Management Accounting: Concepts, Techniques & Controversial Issues

Chapter 9
The Master Budget or Financial Plan¹

James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida

MAAW's Textbook Table of Contents

LEARNING OBJECTIVES

After you have read and studied this chapter, you should be able to:

1. Discuss the concept of financial performance including the elements involved.
2. Describe four types of budgets and how they are used for different types of costs.
3. Outline the main parts of a master budget including the sequence in which they are developed.
4. Discuss the purposes and benefits of the master budget.
5. Discuss the limitations and problems associated with the master budget.
6. Briefly describe the assumptions underlying the master budget.
7. Describe responsibility accounting and discuss the controversy associated with this concept.
8. Discuss the sources of the various information needed for the master budget.
9. Explain the difference between standard costs and budgeted costs.
10. Prepare the various schedules or sub-budgets included in a master budget or financial plan.

INTRODUCTION

The purpose of this chapter is to introduce the master budget or financial plan. This topic includes an important set of concepts and techniques that represent the major planning device for an organization, as well as the foundation for a traditional standard cost performance evaluation and control system.¹ The chapter includes seven sections. The first section provides a discussion of the underlying concepts of financial planning and budgeting including the various types of budgets. This section also includes a diagram of the master budget that provides an overview of the overall budgeting process. Sections two and three include short, but important discussions of the purposes and benefits of budgeting and the limitations and problems involved in budgeting. The assumptions upon which the budget is based are briefly described in section four. Section five introduces the underlying concept of responsibility accounting and provides a brief discussion of a controversial issue associated with this concept. The techniques used to prepare a master budget are discussed and illustrated in section six. This is the longest section and includes a discussion of where the budget director obtains the budget information as well as how the information is used to complete the various schedules and sub-budgets involved. The last section includes a simplified, but fairly comprehensive example. A somewhat more involved example is provided in Appendix 9-1. Appendix 9-2 provides instructions for using a computer program designed to facilitate the preparation of a master budget.

BUDGETING CONCEPTS

Budgeting involves planning for the various revenue producing and cost generating activities of an organization. The importance of budgeting is emphasized by an old saying, "Failing to plan, is like planning to fail." Budgeting is essentially financial planning, or planning for financial performance. Consider the conceptual view of financial performance presented in Exhibit 9-1. As illustrated in the exhibit, financial performance depends on revenue and cost. Revenue is provided from sales of merchandise by retailers, sales of products, harvested, mined, constructed, formed, processed or assembled by farms, mining companies, construction companies and manufacturers and from sales of various services by firms involved in activities such as banking, insurance, accounting, law, medical care, food distribution, repair and entertainment. In addition to producing revenue, all of these companies generate three types of costs including discretionary, engineered and committed costs. Various costs fall into one of these three categories based on the cause and effect relationships involved. Although there are a variety of ways to define costs, categorizing costs in terms of the cause and effect relationships is a prerequisite for understanding the different types of budgets that are introduced in this chapter. These three cost concepts are summarized in Exhibit 9-2 and discussed in more detail below.

Discretionary Costs

Many activities are viewed as beneficial to an organization, even thought the benefits obtained, or value added by performing the activities cannot be defined precisely, either before or after the activity is completed. The costs of the inputs, or resources required to perform such activities are referred to as discretionary costs. These costs are discretionary in the sense that management must choose the desired level of the activity based on intuition or experience because there is no well defined cause and effect relationship between cost and benefits. Discretionary costs are usually generated by service or support activities. Examples include employee training, advertising, sales promotion, legal advice, preventive maintenance, and research and development. The value added by each of these activities is intangible and difficult, if not impossible to measure, where value added refers to the benefits obtained by either internal or external customers. In terms of cost behavior, discretionarycosts may be fixed, variable or mixed.

Engineered Costs

Engineered costs result from activities with reasonably well defined cause and effect relationships between inputs and outputs and costs and benefits. Direct material costs provide a good example. Engineers can specify precisely how many parts (inputs) are required to generate a specific output such as a microcomputer, a coffee maker, an automobile, or a television set. Direct labor also falls into the engineered cost category as well as indirect resources that vary with product specifications and production volume. Although the cause and effect relationships are not as precise for indirect resources, these relationships can be established using statistical techniques such as regression and correlation analysis. A key difference between discretionary costs and engineered costs is that the value added by the activities associated with engineered costs is relatively easy to measure. Engineered costs are variable in terms of cost behavior.

Committed Costs

Committed costs refers to the costs associated with establishing and maintaining the readiness to conduct business. The benefits obtained from these expenditures are represented by the company's infrastructure. For example, the costs associated with the purchase of a franchise, a patent, drilling rights and plant and equipment create long term obligations that fall into the committed cost category. These costs are mainly fixed in terms of cost behavior and expire to become expenses in the form of amortization and depreciation.

Four Types of Budgets

Four types of budgets are used for planning and controlling the various types of costs discussed above. These four techniques are summarized in Exhibit 9-3.

Appropriation Budgets

The oldest type of budget is referred to as an appropriation budget. Appropriation budgets place a maximum limit on certain discretionary expenditures and may be either incremental, priority incremental, or zero based. Incremental budgets are essentially last year's budget amount plus an increment, i.e., small increase. Priority incremental budgets also involve an increase, but require managers to prioritize, or rank discretionary activities in terms of their importance to the organization. The idea is for the manager to indicate which activities would be changed if the budget were increased or decreased. Zero based budgeting was popular for a while around the time of Jimmy Carter's Presidency, but was dropped by most users because it was too expensive and time consuming.² The technique is expensive to use because zero based budgets theoretically require justification for the entire budget amount. When it was popular, a more typical approach was to justify the last twenty percent of the budget, i.e., use eighty percent based budgeting.

From a control perspective, appropriation budgets are effective in limiting the amount of an expenditure, but create a behavioral bias to spend to the limit. Establishing a maximum amount for an expenditure encourages spending to the limit because spending below the limit implies that something less than the maximum appropriation was needed. Spending below the limit might result in a budget cut in future periods. Since nearly every manager views a budget reduction in their discretionary costs as undesirable, there are frequently crash efforts at the end of a budget period to spend up to the limit. (See Supplemental Exhibit).

Flexible Budgets

The flexible budget was introduced in Chapter 4. Recall that flexible budgets are based on a cost function such as Y = a + bX, where Y represents the budgeted cost, or dependent variable. The constant "a" represents a static amount for fixed costs and the constant "b" represents the rate of change in Y expected for a unit change in the independent variable X. The expression " bX" is the flexible part of the budget cost function. The flexible budget technique is used for planning and monitoring all types of costs. The static amount "a" includes both discretionary and committed costs, while the flexible part "bX" includes various types of engineered costs. The flexible characteristic of the technique enables the flexible budget to play a key role in both financial planning and performance evaluation. The planning dimension is emphasized in this chapter and the performance evaluation aspect is given considerable attention in Chapters 10 and 13.

