studied. Slopes, Inc., also
incursfixed manufacturing overhead costs of $5,500 per month and fixed nonmanufacturing overhead costs
of$2,500per month.
Projected Sales
May
June
July

80 units
120 units
200 units

August
September
October

100 units
60 units
40 units

215

Required

216

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2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
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20
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23
24
25
26
27

Sbuport, Inc.
C h Budget for 1he Vear Ending Deeemher 31, 2007 (in thousands)
Quarton
Cash balance, beginning
Add receipts
Collections from customers
Total cash available for needs
Deduct disbursements
Direct materials
Payroll
Other costs
Machine>y purchese
Interest costs (bond)
Income taxes
Total disbursements
Minimum cash balance desired
Total cash needed
Cash ",:ess (defICiency)
Financing
Borrowing (at be!9nning)
Repayment (at end)
Interest (at 12% per annum)
Total effects of fmancing
Cash balance, ending

1
$ 15,000

385,000
?

?
$347,000

175,000
?
50,000
0

125,000
110,000
45,000
?
?
14,000

15,000
368,000

?
?

?
$ (50.000)

0
0
0

L-.Q
$ 32 000

?
$310,000

?
$

0
0
0
0

0
0
?
?

Whole
?

$365,000
?

$1,360,000
?

?
95,000
40,000
0
?
12,000
260,000
?
?
?

---

Vearas a

4
?

J
?

155,000
118,000
49,000
0
?
?
345,000
?
?
?
$

0
(50,000)
(4,500)
$ (54 500)
$ 15.500

?
448,000
?
85,000
?

61,000
?
15,000
1,370,000
$
5000
?
(50,000)
(4,500)
$ (4500)
?
$

6-37
Cash budgeting, chapter appendix. On December 1, 2007, the Itami Wholesale Co. is attempting to
project cash receipts and disbursements through January 31,2008. On this latter date, a note will be payable
in the amount of $100,000. This amount was borrowed in September to carry the company through the seasonal peak in November and December.
Selected general ledger balances on December 1 are:

$ 10,000
280,000

Cash
Accounts receivable
Allowance for bad debts
Inventory
Accounts payable

$15,800
87,500
92,000

Sales terms call for a 2% discount if payment is made within the first 10 days of the month after sale, with
the balance due by the end of the month after sale. Experience has shown that 70% of the billings will be
collected within the discount period, 20% by the end of the month after purchase, and 8% in the following
month. The remaining 2% will be uncollectable. There are no cash sales.
The average selling price of the company's products is $100 per unit. Actual and projected sales are:
October actual
November actual
December estimated
January estimated
February estimated
Total estimated for year ending June 30, 2008

$ 180,000
250,000
300,000
150,000
120,000
$1,500,000

All purchases are payable within 15 days. Thus, approximately 50% of the purchases in a month are due and
payable in the next month. The average unit purchase cost is $70. Target ending inventories are 500 units
plus 25% of the next month's unit sales.
Total budgeted marketing, distribution, and customer-service costs for the year are S400,000. Of this
amount,$150,000 are considered fixed land include depreciation of $30,000). The remainder vary with sales.
Both fixed and variable marketing, distribution, and customer-service costs are paid as incurred .
Prepare a cash budget for December 2007 and January 2008. Supply supporting schedules for collections of receivables; payments for merchandise; and marketing, distribution, and customer-service costs.

qul

6-38 Comprehensive budget, fill in schedules. The manager of Newport Stationery Store is working on
the final quarter's budget for 2007. She has the following information:
1.

I
N""1'ort Stationery Store
2 BalaJu:e Sheet as of Sep1emberJO, 2007
3 CurrentAssets
4
Cash
$ 12,000
5
Accounts ReceNoble
10,000
6
Inventory
63,600
7 Equipment .. net
100,000
8 Liabilities as of September 30
2.

