Chapter 06 Master Budget PDF

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CHAPTER 6 MASTER BUDGET AND RESPONSIBILITY ACCOUNTING 6-1. What are the four elements of the budgeting cycle? The budgeting cycle includes the following elements a. Planning the performance of the company as a whole is well as planning the performance of its subunits Management agrees on what is expected b. Providing a frame of reference, a set of specific expectations against which results can be compared c. Investigating variations from plans. If necessary, corrective action follows investigation d. Planning again, in light of feedback and changed conditions

6-2. Define master budget The master budget expresses management's operating and financial plans for a specified period (usually a fiscal year) and includes a set of budgeted financial statements. It is the initial plan of what the company intends to accomplish in the period 6-3. "Strategy, plans, and budgets are unrelated to one another." Do you agree? Explain. Strategy, plans, and budgets are interrelated and affect one another Strategy specifies how an organization matches its own capabilities with the opportunities in the marketplace to accomplish its objectives Strategic analysis underlies both long-run and short-run planning. In turn, these plans lead to the formulation of budgets. Budgets provide feedback to managers about the likely effects of their strategic plans Managers use this feedback to revise their strategic plans and sometimes their strategies 6-4. "Budgeted performance is a better criterion than past performance for judging managers”. Do you agree? Explain We agree that budgeted performance is a better criterion than past performance for judging managers because inefficiencies included in past results can be detected and eliminated in budgeting Also, future conditions may be expected to differ from the past, and these can also be factored into budgets. 6-5. “Production managers and marketing managers are like oil and water. They mix” How can a budget assist in reducing conflicts between these two areas?

Production and marketing traditionally have operated as relatively independent business functions Budgets can assist in reducing conflicts between these two functions in two ways consider a beverage company such as Coca-Cola of Pepsi-Cola:  

Communication Marketing could share information about seasonal demand WAT production. Coordination Production could ensure that output is sufficient to meet, for example high seasonal demand in the summer.

6-6. "Budgets meet the cost-benefit test. They force managers to act differently” Do you agree? Explain In many organizations, budgets impel managers to plan Without budgets, managers drift from crisis to crisis Research also shows that budgets can motivate managers to meet targets and improve their performance Thus, many top managers believe that budgets meet the cost-bench test.

6-7. Define rolling budget. Give an example A rolling budget, also called a continuous budget, is a budget or plan that is always available for a specified future period, by continually adding a penod (month, quarter, or year) to the period that just ended. A four-quarter rolling budget for 2017 is superseded by a four-quarter rolling budget for April 2017 to March 2018, and so on.

6-8. Outline the steps in preparing an operating budget The steps in preparing an operating budget are as follows: 1. Prepare the revenues budget 2. Prepare the production budget (in units). 3. Prepare the direct material usage budget and direct material purchases budget 4. Prepare the direct manufacturing labor budget. 5. Prepare the manufacturing overhead budget 6. Prepare the ending inventories budget 7. Prepare the cost of goods sold budget. 8. Prepare the nonmanufacturing costs budget 9. Prepare the budgeted income statement. 6-9. "The sales forecast is the cornerstone for budgeting." Why?

The sales forecast is typically the cornerstone for budgeting because production (and, hence, costs) and inventory levels generally depend on the forecasted level of sales.

6-10. How can sensitivity analysis be used to increase the benefits of budgeting? How can sensitivity analysis be used to increase the benefits of budgeting? Sensitivity analysis adds an extra dimension to budgeting. It enables managers to examine how budgeted amounts change with changes in the underlying assumptions. This assists managers in monitoring those assumptions that are most critical to a company in attaining its budget and allows them to make timely adjustments to plans when appropriate. 6-11. Define Kaizen budgeting. Kaizen budgeting explicitly incorporates continuous improvement anticipated during the budget penod into the budget numbers.

6-12. Describe how nonoutput-based cost drivers can be incorporated into budgeting. Nonoutput-based cost drivers can be incorporated into budgeting by the use of activity-based budgeting (ABB) ABB focuses on the budgeted cost of activities necessary to produce and sell products and services. Nonoutput-based cost drivers, such as the number of parts number of batches, and number of new products can be used with ABB.