Capital Budgets

Capital budgets represent the major planning device for new investments. Discounted cash flow techniques such as net present value and the internal rate of return are used to evaluate potential investments. Capital budgets are part of a somewhat more encapsulating concept referred to as investment management. Investment management involves the planning and decision process for the acquisition and utilization of all of the organization's resources, including human resources as well as technology, equipment and facilities. The concept of investment management includes the discounted cash flow methods, but is more comprehensive in that the organization's portfolio of interrelated investments is considered as well as the projected effects of not investing.

Master Budgets

The fourth type of budget is referred to as the master budget or financial plan. The master budget is the primary financial planning mechanism for an organization and also provides the foundation for a traditional financial control system. More specifically, it is a comprehensive integrated financial plan developed for a specific period of time, e.g., for a month, quarter, or year. This is a much broader concept than the first three types of budgeting. The master budget includes many appropriation budgets (typically in the administrative and service areas) as well as flexible budgets, a capital budget and much more. A diagram illustrating the various parts of a master budget is presented in Exhibit 9-4.

The master budget has two major parts including the operating budget and the financial budget (See Exhibit 9-4). The operating budget begins with the sales budget and ends with the budgeted income statement. The financial budget includes the capital budget as well as a cash budget, and a budgeted balance sheet. The main focus of this chapter is on the various parts of the operating budget and the cash budget. The budgeted balance sheet is covered briefly, but not emphasized. A detailed discussion of capital budgeting and investment management is provided in Chapter 18 after some other prerequisite concepts are introduced. In the next section, we consider the purposes, benefits, limitations and assumptions of the master budget.

THE PURPOSES AND BENEFITS OF THE MASTER BUDGET

There are a variety of purposes and benefits obtained from budgeting. Consider the following:

Integrates and Coordinates

The master budget is the major planning device for an organization. Thus, it is used to integrate and coordinate the activities of the various functional areas within the organization. For example, a comprehensive plan helps ensure that all the needed inputs (equipment, materials, labor, supplies, etc.) will be at the right place at the right time when needed, just-in-time if possible. It also helps insure that manufacturing is planning to produce the same mix of products that marketing is planning to sell. The idea is that the products should be pulled through the system on the basis of the sales budget, rather than produced speculatively and pushed on the sales force. As discussed in Chapter 8, excess inventory and other resources hide problems and add unnecessary costs. The integrative nature of the budget provides a way to implement the lean enterprise concepts of just-in-time and the theory of constraints where the emphasis is placed on the performance of the total system (organization) rather than the various subsystems or functional areas.

Communicates and Motivates

Another purpose and benefit of the master budget is to provide a communication device through which the company’s employees in each functional area can see how their efforts contribute to the overall goals of the organization. This communication tends to be good for morale and enhance jobs satisfaction. People need to know how their efforts add value to the organization and its' products and services. The behavioral aspects of budgeting are extremely important.

Promotes Continuous Improvement

The planning process encourages management to consider alternatives that might improve customer value and reduce costs. Recall that "Plan" is the first step in the Shewhart-Deming plan- do-check-action continuous improvement cycle discussed in Chapter 8. The PDCA cycle supports specific improvements in the company’s processes. The financial plan and subsequent financial performance measurements reflect the financial expectations and consequences of those efforts.

Guides Performance

The master budget also provides a guide for accomplishing the objectives included in the plan. The budget becomes the basis for the acquisition and utilization of the various resources needed to implement the plan. Perfection of the guidance aspect of budgeting can significantly reduce the amount of uncertainty and variability in the company’s operations. In a JIT environment, the budget can also serve as a guide to vendors. For example, suppliers to General Motors Saturn plant in Tennessee have access to Saturn’s production schedule through an on-line database. This information allows Saturn’s vendors to deliver the required parts in the order needed to precise locations just-in-time without a purchase order or delivery schedule.³

Facilitates Evaluation and Control

The master budget provides a method for evaluating and subsequently controlling performance. We will develop this idea in considerable detail in the following chapter. Performance evaluation and control is a very powerful and very controversial aspect of budgeting. (For example, see the discussion of Johnson's ABM Model in Chapter 8).

LIMITATIONS AND PROBLEMS

There are several limitations and problems associated with the master budget that need to be considered by management. These problems involve uncertainty, behavioral bias and costs.

Uncertainty

Budgeting includes a considerable amount of forecasting and this activity involves a considerable amount of uncertainty. Uncertainty affects both sides of the financial performance dichotomy, (see Exhibit 9-1) but uncertainty on the revenue side presents a more serious limitation for planning. The sales budget is frequently based on a forecast supported by a variety of assumptions about the economy, the actions of the federal reserve board and congress in implementing monetary and fiscal policy, and the actions of competitors, suppliers, and customers. The uncertainty associated with sales forecasting creates a greater problem than uncertainty on the cost side because the other parts of the budget (see Exhibit 9-4) are derived from the sales forecast. This forces management to constantly monitor and analyze changes in the economic environment. From the planning perspective, the inability to accurately forecast the future reduces the usefulness of the original budget estimates for materials requirements planning (MRP) and planning for other resource needs. Uncertainty on the cost side tends to be less of a problem because management has more influence over the quantities of resources consumed than over the quantities of their own products purchased by customers. From a performance evaluation and control perspective, uncertainty on both sides of the financial performance dichotomy is not as much of a problem because flexible budgets are used to fine tune the original budget to reflect expectations at the current level of activity. The manner in which flexible budgets are used for performance evaluation is given considerable attention in Chapter 10 and Chapter 13.

Behavioral Bias

A second problem involves a variety of behavioral conflicts that are created when the budget is used as a control device. To be effective, the budget must be used by the managers it is designed to help. Thus, it must be acceptable to all levels of management. The behavioral literature on budgeting supports the view that the budget should reflect what is most likely to occur under efficient operating conditions. If a budget is to be used as an effective planning and monitoring device, it should encourage a high level of performance and efficiency, but at the same time, it should be fair and obtainable. If the budget is viewed by managers as unfair, (too optimistic) it may intimidate rather than motivate. One way to gain acceptance is referred to as participative (rather than imposed) budgeting. The idea is to include all levels of management in the budget preparation process. Of course this process must be coordinated by a budget director to ensure that a fair budget is obtained that will help achieve the goals of the total organization.

Another way to reduce the behavioral bias against budgeting is to recognize the concepts of variation and interdependence when using the budget to evaluate performance. Recall from our discussion of the statistical control concept in Chapter 3 that there is variation in all performance and most of this variation is caused by the system , (i.e., common causes) not the people working in the system. The concept of interdependence refers to the fact that the various segments of a company are part of a system. Inevitably, these segments, or subsystems influence each other. Failure to adequately recognize the interdependencies within an organization tends to cause behavioral conflicts and motivate participants to optimize the performance of the various segments (subsystems) rather than to optimize the performance of the overall system.

Finally, the behavioral conflicts associated with budgeting are reduced by using flexible budgets when evaluating performance. We will return to these ideas below and again in Chapter 10.

