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Managerial Accounting, 11/e 9- © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the priorCHAPTER 9Financial Planning and Analysis:The Master BudgetFOCUS ON ETHICS (Located before the Chapter Summary in the text.)Is padding the budget unethical? Some accou...

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CHAPTER 9 Financial Planning and Analysis: The Master Budget FOCUS ON ETHICS (Located before the Chapter Summary in the text.) Is padding the budget unethical? Some accountants argue that budget padding is a vicious cycle: budgets are padded by lower-level managers because they believe top management will cut the budget, and budgets are cut by top management because they believe the submitted budget has been padded by lower-level managers. This situation contains an unfortunate array of elements, which raise serious obstacles to effective cost management. It is regrettable that the budget process is intermingled with the employee incentive scheme via the bonus system in this way, since it is hindering transparent cost management. However, given the situation, there are several possible scenarios for the division controller to deal with. In cutting expenses, top corporate managers may be revealing one of two things. They may be more focused on the use of the budget data to drive incentives than as accurate cost control tools, and thus may cut budgeted expenses specifically to provide a ‘stretch’ goal for the division. Alternatively, top management may believe that the budget has been padded by the division, possibly based on previous budget submissions, and thus believe they are handing back a more accurate expense budget than was submitted to them. No matter what the situation, the controller should make every effort to provide accurate cost forecasts for the budgeting purpose. To do otherwise would be to compromise his or her own integrity and authority within the organization. Further, inaccurate information creates a poor basis for cost management. If greater ‘stretch’ goals are required by top management, then the divisional team could establish these for themselves. If there is doubt at corporate level about the accuracy of the forecasts, then it should be dispelled. For example, the controller could provide supporting documentation with the budget to validate the estimates and to discourage top corporate managers from cutting the expense budget. Guidance on resolving the issue can be found in the final section of the IMA Code of Professional Ethics (reproduced in Chapter One).

Managerial Accounting, 11/e 9-1 © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

ANSWERS TO REVIEW QUESTIONS 9-1

A budget facilitates communication and coordination by making each manager throughout the organization aware of the plans made by other managers. The budgeting process pulls together the plans of each manager in the organization.

9-2

An example of using the budget to allocate resources in a university is found in the area of research funds and grants. Universities typically have a limited amount of research-support resources that must be allocated among the various colleges and divisions within the university. This allocation process often takes place within the context of the budgeting process.

9-3

A master budget, or profit plan, is a comprehensive set of budgets covering all phases of an organization's operations for a specified period of time. The master budget includes the following parts: sales budget, operational budgets (including a production budget, inventory budgets, a labor budget, an overhead budget, a selling and administrative expense budget, and a cash budget), and budgeted financial statements (including a budgeted income statement, budgeted balance sheet, and budgeted statement of cash flows).

9-4

The flowchart on the following page depicts the components of the master budget for a service station.

9-5

General economic trends are important in forecasting sales in the airline industry. The overall health of the economy is an important factor affecting the extent of business travel. In addition, the health of the economy, inflation, and income levels affect the extent to which the general public travels by air. For example, with inflation and rising price levels, consumer confidence falls and spending decreases. Airlines may therefore budget lower sales in future quarters of the year.

9-6

Operational budgets specify how an organization's operations will be carried out to meet the demand for its goods and services. The operational budgets prepared in a hospital would include a labor budget showing the number of professional personnel of various types required to carry out the hospital's mission, an overhead budget listing planned expenditures for such costs as utilities and maintenance, and a cash budget showing planned cash receipts and disbursements.

9-2 Solutions Manual © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Flowchart for Review Question 9-4 Sales Budget: Gasoline, Related Products, and Services

Sales Budget

Operational Budgets

Ending Inventory Budget: Gasoline

Materials Budget: Gasoline and Related Products

Labor Budget

Overhead Budget

Selling and Administrative Expense Budget

Cash Budget Budgeted Income Statement

Budgeted Financial Statements

Budgeted Balance Sheet

Budgeted Statement of Cash Flows

Managerial Accounting, 11/e 9-3 © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

9-7

Application of activity-based costing to the budgeting process yields activity-based budgeting (ABB). In the logic of activity-based costing, the company engages in a certain mix and quantity of activities and this enables it to produce the products or services that it markets. ABB follows this logic: the planned production tells us how much of various activities will be needed, and if we can then project the cost per unit of the activity (much as we project the cost per hour for direct labor) we can then extend the calculation to tell us how much will have to be spent.

