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Chapter 14 - Planning for Profit and Cost Control
Teaching Notes for Chapter 14
To simplify describing the budgeting process, this chapter focuses on a retail sales
company that sells only one inventory item. Even so, the components of the budgeting
process are so interrelated that we recommend you use a comprehensive problem such as
Demonstration Problem 14-1. Demonstration Problem 14-1 illustrates the primary
components of a master budget. We also suggest that you duplicate the demonstration
problem work papers for your students. The work papers help students keep up as you
explain the material, and they provide a comprehensive set of notes for later study.
Detailed Outline of a Lesson Plan for Chapter 14
I. Provide an overview of how information flows through a budget system. Use
Exhibit 14.1 from the text as a guide. Highlight the sales budget as the starting
point, and explain some of the interrelationships or connections among the
budgets.
II. Have students read requirement a from Demonstration Problem 14-1. Show
them how to prepare a sales budget for the month of January. Have them prepare
the budgets for February and March. Circulate around the room, helping as
needed. Continue this pattern throughout the problem. Work a part of each
requirement and have your students do the rest. Keep them actively involved.
III. Have students read requirement b from Demonstration Problem 14-1. Show
them how to prepare a cash receipts schedule for the month of January. Have
them prepare the schedules for February and March.
IV. Have students read requirement c from Demonstration Problem 14-1. Show
them how to determine the amount of accounts receivable that will appear on the
March 31 balance sheet and the amount of sales revenue that will appear on the
first quarter income statement. Have students post the financial statement data to
the pro forma financial statements as you go along. It is helpful for them to see
how the individual budgets are related to developing the pro forma statements.
V. Have students read requirement d from Demonstration Problem 14-1. Show
them how to prepare an inventory purchases budget for the month of January.
Have them prepare the budgets for February and March.
VI. Have students read requirement e from Demonstration Problem 14-1. Show
them how to prepare a cash payments schedule for the month of January. Have
them prepare the schedules for February and March.
VII. Have students read requirement f from Demonstration Problem 14-1. Show
14-2
that will appear on the March 31 balance sheet and the amount of cost of goods
sold that will appear on the first quarter income statement. Have them post these
amounts to the appropriate pro forma financial statements.
VIII. Have students read requirement g from Demonstration Problem 14-1. Show
them how to prepare a selling and administrative expense budget for the month of
January. Have them prepare the budgets for February and March.
IX. Have students read requirement h from Demonstration Problem 14-1. Show
them how to prepare a selling and administrative cash payments schedule for the
month of January. Have them prepare the schedules for February and March.
X. Have students read requirement i from Demonstration Problem 14-1. Show
them how to determine the amounts of sales commissions payable, utilities
payable, and accumulated depreciation that will appear on the March 31 balance
sheet and the amount of selling and administrative expense that will appear on the
first quarter income statement. Have them post these amounts to the appropriate
pro forma financial statements.
XI. Have students read requirement j from Demonstration Problem 14-1. Show
them how to prepare a cash budget for the month of January. Have them prepare
the budgets for February and March. Many students find cash budgets difficult to
prepare. Allow ample time to cover this topic.
XII. Have students read requirement k from Demonstration Problem 14-1. Show
them how to determine the cash flows from operating, investing, and financing
activities that will appear on the first quarter pro forma statement of cash flows.
Also, show them how to determine the amount of the ending cash balance and the
line of credit liability that will appear on the March 31 pro forma balance sheet
and the amount of interest expense that will appear on the first quarter pro forma
income statement.
XIII. Have students complete requirements l, m, and n to complete the pro forma
financial statements.
XIV. It normally requires 1 to 1½ hours to complete the demonstration problem.
Students need not complete all parts of the problem in class. Move on when a
majority of the class is ready. Stragglers can complete the problem as a
homework assignment. We suggest you use Exercises 14-2, 14-3, 14-7, 14-11,
and 14-13 as follow-up homework assignments to accustom students to
completing parts of a budget rather than a whole one, especially if you plan to
give short answer or multiple choice exams. If, however, you plan to include a
comprehensive budgeting problem on your exam and you want students to have
practice completing comprehensive problems, you should use Problem 14-23 as a
homework assignment.
