4. Estimated cash payments on accounts payable (including operating expenses).
b. Once the schedules have been prepared, complete the cash budgets for July, August, and September showing the cash balance at the end of each month.
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Eight Flags is a retail department store. The following cost-volume relationships were used in developing a flexible budget for the company for the current year:
PROBLEM 23.7B Preparing and Using a Flexible Budget P
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Yearly Variable
Fixed Expenses per
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Cost of merchandise sold . . . $0.65 Selling and promotion expense . . . $160,000 0.09 Building occupancy expense . . . 120,000 0.02 Buying expense . . . 100,000 0.05 Delivery expense . . . 110,000 0.01 Credit and collection expense . . . 60,000 0.01 Administrative expense . . . 300,000 0.02 Totals . . . $850,000 $0.85
Net sales . . . $18,000,000 Cost of goods sold . . . 11,160,000 Selling and promotion expense . . . 800,000 Building occupancy expense . . . 450,000 Buying expense . . . 720,000 Delivery expense . . . 200,000 Credit and collection expense . . . 100,000 Administrative expense . . . 360,000
Budgeted Costs
Actual Over for 4,000 Units
Costs (Under)
Per Unit Total Incurred Budget Variable manufacturing costs:
Direct materials . . . $ 25.00 $100,000 $120,000 $20,000 Direct labor . . . 50.00 200,000 210,000 10,000 Indirect labor . . . 12.00 48,000 50,000 2,000 Indirect materials, supplies, etc. . . . 10.00 40,000 43,000 3,000 Total variable manufacturing costs . . . $ 97.00 $388,000 $423,000 $35,000 Fixed manufacturing costs:
Lease rental . . . $ 10.00 $ 40,000 $ 40,000 –0–
Salaries of foremen . . . 25.00 100,000 104,000 $ 4,000 Depreciation and other . . . 18.00 72,000 75,000 3,000 Total fixed manufacturing costs . . . $ 53.00 $212,000 $219,000 $ 7,000 Total manufacturing costs . . . $150.00 $600,000 $642,000 $42,000 Management expected to attain a sales level of $20 million during the current year. At the end of the year, the actual results achieved by the company were as follows:
Instructions
a. Prepare a schedule comparing the actual results with flexible budget amounts developed for the actual sales volume of $18,000,000. Organize your schedule as a partial multiple-step income statement, ending with operating income. Include separate columns for ( 1 ) flexible budget amounts, ( 2 ) actual amounts, and ( 3 ) any amount over (under) budget. Use the cost- volume relationships given in the problem to compute the flexible budget amounts.
b. Write a statement evaluating the company’s performance in relation to the plan reflected in the flexible budget.
c. Why is a flexible budget useful in evaluating the performance of the Eight Flags store?
d. Do fixed costs and variable costs always change in a flexible budget?
XL Industries uses department budgets and performance reports in planning and controlling its manufacturing operations. The following annual performance report for the widget production department was presented to the president of the company:
PROBLEM 23.8B Flexible Budgeting P
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Although a production volume of 4,000 widgets was originally budgeted for the year, the actual volume of production achieved for the year was 5,000 widgets. Direct materials and direct labor are charged to production at actual costs. Factory overhead is applied to production at the predeter- mined rate of 150 percent of the actual direct labor cost.
After a quick glance at the performance report showing an unfavorable manufacturing cost vari- ance of $42,000, the president said to the accountant: “Fix this thing so it makes sense. It looks as though our production people really blew the budget. Remember that we exceeded our budgeted production schedule by a significant margin. I want this performance report to show a better pic- ture of our ability to control costs.”
Instructions
a. Prepare a revised performance report for the year on a flexible budget basis. Use the same format as the production report above, but revise the budgeted cost figures to reflect the actual production level of 5,000 widgets.
b. Briefly comment on XL’s ability to control its variable manufacturing costs.
c. What is the amount of over- or underapplied manufacturing overhead for the year?
The purpose of this problem is to demonstrate some of the interrelationships in the budgeting process. Shown below is a very simple balance sheet at January 1, along with a simple budgeted income statement for the month. (Assume dollar amounts are stated in thousands; you also may state dollar amounts in this manner.)
