Blocher 8e Eoc SM ch10 Final Student

CHAPTER 10: STRATEGY AND THE MASTER BUDGET
QUESTIONS
10-2 A master budget is a comprehensive plan of action for a future period; as such, the
master budget includes both operating and financial budgets. An operating budget
consists of plans regarding revenues and resource acquisition/use across all major
operating areas of the organization (e.g., sales, production, purchasing, marketing,
research and development, and general administrative activities). The set of
operating budgets culminates in a budgeted income statement. Financial budgets
relate to sources and uses of funds for an upcoming period. The set of financial
budgets culminates in a budgeted statement of cash flows and budgeted balance
sheet.
10-4 Some would argue that the primary purpose of budgets is for planning and that
problems are created when budgets are used for control and incentive-
compensation purposes. The latter use of budgets is thought to engender both
unethical practices (e.g., Enron, WorldCom) or, more prevalently, gaming behavior.
For example, people whose performance will be compared to the budget targets
may understate their potential in order to have achievable targets set. Therefore,
tying plans to after-the-fact control compromises the integrity of the information-
gathering process. Some people have argued that information used for planning
should not be used in after-the-fact control. (Standards for after-the-fact control
could, instead, be based on independent benchmark information or improvements
on previous performance.) Some organizations have designed incentive schemes
that reward people jointly on their ability to improve performance and to meet
budget projections. This approach partially mitigates the problem of gaming
behavior on the part of employees.
10-6 Additional factors include:

 Beginning and desired ending inventories of work-in-process (WIP) and
finished goods
 The required material inputs (in lbs., liters, etc.) for each product
 Beginning and desired ending inventories of direct materials
 The cost of materials (per lb., liter, etc.)
10-8 Zero-base budgeting (ZBB) is a budgeting process that requires managers to

prepare budgets each period from a zero base for all operations.
A typical budgeting process is “incremental” in nature. That is, budgets for the
upcoming period start from the approved budgets for the current period, with
amounts added to reflect planned changes for the upcoming period. Thus,
traditional budgets assume that most, if not all, of the current activities and
functions will continue into the coming budget period. In contrast, a zero-base
budgeting process allows no activities or functions to be included in the budget
unless managers can justify their need. Pure forms of ZBB are expensive and
1
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McGraw-Hill Education.
time-consuming. For this reason, some companies have partial ZBB systems.
A number of companies (e.g., Xerox, Texas Instruments) and government
organizations (e.g., State of Georgia) have at one time or another used ZBB. And
ZBB has been gaining in popularity in recent years.
10-10 A time-driven activity-based costing (TDABC) system, as explained in Chapter 5,
is a refinement and simplification of a traditional ABC system. Rather than
identifying activities and associated activity costs, a TDABC system calculates a
cost rate for each major activity, process, or department using only the following
pieces of information: (1) the resource cost associated with the process or
department, and (2) the resource consumption (measure in time) of each activity
(handling a production run, shipping a product, packaging a product, etc.). More
complex situations can be captured by time equations used in a TDABC system.
Advocates of TDABC believe that this system both reduces the cost of
implementing an ABC system and improves the accuracy of the resulting activity-
cost data. Resulting activity-cost data from a TDABC system can be used, as is
the case with ABB, to budget resource requirements once a sales and production
plan has been determined for an upcoming period. As with ABB, we work
backwards from this plan to determine resource requirements. This planning
process is facilitated by simplifications introduced by a TDABC system.
Finally, both ABB and TDABB facilitate the budgeting process because both
systems tend to reduce the amount of “negotiations” that occur. That is, there is
less room to negotiate because once the production and sales plan for the
upcoming period has been determined, the resources requirements (and therefore
resource budgets) are all but automatically determined.
10-12What-if analysis, within the context of budgeting, refers to the process of varying
one or more budget inputs for the purpose of examining the resulting effect on a
variable of interest (e.g., budgeted sales, operating income, or operating cash
flows). Scenario analysis can be viewed as the result of simultaneously changing
two or more inputs and examining the resulting effect on a variable of interest.
The basic version of Excel can perform three kinds of what-if analyses: scenarios,
data tables, and Goal Seek. Scenarios and data tables take sets of input values
and determine possible results. A data table works only with one or two variables,
but it can accept many different values for those variables. A scenario can have
multiple variables, but it can accommodate only up to 32 values. Goal Seek works
differently from scenarios and data tables in that it takes a result and determines
possible input values that produce that result. In addition to these three methods,
an Excel add-in, Solver, can be used to perform “what-if” analyses. The Solver
add-in is similar to Goal Seek, but it can accommodate more variables.
See the following tutorials for additional information about performing what-if
analyses using Excel 2016, Excel 2013, and Excel 2010:
2
1. Introduction to What-If Analysis:
https://support.office.com/en-US/article/Introduction-to-what-if-analysis-22BFFA5F-E891-4ACC-
BF7A-E4645C446FB4
2. Using Excel to Perform Scenario Analysis:

http://office.microsoft.com/en-us/excel-help/switch-between-various-sets-of-values-by-
using-scenarios-HP010072669.aspx
3. Using Excel to Create Data Tables:

http://office.microsoft.com/en-us/excel-help/calculate-multiple-results-by-using-a-data-table-
HP010342214.aspx
4. Using Goal Seek in Excel:

http://office.microsoft.com/en-us/excel-help/use-goal-seek-to-find-the-result-you-want-by-
adjusting-an-input-value-HP010342990.aspx
5. Using Solver to Perform What-If Analysis:

http://office.microsoft.com/en-us/excel-help/define-and-solve-a-problem-by-using-solver-
HP010342416.aspx
https://support.office.com/en-US/article/Define-and-solve-a-problem-by-using-Solver-9ed03c9f-
7caf-4d99-bb6d-078f96d1652c
3
BRIEF EXERCISES
10-14
Q2 Q3
Sales—2019 16,000 15,000
Plus projected 25% increase for 2020 4,000 3,750
Estimated sales volume—2020 20,000 18,750

× Estimated unit selling price—2020 $4.00 $4.00
Estimated sales dollars—2020 $80,000 $75,000
10-16 Number of units produced in Qtr. 1:

Ending inventory of direct materials (DM) = 50,000 lbs.
Desired ending inventory = 25% of following month’s production
requirements
Therefore, DM used for production in Qtr. 1 = 50,000 ÷ 0.25 = 200,000 lbs.
Units produced in Qtr. 1 = lbs. of DM used/lbs. of DM per unit of

output = 200,000 ÷ 8 = 25,000 units
DM requirements (in lbs.), Qtr. 2 = Planned production, Qtr. 2 × DM lbs./unit

= (25,000 units × 1.10) × 8 lbs./unit
= 27,500 units × 8 lbs./unit = 220,000 lbs.
10-18 Current level of monthly operating costs = $10,000:

Estimated operating costs, January = $10,000 × 0.991 = $9,900
Estimated operating costs, June = $10,000 × 0.996 = $9,415
Estimated operating costs, December = $10,000 × 0.9912 = $8,864
10-20 Collection of Credit Sales—December:

From credit sales made in November = 0.20 × $90,000 = $18,000
From credit sales made in December:
= (0.75 × $100,000) × 0.98 = $73,500
Total estimated collections—December = $91,500
10-22 Direct Material (DM) Purchases, December = (DM issued to production +

ending DM inventory) – beginning DM inventory
= ($150,000 + $39,500) – $37,000 = $152,50
4
EXERCISES
10-24 Purchase Discounts (25 minutes)
The financial cost of not taking advantage of the early-payment discount for
purchases made on credit can be approximated by the following formula (we use
the term “approximate” here to denote the fact that the estimate below does not
assume compounding of interest and as such provides a conservative estimate):
Opportunity cost (%) = [discount % ÷ (1 − discount %)] × [365 ÷ no. of

extra days allowed if discount is not taken]
1. In the case of 2/10, n/30, the approximate economic cost of not taking
advantage of the early-payment discount is:
= [0.02 ÷ (1 − 0.02)] × [365 ÷ 20] = 0.020408 × 18.25 = 37.24%
Basically, if you choose not to take the early-payment discount, you are giving
up a 2% discount (on the net amount) in return for an extra 20 days in which
to pay. There are 18.25 (365 ÷ 20) 20-day periods in a year. Note that in the
first term of this formula we divide the 2% discount rate by 98% (100% − 2%)
because, in effect, you are paying 2% to delay for 20 days paying 98% of the
total bill. So, the percentage rate you are paying in this case is really 2.0408%
of the net bill (the bill without financing cost).
2. In the case of 1/10, n/30, the opportunity cost of not taking advantage of the
early-payment cash discount is:
= [0.01 ÷ (1 − 0.01)] × [365 ÷ 20] = 0.010101 × 18.25 = 18.43%
3. Given the significant opportunity cost of not taking advantage of early-