14-3
Summary Outline of a Lesson Plan for Chapter 14
I. Provide an overview of how information flows through a budget system. Use
Exhibit 14.1 from the text as a guide. Highlight the sales budget as the starting
point.
II. Actively involve students in completing requirements a through n of
Demonstration Problem 14-1. Show them how to complete each requirement
for the month of January and then circulate around the room helping as students
complete the requirements for February and March. Continue to work a part of
each requirement and have your students do the remainder. Have them post the
financial statement data to the pro forma financial statements as you go along.
Keep them actively involved.
III. Use Exercises 14-2, 14-3, 14-7, 14-11, and 14-13 as short follow-up homework
assignments. Use Problem 14-23 for a comprehensive homework assignment.
Quiz Questions for Chapter 14
1. Strategic planning focuses on
a. short-range decisions.
b. intermediate-range decisions.
c. sales targets.
d. long-range decisions.
2. A plan that formalizes in financial terms the overall goals and objectives of a company is called a
a. capital budget.
b. master budget.
c. participative budget.
d. strategic plan.
3. For the month of November, the beginning inventory of Product M is expected to be 2,000 cases.
Expected sales are 10,000 cases, and the company wishes to begin the next period with an inventory
of 1,000 cases. The number of cases of M that the company must purchase during November is
a. 11,000 cases.
b. 10,000 cases.
c. 9,000 cases.
d. 13,000 cases.
4. Cash receipts for January are expected to total $171,000. Cash disbursements for January are
expected to be $158,000. The company’s minimum desired cash balance is $10,000. It started the
period with $35,000. What is the expected cash balance at the end of January?
a. $10,000
b. $48,000
c. $25,000
d. $206,000
5. Manufacturing overhead expenses are budgeted at $2,000 per month. Included in the $2,000 are
$500 of monthly depreciation expense and $200 of allocated expenses related to manufacturing
insurance that was paid in February. What is the cash outflow for overhead for the month of May?
Chapter 14 - Planning for Profit and Cost Control
14-4
a. $ 200
b. $ 500
c. $1,300
d. $1,200
6. A sales budget has been prepared for April. Management wants the amount of ending inventory
each month to be equal to 10% of the next month’s cost of goods sold. April cost of goods sold is
projected at $80,000 and May cost of goods sold is projected at $60,000. Ending inventory at the
end of March is expected to be $8,000. Based on this information, what would the amount of
purchases be for April?
a. $82,000
b. $86,000
c. $72,000
d. $78,000
7. Budgeted sales are shown in the following table:
Sales
April
May
June
Cash Sales
$500
Sales on Account
$800
The company expects a 25% increase in sales per month for May and June. The amount of sales
revenues that would appear on the company’s 2nd quarter pro forma income statement would be
a. $4,956.25.
b. $4,225.50.
c. $3,050.00.
d. $2,031.25.
8. XYZ Company projected unit credit sales for the last four months of the year as shown below:
September 3,000
October 3,200
November 4,100
December 5,600
The company’s past records show collection of credit sales as 60% in the month of sale and the
balance in the following month. If inventory units are sold for $25, the total cash collections in
November will be
a. $93,500.
b. $37,400.
c. $102,500.
d. $61,500.
Use the following information to answer the next two questions:
The following budget information is available for the XYZ Company for the first quarter of 2014:
Sales ($16 per unit) $320,000
Freight out $.25 per unit sold
Depreciation on Administrative Equipment $10,000
Sales & Admin. Salaries $40,000 +2% of sales
Advertising $12,000
Depreciation on Manufacturing Equipment $15,000
Lease on Sales Building $45,000
Miscellaneous Selling Expenses $5,000
All operating expenses are paid in cash in the month incurred.
9. If XYZ expects to sell 20,000 inventory units in the first quarter, what would be the amount of the
total budgeted selling and administrative expenses for the first quarter of 2014?
14-5
a. $123,400
b. $138,400
c. $113,400
d. $293,400
10. Based on first quarter sales of 20,000 units, the amount of XYZ’s expected cash outflow for selling
and administrative expenses would be
a. $123,400.
b. $131,250.
c. $113,400.
d. $128,400.