6-13. Explain how the choice of the type of responsibility center (cost, revenue, profil, or investment) affects behavior. The choice of the type of responsibility center determines what the manager is accountable for and thereby affects the manager's behavior. For example, if a revenue center is chosen, the manager will focus on revenues, not on costs or investments. The choice of a responsibility center type guides the variables to be included in the budgeting exercise.

6-14. What are some additional considerations that arise when budgeting in multinational companies? Budgeting in multinational companies may involve budgeting in several different foreign currencies. Further, management accountants must translate operating performance into a single currency for reporting to shareholders by budgeting for exchange rates. Managers and accountants must understand the factors that impact exchange rates and, where possible, plan financial strategies to limit the downside of unexpected unfavorable moves in currency valuations in developing budgets for operations in different countries, they must also have good understanding of political, legal, and economic issues in those countries.

6-15. "Cash budgets must be prepared before the operating income budget." Do you agree? Explain No Cash budgets and operating income budgets must be prepared simultaneously. In preparing their operating income budgets, companies want to avoid unnecessary idle cash and unexpected cash deficiencies. The cash-budget, unlike the operating income budget, highlights periods of idle cash and periods of cash shortage, and it allows the accountant to plan cost effective ways of either using excess cash or raising cash from outside to achieve the company's operating income goals 6-16. Master budget. Which of the following statements is correct regarding the components of the master budget? a. The cash budget is used to create the capital budget. b. Operating budgets are used to create cash budgets. c. The manufacturing overhead budget is used to create the production budget. d. The cost of goods sold budget is used to create the selling and administrative expense budget. SOLUTION Master budget. Choice “b” is correct. All of the operating budgets (like the sales budget, production budget, selling and administrative expense budget, etc.) are used to create financial budgets like the cash budget and the proforma financial statements Of course, after cash budgets have been formulated, companies use this information to also adjust the operating budget Choice “a” is incorrect. The capital budget is used to create the cash budget. Choice “c” is incorrect. The factory overhead budget is derived from the production budget. Choice “d” is incorrect. The cost of goods sold budget and the selling and administrative expense budget are completely independent of one another and both are usually determined based on the revenues budget.

6-17. Operating and financial budgets. Which of the following statements is correct rewarding the drivers of operating and financial budgets? a. The sales budget will drive the cost of goods sold budget. b. The cost of goods sold budget will drive the units of production budget. c. The production budget will drive the selling and administrative expense budget. d. The cash budget will drive the production and selling and administrative expense budgets. SOLUTION Operating and financial budgets.

Choice "a" is correct. The sales (or revenues) budget is the primary driver of most components of the master budget, which includes both operating and financial budgets The sales budget will drive the production budget, which in tum drives budgets for direct materials, direct labor, and factory overhead All three of these budgets combine to form the cost of goods sold budget. Choice "b" is incorrect. The units of production budget drives the budgets for direct materials, direct labor, and manufacturing overhead These three budgets combine to form the cost of goods sold budget. Choice "c" is incorrect The selling and administrative expense budget is separate from the production budget, although both are driven by the sales budget. Choice "d" is incorrect. The cash budget is driven by the production and selling and administrative expense budgets Of course, cash needs might affect the final production and selling budget.

6-18. Production budget. Superior Industries sales budget shows quarterly sales for the next year as follows Quarter T-10,000, Quarter 2-8,000, Quarter 3-12,000, Quarter 4-14,000 Company policy is to have a target finished-goods inventory at the end of each quarter equal to 20% of the next quarter's sales Budgeted production for the second quarter of next year would 1. 7,200 units, 2. 8,800 units, 3. 12,000 units, 4. 10,400 units SOLUTION Production budget Choice 2 is correct 8,800 units are the budgeted production for the second quarter. The calculation proceeds with first determining the beginning inventory for the second quarter (20% second quarter sales 8000 units -1.600 units) and the ending inventory for the second quarter (20% third quarter sales. 12,000 units = 2,400 units) We then use the following Beginning inventory + Production = Sales + Ending inventory Production = Sales + Ending inventory - Beginning inventory = 8,000 + 2,400 - 1,600 = 8,800 units Check Second Quarter Beginning inventory (20% * 8,000) 1,600 units Add Production (plug)