payment cash discounts, the appropriate accounting practice (to motivate
mangers to avoid or at least minimize such opportunity costs) would be to
record purchases at their net-of-discount amount and then to record as
“interest expense” or “purchase discounts lost” any cash discounts not taken
advantage of.
5
10-26 Budgeted Cash Receipts and Cash Disbursements (30 minutes)
1. Budgeted Cash Receipts:
November:
Cash sales = $120,000
Collection of accounts receivable:
From Oct sales:
($100,000 × 0.95) × 0.40 × 0.75 × 0.985 = $28,073
($100,000 × 0.95) × 0.40 × 0.25 = $9,500
From Nov sales:
($150,000 × 0.95) × 0.60 × 0.75 × 0.985 = $63,163
($150,000 × 0.95) × 0.60 × 0.25 = $21,375 $242,111
December:
Cash sales = $80,000
Collection of accounts receivable:
From Nov sales:
($150,000 × 0.95) × 0.40 × 0.75 × 0.985 = $42,109
($150,000 × 0.95) × 0.40 × 0.25 = $14,250
From Dec sales:
($ 90,000× 0.95) × 0.60 × 0.75 × 0.985 = $37,898
($ 90,000× 0.95) × 0.60 × 0.25 = $12,825 $187,082
2. Budgeted Cash Disbursements:
November:
From Nov purchases:
($170,000 × 0.70) × 0.25 = $29,750
From Oct purchases:
($270,000 × 0.70) × 0.75 = $141,750 $171,500
December:
From Dec purchases:
($200,000 × 0.70) × 0.25 = $35,000
From Nov purchases:
($170,000 × 0.70) × 0.75 = $89,250 $124,250
6
10-28 Cash Budget—Financing Effects (30 minutes)
Hartz & Co.

Cash Budget
For November and December
November December
Cash balance, beginning $75,000 $99,000

Plus: Cash receipts $525,000 $450,000
Total cash available (A) $600,000 $549,000
Cash disbursements, prior to financing (B) $450,500 $550,000

Plus: Minimum cash balance (given) $50,000 $50,000
Total cash needed (C) $500,500 $600,000
Excess (deficiency of) cash, before

financing effects (D) = (A) − (C) $99,500 ($51,000)
Financing:
Short-term borrowing, beginning of month -0- $52,000
Repayments (long-term loan principal),
end of month ($50,000) -0-
Cash Interest (@12%/year), end of month ($500) ($520)
Total Effects of Financing = (E) ($50,500) $51,480
Ending cash balance = (A) − (B) + (E) $99,000 $50,480
Note: Financing of $52,000 at the beginning of December is needed to cover both the
$51,000 projected deficiency of cash (before financing effects) plus the interest charge
that would have to be made in December ($520) based on this new financing. Also
note that the cash budget is not the same as the statement of cash flows prepared for
external users, so we include interest expense as part of the financing activities.
7
10-30 Budgeted Cash Receipts: Cash Discounts Allowed on Receivables (45
Minutes)
1. Breakdown of Cash/
Sales Data Amount Bank Credit-Card Sales
June $60,000 Cash sales 40%
July $80,000 Credit cards 60%
August $90,000
September $96,000 Bank charges 3%
October $88,000
Credit sales: Collection of Credit Sales
Current month 20%
Sales Breakdown and Terms 1st month 50%
Cash and bank credit card sales 25% 2nd month 15%
Credit sales 75% 3rd month 12%
Terms 1/eom, n/45 Late charge/month 2%
Discount (if paid by eom) 1%
Schedule of Cash Receipts: September & October
8
10-30 (Continued)
2. Appropriate accounting treatment for:
a) Bank service (collection) fees: These can be considered an offset to gross sales
and thus can be reflected as a deduction in determining “net sales” (see text
Exhibit 10.13). Alternatively, these amounts can be considered “selling
expenses” and, as such, be treated as an “operating expense,” (i.e., an element
of “Selling and Administrative Expenses” on the Income Statement).
b) Cash discounts allowed on collection of receivables: These are offered as an

incentive to speed up the collection process. They are recorded as an offset
(decrease) to revenue.
9
10-32 Retailer Budget (50 minutes)
1. Budgeted merchandise purchases: May and June
D. Tomlinson Retail
Budgeted Merchandise Purchases
May and June
May June July

Sales (in units) 11,900 11,400 12,000
Cost per unit × $20 × $20 × $20
Cost of Goods Sold (CGS) $238,000 $228,000 $240,000
Ending inventory (130% of
next month’s CGS) + 296,400 + 312,000
Total needed $534,400 $540,000
Beginning inventory (130% of
this month’s CGS) – 309,400 – 296,400
Budgeted Merchandise Purchases $225,000 $243,600
2. Budgeted cash disbursements: June
Budgeted Selling, General, and Administrative (SG&A) expenses:
May June
Sales revenue $357,000 $342,000
SG&A expense ratio × 0.15 × 0.15
Total SG&A expense $ 53,550 $ 51,300
Non-depreciation SG&A expense $ 51,550 $ 49,300
D. Tomlinson Retail
Budgeted Cash Disbursements, June
May June
Merchandise purchases $ 225,000 $ 243,600
Non-depreciation SG&A expenses + 51,550 + 49,300
Total payables $276,550 $292,900
Payment for the current month’s payables (54%) $158,166
Owed from last month (46%) + 127,213
Budgeted cash disbursements $285,379
10
10-32 (Continued)
3. Budgeted cash collections: May

D. Tomlinson Retail
Cash Collections
May
From last month's (April) sales:
Within the discount period ($363,000) × 60% × 97% = $211,266

After the discount period $363,000 × 25% = 90,750
From credit sales two months ago (i.e., March):
Collection of credit sales made in March $354,000 × 9% = 31,860

Total cash collections $333,876
4. Gross and net balance of Accounts Receivable (AR) as of May 31
March April May Total

Sales $354,000 $363,000 $357,000
Remaining AR % 6% 15% 100%
AR Balance (Gross) $21,240 $54,450 $357,000 $432,690
Bad-debt allowance* $21,240 $21,780 $21,420 64,440
AR Balance (Net) $368,250
* @ 6% of gross sales dollars
11
10-34 Budgeting for Marketing Expenses; Strategy (50 minutes)
1. The following screen shots are from the Excel spreadsheet created for this problem.
It shows that the original monthly budgeted marketing expense is $338,000 and that
the revised (budgeted) amount is $372,628, an overall increase of 10.24%.
12
10-34 (Continued-1)
Monthly Marketing Expenses: Cost Change

Sales Commissions $125,400 4.50%
Sales Staff Salaries $44,000 10.00%
Telephone and mailing $44,308 16.60%
Rental--Sales office building $25,000 0.00%
Gas (utilities) $13,800 15.00%
Delivery charges $81,620 16.60%
Depreciation--Office furniture:
Exisiting furniture $8,000 0.00%
New furniture $500 100.00%
Marketing consultants $30,000 20.00%
Total Budgeted Costs $372,628 10.24%
2. To achieve the monthly targeted cost of $350,000, the rate of “telephone and mailing”
costs cannot increase at all (as is the case in the proposed budget); in fact, the
results of the Goal Seek analysis indicates that such rates must be decreased by
approximately 43%, as shown below:
Monthly Marketing Expenses: Cost Change

Sales Commissions $125,400 4.50%
Sales Staff Salaries $44,000 10.00%
Telephone and mailing $21,680 -42.95%
Rental--Sales office building $25,000 0.00%
Gas (utilities) $13,800 15.00%
Delivery charges $81,620 16.60%
Depreciation--Office furniture:
Exisiting furniture $8,000 0.00%
New furniture $500 100.00%
Marketing consultants $30,000 20.00%
Total Budgeted Costs $350,000 3.55%
These results are generated by completing the following dialog box that appears after
activating the Goal Seek command from the Data tab, then What-If Analysis menu in
Excel:
13
10-34 (Continued-2)
3. As indicated in the text, budgets can be used both for control and for planning
purposes. The relative importance of each can be linked either to the competitive
strategy the business is pursuing or to the product life-cycle. In the present case (a
start-up company, competing on the basis of a product-differentiation strategy), the
relative emphasis of the marketing budget is likely more for planning than control.
That is, the information contained in this budget can assist the company in
determining its financing needs. However, it probably should not be used for
“controlling” (i.e., cutting) expenses in situations where the underlying expenditures
are determinants of competitive success. Further, many types of so-called
“discretionary costs” (such as marketing) are fixed (or at least “sticky”) and therefore
difficult to cut in the short run. As such, the primary benefit of the budget in such
cases is to better plan for, rather than control, the underlying expenses.
14
10-34 (Continued-3)
See the following tutorials for additional information about performing What-If
analyses using Excel 2016, Excel 2013, and Excel 2010:

BF7A-E4645C446FB4

http://office.microsoft.com/en-us/excel-help/switch-between-various-sets-of-values-by-using-
scenarios-HP010072669.aspx