9-8

E-budgeting stands for an electronic and enterprise-wide budgeting process. Under this approach the information needed to construct a budget is gathered via the Internet from individuals and subunits located throughout the enterprise. The Internet also is used to disseminate the resulting budget schedules and information to authorized users throughout the enterprise.

9-9

The city of Boston could use budgeting for planning purposes in many ways. For example, the city's personnel budget would be important in planning for required employees in the police and fire departments. The city's capital budget would be used in planning for the replacement of the city's vehicles, computers, administrative buildings, and traffic control equipment. The city's cash budget would be important in planning for cash receipts and disbursements. It is important for any organization, including a municipal government, to make sure that it has enough cash on hand to meet its cash needs at all times.

9-10

The budget director, or chief budget officer, specifies the process by which budget data will be gathered, collects the information, and prepares the master budget. To communicate budget procedures and deadlines to employees throughout the organization, the budget director often develops and disseminates a budget manual.

9-11

The budget manual says who is responsible for providing various types of information, when the information is required, and what form the information is to take. The budget manual also states who should receive each schedule when the master budget is complete.

9-12

A company's board of directors generally has final approval over the master budget. By exercising its authority to make changes in the budget and grant final approval, the board of directors can wield considerable influence on the overall direction the organization takes. Since the budget is used as a resource-allocation mechanism, the board of directors can emphasize some programs and curtail or eliminate others by allocating funds through the budgeting process.

9-13

A master budget is based on many assumptions and predictions of unknown parameters. For example, the sales budget is built on an assumption about the nature of demand for goods or services. The direct-material budget requires an estimate of the direct-material price and the quantity of material required per unit of production. Many other assumptions are used throughout the rest of the budgeting process.

9-4 Solutions Manual © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

9-14

The difference between the revenue or cost projection that a person provides in the budgeting process and a realistic estimate of the revenue or cost is called budgetary slack. Building budgetary slack into the budget is called padding the budget. A significant problem caused by budgetary slack is that the budget ceases to be an accurate portrayal of likely future events. Cost estimates are often inflated, and revenue estimates are often understated. In this situation, the budget loses its effectiveness as a planning tool.

9-15

An organization can reduce the problem of budgetary slack in several ways. First, it can avoid relying on the budget as a negative evaluative tool. Second, managers can be given incentives not only to achieve budgetary projections but also to provide accurate projections.

9-16

The idea of participative budgeting is to involve employees throughout an organization in the budgetary process. Such participation can give employees the feeling that "this is our budget," rather than the feeling that "this is the budget you imposed on us." When employees feel that they were part of the budgeting process, they are more likely to strive to achieve the budget.

9-17

This comment is occasionally heard from entrepreneurs and others who have started and/or run their own small business for a long period of time. These individuals have great knowledge in their minds about running their business. They feel that they do not need to spend a great deal of time on the budgeting process, because they can essentially run the business by feel. This approach can result in several problems. First, if the person who is running the business is sick or traveling, he or she is not available to make decisions and implement plans that could have been clarified by a budget. Second, the purposes of budgeting are important to the effective running of an organization. Budgets facilitate communication and coordination, are useful in resource allocation, and help in evaluating performance and providing incentives to employees. It is difficult to achieve these benefits without a budgeting process. This is one of the reasons that many entrepreneurs are replaced by “professional managers” as the company grows.

9-18

In developing a budget to meet your college expenses, the primary steps would be to project your cash receipts and your cash disbursements. Your cash receipts could come from such sources as summer jobs, jobs held during the academic year, college funds saved by relatives or friends for your benefit, scholarships, and financial aid from your college or university. You would also need to carefully project your college expenses. Your expenses would include tuition, room and board, books and other academic supplies, transportation, clothing and other personal needs, and money for entertainment and miscellaneous expenses.

Managerial Accounting, 11/e 9-5 © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

9-19

Firms with international operations face a variety of additional challenges in preparing their budgets.

 A multinational firm's budget must reflect the translation of foreign currencies into U.S. dollars. Almost all the world's currencies fluctuate in their values relative to the dollar, and this fluctuation makes budgeting for those translations difficult.

 It is difficult to prepare budgets when inflation is high or unpredictable. Some foreign countries have experienced hyperinflation, sometimes with annual inflation rates well over 100 percent. Predicting such high inflation rates is difficult and complicates a multinational's budgeting process.

 The economies of all countries fluctuate in terms of consumer demand, availability of skilled labor, laws affecting commerce, and so forth. Companies with foreign operations face the task of anticipating such changing conditions in their budgeting processes. 9-20

Most of the differences in budgeting between manufacturing and non-manufacturing firms derive from the need for inventories in manufacturing. Because of this, additional budget schedules are generally required in manufacturing firms. These usually include: (a) Production budget (b) Direct-materials budget (c) Budgeted schedule of cost of goods manufactured and sold In addition, other budgets are often more complex because of the large number of suppliers needed for manufacturing.