None

DIE
I F
G
H
Recent and anticipated sales:
September October November Dec:ember January
$40,000

$48,000

$60,000

$80,000

$36,000

3. Credit sales: Sales are 75% cash, 25% on credit. Credit accounts are all collected within 30 days of sale.
The accounts receivable on September 30 are the result of September's credit sales (25% of $40,000).
4. Gross margin averages 30% of revenues. Newport treats cash discounts on purchases as "other
income" in the income statement.
5. Monthly operating costs: Salaries and wages average 15% of revenues; rent 5%; other operating costs,
excluding depreciation, 4%. These costs are paid in cash each month. Depreciation is $',000 per month.
6. Inventory purchases: Newport always keeps a basic minimum inventory of $30,000. Each month it purchases just enough inventory to cover the following month's sales. The inventory on September 30 is the
S30,000minimum inventory plus cost of sales equal to 70% (100% - gross margin of 30%) of October's
anticipated sales of $48,000 [$30,000 + 10.7x $48,0001 = $63,600]. Terms on inventory purchases are 2110,
n130.(Payments on purchases are to be made in 30 days; a 2% discount is available if full payment is made
within 10 days of purchase.) Newporttakes all available discounts by paying in the month of the purchase.
1. Equipment purchases: In October, Newport will spend $600 on light fixtures, and in November, $400;
these amounts will be capitalized.
8. A minimum cash balance of $8,000 must be maintained. All borrowing-in
multiples of $1,OOo-occurs
atthe beginning of the month; all repayments are made at month-end. Loans are repaid when sufficient
cash is available, and interest is paid only at the time of repaying the principal. The interest rate is 18%

217

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

------ ul d

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

1. Complete the lollowing schedules A through F.

2. What do you think is the mostlogical type of loan lor Newport to take when it needs cash? Explain your
reasoning.
3. Prepare a budgeted income statement for the fourth quarter and a budgeted balance sheet as of
December 31, 2007. Ignore income taxes.
4. Some simplifications have been made in the design of this problem. What complicating factors may
arise in compiling cash and financing budgets in a business such as Newport Stationery Store?

..,
'"

1-

-<:

:r:
u

218

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B
Schedule A
Budgeted Monthly Cash
's tember
$40,000
10,000

Item
Total sales
Credit ,ales
Cash sales
~ceipts:
Cash sales
Collections on accounts receivable
Total

--

Receipts
October
$48,000
12,000

-$36,000
10,000
$46 000

November

December

$60,000

$80,000

--

--

--

--

Schedule B
Budgeted Monthly Cash Disbursements for Purchases
Item
October
November December
Purchases (70% of next month', sales)
$42,000
Deduct 2% cash discount
840
Total disbursement,
$41.160
Schedule C
Budgeted Monthly Cas. Disbursements for Operations
Item
October
November December
Salaries and wages
$ 7,200
ut, 2,400
Rent
Other cash operating costs
~
Total disbursement,
$11 520
-Schedule D
Budgeted Total Monthly Cash Disbursements
Item
October
November 1December
Purchases
$41,160
Cash operating costs
11,520
Light fIxtures
600
Total disbursement,
$53280
Schedule E
Budgeted Cash Receipts and Disbursements
Item
October
November I December
Total receipts
$46,000
Total disbursements
53,280
Net cash increase (decrease)
$ (7 280)

--

--

--

t-

--

Item
Beginning cash baleru:e
Net cash increase (decrease)
Cash position before borrowing
Mincmurn cash baleru:e required
Cash excess (defu:iency)
Borrowing required
Interest payments
Borrowing repaid
Ending cash baleru:e

Schedule F
Financing Required
October
November
$12,000
(7,280)
4,720
8,000
(3,280)
4,000

$ 8720

--

--

--

4th

-4th.

uarter

-4th

uarter

-4th

wu1er

--

I December' 4th

--

uarter

uarter

--

6-39 Budgetary slack and ethics.ICMAllt

is fall 2006 and Marge Atkins, the new management accountant
at Norton Company, a manufacturer of baby furniture, is working on the 2007 budget. Scott Ford, the northeast
sales manager, whose sales team will easily meet its $2,000,000 sales budget this year, has projected sales of
S2,200,000in 2007. But, in conversations with individual salespeople, Atkins learns that each salesperson is
expecting to make sales of at least 20% more in 2007 than in the current year. When Atkins asks Ford about this,
he says, "Well, not meeting projections is so bad for the morale of the sales team ... and you know how the top
brass froths at the mouth when we miss our target by even a little bit ... so, we give ourselves a little breathing
room." Intrigued, Atkins investigates further and finds that Pete Granger, the production manager, makes similar
adjustments, padding estimated costs by about 10% to come up with the budgeted costs.
1. As a management accountant, should Marge Atkins take the position that the behavior described by
Scott Ford and Pete Granger is unethical? Refer to the Standards of Ethical Conduct for Management
Accountants described in Chapter lip. 16).
2. How would you suggest Marge Atkins handle this situation?

