To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 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 This question requires students to extend knowledge beyond the applications e shown in the textbook Open-ended questions are coded according to the skills described in Steps for Better Thinking (Exhibit 1.10):  Step skills (Identifying)  Step skills (Exploring)  Step skills (Prioritizing)  Step skills (Envisioning) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-2 Cost Management 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 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 10: Static and Flexible Budgets 10-3 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 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-4 Cost Management EXERCISES 10.13 Seer Manufacturing A Production Budget Desired ending inventory Planned sales Total units needed Planned beginning inventory Production requirements February 180 90 270 190 80 March 110 100 210 180 30 April 100 80 180 110 70 February 120 240 360 150 210 March 45 90 135 120 15 April 105 210 315 45 270 B Direct Materials Unit Forecast Desired ending inventorya Planned usageb Total units needed Planned beginning inventoryc Materials acquisitions a Current production x units direct materials x 0.5 to reflect direct materials units per product, and half of this month’s production for ending inventory balance b Current production x c Prior month's production x 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 Labor hours needed a Current production x 10 February 800 March 300 April 700 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 10: Static and Flexible Budgets 10-5 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) Sales units (a) Plus ending inventory (b) Total Units needed Less Beginning inventory Total units to be produced January February 20,000 24,000 12,000 8,000 32,000 32,000 10,000 12,000 22,000 20,000 March Quarter 16,000 60,000 9,000 9,000 25,000 69,000 8,000 10,000 17,000 59,000 (a) Current month's sales (b) 50% of following month's sales (2) Direct labor budget (hours) January 22,000 4.0 88,000 February 20,000 4.0 80,000 March 17,000 3.5 59,500 January 22,000 $10 $220,000 February 20,000 $10 $200,000 March 17,000 $10 $170,000 January 20,000 $80 $1,600,000 February 24,000 $80 $1,920,000 March 16,000 $75 $1,200,000 Units to be produced Direct labor hours per unit Total labor budget (hours) Total 59,000 227,500 (3) Direct materials budget (dollars) Units to be produced Cost per unit Total direct material cost Total 59,000 $590,000 (4) Sales budget (dollars) Sales units Sales price per unit Total sales revenue budget Total 60,000 $4,720,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-6 Cost Management B Bullen & Company Budgeted Contribution Margin First Quarter, 20X5 January Direct labor hours per unit 4.0 Direct labor hourly rate $15 Direct labor cost per unit $60 Sales units Sales revenue Direct labor cost Direct materials cost Contribution margin February 4.0 $15 $60 20,000 March 3.5 $16 $56 24,000 Quarter 16,000 60,000 $1,600,000 $1,920,000 $1,200,000 $4,720,000 1,200,000 1,440,000 896,000 3,536,000 200,000 240,000 160,000 600,000 $ 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 Revenues Static Budget $16,491 Flexible Budget $17,480 Flexible Budget Actual Variance $17,480 $ Cost of Sales Fixed overhead Variable selling Fixed selling Administration Total costs 5,892 1,977 456 1,275 4,773 14,373 6,245 (a) 1,977 483 (b) 1,275 4,773 14,753 6,451 2,032 550 1,268 5,550 15,851 Income $ 2,118 $ 2,727 $ 1,629 (206) (55) (67) (777) $(1,098) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 10: Static and Flexible Budgets 10-7 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: Revenue Less variable costs: Cost of sales Variable selling Contribution Margin Contribution Margin Ratio $16,491 (5,892) (456) $10,143 61.51% 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 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-8 Cost Management 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) + July cost of goods sold (0.8*1,810,000) - Beginning inventory (part B) = Purchases $ 460,800 1,448,000 (434,400) $1,474,400 D 40% of receivables are collected in the month sold, and 50% are collected the next month For July: Cash sales Collections from July credit sales (0.4 * $1,600,000) Collections from June credit sales (0.5 * $1,500,000) July cash collections $ 210,000 640,000 750,000 $1,600,000 10.17 New Ventures First, determine the purchases budget for the 1st quarter: Production (units) Raw materials needed per unit Production requirement Ending inventory requirement (25% of next month's production requirement) Total needed Less: Beginning inventory Raw materials purchases (units) Raw material unit cost Raw materials purchases January February March April 20,000 50,000 70,000 70,000 x2 x2 x2 x2 40,000 100,000 140,000 140,000 25,000 35,000 65,000 135,000 (0) (25,000) 65,000 110,000 x $7 x $7 $455,000 $770,000 35,000 175,000 (35,000) 140,000 x $7 $980,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 10: Static and Flexible Budgets 10-9 Next compute cash disbursements for purchases of raw materials: January purchases (a) February purchases (b) March purchases (c) Total cash payments January February $163,800 $273,000 277,200 $163,800 $550,200 March $462,000 352,800 $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 January (25,000 x €18 x 70) From February (30,000 x €18 x 25 x 97) Total February cash receipts €315,000 130,950 €445,950 Production requirements are Sales requirement (units) Plus: Ending inventory (units) Total needs Less: Beginning inventory (units) Production requirement (units) January February 25,000 30,000 7,500 8,000 32,500 38,000 (7,500) 32,500 30,500 Materials Purchases Budget To support production (units) Plus: Ending inventory (units) Total needs Less: Beginning inventory (units) Total purchases (units) Raw materials cost per unit Total purchases 65,000 12,200 77,200 77,200 €0.75 March 32,000 8,750 40,750 (8,000) 32,750 61,000 13,100 74,100 (12,200) 61,900 €0.75 €57,900 Cash disbursements in February for raw materials are From January (€57,900 x 0.40) From February (€46,425 x 0.60) Total raw materials disbursements €45,425 €23,160 27,855 €51,015 65,500 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-10 Cost Management Labor costs in February are 30,500 units x 50 hour per unit Wage rate Total cash disbursement, labor 15,250 hours €15 €228,750 Overhead costs in February are Total costs = €2(30,500) + 25,000 Less: Depreciation Total cash overhead costs The February cash budget is thus: Beginning balance, February Plus: February receipts Subtotal Less: Disbursements Raw materials Labor Overhead Total disbursements Ending balance, February 28 €86,000 12,000 €74,000 € 80,000 445,950 525,950 51,015 228,750 74,000 353,765 €172,185 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 Volume Revenue Direct Materials Direct Labor Variable Overhead Fixed Overhead Total Costs Budget Benchmark 1,000 1,100 $12,000 $13,200 $2,000 1,000 1,000 800 $4,800 $2,200 1,100 1,100 800 $5,200 Actual Variance 1,100 $12,400 $2,100 1,225 1,100 1,020 $5,445 $ 100 (125) (220) $(245) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-24 Cost Management to facilitate preparation of the cash disbursements budget; the percent of fixed costs paid during each quarter is included in the input section CASH DISBURSEMENTS BUDGET Raw material purchases Direct labor paid Variable overhead costs paid Fixed overhead costs paid: Property taxes Insurance Other Support costs Income taxes Subtotal Purchase equipment Total Disbursements JanuaryMarch $137,756 135,300 49,200 AprilJune $621,489 660,000 240,000 JulySeptember $438,222 396,000 144,000 OctoberNovember Total $166,222 $1,363,689 132,000 1,323,300 48,000 481,200 14,436 14,436 28,872 67,368 0 67,368 163,608 163,608 163,608 163,608 654,432 517,290 517,290 517,290 517,290 2,069,160 0 0 1,017,590 2,269,755 1,673,556 1,027,120 5,988,021 50,000 0 50,000 $1,067,590 $2,269,755 $1,673,556 $1,027,120 $6,038,021 Here are details for some of the calculations: Direct labor paid = Units produced during quarter * ($15+$1.50) Variable overhead costs paid = Units produced during quarter * $6 Payments for property taxes, insurance, support costs, and income taxes are calculated by multiplying the total cost by the percent paid in each quarter shown in the input section Other fixed overhead costs = (Plant management + Fringe benefits + Miscellaneous) * 25% Notice that depreciation is excluded because it is a noncash expense The short-term financing budget includes a summary of cash receipts and disbursements, which includes interest on the bank loan It then calculates the estimated amounts repaid or borrowed on the company’s line of credit The spreadsheet allows any extra cash to be deposited in the cash account (but there is no extra cash in this problem) Recall that the company’s line of credit agreement requires a minimum balance of $100,000 in the cash accounting, and this account is non-interest-bearing To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 10: Static and Flexible Budgets 10-25 QUARTERLY SHORT-TERM FINANCING BUDGET JanuaryAprilJulyOctoberBeginning March June September November Total cash receipts $582,600 $2,534,000 $1,934,000 $770,000 Total cash disbursements 1,067,590 2,269,755 1,673,556 1,027,120 Subtotal (484,990) 264,245 260,444 (257,120) Interest on loan (2,063) (8,759) (5,247) (1,738) Excess receipts (disb.) ($487,052) $255,486 $255,197 ($258,858) Loan borrowing (repayment) $487,052 ($255,486) ($255,197) $258,858 Increase (decrease) in cash $0 $0 $0 $0 Line of Credit: Beginning loan balance Borrowing (repayment) Ending loan balance $150,000 487,052 $637,052 $637,052 (255,486) $381,566 $381,566 (255,197) $126,369 $126,369 258,858 $385,227 Cash Account: Beginning cash balance Increase (decrease) in cash Ending cash balance $100,000 $100,000 100,000 $100,000 100,000 $100,000 100,000 $100,000 100,000 Less cash minimum balance Excess cash balance 100,000 $0 100,000 $0 100,000 $0 100,000 $0 100,000 $0 Here are details for some of the calculations: Interest on loan = Beginning loan balance * 5.5% * 1/4 year Although the problem does not explicitly provide the beginning cash balance, it is assumed to be $100,000 because of the minimum balance requirement and because the company had an outstanding bank loan It is reasonable to assume