8,800 units 10,400 units

Deduct Sales

8,000 units

Ending inventory (20% * 12,000)

2,400 units

6-19. Responsibility centers. Elmhurst Corporation is considering changes to its responsibility accounting system Which of the following statements is/are correct for a responsibility accounting system. I. In a cost center, managers are responsible for controlling costs but not revenue. II. The idea behind responsibility accounting is that a manager should be held responsible for those items that the manager can control to a significant extent. III. To be effective, a good responsibility accounting system must help managers to plan and to control. IV Costs that are allocated to a responsibility center are normally controllable by the responsibility center manager. 1. I and II only are correct. 2. II and III only are correct 3. I, II, and III are correct 4. I, II and IV are correct SOLUTION Responsibility centers. Choice "3" is correct. The question asks which of a series of statements is/are correct for a responsibility accounting system "None of the above" is not an available option, and neither is "All of the above Statement I says that, in a cost center, managers are responsible for controlling costs but not revenue. Statement I is correct. Statement II says that the idea behind responsibility accounting is that a manager should be held responsible for those items that the manager can control to a significant extent. Statement II is correct. Statement III says that, to be effective, a good responsibility accounting system must help managers to plan and control Planning without control and control without planning is not effective. Statement III is correct. Statement IV says that costs that are allocated to a responsibility center are normally controllable by the responsibility center manager Costs that are allocated are normally not controllable by the responsibility center manager Statement IV is incorrect.

6-20. Cash budget. Mary Jacobs, the controller of the Jerks Company is working on Jenks’ cash budget for year 2. She has information on each of the following items: I. Wages due to workers accrued as of December 31, year 1

II. Limits on a line of credit that may be used to fund Jenks' operations in year 2 III. The balance in accounts payable as of December 31, year I, from credit purchases made in year 1. Which of the items above Should Jacobs take into account when building the cash budget for year 2? a.

I , II c. II , III

b. I , III d. I , II , III

SOLUTION Cash budget Choice "d" is correct. All of the elements listed should be considered when building the cash budget. Accrued wages will be factored into the determination of cash disbursements in year 2 which is part of the cash budget. Financing budgets, a component of the cash budget, cover how a company will fund its current operations. One of the methods the company may use is a line of credit which will have limits as to how much cash a company can access at a given time The accounts payable balance is important as well, as eventually vendors must be paid in cash in year 2 for credit purchases made by the company in year 1. Choice “a” is incorrect. This choice leaves out accounts payable, which eventually must be paid with cash in year 2. Choice “b”is incorrect. This choice leaves out the analysis of limits on a line of credit that the company may need to fund its operations in year 2. Choice “c” is incorrect. This choice leaves out accrued wages, which will ultimately have to be pand by the company in year 2. 6-21. Sales budget, service setting. In 2017, Hart & Sons, a small environmental-testing firm, performed 11,400 radon tests for $260 each and 15,000 lead tests for $210 each. Because newer homes are being built with lead-free pipes, lead-testing volume is expected to decrease by 12% next year However, awareness of radon-related health hazards is expected to result in a 5% increase in radon-test volume each year in the near future. Jim Hart feels that if he lowes his price for lead testing to $200 per test, he will have to face only a 4% decline in lead-test sales in Required 1. Prepare a 2018 sales budget for Hart & Sons assuming that Hart holds prices at 2017 levels. 2. Prepare 2018 sales budget for Hart & Sons assuming that Hart lowers the price of a lead test $200 Should Hart lower the price of a lead test in 2018 if the company's goal is to maximize sales revenue?