HP010342214.aspx


HP010342416.aspx
https://support.office.com/en-US/article/Define-and-solve-a-problem-by-using-Solver-
9ed03c9f-7caf-4d99-bb6d-078f96d1652c
15
10-36 Profit Planning and Sensitivity Analysis (45 minutes)
1. Sales volume in units:
Let "X" = required sales volume. Thus, when total cost at each alternative cost
structure is the same, we have:
$85.00X + $40,000 = $80.00X + $45,000

X = 1,000 units
2. Sales level needed (note: cm = contribution margin; sp = selling price; X =

sales volume, in units; FC = total fixed costs):
Pre-tax profit = (cm/unit × X) − FC = 5% (sp/unit × X)

0 = [(cm/unit × X) − 5% (sp/unit × X)] − FC
X = FC ÷ [(cm/unit) − 5% (sp/unit)]
Alternative 1 Alternative 2
Selling price/unit = $100.00 $100.00
Variable cost/unit = $85.00 $80.00
Contribution margin/unit = $15.00 $20.00
Operating profit target (%) = 5% 5%
Required Sales Volume (in units) = 4,000 3,000
Check:
Sales Revenue $400,000 $300,000
Variable Costs $340,000 $240,000
CM $60,000 $60,000
Fixed Costs $40,000 $45,000
Operating Profit $20,000 $15,000
16
Operating Profit ÷ Sales Revenue 5.00% 5.00%
3. Sales volume in dollars needed under each alternative to achieve a profit goal of 5% on sales.
Let X = sales dollars, then:

Pre-tax profit = [(cm ratio) × X] − FC = 5.00%X
FC = (cm ratio × X) − 5.00%X
FC = (cm ratio − 5.00%)X
X = FC ÷ [(cm ratio − 5.00%) × X]
Targeted pre-tax profit (% of sales) = 5.00% 5.00%
17
10-36 (Continued)
Alternative 1 Alternative 2
Selling price/unit = $100.00 $100.00
Contribution margin/unit = $15.00 $20.00
Contribution margin ratio = 15.00% 20.00%
Operating profit target (%) = 5% 5%

Required Sales Volume = $400,000 $300,000
Check:
Sales Revenue $400,000 $300,000
Variable Costs $340,000 $240,000
CM $60,000 $60,000
Fixed Costs $40,000 $45,000
Operating Profit $20,000 $15,000
Operating Profit ÷ Sales Revenue 5.00% 5.00%
18
10-38 Cash Budgeting: Not-for-Profit Context (45 minutes)
1. An endowment fund is a gift (contribution) whose principal must be maintained but whose income may be expended by
the receiver of the gift. (You might use the example of an “endowed professorship” as an example.)
2.
Cash Budget for Tri-County Social Service Agency
(in thousands)
Quarters
I II III IV Year
Cash Balance, beginning $11 $8 $8 $8 $11
Receipts:
Grants $80 $70 $75 $75 $300
Contracts (evenly during year) $201 $201 $201 $201 $80
Mental Health Income (+5 in Qtrs. II, III) $20 $25 $30 $30 $105
Charitable donations $250 $350 $200 $400 $1,200
Total Cash Available $3812 $473 $333 $533 $1,696
Less: Disbursements:
Salaries and Benefits $3354 $342 $342 $346 $1,365
Office expenses $70 $65 $71 $50 $256
Equipment purchases & maintenance $2 $4 $6 $5 $17
Specific assistance $20 $15 $18 $20 $73
Total disbursements $4273 $426 $437 $421 $1,711
Excess (deficiency) of cash available
over disbursements ($46) $47 ($104) $112 ($15)
Financing:
Borrow from endowment fund $545 $0 $112 $0 $166
Repayments $06 ($39) $0 ($104) ($143)
Total financing effects $547 ($39) $112 ($104) $23
Cash Balance, ending $88 $8 $8 $8 $8
19
Notes:
1
Annual total ($80,000) ÷ 4
2
$11,000 + $80,000 + $20,000 + $20,000 + $250,000 = $381,000
3
$381,000 – ($46,000) = $427,000
4
$427,000 – $20,000 – $2,000 – $70,000 = $335,000
5
ABS(($46,000) – $8,000) = $54,000
6
Must borrow in Qtr.; therefore, repayments = $0.
7
$54,000 (borrowings) + $0 repayments (entered as a negative)
8
Total financing effects ($54,000) + Excess (deficit) of cash available over disbursements (($46,000)) = $8,000
20
10-38 (Continued)
3. $23,000.
4. It is probable that both donations and requests for services are unevenly distributed over the year. Alternatively, the
recurring need to borrow money suggests an overreliance (dependency) on the endowment. Therefore, the agency may
want to increase requests for donations, seek additional grants, or petition for an increase in the present endowment
fund.
5. No. Assuming there is careful fiscal management, borrowing only occurs when necessary.
21
10-40 Budgeting for a Service Firm (75 minutes)
1.
Total hours for the budgeted activities:

Hourly
Budgeted Charge
Revenue Rate Required
(Given) (Given) Hours
Business returns $1,000,000 $250 4,000
Complex individual returns $1,200,000 $100 12,000
Simple individual returns $1,640,000 $50 32,800
$3,840,000 48,800
Professional staff requirements for the budgeted revenue:
Senior
Total Hours
Manager Consultant _Consultant_
Required
Total Each Total
Business returns 4,000 0.30 1,200 0.20 800 0.502,000 0.00 0
Complex individual returns 12,000 0.05 600 0.15 1,800 0.404,800 0.40 4,800
Simple individual returns 32,800 0.00 0 0.00 00.20 6,560 0.80 26,240
Total Hours 48,800 1,800 2,600 13,360 31,040
Hours per week 50 45 40 40
# of weeks needed 36 58 334 776
# of weeks per professional staff per year 40 45 45 48
# of professional staff needed 1 1 8 16
Excess (deficiency) hours 1,040 (320)
22
Note: Because Consultants can be hired on a part-time basis, we round the calculation DOWN for this class of labor. The
other three labor classes are given (i.e., do not have to be planned for based on data in the problem).
Since, according to the present staffing plan and anticipated workload needs, there is an excess of senior
consultant hours, the budgeted cost for overtime hours worked by senior consultants would be $0.
23
10-40 (Continued-1)
2. Number of full-time consultants needed for the year:
No. of consultant-weeks needed for the year = 776 (from solution to requirement
#1, above)
No. of weeks/full-time consultant/year = 48 (from solution to requirement #1,
above)
No. of full-time consultants needed = 16 (776 ÷ 48, rounded down)
3. The manager's total compensation, assuming that the revenues from preparing tax
returns remains the same:
Consultant's pay:
Earning per year = $60,000
Hrs. worked/year = 1,920
Hourly pay rate = $31.25
No. of PT hours, consultants = 320
Annual Salaries:
Per partner = $250,000
Per manager = $90,000
Per senior consultant = $90,000
Per support staff = $40,000
Staffing Plan:
Partners = 1
Managers = 1
Senior consultants = 8
Full-time Consultants = 16
Support staff = 5
Blocher, Stout, Juras, Smith, Cost Management, 8/e 10-24

10-40 (Continued-2)
AccuTax Inc.
Budgeted Operating Income
For the Year ended August 31, 2019
Revenue $3,840,000
Payroll expenses:
Partner $250,000
Manager 90,000
Senior consultants—base pay 720,000
Senior consultants—pay for overtime hours 0
Consultants:
Full-time $960,000
Part-time 10,000 970,000
Support staff 200,000 $2,230,000
General and administrative expenses 373,000
Operating income before bonus to manager $1,237,000
Less: manager's bonus 73,700
Operating income before taxes $1,163,300
Total compensation for the manager:

Salary (given) $90,000
Bonus (0.10 × [$1,237,000 − $500,000]) 73,700
Total $163,700

10-42 Activity-Based Budgeting (ABB) with Continuous Improvement (40 Minutes)
1. Unit-Level: Storage, Pick packing, Data entry—Lines

Batch-Level: Requisition handling, Data entry—Requisitions,
Desktop delivery
2. Budgeted cost for each activity and for the division as a whole, in February &
March:
Budgeted cost-driver rates:

Cost-Reduction Cost-Driver Rates
Activity Rate (per month) January February March
Storage -- $0.4925 $0.4925 $0.4925
Requisition Handling 2% $12.5000 $12.2500 $12.0050
Pick Packing 1% $ 1.5000 $ 1.4850 $ 1.4702
Data Entry—Lines 1% $ 0.8000 $ 0.7920 $ 0.7841
Data Entry—Requisitions 2% $ 1.2000 $ 1.1760 $ 1.1525
Desktop Delivery 2% $30.0000 $29.4000 $28.8120
Budgeted Costs by Activity and for the Division as a whole, February and March:
Activity
Activity Volume February March
Storage 400,000 $ 197,000 $ 197,000
Requisition Handling 30,000 $ 367,500 $ 360,150
Pick Packing 800,000 $1,188,000 $1,176,120
Data Entry—Lines 800,000 $ 633,600 $ 627,264
Data Entry—Requisitions 30,000 $ 35,280 $ 34,574
Desktop Delivery 12,000 $ 352,800 $ 345,744
Divisional Totals $2,774,180 $2,740,852
3. Factors that may influence the success of a continuous-improvement (kaizen)

program include:
 Reasonable or achievable cost reductions.
 Awareness of all employees on the expected (scheduled) cost
improvements over at least the immediate future periods.
 Acceptance by both management and employees.
 Commitment of both management and employees on the strategic
importance of the success of the continuous improvement program.
 Close link between the scheduled improvements and performance
evaluations and rewards.
 Cost reductions possible from small, incremental improvements, not from

large discontinuous changes in factors such as operating processes, capital
equipment, supplier networks, or customer interactions.