Reulred

Collaborative Learning Problem

6-40 Comprehensive Review 01 Budgeting, Cash Budgeting, Chapter Appendix. Wilson Beverages bottles two soft drinks under license to Cadbury Schweppes at its Manchester plant. All inventory is in direct
materials and finished goods at the end of each working day. There is no work-in-process inventory.
The two soft drinks bottled by Wilson Beverages are lemonade and diet lemonade. The syrup for both
soh drinks is purchased from Cad bury Schweppes.
Wilson Beverages uses a lot size of 1,000 cases as the unit of analysis in its budgeting. (Each case contains 24 bottles.) Direct materials are expressed in terms of lots, in which one lot of direct materials is the
input necessary to yield one lot (1,000 cases) of beverage. The following purchase prices are forecast for
direct materials in 2005:

Syrup
Containers (bottles, caps, etc.)
Packaging

lemonade

Diet lemonade

$1,200 per lot

$1,000 per lot
$ 800 per lot

SI,100 per lot

$1,000 per lot
$ 800 per lot

All direct material purchases are on account.

The two soft drinks are bottled using the same equipment. The only difference in the bottling process for
thetwo soft drinks is the syrup.
Summary data used in developing budgets for 2005 are
1. Sales
Lemonade, 1,080 lots at $9,000 selling price per lot
All sales are on account.
1. Beginning (January I, 20051 inventory of direct materials

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

Syrup for lemonade, 80 lots at $1,100 purchase price per lot

Containers, 200 lots at S950 purchase price per lot
Syrup for diet lemonade, 70 lots at $1,000 purchase price per lot Packaging, 400 lots at $900 purchase price per lot
3. Beginning IJanuary I, 2005) inventory of finished goods
Lemonade, 100 lots at $5,300 per lot
Diet lemonade, 50 lots at $5,200 per lot
4. Target ending IDecember 31, 2005) inventory of direct materials
Syrup for lemonade, 30 lots
Containers, 100 lots
Syrup for diet lemonade, 20 lots
Packaging, 200 lots
5. Target ending (December 31, 20051 inventory of finished goods
Lemonade, 20 lots
Diet lemonade, 10 lots
6. Each lot requires 20 direct manufacturing labor-hours at the 2005 budgeted rate of $25 per hour. Direct
manufacturing labor costs are paid atthe end of each month.
7. Variable manufacturing overhead is forecast to be $600 per hour of bottling time; bottling time is the
time the filling equipment is in operation. Ittakes two hours to bottle one lot of lemonade and two hours
to bottle one lot of diet lemonade. Assume all variable manufacturing overhead costs are paid during
the same month when incurred.
Fixed manufacturing overhead is forecast to be $1,200,000for 2005. Included in the fixed manufacturing
overhead forecast is $400,000 for depreciation. All manufacturing overhead costs are paid as incurred.
8. Hours of budgeted bottling time is the sale cost~allocation base for all fixed manufacturing overhead.
9. Administration costs are forecast to be 10% of the cost of goods manufactured for 2005. Marketing
costs are forecast to be 12% of revenues for 2005. Distribution costs are forecast to be 8% of revenues
for 2005. All these costs are paid during the month when incurred. Assume there are no depreciation
or amortization expenses.
10. Budgeted beginning balances on January I, 2005:
Accounts receivable (from sales)
Accounts payable Ifor direct materials)
Cash

$550,000
300,000
100,000

219

11. Budgeted ending balances on December 31, 2005:

Accounts receivable (from sales)
Accounts payable (for direct materials)

$600,000
400,000

12. Budgeted equipment purchase in May

13. Estimated income tax expense for 2005

------lI.qulre"

$1,350,000
$ 625,000

Assume Wilson Beverages uses the first-in, first-out method for costing all inventories. On the basis of the
preceding data, prepare the following budgets for 2005:
.
b,
c.
d.
k.
e.