Costs

A third problem or limitation is that budgeting requires a considerable amount of time and effort. Many companies maintain a twelve month budget on a continuous basis by adding a future month as the current month expires.⁴ While this does not create a major expenditure for large or medium sized organizations, smaller companies may find it difficult to justify the costs involved. Many small, potentially profitable firms, do not plan effectively and eventually fail as a result. Cash flow problems are common, e.g., not having enough cash available (or accessible through a line of credit with a bank) to pay for merchandise or raw materials or to meet the payroll. Many of these problems can be avoided by preparing a cash budget on a regular basis.

THE ASSUMPTIONS OF THE MASTER BUDGET

Typically, the following simplifying assumptions are made when preparing a master budget: 1.) sales prices are constant during the budget period, 2.) variable costs per unit of output are constant during the budget period, 3.) fixed costs are constant in total and 4.) sales mix is constant when the company sells more than one product. These assumptions facilitate the planning process by removing many of the economic complexities. The overall effects of these simplifications are illustrated graphically in Exhibit 9-5. Instead of planning on the basis of the more complicated non-linear model on the left, the master budget is very similar to the more easily understood linear model on the right.⁵ These assumptions are discussed in more depth in Chapter 11 where the illustrations in Exhibit 9-5 are developed and explained. In addition, a practical approach for analyzing the differences between budgeted and actual sales prices, unit cost, sales mix and sales volume is discussed in Chapter 13. For now, think of Exhibit 9-5 as a preview of those future topics.

RESPONSIBILITY ACCOUNTING

Responsibility accounting is an underlying concept of accounting performance measurement systems. The basic idea is that large diversified organizations are difficult, if not impossible to manage as a single segment, thus they must be decentralized or separated into manageable parts. These parts, or segments are referred to as responsibility centers which include: 1) revenue centers, 2) cost centers, 3) profit centers and 4) investment centers. This functional approach allows responsibility to be assigned to the segment managers that have the greatest amount of influence over the key elements to be managed. These elements include revenue for a revenue center (a segment that mainly generates revenue with relatively little costs), costs for a cost center (a segment that generates costs, but no revenue), a measure of profitability for a profit center (a segment that generates both revenue and costs) and return on investment (ROI) for an investment center (a segment such as a division of a company where the manager controls the acquisition and utilization of assets, as well as revenue and costs). We will discuss the return on investment measurement in detail later in Chapter 14. Conceptually, ROI is some measure of the segment's income divided by some measure of the segment's investment. Typically, ROI is net income divided by total assets, but an operational definition requires a great deal more specificity, as we shall see in Chapter 14. (See ROI).

Advantages and Disadvantages

Responsibility accounting has been an accepted part of traditional accounting control systems for many years because it provides an organization with a number of advantages.⁶ Perhaps the most compelling argument for the responsibility accounting approach is that it provides a way to manage an organization that would otherwise be unmanageable. In addition, assigning responsibility to lower level managers allows higher level managers to pursue other activities such as long term planning and policy making. It also provides a way to motivate lower level managers and workers. Managers and workers in an individualistic system tend to be motivated by measurements that emphasize their individual performances. However, this emphasis on the performance of individuals and individual segments creates what some critics refer to as the "stovepipe organization." Others have used the term "functional silos" to describe the same idea.⁷ Consider Exhibit 9-6. Individuals in the various segments and functional areas are separated and tend to ignore the interdependencies within the organization. Segment managers and individual workers within segments tend to compete to optimize their own performance measurements rather than working together to optimize the performance of the system.

Summary and Controversial Question

An implicit assumption of responsibility accounting is that separating a company into responsibility centers that are controlled in a top down manner is the way to optimize the system. However, this separation inevitably fails to consider many of the interdependencies within the organization. Ignoring the interdependencies prevents teamwork and creates the need for buffers such as additional inventory, workers, managers and capacity.⁸ Of course, a system that prevents teamwork and creates excess is inconsistent with the lean enterprise concepts of just-in-time and the theory of constraints. For this reason, critics of traditional accounting control systems advocate managing the system as a whole to eliminate the need for buffers and excess. They also argue that companies need to develop process oriented learning support systems, not financial results, fear oriented control systems. The information system needs to reveal the company's problems and constraints in a timely manner and at a disaggregated level so that empowered users can identify how to correct problems, remove constraints and improve the process. According to these critics, accounting control information does not qualify in any of these categories because it is not timely, disaggregated, or user friendly.

This harsh criticism of accounting control information leads us to a very important controversial question. Can a company successfully implement just-in-time and other continuous improvement concepts while retaining a traditional responsibility accounting control system? Although the jury is still out on this question, a number of field research studies indicate that accounting based controls are playing a decreasing role in companies that adopt the lean enterprise concepts. In one study involving nine companies, each company answered this controversial question in a different way by using a different mix of process oriented versus results oriented learning and control information.⁹ Since each company is different, a generalized answer to this question for all firms in all situations cannot be given in a textbook. However, a great deal more information is provided in the next chapter to help you answer this question for the companies you are likely to encounter in practice. This chapter concentrates on the planning aspects of budgeting, while the next chapter addresses the control methodology. (See MAAW's Budgeting and Responsibility Accounting topics for more information on these issues).

PREPARING A MASTER BUDGET

THE OPERATING BUDGET

Preparing an Operating Budget is a sequential process of developing nine sub-budgets. Except for one or two exceptions the sub-budgets must be prepared in the following order: sales, production, direct materials, direct labor, factory overhead, ending inventory, cost of goods sold, selling & administrative and income statement (see Exhibit 9-4). Each part is described below.

1. SALES BUDGET

Developing a sales budget involves the following calculations:

Budgeted Sales $ = (Budgeted Unit Sales)(Budgeted Sales Prices)

Current Period Cash Collections = Current Period Cash Sales + Current Period Credit Sales Collected in Current Period + Prior Period Credit Sales Collected in Current Period

These calculations are relatively simple, but where does the budget director obtain this information? Well, sales forecasting is a marketing function. Sales estimates are frequently generated by the company's sales representatives who discuss future needs with customers (wholesalers and retailers). Statistical forecasting techniques can also be used to make estimates of expected future sales, considering the company's previous sales performance and various assumptions about the future economic climate, and the actions of competitors and consumers. Pricing is also a marketing function, but many prices are based on costs plus a markup (the supply function) and consideration of what consumers are willing and able to pay for the product (the demand function). Thus, the budgeted sales price is usually determined after the budgeted unit cost has been calculated (see 6b. below).

The information needed to develop an equation for collections is provided by the finance department and is normally based on past experience. These calculations are somewhat more involved than they appear to be in the equation above because of the effects of cash discounts and the time lags between credit sales and collections. Cash discounts are frequently used to speed up cash inflows. This puts the funds back to work sooner and reduces the need for short term loans. However, even with a generous cash discount for prompt payment, collections for credit sales are typically spread out over several months. The examples illustrated below provide some of the possibilities.