10-42 (Continued)
4. Primary criticisms of kaizen (continuous-improvement) budgets include the

following:
 The budgeting process tends to place enormous pressure on employees

to reduce all costs, which can lead to employee “burnout.”
 The use of kaizen budgets tends to motivate small, incremental rather
than major/significant process improvements.
 If the kaizen targets are confined to the manufacturing function (including
product and process design engineering), frictions can arise if
manufacturing believes that other parts of the organization (e.g.,
marketing) are not subjected to the same budgetary pressure.

10-44 Rolling Financial Forecasts (25 minutes)
1. Schedule of forecasted sales, rolling forecast basis, January through June:
Month of Forecast for Month of

Forecast January February March April May June
December 100 95 100 110 120 125
January 90 100 105 110 120
February 95 105 105 120
March 105 100 110
April 90 105
May 105
2. Three-month forecast error rates, March through June (rounded to two decimal
places):
January February___March April May June

Actual Sales 98 95 92 108 98 100
Forecast error rate - - 8.70% 2.78% 7.14% 10.00%
Direction of error - - Below Above Below Below
Note: Error rate (%) = 1 – absolute forecast error %. For example, the absolute
forecast error rate (%) for March’s sales is found by dividing the absolute value of the
forecast error for this month by the actual sales volume for the month. For purposes
of this question, the forecast error for any month (e.g., March) is defined as the
difference between the actual sales volume for the month and the sales volume for
that month provided three months earlier (i.e., December).
Calculations:
March: (ABS(92 – 100)) ÷ 92 = 8.70% (below forecast)
April: (ABS(108 – 105)) ÷ 108 = 2.78% (above forecast)
May: (ABS(98 – 105)) ÷ 98 = 7.14% (below forecast)
June: (ABS(100 – 110)) ÷ 100 = 10.00% (below forecast)

10-46 Kaizen Budgeting (50 minutes)
1. Recalculated budgeted factory overhead costs for June (rounded to nearest whole
dollar), under the assumption that, starting in May, each budgeted cost-driver rate
decreases by 0.5% relative to the preceding month.
Activity-Based Budget (ABB)

April May June
Activity- Budgeted Activity- Budgeted Activity- Budgeted
Cost Pools Cost Rate Overhead Cost Rate Overhead Cost Rate Overhead
Semi-skilled, hour-related $0.60 $6,750 $0.597 $8,955 $0.594 $11,138
Skilled, hour-related $0.40 $1,800 $0.398 $2,388 $0.396 $2,970
Machine-hour-related $3.20 $21,600 $3.184 $28,656 $3.168 $35,641
Batch-related $2,000 $18,000 $1,990 $23,880 $1,980 $29,701
Product-related $15,000 $15,000 $14,925 $29,850 $14,850 $44,551
Facility-level costs $50,000 $50,000 $50,000 $50,000 $50,000 $50,000
Total $113,150 $143,729 $174,001
Sample Calculations:
1. Activity cost rates in April: Given (text Exhibit 10.19)

2. Budgeted overhead in April: Given (text Exhibit 10.19)
3. Activity cost rates in May: Rate from April × (1 – improvement rate/month, 0.5%). For
example, rate in May for Semi-skilled, hour-related = $0.60/hour × (1 – 0.005) =
$0.597/hour.
4. Budgeted overhead in May = budgeted activity (from text Exhibit 10.19) × activity cost
rate for May. For example, for Semi-skilled, hour-related Budgeted overhead for May
= $0.597/hour × 15,000 hours = $8,955.
5. Activity cost rates in June = rate for May × (1 – 0.005). For example, for semi-skilled,
hour-related, June’s activity cost rate = $0.597/hour × (1 – 0.005) = $0.594/hour.
6. Budgeted overhead in June = budgeted activity (from text Exhibit 10.19) × activity
cost rate for June. For example, for Semi-skilled, hour-related, Budgeted overhead
for June = $0.594/hour × 18,750 hours = $11,138.

10-46 (Continued-1)
2. In general, the benefits associated with a move to continuous (i.e., kaizen) budgeting
include the following:
 helps ensure that the budget is a forward-looking tool
 may help the organization stave off competition or otherwise secure a competitive
advantage
 is consistent with the move to "lean manufacturing" (to support total quality,
elimination of waste and inefficiency, etc.)
 used during the manufacturing stage and thus complements the use of target
costing (used during the design stage)
 necessarily involves employees (who are knowledgeable about operating
processes) in the planning/control system (i.e., under a kaizen approach, workers
are assumed to have better knowledge as to how cost-saving goals can be
achieved); as such, its use is consistent with theories of decentralization and
worker empowerment
3. Principal concerns or limitations associate with kaizen budgeting:
 a kaizen approach places pressure on employees to meet continually revised (and

stricter) performance goals; dysfunctional consequences include employee burnout
and internal conflicts among various parties in the organization
 the kaizen approach, by its very design, motivates incremental, not radical,
operational improvements and cost savings
4. The activity cost rates for KWS are calculated as budgeted spending (on resources)
divided by the practical capacity (i.e., supply) of resources acquired. Therefore, the rate
can go down either because total budgeted spending is decreased, or the supply of
activities is increased while holding spending constant. Both would seem to rest on
notions of increasing efficiency. Some examples, referenced to text Exhibit 10.19, might

10-46 (Continued-2)
 move to a JIT production system

 incorporate technology into (i.e., automate) the order-processing system used by
KWS
 analyze major expenditures to determine whether they are adding value in the
eyes of the consumer
 implement process improvements for all value-adding activities performed by the
business
 are there alternative forms of capacity that would be available at a less expensive
rate?
 greater attention to personnel planning, along the lines discussed in the text (see
section on budgeting for service organizations)
 requiring minimum order sizes (to eliminate short, unprofitable, production runs)
 effecting changes in the layout of the facility (e.g., to reduce movement and
storage of inventory
Notice, too, that in order to reduce spending (on resources), management has to take
direct and deliberate action to do so. This is due in large part because some of the
activity costs in an ABC model are considered short-term fixed costs. As such, the only
way to reduce spending on these activities is to eliminate the underlying resource or
deploy to excess resources (i.e., the unused supply of resources) elsewhere in the
organization. While the activity-cost rates seem to imply short-term variable costs, in
reality they do not.

10-48 Budgetary Pressure and Ethics (30 minutes)
1. The use of alternative accounting methods to manipulate reported earnings is

professionally unethical because it violates the Standards contained in the IMA’s
Statement of Ethical Professional Practice (see: https://www.imanet.org/career-
resources/ethics-center?ssopc=1). The Competence standard is violated
because of failure to perform duties in accordance with relevant accounting
(technical) standards. It can probably be argued that the competence standard is
also violated because the accountant is not providing information that is
accurate. The Integrity standard is violated because the underlying activity
would discredit the profession. The Credibility standard is violated because of
failure to communicate information fairly and objectively.
2. Yes, costs related to revenue should be expensed in the period in which the
revenue is recognized (“matching principle”). Perishable supplies are purchased
for use in the current period, will not provide benefits in future periods, and should
therefore be matched against revenue recognized in the current period. In short,
the accounting treatment for supplies was not in accordance with generally
accepted accounting principles (GAAP). Note that similar issues, but on an
extremely large basis, occurred at WorldCom and at Global Crossing. In the case
of the latter, the company was engaging simultaneously in contracts to buy and to
sell bandwidth, treating the former as capitalized expenses and the latter as
revenue for the current accounting period.
3. The actions of Gary Woods were appropriate. Upon discovering how supplies
were being accounted for, Wood brought the matter to the attention of his
immediate superior, Gonzales. Upon learning of the arrangement with P&R,
Wood told Gonzales that the action was improper; he then requested that the
accounts be corrected and the arrangement discontinued. Wood clarified the
situation with a qualified and objective peer (advisor) before disclosing Gonzales’s
arrangement with P&R to Belco’s division manager, Tom Lin—Gonzales’s
immediate superior. Contact with levels above the immediate superior should be
initiated only with the superior’s knowledge, assuming the superior is not involved.
In this case, however, the superior is involved. According to the IMA’s statement
regarding Resolution of Ethical Conduct, Wood acted appropriately by
approaching Lin without Gonzales’s knowledge and by having a confidential
discussion with an impartial advisor.