that the company would have reduced its bank loan with any excess cash 10.25 Fighting Kites (continued) 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 Assumptions that can be changed: Revenue assumptions: price per kite and number of kites sold Direct materials assumptions: price and quantity used for each direct material Direct labor assumptions: labor hourly rate and number of labor hours per unit in each department (assembly and packing) Overhead and support department costs: estimated costs in each category can be modified To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-26 Cost Management B This question is an extension of Part A; it involves identifying the types of changes that the company might could make to eliminate its forecasted loss Here are some ideas; students may think of others: Increase the selling price This change might also require a reduction in the volume of kites sold, because the quantity demanded is likely to be smaller if the price is increased Reduce the selling price and increase sales volume Increase the marketing support cost budget for advertising or other product promotions, and increase the volume sold Reduce raw material costs by locating new raw material vendors or renegotiating prices with existing vendors Establish a change in operating process to reduce assembly and packing time This change would allow a reduction in direct labor cost, assuming that the company is able to maintain a smaller work force Identify ways to reduce variable and fixed overhead costs by reducing the need for indirect labor, becoming more efficient in using supplies, obtaining competitive insurance bids, reevaluating the employee benefits package, etc Identify ways to reduce support costs by outsourcing some activities, seeking a new office supplies vendor, eliminating unnecessary job positions, reducing discretionary spending, etc C There is no one solution to this part Try different combinations of the changes identified in Part B to achieve the breakeven point The sample spreadsheet for this problem shows the following combination of changes and achieves income close to zero (loss of $210): Increase marketing costs by $65,000 Increase sales volume by 5,000 kites Reduce the cost of nylon from $10 per kite to $9,75 per kite Decrease administrative costs by $20,000 BUDGETED INCOME STATEMENT Revenues $6,375,000 Cost of goods sold 4,261,050 Gross Margin 2,113,950 Operating costs: Administration $1,014,580 Marketing 685,748 Distribution 310,374 Customer service 103,458 2,114,160 Pretax Income (210) Income tax expense Net Income $(210) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 10: Static and Flexible Budgets 10-27 D For selling price changes: Wok managers not know the effects of price on demand or what competitors will if price changes are made If Wok increases its price but competitors not increase theirs, the company may lose sales For sales volume changes: Managers not know whether their efforts such as advertising or sales representative visits to customers will cause sales volumes to increase For cost changes: Managers not know how easy it would be to reduce fixed or variable costs They also not know whether improvements can be made in productivity of labor and efficiency in the use of materials 10.26 Wok and Egg Roll Express Part 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) Below is the input section of the sample spreadsheet for this problem The data input box shown here includes only the input for Part The solution for later parts will show additional input items Input Area Meals: Noodle bowl Egg Roll Rice bowl Price $4.00 $3.00 $3.50 Daily Volume 200 100 500 A The revenue budget is calculated assuming 30 days per month: REVENUE BUDGET (30-DAY MONTH) Monthly Meals: Price Volume Noodle bowl $4.00 6,000 Egg Roll $3.00 3,000 Rice bowl $3.50 15,000 Total revenue Revenue $24,000 9,000 52,500 $85,500 B There can be unanticipated changes in demand An eating establishment can be very popular and then become less popular A new restaurant could open nearby and take some of Wok’s market share Economic downturns can also affect volumes If people are not using expensive restaurants, they may increase their use of Wok However, if people not eat out as often, demand could drop If a new office building opens nearby, lunch traffic could increase C Launch an advertising campaign Pros: Increase volume, thus increasing revenues; potential increase in market share Cons: Cost might exceed the benefit To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-28 Cost Management Distribute coupons to attract new customers Pros: Increase volume, thus increasing revenues; potential increase in market share Cons: Cost to distribute and price discounts might exceed benefit Increase prices Pros: Increase price per meal Cons: Decrease in sales volume might exceed benefit 10.26 Wok and Egg Roll Express Part 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) As shown below, the product cost information is added as a new column in the input area of the spreadsheet Input Area Meals: Noodle bowl Egg Roll Rice bowl Price $4.00 $3.00 $3.50 Daily Volume 200 100 500 Cost $1.00 $0.75 $0.90 D Beginning and ending inventories are