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6-1
1. When the office manager receives calls from potential customers, she is instructed to handle
the contracts herself. Recently, however, the number of contracts written up by the office
manager has declined. At the same time, one of the sales representatives has experienced a
significant increase in contracts. The other two representatives believe that the office manager
has been colluding with the third representative to send him the prospective customers.
2. One of the motor coach drivers seems to be reaching his destinations more quickly than any of
the other drivers and is reporting longer idle time.
3. Fuel costs have increased significantly in recent months. Driving the motor coaches at 60 miles
per hour on the highway consumes significantly less fuel than driving them at 65 miles per
hour.
4. Regular preventive maintenance of the motor coaches has been proven to improve fuel
efficiency and reduce overall operating costs by averting costly repairs. During busy months,
however, it is difficult for the maintenance technician to complete all of the maintenance tasks
within his 40-hour workweek.
5. Jason Haslett has read about stretch targets, and he believes that a change in the compensation
structure of the sales representatives may improve sales. Rather than a straight commission of
10% of sales, he is considering a system where each representative is given a monthly goal of
50 contracts. If the goal is met, the representative is paid a 12% commission. If the goal is not
met, the commission falls to 8%. Currently, each sales representative averages 45 contracts per
month.
Required:
For situations 1–4, discuss which employee has responsibility for the related costs and the extent
to which costs are controllable and by whom. What are the risks or costs to the company? What
can be done to solve the problem or improve the situation? For situation 5, describe the potential
benefits and costs of establishing stretch targets.
SOLUTION
1. The office manager has the responsibility to follow company guidelines and write contracts
herself for customers who call her directly. Diverting potential customers to the sales
representative costs the company a sales commission that would not have otherwise been paid. If
satisfaction surveys are sent to customers asking about their first contact with the company, this
may be enough to prevent the office manager from breaking the rules.
2. Each driver is responsible for keeping an accurate accounting of his or her time. Because the
drivers are paid for mileage while driving and an hourly rate while in idle, there is an incentive to
report less travel time and more idle time. The cost could be controlled by using global positioning
systems (GPS) to track the movement and location of the motor coaches.
3. The drivers are responsible for driving the motor coaches at fuel-efficient speeds on the
highway. The maintenance technician is responsible for maintaining the vehicles to improve
efficiency. An increase in fuel consumption would be difficult to pin on either employee because
either could be responsible. Further, there is no incentive for the drivers to drive slower, as they
are paid by the mile. Again, global positioning systems (GPS) could be used to track the movement
6-2
of the vehicles. Some kind of bonus could be offered to the technician for improvements in fuel
efficiency.
4. The maintenance technician is clearly responsible for completing all of the preventative
maintenance. If he cannot complete the tasks during busy months, the company should consider
outsourcing some of the more routine maintenance jobs. Requiring the technician to work
significant overtime will likely decrease his efficiency. Ignoring routine maintenance will end up
costing the company more money in fuel and repair costs.
5. Haslett has designed the stretch target system correctly. Taking advantage of loss aversion,
Haslett has set a stretch target of 50 contracts rewarding the representative with a 12 percent
commission (assuming paying this amount of commission is profitable). If the target is not met,
the commission decreases to 8 percent. This will motivate the representatives to achieve 50
contracts.
In establishing “stretch targets,” Haslett should be sure that there are sufficient potential
contracts to allow all three sales representatives to achieve the higher target. Otherwise, the stretch
target may cause friction among the representatives. One or more of representatives may decide
that the 8 percent commission is not sufficient incentive to stay with the company, and may leave
to work for a competitor, resulting in overall reduced sales.
6-29 (30 min.) Cash flow analysis, sensitivity analysis.
Game Depot is a retail store selling video games. Sales are uniform for most of the year but pick
up in June and December both because new releases come out and because consumers purchase
games in anticipation of summer or winter holidays. Game Depot also sells and repairs game
systems. The forecast of sales and service revenue for the March–June 2014 is as follows:
Almost all the service revenue is paid for by bank credit card, so Game Depot budgets this as 100%
bank card revenue. The bank cards charge an average fee of 3% of the total. Half of the sales
revenue is also paid for by bank credit card, for which the fee is also 3% on average. About 10%
of the sales are paid in cash, and the rest (the remaining 40%) are carried on a store account.
Although the store tries to give store credit only to the best customers, it still averages about 2%
for uncollectible accounts; 90% of store accounts are paid in the month following the purchase,
and 8% are paid 2 months after purchase.
Required:
1. Calculate the cash that Game Depot expects to collect in May and in June 2014. Show
calculations for each month.