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As Nutshell has no plant assets, there is no depreciation expense. Prepare a cash budget for January and a budgeted balance sheet as of January 31.
These budgets are to reflect your own assumptions as to the amounts of cash and credit sales, collections of receivables, purchases of inventory, and payments to suppliers. We require only that the cash balance be $50 at January 31, that receivables and inventory change from the January 1 levels, and that the company engage in no “financing” or “investing” activities (as these terms are used in a statement of cash flows).
Clearly state your assumptions as part of your solution, and be prepared to explain in class how they result in the amounts shown in your budgets.
Beta Computers is experiencing financial difficulties attributed to declining sales of its main- frame computer systems. Several years ago, the company obtained a large loan from Midland State Bank. The covenants of the loan agreement strictly state that if Beta is unable to maintain a current ratio of 3:1, a quick ratio of 1:1, and a return on assets of 12 percent, the bank will exercise its right to liquidate the company’s assets in settlement of the loan. To monitor Beta’s performance, the bank demands quarterly financial statements that have been reviewed by an independent CPA.
Nick Price, Beta’s CEO, has just reviewed the company’s master budget projections for the first two quarters of the current year. What he has learned is disturbing. If sales trends continue, it appears that Beta will be in violation of its loan covenants by the end of the second quarter. If CASE 23.2
An Ethical Dilemma
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NUTSHELL BUDGETED INCOME
STATEMENT FOR JANUARY
Sales . . . $100 Cost of goods
sold . . . 60 Gross profit . . . $ 40 Expenses . . . 25 Net income . . . $ 15
NUTSHELL BALANCE SHEET
JANUARY 1
Assets
Cash . . . $ 40 Accounts
receivable . . . 120 Inventory . . . 50 Total . . . $210
Liabilities & Equity Accounts
payable . . . $ 30 Owners’
equity . . . 180 Total . . . $210
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these projections are correct, the bank might foreclose on the company’s assets. As a consequence, Beta’s 750 employees will join the ranks of the unemployed.
In February of the current year, Rembrant International contacted Beta to inquire about pur- chasing a custom-configured mainframe computer system. Not only would the sale generate over a million dollars in revenue, it would put Beta back in compliance with its loan covenants. Unfor- tunately, Rembrant International is an extremely bad credit risk, and the likelihood of collecting on the sale is slim. Nonetheless, Nick Price approved the sale on February 1, which resulted in the recording of a $1.4 million receivable.
On March 31, Edgar Gamm, CPA, arrived at Beta’s headquarters. In Gamm’s opinion, the
$1.4 mil lion receivable from Rembrant International should immediately be written off as uncol- lectible. Of course, if the account is written off, Beta will be in violation of its loan covenants and the bank will soon foreclose. Gamm told Price that it is his professional duty to prevent any mate- rial misstatement of the company’s assets.
Price reminded Gamm that if the account is written off, 750 employees will be out of work, and that Gamm’s accounting firm probably could not collect its fee for this engagement. Price then showed Gamm Beta’s master budget for the third and fourth quarters of the current year. The budget indicated a complete turnaround for the company. Gamm suspected, however, that most of the budget’s estimates were overly optimistic.
Instructions
With a group of students answer the following questions:
a. Should Gamm insist that the Rembrant International account be classified as uncollectible?
Should the optimistic third and fourth quarter master budget projections influence his deci- sion? What would you do if you were in his position? Defend your actions.
b. If you were the president of Midland State Bank, what would you do if you discovered that the Rembrant International account constituted a large portion of Beta’s reported liquid assets and sales activity for the quarter? How would you react if Edgar Gamm’s accounting firm had permitted Beta to classify the account as collectible?
The importance of cash budgets for all types of businesses and individuals cannot be overempha- sized. The following six steps to cash flow control are critical.
1. Create a monthly cash flow budget. Determine the amount you need to achieve your business and personal financial goals, including enough to pay taxes and fund your retirement.