PROBLEMS
10-50 Comprehensive Profit Plan (90 minutes)
1. Sales Budget
Spring Manufacturing Company

Sales Budget
2019
C12 D57 Total

Sales (in units) 12,000 9,000
× Selling Price per unit $150 $220
Total Sales Revenue $1,800,000 $1,980,000 $3,780,000
2. Production Budget

Production Budget
2019
C12 D57
Budgeted Sales (in units) 12,000 9,000
+ Desired finished goods ending inventory 300 200
Total units needed 12,300 9,200
– Beginning finished goods inventory 400 150
Budgeted Production (in units) 11,900 9,050
10-34
10-50 (Continued-1)
3. Direct Materials Purchases Budget

Direct Materials Purchases Budget (units and dollars)
2019
C12 D57 Total

Raw Material (RM) 1:
Budgeted Production 11,900 9,050
Pounds per Unit × 10 ×8
RM 1 needed for production 119,000 72,400 191,400
Plus: Desired Ending Inventory (lbs.) 4,000
Total RM 1 needed (lbs.) 195,400
Less: Beginning inventory (lbs.) 3,000
Required purchases of RM 1 (lbs.) 192,400
Cost per pound $2.00
Budgeted purchases, RM 1 $384,800

Pounds per Unit ×0 ×4
RM 2 needed for production 0 36,200 36,200

10-35
10-50 (Continued-3)
4. Direct Manufacturing Labor Budget

Direct Labor Budget
2019
C12 D57 Total

Budgeted production 11,900 9,050
Direct labor hours per unit × 2 × 3
Total direct labor hours needed 23,800 27,150 50,950
Hourly wage rate $25.00
Budgeted direct labor costs $1,273,750
5. Factory Overhead Budget

Factory Overhead Budget
2019
Variable Factory Overhead:

Indirect materials $10,000
Miscellaneous supplies and tools 5,000
Indirect labor 40,000
Payroll taxes and fringe benefits 250,000
Maintenance costs 10,080
Heat, light, and power 11,000 $326,080
Fixed Factory Overhead:
Supervision $120,000
Heat, light, and power 43,420
Total Cash Fixed Factory Overhead $183,420
Depreciation 71,330 $254,750
Total Budgeted Factory Overhead $580,830
10-36
10-50 (Continued-4)
6. Budgeted Cost of Goods Sold

Ending Finished Goods Inventory and Budgeted CGS
2019
C12 D57 Total

Sales volume 12,000 9,000 21,000
Cost per unit (Schedule 1 and 2) $93.80 $135.70
Cost of Goods Sold $1,125,600 $1,221,300 $2,346,900
Ending Finished Goods Inventory 300 200

Cost per unit (Schedule 1 and 2) $93.80 $135.70
Budgeted ending inventories $28,140 $27,140 $55,280
Schedule 1: Cost per Unit--Product C12:

Inputs_____ Cost
Cost Element Unit Input Cost Quantity Per Unit
RM-1 $2.00 10 $20.00
RM-3 $0.50 2 $1.00
Direct labor $25.00 2 $50.00
Variable factory OH ($326,080 ÷ 50,950) $6.40 2 $12.80
Fixed factory OH ($254,750 ÷ 50,950) $5.00 2 $10.00
Manufacturing cost per unit $93.80
Schedule 2: Cost per Unit--Product D57:

Inputs Cost
RM-1 $2.00 8 $16.00
RM-2 $2.50 4 $10.00
RM-3 $0.50 1 $0.50
Direct labor $25.00 3 $75.00
Fixed factory OH ($254,750 ÷ 50,950) $5.00 3 $15.00
10-37
10-50 (Continued-5)
7. Budgeted selling and administrative expenses:

Selling and Administrative Expense Budget
2019
Selling Expenses:
Advertising $60,000
Sales salaries 200,000
Travel and entertainment 60,000
Administrative expenses:
Offices salaries $60,000
Executive salaries 250,000
Supplies 4,000
Total selling and administrative expenses $645,000
8. Budgeted Income Statement:

Budget Income Statement
For the Year 2019
C12 D57 Total

Sales (part 1) $1,800,000 $1,980,000 $3,780,000
Cost of Goods Sold (part 6) 1,125,600 1,221,300 2,346,900
Gross Profit $674,400 $758,700 $1,433,100
Selling and Administrative Expenses (part 7) $645,000
Pre-tax Operating Income $788,100
Income Taxes (@40%) $315,240
After-tax Operating Income $472,860
10-38
10-52 Comprehensive Profit Plan with Kaizen (90 minutes, but much less if assigned in
conjunction with 10-50 and completed with an Excel spreadsheet)
1. Revised Budgets:
Sales Budget

Sales Budget
2019
C12 D57 Total

Sales (in units) 12,000 9,000 21,000
× Selling Price Per Unit $150 $220
Total revenue $1,800,000 $1,980,000 $3,780,000
Production Budget

Production Budget
2019
C12 D57
Budgeted Sales (in units) 12,000 9,000
Plus: Desired finished goods ending inventory 300 200
Total units needed
12,300
9,200
Less: Beginning finished goods inventory 400 150
Budgeted Production (in units) 11,900 9,050
10-39
10-52 (Continued-1)

2019
C12 D57 Total


Pounds per Unit ×0 × 3.6
RM 2 needed for production 0 32,580 32,580
Raw Material 3:
Pounds per Unit × 1.8 × 0.8
10-40
10-52 (Continued-2)
Direct Manufacturing Labor Budget

Direct Labor Budget
2019
C12 D57 Total

Budgeted production 11,900 9,050
Direct labor hours per unit × 1.5 × 2
Total direct labor hours needed 17,850 18,100 35,950
Hourly wage rate $30.00
Budgeted direct labor costs $1,078,500

2019
Original Variable OH Budget:

Indirect materials $10,000
Miscellaneous supplies and tools 5,000
Indirect labor 40,000
Payroll taxes and fringe benefits 250,000
Total Variable Factory Overhead $326,080
Reduction Rate for Variable OH Costs 10.00%
Original Fixed OH, Excluding Depreciation:

Supervision $120,000
Total Cash Fixed Factory Overhead $183,420
Depreciation 71,330
Total Original Fixed OH $254,750
Reduction Rate for Cash Fixed OH Costs = 5.00%
10-41
10-52 (Continued-3)
Budgeted Variable OH:

($326,080 × (1 − 0.10)) = $293,472
Budgeted Fixed OH:
Cash Charges = ($183,420 × (1 − 0.05)) = $174,249
Depreciation (same as last year) = $71,330
Total Budgeted Fixed OH = $245,579
Budgeted CGS and Ending Finished Goods Inventory Budget

Ending Finished Goods Inventory and Budgeted CGS
2019
C12 D57 Total

Sales volume 12,000 9,000 21,000
Cost per unit (see above schedule) $86.39170 $113.38893
Cost of Goods Sold $1,036,700 $1,020,500 $2,057,200
Ending Finished Goods Inventory 300 200

Cost per unit (see above schedule) $86.39170 $113.38893
Budgeted ending inventories $25,918 $22,678 $48,596
Schedule 1: Cost per Unit—Product C12:

Inputs __ Cost
Cost Element Unit Input Cos Quantity Per Unit
RM-1 $2.00 9 $18.00
RM-3 $0.50 1.8 $0.90
Direct labor $30.00 1.5 $45.00
Variable factory OH ($293,472 ÷ 35,950) $8.1633 1.5 $12.2450
Fixed factory OH ($245,579 ÷ 35,950) $6.8311 1.5 $10.2467
10-42
10-52 (Continued-4)
Schedule 2: Cost per Unit—Product D57:

Inputs Cost
RM-1 $2.00 7 $14.00
RM-2 $2.50 3.6 $9.00
RM-3 $0.50 0.8 $0.40
Direct labor $30.00 2 $60.00
Fixed factory OH ($245,579 ÷ 35,950) $6.8311 2 $13.6622

2019
Selling Expenses:
Advertising $60,000
Sales salaries 200,000
Travel and entertainment 60,000
Administrative expenses:
Offices salaries $60,000
Executive salaries 250,000
Supplies 4,000
Total Selling and Administrative Expenses $645,000
10-43
10-52 (Continued-5)
Budgeted Income Statement