Use the following information to answer the next three questions:
Janus Industries has budgeted the following information for January:
Cash Receipts $40,000
Beginning Cash Balance $10,000
Cash Payments $48,000
Desired Ending Cash Balance $ 7,000
If there is a cash shortage, the company borrows money from the bank. All cash is borrowed at the
beginning of the month in $1,000 increments. Interest is paid monthly on the first day of the following
month. The interest rate is 1% per month. The company had no debt before January 1st.
11. The shortage or surplus of cash before considering cash borrowed or interest payments in January
would be
a. $5,000 surplus.
b. $10,000 shortage.
c. $7,000 surplus.
d. $2,000 surplus.
12. The ending cash balance on January 31 would be
a. $5,000.
b. $4,950.
c. $4,970.
d. $7,000.
13. The amount of interest paid in February would be
a. $50.
b. $300.
c. $0.
d. $100.
Solutions to Quiz Questions
Question
Answer
1
D
2
B
3
C
4
B
5
C
Chapter 14 - Planning for Profit and Cost Control
14-6
6
D
7
A
8
A
9
A
10
C
11
D
12
D
13
A
Demonstration Problem for Chapter 14
Demonstration Problem 14-1 Comprehensive Budgeting
Problem
Chang Distributors, a wholesale company, is considering whether to open a new
distribution center. The center would open January 1, 2014. To make the decision, the
planning committee requires a master budget for the center’s first quarter of operation
(January, February, and March of 2014).
Required
You are to construct the first quarter master budget based on the following expectations:
a. January sales are estimated to be $400,000 of which $100,000 will be cash sales and
$300,000 will be on credit. The company expects sales to grow 10% per month for
the first few months of operation. Prepare a sales budget for the first quarter.
b. The company expects to collect 100% of accounts receivable in the month following
the sale. Prepare a schedule of expected cash receipts for the first quarter.
c. Use the information developed in requirements a and b to determine the amount of
accounts receivable on the March 31 pro forma balance sheet and the amount of
sales on the first quarter pro forma income statement.
d. Cost of goods sold will be 60% of sales. Company policy is to budget an ending
inventory balance equal to 25% of the next month’s projected cost of goods sold.
Assume Chang expects April cost of goods sold to be $314,000. Prepare an
inventory purchases budget.
e. All inventory purchases are on account. The company pays 70% of accounts
payable in the month of purchase. It pays the remaining 30% in the following
month. Prepare a schedule of expected cash payments for inventory purchases.
Chapter 14 - Planning for Profit and Cost Control
14-7
f. Use the information developed in requirements d and e to determine the amount of
cost of goods sold on the first quarter pro forma income statement and the amounts
of ending inventory and accounts payable on the March 31 pro forma balance sheet.
g. Budgeted monthly selling and administrative expenses are:
Salary Expense (Fixed)
$24,000
Sales Commissions
5% of Sales
Supplies Expense
2% of Sales
Utilities (Fixed)
$ 1,400
Depreciation on Center Equipment (Fixed)*
$ 750
Rent (Fixed)
$ 3,600
Miscellaneous (Fixed)
$ 900
*The capital expenditures budget shows that Chang must purchase $100,000 of equipment on
January 1 to establish the new center. The equipment supplier allows a thirty-day trial period.
Chang will pay for the equipment on January 31. The equipment is expected to have a 10-year
useful life and a $10,000 salvage value. Prepare a selling and administrative expense budget.
h. Sales commissions and utilities are paid in the month after the month in which they
are incurred. All other expenses are paid in the month they are incurred. Prepare a
schedule of cash payments for selling and administrative expenses.
i. Use the information developed in requirements g and h to determine the amount of
sales commissions payable, utilities payable, and accumulated depreciation on the
March 31 pro forma balance sheet and the amount of selling and administrative
expense on the first quarter pro forma income statement.
j. Using a line of credit, Chang borrows and repays principal in increments of $1,000
on the last day of the month as needed. It pays interest of 1 percent per month in
cash on the last day of the month. Company policy is to maintain an ending cash
balance of at least $12,000. Use this information and the schedules prepared in
requirements b, e, and h to prepare a cash budget.
k. Use the information developed in requirement j to determine the cash flows from
operating, investing, and financing activities on the first quarter pro forma statement
of cash flows, the interest expense on the first quarter pro forma income statement
and the amount of the ending cash balance and the line of credit liability on the
March 31 pro forma balance sheet.
l. Complete the first quarter pro forma income statement.