Revenues budget (in dollars)

Production budget (in unitsl
Direct materials usage budget (in units and dollars)
Direct materials purchases budget
Administration costs budget (in units and dollars)
Direct manufacturing labor budget
f. Manufacturing overhead costs budget

Get Connected:

Cost Accounting

g. Ending finished goods inventory budget

h, Cost of goods sold budget
i. Marketing costs budget
j. Distribution costs budget
I. Budgeted income statement
m, Cash budget

in the News

Go to wwworenhall.com/hornaren/cost12eforadditional
online exercise!s) that explore issues affecting the
accounting world today. These exercises offer you the opportunity to analyze and reflect on how cost
accounting helps managers to make better decisions and handle the challenges of strategic planning and
implementation.

CHAPTER

Video

Case

RITZ-CARLTON HOTELS: Budgets and Responsibility Accounting

'"'"

...
w

0-

::c

220

"ladies and gentlemen serving ladies and gentlemen." That's

the motto of the Ritz-Carlton. With locations ranging from the
United States to Bahrain to China, the grand 58-hotel chain is
known for its indulgent luxury and sumptuous surroundings.
This aura of old-world elegance stands in stark contrast to its
rather heavy emphasis, behind the scenes of course, on cost
control and budgets. Yet it is this very approach that makes it
possible for the Ritz-Carlton to offer the legendary grandeur all
guests expect during their stay.
A hotel's performance is the responsibility of the general
manager and controller at each location worldwide. local forecasts and budgets are prepared annually and are the basis of
subsequent performance evaluations. Preparation of the annual
budget begins with the sales budget, prepared by the hotel's
sales director. Budgeted sources of revenue include hotel
rooms; convention, wedding, and meeting facilities; merchandise; and food and beverage. The controller then seeks input
from all employees-from
maintenance staff to kitchen workers-about
anticipated payroll changes, operating costs, and
planned events or promotions that might affect costs. Standard
costs, based on cost per occupied room, are used to build the
budget for guest room stays. Other standards are used for meeting rooms and food and beverages. The completed sales budget
and annual operating budget are sent to corporate headquarters. From there, actual monthly performance against plan is
monitored.
On the 25th of each month, budgets for the next three months
are reviewed to be sure goals are still accurate. Accuracy can be
critical for a business whose occupancy can fluctuate significantly from day to day, depending on group or company bookings,
special events, or changes in local competition. Any changes are
communicated to corporate headquarters, with explanations of

revisions provided as needed. Managers of each hotel meet daily

to review performance to date, and have the ability to adjust
prices in the reservation system if they so choose. Adjusting
prices can be particularly important if a large group cancels at
the last minute or if other unforeseen events cause occupancy to
drop suddenly, as happened after the World Trade Center terrorist attacks in 2001.
Meeting the monthly budgeted goals is primarily the
responsibility of each hotel's controller. The controller of each
hotel receives a monthly report from corporate headquarters
that shows how the hotel performed against budget, as well as
against the actual performance of other Ritz-Carlton hotels.
Ideas for boosting revenues and reducing costs are regularly
shared among hotel controllers, who recognize the value of
contributing to the entire organization's success, not just the
success of their own hotel properties.

QUESTIONS
1. The Ritz-Carlton gives all employees at each of its hotels
the chance to meet with their hotel's controller to review
budgets and reports on actual performance, as a form of
participatory budgeting. What advantages or disadvantages do you see with this approach?
2. What factors might affect the Ritz-Carlton's annual sales
forecast for room occupancy, restaurants, and use of
meetings rooms and conference facilities?
3. How is uncertainty handled in Ritz-Carlton's budgeting
process?
4. The Ritz-Carlton uses responsibility accounting for its world
wide hotel and resort operations. What levels of responsibility reports would you expectto see throughoutthe company?