SOLUTION (15 min.) Sales budget, service setting. 1. 2017 Hart & Sons Volume Radon Tests 11,400 Lead Tests 15,000

At 2017 Selling Expected 2018 Prices Change in Volume $260.00 5% $210.00 -12%

Expected Volume 11,970 13,200

2018

Expected Volume 11,970 14,400

2018

Hart & Sons Sales Budget For the Year Ended December 31, 2018 Selling Units Total Price Sold Revenues Radon Tests

$260.00

11,970

Lead Tests

$210.00

13,200

3112200 2772000 5884200

2. 2017 Hart & Sons Volume Radon Tests 11,400 Lead Tests 15,000

At 2017 Selling Expected 2018 Prices Change in Volume $260.00 5% $210.00 -4%

Hart & Sons Sales Budget For the Year Ended December 31, 2018 Selling Price Units Sold Total Revenues Radon Tests $260.00 11,970 3112200 Lead Tests $210.00 14,400 2880000 5992200 Expected revenues at the new 2018 prices are $5,992,200, which is higher than the expected 2018 revenues of $5,884,200 if the prices are unchanged. So, if the goal is to maximize sales revenue and if Jim Hart's forecasts are reliable, the company should lower its price for a lead test in 2018.

6-22. Sales and production budget. The Coby Company expects sales in 2018 of 201,000 units of serving trays. Coby's beginning inventory for 2018 is 13,000 trays, and its target ending inventory is 29,000 trays. Compute the number of trays budgeted for production in 2018.

SOLUTION (5 min )

Sales and production budget. Budgeted sales in units Add target ending finished goods inventory Total requirements Deduct beginning finished goods inventory Units to be produced

201000 29000 230000 13000 217000

6-23. Direct material budget. Dawson Co produces wine The company expects to produce 2,535,000 two-liter bottles of Chablis in 2018 Dawson purchases empty glass bottles from an outside vendor. Its target ending inventory of such bottles is 77.000, its beginning inventory is 54,000 For simplicity, ignore breakage Compute the number of bottles to be purchased in 2018.

SOLUTION (5 min)

Direct materials purchases budget. Direct materials to be used in production (bottles) Add target ending direct materials inventory (bottles) Total requirements (bottles) Deduct beginning direct materials inventory (bottles) Direct materials to be purchased (bottles)

2535000 77000 2612000 54000 2558000

6-24. Material purchases budget. The McGrath Company has prepared a sales budget of 42,000 finished units for a 3-month period The company has an inventory of 13.000 units of finished goods on hand at December 31 and has a target finished-goods inventory of 15,000 units at the end of the succeeding quarter. It takes 3 gallons of direct materials to make one unit of finished product. The company has an inventory of 61,000 gallons of direct materials at December 31 and has a target ending inventory of 53,000 gallons at the end of the succeeding quarter How many gallons of direct materials should McGrath Company purchase during the 3 months ending March 31?

SOLUTION (10 min)

Budgeting material purchases.

Production Budget Finished Goods (units) 42000 15000 57000 13000 44000

Budgeted sales Add target ending finished goods inventory Total requirements Deduct beginning finished goods inventory Units to be produced Direct Materials Purchases Budget

Direct Materials (in gallons) Direct materials needed for production (44,000 * 3) Add target ending direct materials inventory Total requirements Deduct beginning direct materials inventory Direct materials to be purchased

132000 53000 185000 61000 124000

6-25. Revenues, production, and purchases budgets. The Yucatan Co in Mexico has a division that manufactures bicycles. Its budgeted sales for Model XG in 2018 are 95.000 units. Yucatan's target ending inventory is 7,000 units, and its beginning inventory is 11,000 units The company's budgeted selling price to its distributors and dealers is 1,500 pesos per bicycle. Yucatan buys all its wheels from an outside supplier. No defective wheels are accepted Yucatan's needs for extra wheels for replacement parts are ordered by a separate division of the company The company's target ending inventory is 14,000 wheels, and its beginning inventory is 16,000 wheels The budgeted purchase price is 400 pesos per wheel. Required 1. Compute the budgeted revenues in pesos. 2. Compute the number of bicycles that Yucatan should produce. 3. Compute the budgeted purchases of wheels in units and in pesos. 4. What actions can Yucatan's managers take to reduce budgeted purchasing costs of wheels assuming the same budgeted sales for Model XG?

SOLUTION (15-20 min)

Revenues, production, and purchases budget.

1. 95,000 bicycles x 3,500 pesos = 332,500,000 pesos. 2. Budgeted sales (bicycles) Add target ending finished goods inventory Total requirements Deduct beginning finished goods inventory Unit...