2. PRODUCTION BUDGET

Preparing a production budget includes consideration of the desired inventory change as follows:

Units To Be Produced = Budgeted Unit Sales (from 1) + Desired Ending Finished Goods - Beginning Finished Goods

The desired ending inventory is usually based on the next periods sales budget. Considerations involve the time required to produce the product, (i.e., cycle time or lead time) as well as setup costs and carrying costs. In a just-in-time environment the desired ending inventory is relatively small, or theoretically zero in a perfect situation. In the examples and problems in this chapter, the ending finished goods inventory is stated as a percentage of the next period's (month's) unit sales.

3. DIRECT MATERIAL BUDGET

The direct materials budget includes five separate calculations.

a. Quantity of Material Needed for Production = (Units to be Produced)(Quantity of Material Budgeted per Unit)

The quantity of material required per unit of product is determined by the industrial engineers who designed the product. Materials requirements are frequently described in an engineering document referred to asa "bill of materials".

b. Quantity of Material to be Purchased = Quantity of Material Needed for Production + Desired Ending Material - Beginning Material

This calculation is more involved than equation 3b appears to indicate because it includes information for two future periods. The desired ending materials quantity is normally based on the next period's (month's) materials needed for production and this amount depends on the third period's budgeted unit sales. Of course inventories of raw materials (just like finished goods) are kept to a minimum in a JIT environment. Factors that influence the desired inventory levels include the reliability of the company's suppliers, as well as ordering and carrying costs.

c. Budgeted Cost of Material Purchases = (Quantity of Material to be Purchased)(Budgeted Material Prices)

This amount is needed to determine cash payments. Once the quantity to be purchased has been determined, the cost of purchases is easily calculated. Budgeted material prices are provided by the purchasing department.

d. Cost of Material Used = (Quantity needed for Production)(Budgeted Material Prices)

The cost of materials used is needed in the cost of goods sold budget below.

e. Cash Payments for Direct Material Purchases = Current Period Purchases Paid in Current Period + Prior Period Purchases Paid in Current Period

The information needed to determine budgeted cash payments is provided by accounting, (accounts payable) and is usually based on past experience. Normally the budget should reflect a situation where the company pays promptly to take advantage of all cash discounts allowed, thus 3e may be equal to 3c.

4. DIRECT LABOR BUDGET

Fewer calculations are needed for direct labor than for direct materials because labor hours cannot be stored in the inventory for future use. Time can be wasted, but not postponed.

a. Direct Labor Hours Needed For Production = (Units to be Produced)(D.L. Hours Budgeted per Unit)

The amount of direct labor time needed per unit of product is determined by industrial engineers. Estimates are frequently made using a technique referred to as motion and time study. This involves measuring each movement required to perform a task and then assigning a precise amount of time allowed for these movements. The cumulative time measurements for the various tasks required to produce a product provide the estimate of a standard time per unit. There are alternative techniques that are less expensive, but motion and time study provides estimates that are very precise. Learning curves provide another quantitative technique that is helpful in establishing labor standards.

b. Budgeted Direct Labor Cost = (D.L. Hours needed for Production)(Budgeted Rates Per Hour)

The budgeted rates per hour for direct labor are provided by the human resource department. Frequently the labor (union) contract provides the source for this information. Many different types of labor may be required with different levels of expertise and experience. Thus, Equations 4a and 4b may include several calculations.

5. THE FACTORY OVERHEAD BUDGET

The factory overhead budget is based on a flexible budget calculation as described in Exhibit 9-3. More specifically, the calculation is as follows:

a. Budgeted Factory Overhead Costs = Budgeted Fixed Overhead + (Budgeted Variable Overhead Rate)(D.L. Hours needed for Production from 4a)

This is a cumulative equation that combines the equations for the company's various types of indirect resources. This same idea was illustrated in Chapter 4 when introducing predetermined overhead rates. The predetermined overhead rates developed in Chapter 4 and the budgeted overhead rates discussed in this chapter are conceptually the same.

A plant wide rate based on direct labor hours is used as the overhead allocation basis in this chapter and subsequent chapters mainly to simplify the illustrations. Keep in mind however, that although many companies are still using a single production volume based measurement for overhead allocations, most companies use departmental rates and many companies are now using activity based rates.

The calculation for cash payments reflects one of the differences between cash flows and accrual accounting. Since some costs, like depreciation, do not involve cash payments in the current period, these costs must be subtracted from the total overhead costs to determine the appropriate amount.

b. Cash Payments for Overhead = Budgeted Factory Overhead Cost - Depreciation and other costs that do not require cash payments

Alternative Calculation for Budgeted Factory Overhead Costs

Although budgeted factory overhead costs can be calculated in the manner presented above, there is an alternative approach that illustrates the difference between budgeted and standard costs. Budgeted factory overhead costs can be calculated by determining the standard factory overhead costs and then adjusting for the planned production volume variance. The planned production volume variance is similar to the capacity (or idle capacity) variance illustrated in Chapter 4. It is the difference between the denominator inputs used to calculate the overhead rates, i.e., direct labor hours in our example, and the budgeted direct labor hours needed for production, multiplied by the budgeted fixed overhead rate.

The alternative calculation for factory overhead costs is:

Budgeted factory overhead costs = (Total budgeted overhead rate per hour)(D.L. hours needed for production from 4a)
+ Unfavorable planned production volume variance or - Favorable planned production volume variance

Multiplying the total overhead rate by the number of direct labor hours needed for production provides the standard or applied overhead costs. However, if the number of direct labor hours needed for planned production (i.e., budgeted hours) is not equal to the number of hours used to calculate the overhead rates (i.e., denominator hours), then standard fixed overhead costs will not be equal to budgeted fixed overhead costs. The difference is the planned production volume variance. This is illustrated graphically in Figure 9-1.

Since the difference is caused by the way fixed overhead costs are treated, it can be illustrated by comparing standard fixed overhead costs with budgeted fixed overhead costs. Figure 9-1 shows that if planned or budgeted hours (BH1) are less than denominator hours (DH), the planned production volume variance (PPVV) is unfavorable and represents underapplied fixed overhead. However, if planned or budgeted hours (BH2) are greater than denominator hours (DH), then the planned production volume variance (PPVV) is favorable and represents overapplied fixed overhead.

The difference between budgeted and standard total factory overhead costs can be illustrated by simply adding variable overhead costs to the graph. Since budgeted and standard variable overhead costs are always equal at any level of production, the difference between standard and budgeted total overhead costs is the same as the difference between standard and budgeted fixed overhead costs. The difference is the planned production volume variance. This is illustrated in Figure 9-2

Summary of the PPVV Concept

At any particular level of production, e.g., 1,000 hours, budgeted and standard variable overhead costs are always equal. However, budgeted and standard fixed overhead costs are only equal when the budgeted hours planned for the month are equal to the denominator hours used to calculate the overhead rates. The difference between the budgeted hours planned and the denominator hours, multiplied by the fixed overhead rate is the difference between budgeted and standard fixed overhead costs as well as the difference between budgeted and standard total overhead costs. When working with a budget this difference is referred to as the planned production volume variance.