minimal or nonexistent in a restaurant Thus, an appropriate assumption is that production approximately equals sales, and there is no need to calculate production E Given the answer to Part D and assuming no changes in direct material inventories, direct materials usage is equal to direct material purchases: DIRECT MATERIALS USAGE AND PURCHASES BUDGET Direct material costs: Cost Volume Total Cost Noodle bowls $1.00 6,000 $6,000 Egg rolls $0.75 3,000 2,250 Rice bowls $0.90 15,000 13,500 Total usage and purchases $21,750 F Food prices, such as rice, vegetables, and meat, change regularly Weather conditions and government regulation can affect the amount of crops harvested Import and export law changes might affect the price of vegetables and meat Food preferences also might affect prices For example, when people stopped eating as much beef, prices dropped G If food costs increase, portion size could be reduced Or, less expensive ingredients could be used However, it is likely that customers would notice these changes and may go elsewhere if they feel quality or value has diminished The owner could also seek ways to reduce food waste However, there might be little waste that can be eliminated if operations are already efficient To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 10: Static and Flexible Budgets 10-29 10.26 Wok and Egg Roll Express Part 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) Below is the additional input section for this part of the problem Labor Shifts 10 am to pm 11 am to pm pm to 10 pm pm to pm Rate of pay Cooks 3 $10.00 Cashiers 3 $8.00 H The direct labor budget is calculated assuming 30 days per month (same as Part 1): DIRECT LABOR BUDGET Labor Hours: Shift: 10 am to pm 11 am to pm pm to 10 pm pm to pm Number of Employees 3 Cooks Hours per Employee Total Labor Cost: Cooks Cashiers Total Hours Per Day 42 42 Hours Per Month 1,260 1,260 2,520 Employee Hours/Day 16 42 Number of Employees 3 Rate Per Hour $10.00 $8.00 Monthly Cost $12,600 10,080 $22,680 Cashiers Hours per Employee Employee Hours/Day 16 42 I Sometimes employees are sent home when business is slow, reducing labor hours If volumes increase, workers may be asked to stay overtime, and costs would increase There could be a change in minimum wage laws so that the cashiers would need to be paid more If turnover is high, the owner may need to increase the hourly wage for cooks or cashiers to reduce turnover J Labor costs can be reduced by monitoring the shifts carefully to determine whether there are days of the week when fewer people could be used If weekends or certain nights are slow, Wok may not need the same number of workers scheduled for each day of the week A problem arises if volumes are unexpectedly large and people have to wait Long lines annoy customers and cause them to leave or prevent them from coming back Not all of the kitchen employees need to be cooks Some employees could be hired at a cheaper wage just to prepare the foods but not cook them However, if these people are poorly trained, quality could suffer and customers could be lost To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-30 Cost Management 10.26 Wok and Egg Roll Express Part 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) Below is the additional input section for this part of the problem Variable overhead cost per direct labor hour: Fixed overhead costs: Utilities Manager Lease Miscellaneous Total $2.50 $300 5,000 2,000 3,500 $10,800 K Below is the overhead budget: OVERHEAD BUDGET Variable overhead Direct Labor Hours 2,520 Rate Per Hour $2.50 Total $6,300 Fixed overhead: Utilities Manager Lease Miscellaneous Total fixed overhead 300 5,000 2,000 3,500 10,800 Total overhead $17,100 L Before answering this question, it is necessary to visualize the types of costs included in overhead Fixed overhead is likely to include costs such as utilities, manager salary, and fixed rent Utilities vary according to weather (for heating and cooling), so uncertainties exist about the monthly cost If the manager quits, a replacement might cost more or less than the previous manager The lease costs might remain stable, but could be renegotiated at the end of the lease term Variable overhead might include supplies (such as napkins, condiments, and disposable dishes) as well as labor-related costs such as employment taxes and benefits The costs of these items can vary Also, there are likely to be fluctuations in the quantities of supplies used M It could be difficult to reduce utilities, the lease cost, or employment taxes If the manager’s salary is cut, the manager may not as good a job, or may quit If the salary is not competitive, a new manager may not be as effective as the old one The company could put supplies behind the counter and require customers to ask for the, potentially reducing usage However, customers might complain and it may take more time to get people through the line during busy times To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 10: Static and Flexible Budgets 10-31 10.26 Wok and Egg Roll Express Part 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) N Below is the budgeted income statement, which incorporates the answers to Parts 1-4 of this problem: BUDGETED INCOME STATEMENT Revenue Direct Costs: Direct materials $21,750 Direct labor 22,680 Contribution Margin Overhead: Variable Fixed $85,500 44,430 41,070 $6,300 10,800 Operating Profit 17,100 $23,970 O Volume of sales and cost of food are the two most important uncertain estimates If sales are off, profit will be less, or a loss could be incurred If food prices increase, some of the profit will be lost Labor is probably fairly stable, although turnover could be costly and should be monitored P The manager should keep track of advertising costs and volumes to see if advertising is beneficial Also, the company could sponsor sporting events as a way of advertising, or walk-a-thons for good causes All fixed and variable costs could be analyzed for possible reduction, keeping in mind that quality needs to be held constant, or improved if possible A cost benefit analysis needs to be done There are a wide variety of good answers to this question 10.27 The Red Midget Company Cash receipts February sales (14,000 x $0.50 x 100) x 18% March sales (16,000 x $0.50 x 100) x 80% Total March receipts $126,000 640,000 $766,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-32 Cost Management Cash disbursements Advertising: February ($60,000 x 90%) March ($75,000 x 10%) Total cash disbursements for advertising Administrative salaries Sales commissions Direct materials purchases Labor costs Overhead costs ($115,000 less depreciation of $80,000) Total cash disbursements for operations Cash dividends Total cash disbursements $ 54,000 7,500 61,500 80,000 69,000 330,000 90,000 35,000 665,500 15,000 $680,500 The cash budget for March is thus: Beginning balance at March Plus: March receipts Subtotal Less: March disbursements Ending balance at March 31 $ 25,000 766,000 791,000 (680,500) $110,500 Note: Credit loss expense and depreciation are ignored because they not directly affect cash flows 10.28 National Public Radio A An organization’s budget should reflect its strategies, which in turn should reflect its mission and core competencies Therefore, the budgeting process for any organization should begin with clarification of the mission, core competencies, and strategies However, this process might be more important than usual for NPR in light of the significant donation The size of the donation might permit NPR to develop core competencies and pursue strategies that were previously beyond the organization’s financial capability It was critical for NPR’s management to consider possible long-term changes before making specific plans for how money would be spent in the short term B Following are pros for involving affiliate stations and freelance workers in the budgeting process Affiliate stations are likely to better understand consumer preferences Freelance workers who understand factors that affect the budget may have more realistic expectations about their compensation Both affiliate stations and freelance workers are likely to be more motivated to help NPR succeed if they are involved in the budgeting process because they assume greater ownership of the results To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 10: Static and Flexible Budgets 10-33 Following are cons Affiliate stations may not agree with NPR management, resulting in conflicting goals and suboptimal decision-making at the station level Freelance workers may feel that they are not compensated generously enough considering other expenditures Negotiations may take too much time away from top managers at both the NPR administrative level and affiliate station level C If managers use funds to improve programming quality, they would want to invest more funds in hiring quality writers and reporters They may also want to increase funds for surveying their customers to find the types of programming that is preferred by the most listeners Further, money could be invested in research to determine listeners’ perceptions about the quality of current programming To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-34 Cost Management BUILD YOUR PROFESSIONAL COMPETENCIES 10.29 Focus on Professional Competency: Resource Management A The budget includes anticipated spending on various activities within an organization Through the process of creating budgets, managers are forced to make decisions about the amount of resources to allocate to different activities The budget communicates the results of those decisions Budgets are typically prepared at the department level and proceed through a process of negotiations between the department managers and head office Thus, the budget communicates the resources that can be used for individual departments B Prices for most resources are uncertain because they may change and decisions about how to spend resources may change Prices for resources are subject to economic supply and demand as well as firm-specific arrangements For example, companies that pay lower than market wages are likely to lose employees To become more competitive in hiring employees, a company may need to increase pay levels or benefits, modify work hours, or make other concessions that increase resource costs Raw material prices also fluctuate with market prices and with alternative contractual