Chapter 14 - Planning for Profit and Cost Control
14-8
m. Complete the March 31 pro forma balance sheet.
n. Complete the first quarter pro forma statement of cash flows.
Demonstration Problem 14-1 Solution
a. b. c. Sales Budget, Schedule of Cash Receipts, Pro Forma
Data
Estimated Sales Growth Rate
10% per month
Sales Budget
Pro Forma
PROJECTED SALES
Jan
Feb
Mar
Stmt. Data
Cash Sales
100,000
110,000
121,000
Sales on Account
300,000
330,000
363,000
363,000 (a)
Total Budgeted Sales
400,000
440,000
484,000
1,324,000 (b)
SCHEDULE OF CASH RECEIPTS
Current Month’s Cash Sales
100,000
110,000
121,000
+ 100% of Previous Month's A/R
0
300,000
330,000
Total Budgeted Cash Collections
100,000
410,000
451,000
(a) Accounts receivable balance on March 31 pro forma balance sheet.
(b) Sales revenue on first quarter pro forma income statement (sum of monthly sales).
d. e. f. Inventory Purchases Budget, Schedule of Cash
Payments for Inventory, Pro Forma Data
Cost of Goods Sold Percentage
60% of Sales
Inventory Purchases Budget
Pro Forma
Jan
Feb
Mar
Stmt. Data
PROJECTED PURCHASES
Budgeted Cost of Goods Sold
240,000
264,000
290,400
794,400 (a)
Plus Desired Ending Inventory
66,000
72,600
78,500
78,500 (b)
Total Inventory Needed
306,000
336,600
368,900
Less Beginning Inventory
0
(66,000)
(72,600)
Required Inventory Purchases
306,000
270,600
296,300
88,890 (c)
SCHEDULE OF CASH PAYMENTS FOR INVENTORY PURCHASES
70% of Current Purchases
214,200
189,420
207,410
Chapter 14 - Planning for Profit and Cost Control
14-9
30% of Prior Month's
Purchases
0
91,800
81,180
Total Budgeted Inventory
Payments
214,200
281,220
288,590
(a) Cost of goods sold on first quarter pro forma income statement (sum of monthly
amounts).
(b) Inventory balance on March 31 pro forma balance sheet.
(c) Accounts payable balance on March 31 pro forma balance sheet ($296,300 * .3).
Chapter 14 - Planning for Profit and Cost Control
14-10
Demonstration Problem 14-1 Solution
g. h. i. S&A Expense Budget, Schedule of Cash Payments for
S&A Expenses, Pro Forma Data
Sales Commissions Percent
5% of Sales
Supplies Expense Percent
2% of Sales
Equipment Cost
100,000
Equipment Salvage Value
10,000
Equip. Useful Life in Months
120
Selling and Administrative (S&A) Expense Budget
Jan
Feb
Mar
Pro Forma
PROJECTED S&A EXPENSES
Stmt. Data
Salary Expense
24,000
24,000
24,000
Sales Commissions 5% Sales
20,000
22,000
24,200
24,200 (a)
Supplies Expense 2% Sales
8,000
8,800
9,680
Utilities
1,400
1,400
1,400
1,400 (b)
Depreciation on Equipment
750
750
750
2,250 (c)
Rent
3,600
3,600
3,600
Miscellaneous
900
900
900
S&A Expenses before Interest
58,650
61,450
64,530
184,630 (d)
(Interest expense is computed in the cash budget; see requirement j)
SCHEDULE OF CASH PAYMENTS FOR S&A EXPENSES
Salary Expense
24,000
24,000
24,000
100% Prior Month’s Sales
Commissions
0
20,000
22,000
Supplies Expense
8,000
8,800
9,680
100% Prior Month’s Utilities
0
1,400
1,400
Rent
3,600
3,600
3,600
Miscellaneous
900
900
900
Total Payments for S&A
Expenses
36,500
58,700
61,580
(a) Sales commissions payable balance on March 31 pro forma balance sheet.
(b) Utilities payable balance on March 31 pro forma balance sheet.
(c) Accumulated depreciation balance on March 31 pro forma balance sheet (sum of
monthly amounts).
(d) S&A expense on first quarter pro forma income statement (sum of monthly amounts).
Chapter 14 - Planning for Profit and Cost Control
14-11