6. ENDING INVENTORY BUDGET

The dollar amount for the ending inventory of finished goods is needed below to determine cost of goods sold. The dollar amounts for ending direct materials and finished goods are needed for the balance sheet.

a. Ending Direct Materials = (Desired Ending Materials from 3b)(Budgeted Prices)

b. Budgeted or Standard Unit Cost = (Quantity of D.M. required per Unit)(Budgeted Prices) + (D.L. Hours required per Unit)(Budgeted Rate)
+ (Total Overhead Rate)(D.L. Hours required per Unit)

The budgeted or standard unit cost can be calculated at any time after the budgeted quantities per unit and input prices are obtained. The calculation is placed here because it is needed for 6c.

c. Ending Finished Goods = (Desired Ending Finished Goods from 2)(Budgeted Unit Cost)

7. COST OF GOODS SOLD BUDGET

Cost of goods sold is needed for the income statement. One method of determining budgeted COGS involves accumulating the amounts from the previous sub-budgets as follows.

a. Budgeted Total Manufacturing Cost = Cost of Direct Material Used (from 3d.) + Cost of Direct Labor Used (from 4b.)
+ Total Factory Overhead Costs (from 5a.)

b. Budgeted Cost of Goods Sold = Budgeted Total Manufacturing Cost (from 7a.) + Beginning Finished Goods (from previous ending or calculate from 2 and 6b) - Ending Finished Goods (from 6c or calculate from 2 and 6b)

This is the same approach used in Chapter 2 to determine cost of goods sold, but when developing a budget we typically assume no change in Work in Process. Therefore, budgeted cost of goods manufactured is equal to budgeted cost of goods sold.

Alternative Calculation for Budgeted Cost of Goods Sold

Budgeted cost of goods sold can also be calculated by determining standard cost of goods sold, and then adjusting for the planned production volume variance. The alternative calculation for cost of goods sold is:

Budgeted Cost of Goods Sold = (Budgeted unit sales)(Budgeted unit cost)
+ Unfavorable planned production volume variance
or - Favorable planned production volume variance

Although budgeted unit cost equals standard unit cost, budgeted cost of goods sold is not equal to standard cost of goods sold. Again, the difference between standard and budgeted costs is the production volume variance. There are two reasons to become familiar with this alternative. First, it helps strengthen your understanding an important concept that appears again in subsequent chapters, e.g., Chapters 10 and 12. A second reason is that the alternative approach provides a much faster way to calculate budgeted cost of goods sold. Therefore it can be used as a stand alone method, or as a way to check the accuracy of your calculations in 7a and b.

You may wonder why a company would plan a production volume variance in the budget. This occurs because the denominator activity for a particular month is normally the average monthly production based on one twelfth of the planned production for the entire year. The denominator may also be an average based on normal, practical, or theoretical maximum capacity for the year. When the planned production for a particular month is higher or lower than the monthly average, a planned production volume variance results. Actual production volume variances also occur as we shall see in the next chapter.

8. SELLING & ADMINISTRATIVE EXPENSE BUDGET

The preparation of the selling and administrative expense budgets is very similar to the approach used for factory overhead.

a. Budgeted Selling and Administrative Expenses = Budgeted Fixed Selling & Administrative Expenses + (Bud Variable Rate as a Proportion of Sales $)(Budgeted Sales $)

b. Cash Payments for Selling & Administrative Expenses = Budgeted Selling & Administrative Expenses - Depreciation and other cost which do not require cash payments

Although we will place less emphasis on this part of the master budget, (mainly to simplify the illustrations) these costs are usually significant. Also remember that many appropriation budgets (treated as fixed costs) may be included, particularly for certain administrative costs. In addition, as pointed out earlier in the text, a more precise traceable costing approach might be used for management purposes where some selling and administrative costs are allocated (i.e., traced to products) in determining a more precise product cost. Remember however, that selling and administrative costs are treated as expenses (period costs) in the conventional inventory valuation methods.

9. BUDGETED INCOME STATEMENT

Preparing the budgeted income statement involves combining the relevant amounts from the sales, cost of goods sold and selling & administrative expense budgets and then subtracting interest, bad debts and income taxes to obtain budgeted net income. These amounts are provided by the finance department. In a comprehensive practice problem, the applicable amount for interest expense may need to be calculated from information associated with the cash budget. Bad debt expense is based on the expected proportion of uncollectibles stated in the information related to cash collections.

a. Budgeted Sales $ - Budgeted Cost of Goods Sold = Budgeted Gross Profit

b. Budgeted Gross Profit - Budgeted Selling & Administrative Expenses = Operating Income

c. Operating Income - Interest Expense - Bad Debts Expense = Net Income Before Taxes

d. Net Income Before Taxes - Income Taxes = Net Income After Taxes

THE FINANCIAL BUDGET

As indicated in Exhibit 9-4, the financial budget includes the cash budget, the capital budget and the budgeted balance sheet. The cash budget and budgeted balance sheet are discussed below. A detailed discussion of the capital budget is provided in Chapter 18.

10. CASH BUDGET

a. Budgeted Cash Available = Beginning Cash Balance + Budgeted Cash Collections from 1

b. Budgeted Cash Excess or Deficiency = Budgeted Cash Available - Budgeted Cash Payments from 3e, 4b, 5b and 8b

c. Ending Cash Balance = Cash Excess or Deficiency + Borrowings - Repayments including Interest

11. BUDGETED BALANCE SHEET

Preparing the budgeted balance sheet involves accumulating information from the previous period’s balance sheet, the various operating sub-budgets, the cash budget and other accounting records.

ASSETS

a. Current Assets:
Cash (from the cash budget 10c)
Accounts Receivable (from the sales budget and previous balance sheet)
Direct materials (from the ending inventory budget 6a)
Finished goods (from the ending inventory budget 6c)

b. Long Term Assets:
Land (from previous balance sheet and budgeted activity)
Buildings (from previous balance sheet and budgeted activity)
Equipment (from previous balance sheet and budgeted activity)
Accumulated depreciation (from the accounting records)

Total Assets

LIABILITIES

c. Current Liabilities:
Accounts Payable (from various operating sub-budgets)
Taxes Payable (from income statement)

d. Long term Liabilities

Total Liabilities

SHAREHOLDERS EQUITY

e. Common Stock (from previous balance sheet and budgeted activity)

f. Retained Earnings (from previous balance sheet and income statement)

Total Shareholders’ Equity

Total Liabilities and Shareholders’ Equity

EXAMPLES AND PRACTICE PROBLEMS

The following examples and end of chapter practice problems will help you become familiar with the master budget concepts and techniques. The examples and practice problems are simplified to facilitate the learning process. The first example below and most of the practice problems assume that only one period is involved and that only one product is produced from a single direct material. Of course these assumptions are not realistic, but they allow us to prepare budgets by hand in a timely manner to develop an understanding of the budgeting process. A second example is provided in appendix 9-1 that adds more realism and complexity. Although the second example is still relatively simple, it shows how additional periods, products and product requirements cause the complexity of the budget to mushroom quickly. A similar practice problem is included in the end of chapter materials.