arrangements that are available to suppliers Large increases in the cost of an individual resource are likely to cause managers to seek ways to reduce use of that resource For example, as labor costs increase managers may reduce labor time by increasing the quality of raw materials or by modifying production processes to use greater automation Managers may also outsource work to countries having lower labor costs Decreases in resource costs have the opposite effect; managers are likely to seek ways to increase the use of the resource For example, managers have increased their use of automated production equipment as the cost automation has declined Fluctuations in the costs and use of resources are likely to lead to budget variances because specific fluctuations cannot be foreseen when the budget is created Although managers know that prices will fluctuate, they cannot perfectly estimate future prices They also cannot perfectly anticipate modifications in their use of resources until future market conditions occur C One way to measure organizational performance is to compare actual results to budgeted results This comparison provides information about how well the organization met its goals To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 10: Static and Flexible Budgets 10-35 a Using flexible budgets to adjust for actual volumes: When an individual manager is not responsible for differences between budgeted and actual volumes, a flexible budget does a better job of measuring the level of expected costs that are under the manager’s control Thus, variances calculated using a flexible budget provide better measures of the manager’s performance When a flexible budget is not used, the manager may be inappropriately rewarded when actual volume is less than budgeted, and inappropriately penalized when actual volume exceeds the budget b Removing allocated costs: When allocated costs cannot be controlled by the manager, they provide no information about the manager’s performance Therefore, variances related to these costs also provide no information about the manager’s performance To avoid inappropriately rewarding or penalizing managers for variances in allocated costs, these costs should be removed from the performance evaluation c Updating costs for anticipated price changes: managers should be held responsible for their use of resources at the expected price As discussed in Part B above, managers are likely to change their use of resources based on changes in price To encourage managers to make the best use of resources, they should be held accountable for their decisions based on the expected prices Continuous improvement is the process of constantly making small changes to enhance organizational performance The analysis of budget variances helps managers identify areas where organizational performance is different than expected, leading to recommendations for ways to improve future planning and operations For example, a favorable variance can focus manager attention on ways to achieve similar favorable results in the future An unfavorable cost variance can help managers identify and eliminate waste or inefficiencies D If students have difficulty locating a citizen’s budget guide, refer them to guidance available for this problem on the web site for the textbook (available at www.wiley.com/college/eldenburg) Following are possible reasons why a government might publish a citizen’s guide to the budget; students may think of others: Legal requirement; laws may exist to require the government to publish a citizen’s guide Provide an overview of the budget and budgeting process for citizens, government managers and staff, legislative bodies, and other interest parties Improve communication with the general public Demonstrate fiduciary responsibility This answer depends on the governmental entity chosen by the student The purpose of this question is to help students recognize that different organizations use different terminology and slightly different processes, but that the general underlying To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-36 Cost Management budgeting cycle is the same for all types of organizations The purpose is also to encourage student interest in governmental budgeting and accounting Citizens could analyze the budget to study the relative amount of resources assigned to different types of activities They could also analyze the budgeting process for the degree and type of citizen input When financial statements are released after the end of the budget period, citizens could determine whether the original budget was met or whether it was necessary to modify the budget to avoid exceeding the legally-adopted budget 10.30 Integrating Across the Curriculum: Financial Accounting and Attestation The U.S professional standards that are primarily relevant for this problem are Statement of Standards for Attestation Engagements (SSAE) No 10, Attestation Standards: Revision and Recodification; and Prospective Financial Information, AICPA Audit and Accounting Guide, May 1, 2003.1 A Based on the definitions given in the problem, an estimated income statement for the existing store would be considered a financial forecast; it