2. Game Depot has budgeted expenditures for May of $8,700 for the purchase of games and game
systems, $2,800 for rent and utilities and other costs, and $2,000 in wages for the two part-
time employees.
a. Given your answer to requirement 1, will Game Depot be able to cover its payments for
May?
b. The projections for May are a budget. Assume (independently for each situation) that May
revenues might also be 5% less and 10% less and that costs might be 8% higher. Under
each of those three scenarios, show the total net cash for May and the amount Game Depot
would have to borrow if cash receipts are less than cash payments. Assume the beginning
cash balance for May is $200.
3. Why do Game Depot’s managers prepare a cash budget in addition to the revenue, expenses,
and operating income budget? Has preparing the cash budget been helpful? Explain briefly.
4. Suppose the costs for May are as described in requirement 2, but the expected cash receipts for
May are $12,400 and beginning cash balance is $200. Game Depot has the opportunity to
purchase the games and game systems on account in May, but the supplier offers the company
credit terms of 2/10 net 30, which means if Game Depot pays within 10 days (in May) it will
get a 2% discount on the price of the merchandise. Game Depot can borrow money at a rate of
24%. Should Game Depot take the purchase discount?
SOLUTION
1. The cash that Game Depot can expect to collect during May and June is calculated below.
Cash collected in May June
From service revenue
May ($2,800 0.97) $ 2,716
June ($5,200 0.97) $ 5,044
From sales revenue
Cash sales
From credit card sales
May (0.5 $12,400 0.97) 6,014
June (0.5 $19,400 0.97) 9,409
From cash sales
May (0.1 $12,400) 1,240
June (0.1 $19,400) 1,940
Credit sale collections
From March (0.4 $9,000 0.08) 288
From April (0.4 $11,000 0.9) 3,960
(0.4 $11,000 0.08) 352
From May (0.4 $12,400 0.9) _______ 4,464
Total collections $14,218 $21,209
2. (a) Budgeted expenditures for May are as follows.
Costs
Inventory purchases
$ 8,700
Rent, utilities, etc.
2,800
6-4
Wages
2,000
Total
$13,500
Yes, Game Depot will be able to cover its May costs because receipts are $14,218 and
expenditures are only $13,500.
(b)
Original
numbers
May
Revenues
decrease
10%
May Revenues
decrease 5%
May Costs
increase 8%
Beginning cash
$ 200.00
$ 200.00
$ 200.00
$ 200.00
Collections
14,218.00
13,221.00a
13, 719.50b
14,218.00c
Cash Costs
13,500.00
13,500.00
13,500.00
14,580.00
Total
$ 918.00
$ (79.00)
$ 419.50
$ (162.00)
aFrom requirement 1, this is 0.90 × ($2,716 + $6,014 + $1,240) + $288 + $3,960 = $13,221
bFrom requirement 1, this is 0.95 × ($2,716 + $6,014 + $1,240) + $288 + $3,960 = $13,719.50
c$13,500 1.08 = $14,580.
3. Game Depot’s managers prepare a cash budget in addition to the operating income budget
to plan cash flows to ensure that the company has adequate cash to pay vendors, meet payroll, and
pay operating expenses as these payments come due. Game Depot could be very profitable on an
accrual accounting basis, but the pattern of cash receipts from revenues might be delayed and result
in insufficient cash being available to make scheduled payments for its expenses. Game Depot’s
managers may then need to initiate a plan to borrow money to finance any shortfall. Building a
profitable operating plan does not guarantee that adequate cash will be available, so Game Depot’s
managers need to prepare a cash budget in addition to an operating income budget.
4. The cost of inventory purchases without the discount is $8,700, which Game Depot would
not have to pay until June if it buys the inventory on account in May. However, if it takes the
discount and pays in May, the cost will be $8,700 (100% – 2%) = $8,526. This means it will
save $174.
This makes total expenditures for May
Costs
Inventory purchases
$ 8,526.00
Rent, utilities, etc.
2,800.00
Wages
2,000.00
Total
$13,326.00
Game Depot’s total cash available is $200 (cash balance) + $12,400 (cash receipts), so it will have
to borrow $726 ($13,326 – $12,600) at a rate of 24 percent (or 2 percent per month.) Based on the
information from #1, it will be able to pay this back in June (assuming cash expenditures do not
increase dramatically), so it will incur interest costs of $726 0.02 = $14.52. Because it will cost
6-5
them less than $15 to save $174, it makes sense to go ahead and take the short-term loan to pay
the account payable early.
Some students might interpret the question to mean that the cost of inventory purchases after taking
the 2percent discount in May is $8,700. Under this interpretation, the cost of the inventory is
$8,700 ÷ 0.98 = $8,878. If Game Depot takes the discount and pays in May, it will save $8,878 –
$8,700 = $178
Total expenditures in May:
Inventory purchases
$8,700
Rent, utilities, etc.