EXAMPLE 9-1

The Expando Company produces entertainment centers from a type of pressed wood referred to as particle board. Other materials, such as glue and screws are viewed as insignificant and are charged to overhead as indirect materials. Budgeted, or standard quantities allowed per unit along with the budgeted prices and rates are as follows:

Overhead rates are based on 4,800 standard direct labor hours per month, or average monthly production of 12,000 units, i.e., (.4)(12,000) = 4,800 hours. Desired ending inventories are 10% of next periods material needs for direct material and 5% of next periods sales for finished goods. Unit Sales are budgeted as follows for the first six months of the year.

The budgeted sales price is $100 per unit. Sales are budgeted as 50% cash and 50% credit sales. Past experience indicates that 80% of the credit sales are collected during the month of sale, 18% are collected in the following month, and 2% are uncollectible. A 1% cash discount is allowed to customers who pay within the month the sale takes place including cash sales.

Variable selling and administrative expenses are budgeted at 10% of sales dollars. The budget for fixed selling and administrative expenses is $50,000 per month. Cash payments are made for all expenditures made during the month except for depreciation of $100,000 in manufacturing and $25,000 in the selling and administrative area. The budgeted beginning cash balance for March is $100,000 and the tax rate is 40%. Budgeted income taxes from January and February are $200,000. This amount is to be paid at the end of march along with the current months taxes. A three month note for $50,000 is to be repaid at the end of March. The interest rate on the note is 12 percent.

Some additional account balances budgeted for the end of February include: Land $5,000,000, buildings and equipment $15,000,000, accumulated depreciation $6,000,000, other current liabilities 0 , long term liabilities 0, common stock $5,000,000 and retained earnings $8,993,000.

The following illustrations include a partial master budget for March including the various parts of the operating budget, a cash budget and an abbreviated balance sheet. Budgets for February and April can also be prepared with the given data. However, a budget for January would require unit sales for December. A budget for May would require unit sales for July.

APPENDIX - EXAMPLE 9-2

Example 9-2 is more involved than the previous illustration. The idea is to provide a better view of the budgeting process and to show how the size of the budget grows rapidly as additional products and product requirements are added. For example, this problem requires a budget for three months for a company that produces two products in two departments. In addition the products require two types of direct materials and direct labor. It is placed on a separate page because it goes beyond an introductory level problem. (See Chapter 9 Appendix).

FOOTNOTES

¹ Budgeting is revered by some and scorned by others, but according to a survey of 2,700 corporate executives, it is the most important accounting knowledge and skill area for those who enter management accounting. See Siegel, G. and J. E. Sorensen. 1994. What corporate America wants in entry-level accountants. Management Accounting (September): 26-3

² See Anthony, R. N. 1977. Zero-base budgeting is a fraud. The Wall Street Journal (April 27); and 1977. Zero-based budgeting: A useful fraud? Government Accountants Journal (Summer): 7-10. PPBS is a closely related topic. Planning, programming, and budgeting systems were popular for government decision making in the 1960's. See Frank, J. E. 1973. A framework for analysis of PPB success and causality. Administrative Science Quarterly 18(4): 527-543. MAAW's ZBB section includes many other articles.

3 Walmart, Levi Strauss and Ford Motor Company have similar relationships with their vendors. See Hammer, M. and J. Champy. 1993. Reengineering The Corporation. Harper Business Press: 43, 61, 62 and 90.

4 Some companies find it more convenient to use thirteen four week periods, i.e., (28)(13) = 364. An advantage of this approach is that performance is more easily compared from one period to the next. One method of handling the extra day, or two days in leap-years, is to include it in the thirteenth period. For a more extensive discussion of this issue, see Folsom, M. B. 1930. The thirteen-month calendar. Harvard Business Review (January): 218-226.

⁵ The linear model on the right-hand side of Exhibit 9-5 is based on direct costing. This model is discussed in Chapter 11 and altered to conform to absorption costing in Chapter 12.

⁶ An early discussion of the responsibility accounting concept appears in Alford, L. P. 1928. Laws of Management Applied to Manufacturing. Ronald Press. Also see Higgins, J. 1952. Responsibility accounting. Arthur Andersen Chronicle (April). According to Anthony, Higgins was first to use the term "responsibility center" in this paper. See Anthony, R. N. 1989. Reminiscences about management accounting. Journal of Management Accounting Research (1): 1- 20. (Summary).

⁷. Robert K. Elliot, used the term stovepipe organization in Elliot, R. K. 1992. The third wave breaks on the shores of accounting. Accounting Horizons (June): 61-85. (Summary). Hammer and Champy refer to functional silos in Reengineering The Corporation. Deming discusses the same idea in different terms. He refers to traditional performance evaluation methods as one of the seven deadly diseases of American management. See the Deming topic for more information on Deming's theory of management.

⁸ To visualize the idea, refer back to Figures 8-10 and 8-11.

⁹ See McNair, C. J. and L. P. Carr. 1994. Responsibility redefined. Advances in Management Accounting (3): 85-117. (Summary).

QUESTIONS

1. Define three types of cost in terms of: a) the relationship between the inputs and outputs involved, b) the behavior of the cost, i.e., fixed, variable or mixed, c) whether the cost are viewed as short run or long run, and d) how the cost are evaluated. (See Exhibit 9-2).

2. Define four types of budgets. (See Exhibit 9-3).

3. Discuss three types of appropriation budgets. (See Chapter 9 Supplement).

4. Discuss the purposes of budgeting or financial planning. (See Purposes & Benefits).

5. Which purpose tends to cause behavioral conflicts? (See Limitations and the discussion of the Johnson Model of ABM in Chapter 8).

6. Discuss the limitations of budgeting. (See Limitations).

7. Describe the concept of responsibility accounting. (See Responsibility Accounting, Exhibit 9-6 and the Chapter 9 Supplement).

8. Discuss the controversy concerning responsibility accounting.

9. What are the two main parts of the master budget? (See Exhibit 9-4).

10. Refer to Exhibits 9-2 and 9-4. What type of costs are involved in the production budget, i.e., engineered, discretionary and/or committed?

11. Refer to Exhibit 9-4. Will the net amount of cash collections and payments equal net income? Explain.

12. Refer to Exhibit 9-4. What is the connection between the income statement and the balance sheet?

13. What are four assumptions underlying the master budget? Explain each. (See Assumptions).

14. In preparing the sales budget, what functional area would estimate unit sales? How are these estimates made? (See Sales Budget).

15. How are budgeted collections estimated? (See Sales Budget).

16. What is the difference between budgeted unit sales and budgeted units to be produced? (See Production Budget).

17. What factors should be considered in determining the desired ending inventory of finished goods? (See Production Budget).

18. Which calculation in the master budget normally requires data for three periods? Why? (See Direct Material Budget).

19. Why is the direct labor budget less involved than the direct materials budget? (See Direct Labor Budget).

20. Explain two alternative ways to calculate budgeted overhead costs? (See Overhead Budget and Figure 9-1 and Figure 9-2).