Budget Income Statement
For the Year 2019
C12 D57 Total

Sales (see above schedule) $1,800,000 $1,980,000 $3,780,000
Cost of Goods Sold (see above) 1,036,699 1,020,499 2,057,198
Gross Profit $763,300 $959,500 $1,722,802
Selling and administrative expenses (see above) $645,000
Pre-tax Operating Income $1,077,802
Income Taxes (@40%) $431,121
After-tax Operating Income $646,681
2. The revised budgeted after-tax operating income with Kaizen is $646,681. The
immediate benefit, therefore, is an increase of $173,820 in operating income, or 37%
from $472,860.
The firm is also likely to benefit in the long-run from the reductions in direct materials,
direct labor hours, and factory overhead required in production. Decreases in
consumption of manufacturing elements reduce wear and tear of equipment and other
facilities and lessens the need for additional capital investments/replacements.
10-44
10-54 Profit Planning and What-If Analysis (60 minutes)
1. Break-even volume, in units and dollars, for the coming year:

$1,200,00
Annual fixed costs = 0
Contribution margin, per unit:
Selling price per unit = $100.00
Variable cost, per unit = $70.00
Contribution margin, per unit = $30.00
Contribution margin ratio:
Selling price, per unit = $100.00
Contribution margin, per unit = $30.00
Contribution margin ratio = 30.00%
Annual break-even volume (units) = 40,000 units

$4,000,00
Annual break-even volume (dollars) = 0
2. Units needed to be sold for the company to meet the $300,000 pre-tax profit goal:
Annual fixed costs (FC) = $1,200,000

Pre-tax profit target (dollars) = $300,000
Required sales volume (units) = 50,000 Units*
*($1,200,000 + $300,000) ÷ $30.00/unit
3. What-If Analysis
% Change
in $25 DL cost Revised Revised Breakeven Unit Change % Change in
Component Variable Cost Contribution volume in Breakeven Breakeven
Situation (given) per Unit Margin per Unit (units) Point Point
Baseline 0.00% $70.00 $30.00 40,000 0 0.00%
1 4.00% $71.00 $29.00 41,379 1,379 3.45%
2 6.00% $71.50 $28.50 42,105 2,105 5.26%
3 8.00% $72.00 $28.00 42,857 2,857 7.14%
Notes:
1. Revised variable cost/unit = baseline cost/unit + (assumed % change in DL cost
component × labor cost component of variable cost/unit). For example, Situation
1: If there is a 4% increase in the DL cost per unit, the revised variable cost/unit
would be $71.00/unit = $70.00/unit + (0.04 × $25.00/unit) = $70.00/unit +
$1.00/unit = $71.00/unit.
2. Revised contribution/unit = selling price/unit – revised variable cost/unit. For
example, Situation 1: With a 4% increase in the DL cost/unit, the revised
contribution margin/unit = $29.00 = $100.00 – $71.00/unit.
10-45
10-54 (Continued-1)
Notes (continued):
3. Breakeven volume (units) = Fixed costs ÷ contribution margin/unit. For example,

Situation 1: After a 4% increase in the DL cost/unit, the revised breakeven point =
41,379 units = $1,200,000 ÷ $29.00/unit.
4. Unit Change in Breakeven Point = Revised Breakeven Point – Original
(Baseline) Breakeven Point (40,000 units). For example, for Situation 1: After a
4% increase in the DL cost/unit, the new breakeven point (41,379 units) is 1,379
units more than the baseline breakeven point (40,000 units).
5. % Change in Breakeven Point = Unit change in Breakeven Point/Baseline
Breakeven Point (40,000 units). For example, for Situation 1: After a 4% increase
in the DL cost/unit, the revised breakeven point is 3.45% higher than the original
(baseline) breakeven point = 1,379 units ÷ 40,000 units.
4. Selling price per unit the company must charge to maintain the budgeted ratio of
contribution margin to sales (hint: Use the Goal-Seek function in Excel to answer this
question):
Original selling price per unit = $100.00

Original variable cost per unit = $70.00
Original contribution margin per unit = $30.00
Original contribution margin ratio = 30.00%
Increase in labor-cost component of vc per unit = 5.00% (assumed

)
Labor-cost component of variable cost per unit (given) = $25.00
Revised variable cost per unit ($70.00 + (0.05 × $25.00)) = $71.25
Solution without Using Goal Seek
Solution Using Goal Seek in Excel (NOTE: Before running Goal Seek, make
sure under File → Options→ Formulas, that the box labeled “Iterative
Calculation” is checked, that a large number is entered into the space for
“Number of Iterations,” and that "Maximum Change" is set at 0.0001.)
10-46
10-54 (Continued-2)
Step One: Set Up the Model
Note: formula in cell E97 is: =E95-E96; formula in cell E98 is: =E97/E95
Step Two: Call the Goal Seek Routine in Excel (go to Data, then Data Tools, What-If
Analysis, then Goal Seek). Set up Goal Seek as follows:
Step Three: Results (based on Excel 2010)
5. As stated in the chapter, inputs to the construction of individual budgets are subject to
uncertainty. That is, the inputs represent forecasts (e.g., selling price per unit, sales
volume, and sales mix) and therefore are subject to estimation error. What-if analysis
is a tool that allows us to vary one or more of these inputs in order to examine the
resulting effect on one or more budgets (e.g., operating income or cash
10-47
10-54 (Continued-3)
flows). In essence, we attempt to determine how sensitive our budgets and

forecasted financial statements are with respect to assumptions we are making as to
the value of input factors. For example, the analysis in 3 above suggests that the
budgeted breakeven point for the company is sensitive (i.e., it reacts significantly) to
changes in the labor-cost component of variable cost per unit. As such, management
would want to control this cost as carefully as it could.
See the following tutorials for additional information about performing what-if analyses
using Excel 2016, Excel 2013, and Excel 2010:

BF7A-E4645C446FB4

http://office.microsoft.com/en-us/excel-help/switch-between-various-sets-of-values-by-using-
scenarios-HP010072669.aspx

HP010342214.aspx


HP010342416.aspx
https://support.office.com/en-US/article/Define-and-solve-a-problem-by-using-Solver-9ed03c9f-7caf-
4d99-bb6d-078f96d1652c
10-48
10-56: Budgeting Insurance Policy Volume and Monthly Revenues (75-90 Minutes)
1. Monthly budgets broken down into three parts: market size and volume; volume for National Auto Insurance
Company; and, Premium Revenues earned.
January February March April May June

Part a: Market Size &
Volumes
Total # of households (market
size) 100,000,000 100,050,000 100,100,025 100,150,075 100,200,150 100,250,250
% of households--car
ownership 80.00% 80.00% 80.00% 80.00% 80.00% 80.00%
avg. # of cars owned per
household 2.2 2.2 2.2 2.2 2.2 2.2
% of car owners with insurance 85.000% 85.085% 85.170% 85.255% 85.341% 85.426%
total # of insured autos
(market-wide) 149,600,000 149,824,475 150,049,286 150,274,435 150,499,922 150,725,747
market share of National Auto
Insurance 10.00% 10.001% 10.001% 10.002% 10.002% 10.003%
# of autos insured by National,
end of mo. 14,960,000 14,983,197 15,006,429 15,029,698 15,053,002 15,076,343
10-49
10-56 (Continued-2)

Part b: Volume for National
Auto Insurance
# of autos insured, beginning
of month 14,940,000 14,921,325 14,902,673 14,884,045 14,865,440 14,846,858
cancelations during the month 18,675 18,652 18,628 18,605 18,582 18,559
# of insured autos, end of
month 14,921,325 14,902,673 14,884,045 14,865,440 14,846,858 14,828,300
avg. # of insured autos during
the month 14,930,663 14,911,999 14,893,359 14,874,742 14,856,149 14,837,579

Part c: Volume for
National Auto Insurance
avg. # of autos insured
during the month 14,930,663 14,911,999 14,893,359 14,874,742 14,856,149 14,837,579
avg. insurance premium
per auto per month $100.00 $100.00 $100.00 $100.00 $100.00 $100.00
monthly premiums
revenue $1,493,066,250 $1,491,199,917 $1,489,335,917 $1,487,474,247 $1,485,614,905 $1,483,757,886
Change in Total Premiums Revenue, January to June:

January's Total Premiums = $1,493,066,250
June's Total Premiums = $1,483,757,886
Six-month Dollar Change = -$9,308,364
Six-month % change = -0.623%
10-50
10-51
10-56 (Continued-3)
2. What additional real-life refinements would you envision for the budgets you
prepared above in (1)? What additional budgets would you anticipate preparing for
the company were you in charge of the budget-preparation process?
 As the person in charge of the budget-preparation process, one obvious

recommended change would be to report separately the number of new
policies written (the logical offset in Part 1b to the number of policy
cancelations). Currently the number of new policyholders is buried
somewhere in part a of the budget. Thus, a significant improvement is to
disclose prominently each month the net change in (average) policies
outstanding, which is defined as the difference between the number of new
policies written and the number of policy cancellations.
 In the example problem we assumed, for simplicity, that all policyholders

paid the same premium. Alternatively, we used an average premium rate
per month per policy, which is acceptable for budgeting purposes as long
as the mix of policyholders was not anticipated to change from the mix
used to calculate the weighted-average premium amount.
 The budget we created applied to those individuals whose policies

covered the calendar year, January through December. A fuller, more
realistic analysis would gather similar data for policyholders whose
anniversary date is something other than January 1st. Whether the profile
of such policyholders is different from the profile assumed above is an
empirical question.
 The cancelation rate, and growth rate in new underwritings, would

probably be monitored carefully since these are key drivers of future
financial performers. That is, they are "leading indicators" of financial
performance and as such would probably be included in the customer
perspective of the company's balanced scorecard (BSC).
 The problem includes information regarding a midterm policy-cancelation

rate (i.e., policies cancelled before the annual renewal date). It would
seem appropriate, however, to include in the model a policy-renewal rate
(85%, 90%, etc.).
 The above calculations and budgets deal solely with forecasted volume (#
of policies) and premiums revenue ($). The output of the budgets we
prepared would then be used to prepare other budgets for the company.
In this sense, and similar to the extended example in the chapter, we say
that the budgets articulate with one another. For example, once a budget
for volume and sales has been prepared, the company can proceed to
10-52
prepare a "cost of claims" budget. In turn, information from both of these
budgets
10-56 (Continued-4)
would be used to forecast staffing needs, what we might call "claims

handling." Claims processing times, the mix of "simple" versus
"complicated" claims, the average time to process a claim, the time
available per day (month) for each claims handler, the % of submitted
claims that are paid would all be "drivers" that would be incorporated into
the claims-processing budget.
 The budget as presented is static in nature and covers a fixed period of

time. For reasons discussed more fully in the chapter, the limitations of
such budgets can be addressed by generating "rolling forecasts."
3. The budgets you prepared above in (1) can be referred to as “driver-based

budgets.” List some of the pros and the cons of such budgets, relative to traditional
budgeting practices.
Pros
1. Driver-based budgeting (e.g., traditional activity-based budgeting (ABB) or
time-driven activity-based budgeting) reduces the time to produce a budget
or to reforecast.
2. Driver-based budgeting requires fewer iterations--that is, it reduces the "give
and take" and time devoted to the "negotiations" aspect of traditional
budgets.
3. Driver-based budgeting saves costs--for example, overtime payments
(required to support time-consuming traditional budgeting processes) can
be eliminated; similarly, part-time (temporary) help to support the traditional
budget-preparation process can be reduced or eliminated. Managers are
"freed" to attend to more strategic imperatives.
4. Driver-based budgets make managers accountable--situations such as
decreases in efficiency or idle capacity become more visible under driver-
based budgeting.
5. Driver-based budgeting provides insight and agility--if drivers are
appropriately chosen, then information about # of transactions and cost-
driver quantities for the period aid in the end-of-month evaluation of
operating performance. As well, this budgeting process provides valuable
non-financial information, which can be incorporate into the organization's
Balanced Scorecard (BSC).
6. Driver-based budgeting reduces risk exposure--if performance drivers are
appropriately defined and included in the budget, then management can
readily evaluate different risks and scenarios (mix of products/services sold,
productivity ratios, unit resource costs, etc.).
7. Driver-based budgeting may decrease the amount of "gaming behavior" on
10-53
the part of managers and employees. With driver-based budgeting causal
relationships are transparent, a situation that can limit the opportunity for
"gaming." There is simply less opportunity to fool senior managers if all of
the assumptions in budgets are laid out for everyone to see.
10-56 (Continued-5)
Cons
1. Driver-based budgeting is perceived to be difficult to implement.
2. Driver-based budgets require a sophisticated information processing
system--that is, the ability to capture, across the organization, key resource
drivers, activity cost drivers, and activities.
10-54
10-58 Budgeting and Sustainability (75 minutes)
Requirement 1: Short-Term Financial Analysis
For purposes of illustration (and for requirement 3 below), the cell reference for $13,125
(above) is G24; the cell reference for $60,000 (above) is G14.
Requirement #2: Assume the Switch to the New Compound and the Introduction of Continuous-
Improvement (Kaizen) Budgeting
Estimated increase in processing cost, per year with new compound (from above) = $73,125
Estimated annual cost savings, per Kaizen budget:

Original Monthly Processing Costs (other than materials):
Commercial:
Labor ($4.00/batch x 7,500 batches/year ÷ 12 months/year) $2,500.00
Electricity ($1.50/batch x 7,500 batches/year ÷ 12 months/year) $937.50
Individual:
Labor ($4.00/batch x 3,000 batches/year ÷ 12 months/year) $1,000.00
Electricity ($1.00/batch x 3,000 batches/year ÷ 12 months/year) $250.00
Total Monthly Processing Costs (Other than Materials) $4,687.50
Original Annual Processing Costs (other than materials) $56,250.00
Cell references (in Excel file solution): $73,125 = cell G54 (=cell G44); $4,687.50 = cell
G64 (=SUM(G59:G63)); $56,250.00 = cell G65.
10-55
10-58 (Continued-1)
Revised Level of Monthly Processing Costs (other than materials):

Month Labor Electricity
1 $3,465.00 $1,175.63
2 $3,430.35 $1,163.87
3 $3,396.05 $1,152.23
4 $3,362.09 $1,140.71
5 $3,328.47 $1,129.30
6 $3,295.18 $1,118.01
7 $3,262.23 $1,106.83
8 $3,229.61 $1,095.76
9 $3,197.31 $1,084.80
10 $3,165.34 $1,073.95
11 $3,133.68 $1,063.21
12 $3,102.35 $1,052.58
Total--Yr. 1 $39,367.64 $13,356.88 $52,724.52
\ Year 1 Kaizen-based cost savings (processing costs other than material) $3,525.48
Net Increase in Year-One Processing Costs (materials + labor + electricity) = $69,599.52
Difference between fine and net increase in year-one processing costs $9,599.52
Thus, strictly speaking, it is better to incur the fine rather than change to the new cleaning
compound, even after implementing Kaizen budgeting.
Note: Net increase in year-one processing costs ($69,599.52) = Increase in processing

costs, with the new compound ($73,125.00) less the year-one kaizen-based cost
savings ($3,525.48).
For Requirement 3 (below), assume the following input data (cell entries):
Blocher, Stout, Juras, Smith, Cost Management, 8/e 10-56 ©The McGraw-Hill Companies 2018
10-58 (Continued-2)
Requirement 3
a. Determine the Monthly Cost-Reduction Rate that would Equate the net increase in year-one to
processing costs (materials + labor + electricity) with the anticipated fine
Step One: Define the Indifference Cost Equation
Difference between the fine and net increase in year-one processing costs $9,599.52
Step Two: Run Goal Seek
Note: cell E19 contains the assumed monthly rate of cost decrease; cell G95
contains arithmetic difference between the cost of the fine and the net increase in
processing costs—other than materials cost, and after implementing kaizen
budgeting. The value “0” in the above formulation essentially solves for the
breakeven level: that is, the rate of monthly cost savings needed to equate the
value of the fine and the increased processing costs due to the new compound, but
after implementing kaizen. As shown below, Goal Seek provides the answer:
4.164% per month.

In other words, in order to be indifferent between incurring the fine
($60,000) and incurring extra processing costs per year, after
implementing kaizen budgeting, the monthly rate of cost decrease must
be 4.164%. At this level, the year-one kaizen-based cost savings would
be $13,125, while the net year-one processing cost increase would be
$60,000 ($73,125 − $13,125)--an amount exactly equal to the estimated
fine. Note, however, that such a dramatic increase in productivity is highly
questionable.
10-58 (Continued-3)
b. The cost per pound for the new compound that would equate the anticipated fine with
the net year-one costs, assuming no kaizen budgeting plan (i.e., no reduction per month
in processing costs):
Step One: Set Up the Cost Equation
Cost differential: anticipated fine and net one-year processing costs, with no kaizen
budgeting plan = $13,125
Note: the above value is contained (in this example) in cell G121, which in turn is
defined as the contents from cell G45, which contains the difference between the
anticipated cost of the fine, $60,000 (entered in cell G35) and the expected increase
in material cost associated with the use of the new compound (G44), as shown
below:
Step Two: Run Goal Seek
10-58 (Continued-4)
Cell E17 contains the cost of the new compound, per pound of laundry; cell G121
contains the cost difference: the anticipated fine versus the increased processing
cost attributable to the use of the new compound.
Step Three: Results
In other words, if the price of the new compound were to be reduced from $2.25
per pound of laundry to $2.00 per pound of laundry, with no other changes, then
the owner would be indifferent between incurring the estimated fine ($60,000) and
using the new (higher-priced) compound. Of course, other considerations may
affect the ultimate decision.
4. Operational Changes Needed to Ensure Kaizen Cost Savings
The reduction in labor time might be realized by improving the efficiency of