2. At the end of each month compare cash infows and outflows to make necessary adjustments to cash spending or saving.
3. Accounting software can help automate the process.
4. Set aside cash each month to pay your taxes on time.
5. Make quarterly contributions to a retirement account.
6. Establish a line of credit with a bank, or investigate other short-term financing sources, well before you think you’ll need the extra cash.
Instructions
a. Assume for item number 2 that a business’s actual cash flows are not enough to achieve its business goals and some necessary adjustments must be made. Name at least four adjustment procedures that businesses can use to equalize cash flows.
b. Write a short paragraph discussing how cash budgeting can be critical for your ongoing success.
Medlin Accounting Shareware produces accounting programs that Internet users can download and try for free. Access the Medlin Web site at:
www.medlin.com/budget.htm Investigate the Medlin budgeting package.
CASE 23.3 Cash Budgeting C
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Instructions
a. What features are provided with the budgeting software?
b. Explain how the features can be used for ( 1 ) advance warning and assignment of responsibility for corrective action, ( 2 ) coordination of activities among all departments within the organiza- tion, or ( 3 ) the creation of standards for evaluating performance.
Internet sites are time and date sensitive. It is the purpose of these exercises to have you explore the Internet. You may need to use the Yahoo! search engine http://www.yahoo.com (or another favorite search engine) to find a company’s current Web address.
Under the Public Company Accounting Oversight Board (PCAOB) procedures, companies are required to disclose “material weaknesses” in their internal controls. A material weakness means a company’s deficiencies are so bad that there’s more than a remote chance of a material misstatement in its financial reports. An example is when a bank does not regularly check for errors in estimat- ing loan-loss expenses. This type of undetected error, for instance, could be rooted in a formula in a computer spreadsheet that budgets how lending will be affected by interest rate changes. Fan- nie Mae, the mortgage finance company, reported a $1.3 billion error from its computer models prior to a large accounting scandal. Some auditors are reporting that the material weaknesses they are seeing are the result of flawed checks on formulas used to figure, for example, income tax expense.
Instructions
Consider how errors in formulas, embedded in linked budgeting spreadsheets and used to estimate sales each quarter, can impact the budgeting process.
a. Use Exhibit 23–2 to trace how errors can permeate the various budgets of a company. Explain how an error that causes a material overstatement of budgeted sales will affect other budgets for the organization.
b. Explain how the PCAOB requirements to evaluate internal controls can improve the budgeting process at a company.
Answers to Self-Test Questions
1. a, b, c 2. b (70,000 units $10 per unit 80%) ($100,000 50%) $610,000 3. d 4. c 5. d 6. c
CASE 23.5 Budgeting and Internal Controls C
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Standard Cost Systems
A F T E R S T U D Y I N G T H I S C H A P T E R , Y O U S H O U L D B E A B L E TO :
Define standard costs and explain how they assist managers in controlling costs.
Explain the difference between setting ideal standards and setting reasonably achievable standards.
Compute direct materials and direct labor variances and explain the meaning of each.
Compute overhead variances and explain the meaning of each.
Discuss the causes of specific cost variances.
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The U.S. Navy was founded on October 13, 1775, and the Department of the Navy was established on April 30, 1798. Today, the Navy has nearly 300 ships and over 4,000 operational aircraft. You can imagine that the amount of materials and supplies purchased by the Navy in any given year is quite large. To help the Navy and other branches of the armed services with procurement of ships, planes, missiles, rockets, tanks, and supporting equipment and supplies, the Office of Management and Budget operates the Cost Accounting Standards Board.
The five-member Cost Accounting Standards Board (CASB) is an independent, legislatively established board. The board has the exclusive authority to make, promulgate, and amend cost accounting standards and interpretations designed to achieve uniformity and consistency in the cost accounting practices governing the measurement, assignment, and allocation of costs to contracts with the United States. The standards are mandatory for use by all branches of the armed services and by contractors and subcontractors in estimating, accumulating, and reporting costs in connection with pricing and all negotiated prime contract and subcontract procurement with the United States in excess of $500,000. The CASB recommendations include the use of standard costing systems for all government contractors. ■