21. What is the difference between budgeted unit cost and standard unit costs?

22. What is the difference between budgeted total cost and standard total costs? (See Figure 9-2)

23. Describe two alternative ways to calculate budgeted cost of goods sold? (See COGS Budget)

24. What drives variable selling and administrative costs in traditional cost systems? (See S&A Budget).

25. To be consistent with the matching concept, what should be the basis of the amount of bad debts that appears on the income statement? Explain. (See Budgeted Income Statement).

26. Basically, what does a cash budget show? (See Cash Budget).

27. Mind expanding question. If budgeted units to be produced are increased without a corresponding increase in unit sales, what effect will this have on budgeted net income before taxes? Use the Expando Company to test your answer. Assume that units to be produced are arbitrarily increased from 11,050 (from the production budget) to 11,300. Hint: The answer can be found quickly by using the alternative approach to recalculate budgeted cost of goods sold. You might also find it useful to review the discussion of the behavioral aspects of inventory valuation in Chapter 8.

PROBLEMS

PROBLEM 9-1

Choose the best answer for the following multiple choice questions.

1. Which of the following statements is false?

a. The master budget is a flexible budget for the denominator activity level.
b. The technique of flexible budgeting is used to fine tune the master budget for performance evaluation purposes, i.e., to prepare budgets which are comparable with the actual results.
c. The master budget includes appropriation budgets.
d. Appropriation budgets are used to set the maximum amounts for many types of discretionary expenditures.

2. Budgeted unit sales is normally determined by:

a. The accounting department.
b. The engineering department.
c. The personnel department.
d. The marketing department.
e. None of these.

3. Standard quantities per unit of product for direct labor are normally determined by:

a. The accounting department.
b. The engineering department.
c. The personnel department.
d. The marketing department.
e. None of these.

4. If a decrease in the time lag between ordering and receiving direct materials could be obtained by switching to a new vendor, then the average inventory of direct material could be decreased. This would most likely,

a. Increase net income in the current month.
b. Decrease cash outflows in the current month.
c. Increase net income in future months as well as decrease cash outflows in the current and future periods.
d. All of these.
e. None of these.

5. Which of the following is a purpose or advantage of the master budget process?

a. Coordination of the activities of the different functional areas of the firm.
b. Communication to managers of how their efforts add value to the organization's products or services.
c. Forces management to establish profit objectives.
d. Provides a tool for evaluation and control.
e. All of these.

6. Which of the following statements is true? The master budget process for a manufacturing firm

a. may be referred to as either incremental budgeting or zero base budgeting.
b. may include appropriation budgets.
c. may include continuous budgets.
d. b. and c.
e. All of the above.

7. Appropriation budgets are

a. flexible budgets
b. static (fixed) budgets.
c. incremental budgets.
d. zero base budgets.
e. None of these.

8. The planned production volume variance is

a. the difference between planned unit sales and production multiplied by the budgeted fixed overhead rate per unit.
b. the difference between planned unit sales and denominator units multiplied by the budgeted fixed overhead rate per unit.
c. the difference between planned production units and denominator units multiplied by the budgeted fixed overhead rate per unit.
d. the difference between planned direct labor hours and actual direct labor hours multiplied by the fixed overhead rate per hour.
e. None of these.

PROBLEM 9-2

Bibb Company produces and sells a single product with standard costs as follows:

Overhead rates are based on 2,000 units per month or 6,000 standard direct labor hours, i.e., this is the master budget denominator activity level. Overhead is applied on the basis of direct labor hours.

Desired ending inventories of materials and finished goods are based on 5% of next periods needs.

Unit Sales are budgeted as follows:

The budgeted sales price is $160 per unit. All sales are budgeted as credit sales. Past experience indicates that 80% are collected during the month of sale, 18% are collected in the following month, and 2% are uncollectible. A 1% cash discount is allowed to customers who pay within the month the sale takes place.

Required:

A Partial Master Budget for March as follows.

1. Sales budget for March, including net sales dollars.
2. Calculate collections for March.
3. Production Budget, i.e., units to be produced for March.
4. Direct Material quantity needed for production for March.
5. Direct Material quantity to be purchased for March.
6. Budgeted cost of direct material purchases for March.
7. Budgeted cost of direct material used for March.
8. Direct labor needed for production for March.
9. Budgeted cost of direct labor used for March.
10. Budgeted factory overhead costs for March.
11. Budgeted cost of goods sold for March.
12. Prepare a simple Budgeted Income Statement for March. Assume selling and administrative expenses are $54,992. Ignore taxes and interest, but don't forget bad debts.

PROBLEM 9-3

Barker Company produces and sells a single product with budgeted or standard costs as follows:

Overhead rates are based on 8,000 standard direct labor hours per month, i.e., this is the master budget denominator activity level.

Desired ending inventories of materials are based on 10% of the next months materials needed. Desired ending finished goods are based on 5% of next periods budgeted unit sales.

Unit Sales are budgeted as follows:

The budgeted sales price is $1000 per unit. Sales are budgeted as 80% credit sales and 20% cash sales. Past experience indicates that 60% of credit sales are collected during the month of sale, 38% are collected in the following month, and 2% are uncollectible. A 1% cash discount is allowed to all customers (cash or credit) who pay within the month the sale takes place. Selling and administrative expenses are:

Variable = 20% of sales dollars, Fixed = $250,000 per month. The budget assumption concerning cash payment proportions is that all current purchases of direct material, direct labor, factory overhead and selling and administrative items will be paid for during the current period. The beginning cash balance for February is $10,000. Depreciation and other non-cash fixed costs are: manufacturing = $100,000, selling and administrative = $75,000.

Required:

A Partial Master Budget for February as follows.

1. Sales budget for February, including net sales dollars.
2. Calculate collections for February.
3. Production Budget, i.e., units to be produced for February.
4. Direct Material quantity needed for production for February.
5. Direct Material quantity to be purchased for February.
6. Budgeted cost of direct material purchases for February.
7. Budgeted cost of direct material used for February.
8. Direct labor needed for production for February.
9. Budgeted cost of direct labor used for February.
10. Budgeted factory overhead costs for February.
11. Budgeted cost of goods sold for February.
12. Prepare a simple Budgeted Income Statement for February.
13. Prepare a cash budget for February.

PROBLEM 9-4

This problem was omitted but is similar to the appendix problem.

PROBLEM 9-5

I. Master Budget: Grand Company produces and sells a single product with budgeted or standard unit costs as follows:

Overhead rates are based on a capacity level of 1,200 units per month, i.e., this is the master budget denominator activity level.

Desired ending inventories of materials are based on 4% of the next months materials needed. Desired ending finished goods are based on 10% of next periods budgeted unit sales.

Unit Sales are budgeted as follows:

The budgeted sales price is $300 per unit. Sales are budgeted as 60% credit sales and 40% cash sales. Past experience indicates that 40% of credit sales are collected during the month of sale, 58% are collected in the following month, and 2% are uncollectible. A 1% cash discount is allowed to all customers (cash or credit) who pay within the month the sale takes place. Selling and administrative expenses are budgeted as follows: Variable expenses are 10% of sales dollars, budgeted expenses are $50,000.

Required:

A Partial Master Budget for February as follows.