would be based on expected results given current operations and Delanna’s plans for the store However, an estimated income statement for the new store would be considered a financial projection; it would be based on the hypothetical assumption that the store would be opened Taken together, the set of prospective income statements would be considered a financial projection B Assuming that the use of the financial projection would be limited to the client and the bank, the CPA could perform any of the following types of attestation services: Compilation: The CPA would be responsible for reading the prospective financial statements, including the summary of significant assumptions and accounting policies, to determine whether they appear to be presented in accordance with the AICPA Audit and Accounting Guide, Prospective Financial Information Examination: The CPA would be responsible for evaluating evidence and issuing a report stating whether or not, in the CPA’s opinion, the financial statements are presented in conformity with the AICPA Audit and Accounting Guide, Prospective Financial Information and whether the hypothetical assumptions provide a reasonable basis for the projection Agreed-Upon Procedures: The CPA would be responsible for performing procedures agreed-upon with the client and for reporting the findings of the procedures The CPA would not issue an opinion or provide any other type of assurance on the financial statements The information about SSAE 10 discussed in this answer was obtained from Section 2301 in M Guy, D R Carmichael, and L A Lach, Practitioner’s Guide to GAAS: Covering all SASs, SSAEs, SSARSs, and Interpretations, 2004, John Wiley & Sons To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 10: Static and Flexible Budgets 10-37 C There are many possible answers to this question Below is a list of questions; students may think of others Have you investigated potential store locations? Do you have an estimate for the rental cost? Will your other occupancy costs (e.g., electricity and janitorial service) remain about the same over the next years for the existing store? Do you expect about the same level of cost for the new store? What volume of sales you expect for each store over the next years? Is your estimate for the new store comparable to your sales volumes during the first years for the existing store? Do you anticipate any changes in gross margin percentage over the next years? Do you expect the gross margin percentage for the new store be the same as for the existing store? How much time will you spend at the new store? Will you need to hire a store manager for either store? If so, how much will that cost? What portion of employee wages and commissions is a fixed cost, and how much varies with sales? Will the structure of fixed and variable costs be similar for the new store? Will your office and miscellaneous costs for the existing store remain about the same over the next years? How much office and miscellaneous expense you expect for the new store? How much you plan to spend on advertising and promotion for the new store? Will supplies at the existing store remain about the same over the next years? How much will this cost be for the new store? Assuming your loan is approved, what interest rate you think you will pay? What repayment terms have you discussed with your banker? Do you expect any other changes in your revenues or costs over the next years? D For the existing store, estimated future income could be estimated by beginning with the existing income statement and then modifying it for changes expected by the owner The existing store’s financial statements could also be used to help develop cost functions for the new store For example, the owner might expect the gross margin in the new store to be similar to that of the old store The owner also might expect about the same level of fixed costs such as wages, supplies, etc for the new store as in the old store E The assumptions would basically be the answers to the list of questions in Part C For example, one assumption might be that the sales in the existing store will increase by 5% To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-38 Cost Management over each of the next years and that sales in the new store will amount to $X during the first year, increase by 20% during the second year and by 10% during the third year Another assumption might be that cost of goods sold is 55% of sales for both stores F Delanna is likely to be biased because she believes that opening the new store is a good idea and that the store will be successful Specific biases will be difficult to detect when compiling the financial statements, because the CPA’s responsibility is merely to assemble the statements and then read them for obvious deviations from the accounting standards The CPA is not responsible for evaluating evidence to verify the reasonableness of the assumptions ... 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. .. 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... slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 10-16 Cost Management The following costs are most likely fixed To create an estimate for 2005, these costs are adjusted