2,800
Wages
2,000
Total
$13,500
Total cash available is $200 + $12,400 = $12,600, so Game Depot will borrow $900 ($13,500 –
$12,600) at a rate of 24 percent (or 2 percent per month). The company can repay in June, so
interest cost = $900 0.02 = $18. It will cost $18 to save $178, so Game Depot should take the
short-term loan to pay the accounts payable early.
6-30 (40 min.) Budget schedules for a manufacturer.
Lame Specialties manufactures, among other things, woolen blankets for the athletic teams of the
two local high schools. The company sews the blankets from fabric and sews on a logo patch
purchased from the licensed logo store site. The teams are as follows:
▪ Knights, with red blankets and the Knights logo
▪ Raiders, with black blankets and the Raider logo
Also, the black blankets are slightly larger than the red blankets.
The budgeted direct-cost inputs for each product in 2014 are as follows:
Unit data pertaining to the direct materials for March 2014 are as follows:
6-6
Unit cost data for direct-cost inputs pertaining to February 2014 and March 2014 are as follows:
Manufacturing overhead (both variable and fixed) is allocated to each blanket on the basis of
budgeted direct manufacturing labor-hours per blanket. The budgeted variable manufacturing
overhead rate for March 2014 is $16 per direct manufacturing labor-hour. The budgeted fixed
manufacturing overhead for March 2014 is $14,640. Both variable and fixed manufacturing
overhead costs are allocated to each unit of finished goods.
Data relating to finished goods inventory for March 2014 are as follows:
Budgeted sales for March 2014 are 130 units of the Knights blankets and 190 units of the Raiders
blankets. The budgeted selling prices per unit in March 2014 are $229 for the Knights blankets
and $296 for the Raiders blankets. Assume the following in your answer:
▪ Work-in-process inventories are negligible and ignored.
▪ Direct materials inventory and finished goods inventory are costed using the FIFO method.
▪ Unit costs of direct materials purchased and finished goods are constant in March 2014.
Required:
1. Prepare the following budgets for March 2014:
a. Revenues budget
b. Production budget in units
c. Direct material usage budget and direct material purchases budget
d. Direct manufacturing labor budget
e. Manufacturing overhead budget
f. Ending inventories budget (direct materials and finished goods)
g. Cost of goods sold budget
2. Suppose Lame Specialties decides to incorporate continuous improvement into its budgeting
process. Describe two areas where it could incorporate continuous improvement into the
budget schedules in requirement 1.
SOLUTION
1a. Revenues Budget
Knights
Blankets
Raiders
Blankets
Total
Units sold
130
190
Selling price
$ 229
$ 296
Budgeted revenues
$29,770
$56,240
$86,010
b. Production Budget in Units
Knights
Blankets
Raiders
Blankets
Budgeted unit sales
130
190
Add budgeted ending fin. goods inventory
22
27
Total requirements
152
217
Deduct beginning fin. goods inventory
12
17
Budgeted production
140
200
c. Direct Materials Usage Budget (units)
Red
wool
Black
wool
Knights logo
patches
Raiders logo
patches
Total
Knights blankets:
1. Budgeted input per f.g. unit
4
–
1
–
2. Budgeted production
140
–
140
–
3. Budgeted usage (1 × 2)
560
–
140
–
Raiders blankets:
6-8
4. Budgeted input per f.g. unit
–
5
–
1
5. Budgeted production
–
200
–
200
6. Budgeted usage (4 × 5)
–
1,000
–
200
7. Total direct materials
usage (3 + 6)
560
1,000
140
200
Direct Materials Cost Budget
8. Beginning inventory
35
15
45
60
9. Unit price (FIFO)
$ 9
$ 12
$ 7
$ 6
10. Cost of DM used from
beginning inventory (8 × 9)
$ 315
$ 180
$315
$ 360
$ 1,170
11. Materials to be used from
purchases (7 – 8)
525
985
95
140
12. Cost of DM in March
$ 10
$ 11
$ 7
$ 8
13. Cost of DM purchased and
used in March (11 × 12)
$5,250
$10,835
$665
$1,120
$17,870
14. Direct materials to be used
(10 + 13)
$5,565
$11,015
$980
$1,480
$19,040
Direct Materials Purchases Budget
Red wool
Black
wool
Knights
logos
Raiders
logos
Total
Budgeted usage
(from line 7)
560
1,000
140
200
Add target ending inventory
25
25
25
25
Total requirements
585
1,025
165
225
Deduct beginning inventory
35
15
45
60
Total DM purchases
550
1,010
120
165
Purchase price (March)
$ 10
$ 11
$ 7
$ 8
Total purchases
$5,500
$11,110
$840
$1,320
$18,770
d. Direct Manufacturing Labor Budget
Budgeted
Direct
Manuf. Labor-
Units
Hours per
Total
Hourly
Produced
Output Unit
Hours
Rate