1. Sales budget for February, including net sales dollars.
2. Calculate collections for February.
3. Production Budget, i.e., units to be produced for February.
4. Direct Material quantity needed for production for February.
5. Direct Material quantity to be purchased for February.
6. Budgeted cost of direct material purchases for February.
7. Budgeted cost of direct material used for February.
8. Direct labor needed for production for February.
9. Budgeted cost of direct labor used for February.
10. Budgeted factory overhead costs for February.
11. Budgeted cost of goods sold for February.
12. The amount and status (i.e., favorable or unfavorable) of the planned production volume variance for February.
13. Budgeted selling and administrative expenses for February.
14. The amount of Bad debts which should appear on the February Income Statement.

PROBLEM 9-6

AUTOMATED PLANT WHERE ANY DIRECT LABOR IS INCLUDED IN OVERHEAD

The Microtable Company produces and sells special wood tables that are used with microcomputers. The various parts of the table are cut and assembled by robots, thus direct labor is not involved. Budgeted or standard costs for each table are as follows:

Overhead rates are based on a capacity level 500 machine hours per month and overhead is applied on the basis of robot (machine) hours.

Desired ending inventories of materials are based on 10% of the next months materials needed for production. Desired ending finished goods are based on 15% of next periods budgeted unit sales.

Unit Sales are budgeted as follows for 2005

The budgeted sales price is $250 per table. Sales are budgeted as 90% credit sales and 10% cash sales. Past experience indicates that 80% of credit sales are collected during the month of sale, 17% are collected in the following month, and 3% are uncollectible. A 1% cash discount is allowed to all customers (cash or credit) who pay within the month the sale takes place. Selling and administrative expenses are budgeted as follows: Variable expenses are 20% of sales dollars, fixed expenses are $50,000.

Required:

Calculate the budgeted amounts indicated below, then circle the letter for the answer you choose. Show all your supporting calculations next to the question.

1. The net sales dollars budgeted for February:

a. $1,250,000    b.1,240,000    c. 1,241,000   d. 1,239,750    e. None of these.

2. The cash collections budgeted for February:

a. $ 891,000    b. 1,186,875    c.1,014,750    d. 908,125    e. None of the above.

3. Budgeted units (i.e., tables) to be produced for February:

a. 5,000    b.4,970    c. 5,030     d. 5,780    e. None of these.

4. For the remainder of this problem ignore your answer to question 3 and assume that the budgeted units to be produced for February are 5,030.

The number of board feet of Direct Material to be purchased for February:

a. 100,600    b. 101,110    c. 100,170    d. 101,030    e. Some other amount.

5. The Budgeted cost of direct material used for February:

a. $303,090    b. 301,800    c. 300,000    d. 300,510    e. None of these.

6. The budgeted total factory overhead costs for February:

a. $250,300    b. 251,500    c. 250,000    d. 201,200    e. Some other amount.

7. The cost of goods sold for February stated at standard cost:

a. $551,200    b. 548,800    c. 550,000    d. 552,100    e. None of these.

8. The amount and status (i.e., favorable or unfavorable) of the planned production volume variance for February:

a. Zero    b. 1,200 favorable    c. 120 unfavorable     d. 1,200 unfavorable    e. Some other amount.

9. The Budgeted selling and administrative expenses for February:

a. $250,000    b. 297,950    c. 247,950    d. 300,000    e. None of these.

10. During February no specific accounts receivable were determined to be uncollectible. The amount of bad debt expense that should appear on the Budgeted Income Statement for February:

a. Zero    b. $37,500    c. 33,750    d. 33,413    e. Some other amount.

11. The ending accounts receivable balance budgeted for February before subtracting the allowance for bad debts:

a. $191,250    b. 225,000    c. 223,155    d. 189,682    e. None of these.

12. Assume 100 additional units of production are budgeted for February with no change in budgeted unit sales. What effect will this have on budgeted net income for February?

a. Budgeted net income will not change.
b. Budgeted net income will increase by $11,000.
c. Budgeted net income will increase by $4,000.
d. Budgeted net income will decrease by $11,000.
e. None of the above.

PROBLEM 9-7

The R. G. Phelps Company produces and sells a single product with budgeted or standard unit costs as follows:

Overhead rates are based on a capacity level of 2,000 units (or 1,000 direct labor hours) per month, i.e., this is the master budget denominator activity level. Desired ending inventories of materials are based on 10% of the next months materials needed for production. Desired ending finished goods are based on 20% of next periods budgeted unit sales.

Unit Sales are budgeted as follows for 2005:

The budgeted sales price is $240 per unit. Sales are budgeted as 75% credit sales and 25% cash sales. Past experience indicates that 90% of credit sales are collected during the month of sale, 8% are collected in the following month, and 2% are uncollectible. A 1% cash discount is allowed to all customers (cash or credit) who pay within the month the sale takes place. Selling and administrative expenses are budgeted as follows: Variable expenses are 10% of sales dollars, fixed expenses are $100,000.

Required: Choose the best answer for the following questions.

1. The net sales dollars budgeted for March are

a. $480,000    b. 475,200    c. 475,560    d. 476,760    e. None of these.

2. The cash collections budgeted for March are

a. $320,760    b. 439,560    c. 444,000    d. 465,480    e. Some other amount.

3. Budgeted units to be produced for March are

a. 2,000    b. 2,100   c. 1,900    d. 2,040    e. None of these.

4. For the remainder of this problem ignore your answer to question 3 and assume that the budgeted units to be produced for March are 2,100.

The number of gallons of Direct Material to be purchased for March is

a. 12,600    b. 12,852    c. 12,900    d. 13,200   e. Some other amount.

5. The Budgeted cost of direct material used for March is

a. $64,500    b. 64,260    c. 63,000    d. 60,000   e. None of these.

6. The budgeted cost of direct labor used for March is

a. $10,500    b. 21,000    c. 10,000    d. 20,000   e. None of these.

7. The budgeted total factory overhead costs for March are

a. $105,000    b. 315,000    c. 300,000    d. 305,000    e. Some other amount.

8. Now, ignore your answers to questions 5, 6 and 7 and assume that budgeted total manufacturing cost is $378,500. The budgeted cost of goods sold for March is

a. $388,500    b. 378,500    c. 370,000    d. 397,000    e. None of these.

9. The amount and status (i.e., favorable or unfavorable) of the planned production volume variance for March is

a. Zero    b. $10,000 Unfavorable    c. 10,000 Favorable    d. 15,000 Unfavorable   e. Some other amount.

10. The Budgeted selling and administrative expenses for March are

a. $148,000    b. 147,556    c. 146,548    d. 100,000    e. None of these.

11. During March of the previous year $8,000 in actual receivables were written off as uncollectible. The amount of bad debt expense that should appear on the Budgeted Income Statement for March is

a. Zero    b. $9,600    c. 8,000    d. 7,200   e. Some other amount.

12. The ending accounts receivable balance budgeted for March before subtracting the allowance for bad debts is

a. $48,000    b. 36,000    c. 35,640    d. 28,800   e. None of these.

Problem Solutions

Extra MC Questions