9-6 Solutions Manual © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

SOLUTIONS TO EXERCISES EXERCISE 9-21 (20 MINUTES) 1. Sales .......................................................... Cash receipts: From cash sales ................................... From sales on account......................... Total cash receipts ...................................

2.

April $80,000

May $60,000

June $90,000a

$ 40,000b 36,000d $ 76,000

$ 30,000c 34,000 $ 64,000

$ 45,000 39,000e $ 84,000

a$90,000

= $45,000  2

b$40,000

= $80,000  .5

c$30,000

= $60,000  .5

d$36,000

=

($40,000  .6) + ($30,000  .4)

e$39,000

=

($45,000  .6) + ($30,000  .4)

Accounts payable, 12/31/x0 ............................................................ Purchases of goods and services on account during 20x1 ......... Payments of accounts payable during 20x1 ................................. Accounts payable, 12/31/x1 ............................................................

300,000 euros 1,200,000 euros (1,100,000) euros* 400,000 euros

*1,100,000 euros = 300,000 euros + 1,200,000 euros – 400,000 euros 3.

Accounts receivable, 12/31/x0 ........................................................ Sales on account during 20x1 ........................................................ Collections of accounts receivable during 20x1 ........................... Accounts receivable, 12/31/x1 ........................................................

4.

Accumulated depreciation, 12/31/x0 .............................................. Depreciation expense during 20x1 ................................................ Accumulated depreciation, 12/31/x1 ..............................................

$ 810,000 150,000 $ 960,000

5.

Retained earnings, 12/31/x0 ........................................................... Net income for 20x1 ........................................................................ Dividends paid in 20x1 .................................................................... Retained earnings, 12/31/x1 ...........................................................

$2,050,000 400,000 -0-_ $2,450,000

340,000y 900,000y (780,000y) 460,000y

Managerial Accounting, 11/e 9-7 © 2017 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

EXERCISE 9-22 (30 MINUTES) Answers will vary widely, depending on the governmental unit selected and the budgetary items on which the student focuses. In the past, students have expressed surprise at the proportion of the U.S. federal budget that goes to entitlement programs (e.g., Social Security and Medicare), interest expense, and the military. EXERCISE 9-23 (15 MINUTES) 1.

Production (in units) required for the year: Sales for the year .......................................................................................... Add: Desired ending finished-goods inventory on December 31.............. Deduct: Beginning finished-goods inventory on January 1 ...................... Required production during the year...........................................................

2.

480,000 50,000 80,000 450,000

Purchases of raw material (in units), assuming production of 500,000 finished units: Raw material required for production (500,000  2) ................................... Add: Desired ending inventory on December 31 ........................................ Deduct: Beginning inventory on January 1 ................................................. Required raw-material purchases during the year .....................................

1,000,000 45,000 35,000 1,010,000

EXERCISE 9-24 (25 MINUTES) 1.

Cash collections in October: Month of Sale July .............................................................. August ......................................................... September ................................................... October ........................................................ Total .............................................................

Amount Collected in October $ 2,400 $60,000  4% 7,000 70,000  10% 12,000 80,000  15% 63,000 90,000  70% $84,400

Notice that the amount of sales on account in June, $49,000 was not needed to solve the exercise.

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EXERCISE 9-24 (CONTINUED) 2.

Cash collections in fourth quarter from credit sales in fourth quarter. Amount Collected Month of Sale October ............................................ November ........................................ December ........................................ Total ................................................. Total collections in fourth quarter from credit sales in fourth quarter .........................................

Credit Sales $ 90,000 100,000 85,000

October $ 63,000 – – $ 63,000

November $13,500 70,000 – $83,500

December $ 9,000 15,000 59,500 $ 83,500 $230,000

3. In the electronic version of the solutions manual, press the CTRL key and click on the following link: Build a Spreadsheet 09-24.xls EXERCISE 9-25 (20 MINUTES) 1.

The total required production is 655,720 units, computed as follows: Budgeted Sales (in units) June July August September October

200,000 (given) 210,000 (200,000  1.05) 220,500 (210,000  1.05) 231,525 (220,500  1.05)

Planned Ending Inventory (in units) 160,000 (200,000  80%) 185,220 (231,525  80%)

Sales in units: July ............................................................................................................... August .......................................................................................................... September .................................................................................................... Total for third q...