Total
Knights blankets
140
3
420
$27
$11,340
Raiders blankets
200
4
800
$27
21,600
1,220
$32,940
e. Manufacturing Overhead Budget
Variable manufacturing overhead costs (1,220 × $16) $19,520
Fixed manufacturing overhead costs 14,640
Total manufacturing overhead costs $34,160
6-9
Total manuf. overhead cost per hour = $34,160 ÷ 1,220 = $28 per direct manufacturing
labor-hour
Fixed manuf. overhead cost per hour = $ 14,640 ÷ 1,220 = $12 per direct manufacturing
labor-hour
f. Computation of unit costs of ending inventory of finished goods
Knights
Blankets
Raiders
Blankets
Direct materials
Red wool ($10 × 4, 0)
$ 40
$ 0
Black wool ($11 × 0, 5)
0
55
Knights logos ($7 × 1, 0)
7
0
Raiders logos ($8 × 0, 1)
0
8
Direct manufacturing labor ($27 × 3, 4)
81
108
Manufacturing overhead
Variable ($16 × 3, 4)
48
64
Fixed ($12 × 3, 4)
36
48
Total manufacturing cost
$212
$283
Ending Inventories Budget
Cost per Unit
Units
Total
Direct Materials
Red wool
$ 10
25
$ 250
Black wool
11
25
275
Knights logo patches
7
25
175
Raiders logo patches
8
25
200
900
Finished Goods
Knights blankets
212
22
4,664
Raiders blankets
283
27
7,641
12,305
Total
$13,205
g. Cost of goods sold budget
Beginning fin. goods inventory, March 1, 2014 ($1,440 + $2,550) $ 3,990
Direct materials used (from Dir. materials cost budget) $19,040
Direct manufacturing labor (Dir. manuf. labor budget) 32,940
Manufacturing overhead (Manuf. overhead budget) 34,160
Cost of goods manufactured 86,140
Cost of goods available for sale 90,130
Deduct ending fin. goods inventory, March 31, 2014 (Inventories budget) 12,305
Cost of goods sold $77,825
2. Areas where continuous improvement might be incorporated into the budgeting process:
(a) Direct materials. Either an improvement in usage or price could be budgeted. For
example, the budgeted usage amounts for the fabric could be related to the maximum
6-10
improvement (current usage – minimum possible usage) of yards of fabric for either
blanket. It may also be feasible to decrease the price paid, particularly with quantity
discounts on things like the logo patches.
(b) Direct manufacturing labor. The budgeted usage of 3 hours/4 hours could be
continuously revised on a monthly basis. Similarly, the manufacturing labor cost per
hour of $27 could be continuously revised down. The former appears more feasible
than the latter.
(c) Variable manufacturing overhead. By budgeting more efficient use of the allocation
base, a signal is given for continuous improvement. A second approach is to budget
continuous improvement in the budgeted variable overhead cost per unit of the
allocation base.
(d) Fixed manufacturing overhead. The approach here is to budget for reductions in the
year-to-year amounts of fixed overhead. If these costs are appropriately classified as
fixed, then they are more difficult to adjust down on a monthly basis.
6-31 (45 min.) Budgeted costs, Kaizen improvements.
Trendy T-Shirt Factory manufactures plain white and solid- colored T-shirts. Inputs include the
following:
Additionally, the colored T-shirts require 3 ounces of dye per shirt at a cost of $0.40 per ounce.
The shirts sell for $14 each for white and $18 each for colors. The company expects to sell 12,000
white T-shirts and 60,000 colored T-shirts uniformly over the year.
Trendy has the opportunity to switch from using the dye it currently uses to using an
environmentally friendly dye that costs $1.25 per ounce. The company would still need 3 ounces
of dye per shirt. Trendy is reluctant to change because of the increase in costs (and decrease in
profit), but the Environmental Protection Agency has threatened to fine the company $120,000 if
it continues to use the harmful but less expensive dye.
Required:
1. Given the preceding information, would Trendy be better off financially by switching to the
environmentally friendly dye? (Assume all other costs would remain the same.)
2. Assume Trendy chooses to be environmentally responsible regardless of cost, and it switches
to the new dye. The production manager suggests trying Kaizen costing. If Trendy can reduce
fabric and labor costs each by 1% per month, how close will it be at the end of 12 months to
the profit it would have earned before switching to the more expensive dye? (Round to the
nearest dollar for calculating cost reductions.)
3. Refer to requirement 2. How could the reduction in material and labor costs be accomplished?
Are there any problems with this plan?