operations, including a decrease in machine downtime. It is probably the case that
line employees (i.e., operating personnel) would have suggestions for ways to
improve operational efficiency (e.g., changes that would reduce idle time as well as
processing time).
To achieve aggressive cost reductions in labor, however, it might be necessary to

institute some type of employee incentive program.
Savings in electricity consumption may be more difficult to achieve. Some reduction

would likely accompany any planned reductions in labor cost. However, ultimately it
may be necessary to invest in more modern technology to improve electricity
consumption. This is particularly true given recent (and anticipated) increases in
utility rates.
Finally, as the present example shows, effective kaizen budgeting may require
collaborative work with individuals/companies across the value chain. David Duncan
is more likely to achieve his cost-reduction goals by working with his suppliers. As
indicated above, if the cost of the new compound can be decreased by only $0.25
per pound of laundry processed, David would be indifferent (solely on an expected
cost basis) between incurring the fine ($60,000) and the increased processing cost
associated with the use of the new compound ($60,000 as well). Note, however, that
a $0.25/pound reduction amounts to about 11%. This level of reduction may not be
possible if the supplier cannot also reduce costs (e.g., via kaizen [continuous-
improvement] methods).
10-58 (Continued-5)
5. Other (Strategic and Operational) Considerations that Might Affect the Ultimate
Decision:
 What impact, perhaps negative, will the kaizen budgeting approach have on
employee morale?
 Will the quest to achieve aggressive levels of cost reduction have a negative
effect on service quality?
 Will the use of the new, environmentally friendly cleaning compound have a
beneficial effect on the image of the business and therefore on sales?
 Would the use of the new cleaning compound have a beneficial impact on
employee health/working conditions?
 If the existing cleaning compound were to continue to be used, would it require
any special handling costs/preventative measures (e.g., employee health and
safety)?
 Would incurring a fine (rather than incurring increased operating costs)
negatively affect the image of the business, and therefore future service
demand? (Would negative media coverage reduce demand?)
 Does the existing cleaning compound create a hazardous work environment for
employees (the problem is silent on this issue)?
 If the existing cleaning compound is considered hazardous to employee well-
being, is there an effect on employee absenteeism? Or, more critically, are there
potential liability issues should employees become sick, permanently disabled, or
suffer death as a result of long-term exposure to the compound?
 Duncan's business essentially consists of two service lines/segments:
commercial and individual. Is there a differential effect on marketing activity for
these two groups? (That is, do these groups differ in their response to either
positive or negative media coverage?)
 Would it make more sense for Duncan to invest in new technology, which might
bring the company into full compliance with current emission requirements?
10-60 Criticisms of Traditional Budgeting/Incentive Issues (45 Minutes)
Many critics of conventional budgeting procedures cite dysfunctional consequences of

using fixed-performance budgets in managerial compensation contracts. These
individuals believe, among other problems, that such contracts motivate managers and
employees to “game the performance indicator,” that is, to take actions that improve the
performance indicator but are not value-adding to the organization. The following are
selected examples of “gaming behavior”:
 managing earnings by pushing expenses into the future (e.g., by delaying
purchases, delay making new hires, delaying an important product-development
initiative, or delaying needed expenditures)
 managing earnings by moving future revenues to the present (e.g., by booking
orders early or by offering excessive discounts to customers)
 managing earnings from the present to the future (e.g., by prepaying expenses,
or by taking write-offs, or by delaying the realization of revenues)
 managing earnings by pushing profits to the future (e.g., by accelerating
expenses or postponing sales)
 “channel stuffing” (or “trade loading”)—that is, shipping excessive amounts of
products to distributors to meet near-term sales goals, recognizing that many
such products are likely to be returned; such items are sometimes referred to as
“sale-or-return” products
 announcing price hikes for the next fiscal year, in an attempt to motivate
increases in end-of-current-year sales
 shifting funds between accounts to avoid budget overruns (costly, non-value-
added managerial activity)
Other dysfunctional consequences of traditional fixed-performance reward systems
 negotiating low targets and high rewards (i.e., pushing for targets that are
inwardly comfortable yet appear outwardly difficult to achieve)
 failure to take appropriate risks by deviating from the budget (i.e., “if it’s not in the
budget, why take the risk?)
 planning to meet, but not exceed, budgeted performance because such
increased performance might be incorporated into future budgets, which works
against the manager
 spending whatever is in your budget (“use it or lose it”)
 intentionally asking for more resources than you need, anticipating that
reductions to your request will be made during the upcoming budget negotiation
process
10-60 (Continued)
In addition to gaming behavior, some critics suggest that excessive reliance on budget-
based incentive contracts leads to unethical and even fraudulent behavior. This
conclusion is based on the view that in an attempt to meet budgeted performance
requirements (which are tied to compensation), managers resort to questionable, if not
illegal, behaviors. Enron and WorldCom serve as good examples.
Critics of conventional budgeting practices, including those in the Beyond Budgeting

Roundtable (BBRT), believe that the annual fixed-performance contract should be
replaced with a new management model, one in which the tie between budgets and
annual compensation is severed. As discussed in the chapter, this can be accomplished
(for example) by the use of a “linear compensation plan” or the use of relative-
performance contracts combined with “rolling financial forecasts.” Because of its focus
on budgeting activities and activity costs, one might argue that the use of activity-based
budgeting (ABB) decreases some of the negative incentive effects of traditional
budgeting systems. Because of the use of time equations, and therefore greater
specification of resource requirements, the use of time-driven activity-based budgeting
(TDABB) may be particularly useful.

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CHAPTER 10: STRATEGY AND THE MASTER BUDGET

10-6 Additional factors include:

10-8 Zero-base budgeting (ZBB) is a budgeting process that requires managers to

2. Using Excel to Perform Scenario Analysis:

3. Using Excel to Create Data Tables:

4. Using Goal Seek in Excel:

5. Using Solver to Perform What-If Analysis:

Estimated sales volume—2020 20,000 18,750

10-16 Number of units produced in Qtr. 1:

Units produced in Qtr. 1 = lbs. of DM used/lbs. of DM per unit of

DM requirements (in lbs.), Qtr. 2 = Planned production, Qtr. 2 × DM lbs./unit

10-18 Current level of monthly operating costs = $10,000:

10-20 Collection of Credit Sales—December:

10-22 Direct Material (DM) Purchases, December = (DM issued to production +

10-24 Purchase Discounts (25 minutes)

Opportunity cost (%) = [discount % ÷ (1 − discount %)] × [365 ÷ no. of

= [0.02 ÷ (1 − 0.02)] × [365 ÷ 20] = 0.020408 × 18.25 = 37.24%

= [0.01 ÷ (1 − 0.01)] × [365 ÷ 20] = 0.010101 × 18.25 = 18.43%

3. Given the significant opportunity cost of not taking advantage of early-

1. Budgeted Cash Receipts:

2. Budgeted Cash Disbursements:

Hartz & Co.

Cash balance, beginning $75,000 $99,000

Cash disbursements, prior to financing (B) $450,500 $550,000

Excess (deficiency of) cash, before

Ending cash balance = (A) − (B) + (E) $99,000 $50,480

2. Appropriate accounting treatment for:

b) Cash discounts allowed on collection of receivables: These are offered as an

1. Budgeted merchandise purchases: May and June

May June July

2. Budgeted cash disbursements: June

Budgeted Selling, General, and Administrative (SG&A) expenses:

3. Budgeted cash collections: May

From last month's (April) sales:

Within the discount period ($363,000) × 60% × 97% = $211,266

Collection of credit sales made in March $354,000 × 9% = 31,860

4. Gross and net balance of Accounts Receivable (AR) as of May 31

March April May Total

* @ 6% of gross sales dollars

Monthly Marketing Expenses: Cost Change

Monthly Marketing Expenses: Cost Change

6. Introduction to What-If Analysis:

7. Using Excel to Perform Scenario Analysis:

8. Using Excel to Create Data Tables:

9. Using Goal Seek in Excel:

10. Using Solver to Perform What-If Analysis:

1. Sales volume in units:

$85.00X + $40,000 = $80.00X + $45,000

2. Sales level needed (note: cm = contribution margin; sp = selling price; X =

Pre-tax profit = (cm/unit × X) − FC = 5% (sp/unit × X)

Let X = sales dollars, then:

Operating profit target (%) = 5% 5%

Operating Profit ÷ Sales Revenue 5.00% 5.00%

Total hours for the budgeted activities:

Professional staff requirements for the budgeted revenue:

2. Number of full-time consultants needed for the year:

Blocher, Stout, Juras, Smith, Cost Management, 8/e 10-24

Total compensation for the manager:

Blocher, Stout, Juras, Smith, Cost Management, 8/e 10-25