Chapter 16

Budgeting: Capital Expenditures, Research and Development Expenditures, and Cash; PERT/Cost; the Flexible Budget

Discussion Questions

1) A capital expenditure is an expenditure intended to benefit future periods. It is normally associated with the acquisition or improvement of plant assets. The real distinction between a capital and revenue expenditure is not the immediate charging of the expenditure to income, as opposed to its gradual amortization, but the length of time required for its recovery in cash. Recoveries of revenue expenditures, such as product costs, are expected to take place in a matter of weeks or, at the most, months. The financial recovery of capital expenditures is measured in terms of years. 2) Purposes of a research and development program are: (a) A planned search for new knowledge pertaining to the industry without reference to a specific application. (b) Creation of a new product or improvement of an existing product. (c) Invention of a new or improved process or machinery to make a finished product or component. Reasons for a research and development program are: (a) To protect the sales dollar, that is, to meet competition. Improving the quality of performance of products or achieving cost savings in either operating or capital expenditures falls into this category. (b) To do research to promote new sales dollars, either by entering a new market or by significantly expanding an existing market. (c) To investigate problems with respect to environmental protection, safety, working conditions, etc.3) Budgetary procedures for research and development expenditures are designed to: (a) force management to think about planned expenditures; (b) coordinate research and development plans with the immediate and long-range plans of the company; (c) force the research and development staff to consider major nonfinancial aspects of the program, such as personnel, equipment, and facilities requirements.4) A cash budget involves detailed estimates of anticipated cash receipts and disbursements for a specified period of time. It is designed to assist management in coordinating cash flow from operations as a basis for financial plans and control. The cash budget provides a systematic approach to the synchronization of cash resources with needs. It assists management in making intelligent decisions concerning capital expenditures, dividend policies, investments, and other financial matters, and often exerts a cautionary influence on any of the above

plans. Periodic reports comparing actual with planned receipts and disbursements permit effective and continuous control of cash by signaling significant deviations from the financial plans for the period.5) The budgeted balance sheet reveals the expected financial condition at the end of a particular period. One of the measures of the adequacy of proposed operating and financial plans is the effect of the execution of these plans on the financial condition of the business. If the budgeted balance sheet shows a potential unsatisfactory condition, proposed plans can be reviewed and perhaps revised to produce satisfactory results.6) Prospective information should be provided in external financial statements when it will enhance the reliability of the user’s predictions.7) (a) Nonmanufacturing businesses must plan for the future just as carefully as manufacturing concerns. Seasonal patterns in revenues and expenditures must be provided for, and required equipment replacement and expansions must be budgeted. (b) Not-for-profit organizations generally operate on relatively fixed incomes that are received at one time. Such receipt patterns are common for organizations that rely on tax dollars for support. These funds must be allocated throughout the year in order to maintain operations. Careful budget plans are a necessity for such allocations.8) PPBS stand for Planning, Programming, Budgeting System, and is an analytical tool focused on the output or final results rather than input or initial dollars expended. The output is directly relatable to planned goals or objectives.9) Zero-base budgeting (ZBB) is a planning and budgeting tool using cost-benefit analysis of projects and functions to improve an organization’s resource allocation. Budget requests consist of decision packages that are analyzed, evaluated, and ranked in a priority order based on cost-benefit analysis. Management can then evaluate possible activities for the coming period, selecting those that will best achieve organizational goals. Traditional budgeting tends to concentrate on the differential change from the prior year, assuming that existing activities are essential, must be continued, are currently performed in a cost-efficient and optimum manner, and will be cost-effective in the coming year. Costs are developed more on a line-item rather than an activity basis. ZBB organizes all budget costs in the form of activities and/or operations (decision packages) and

evaluates the effectiveness of each decision package as if it were a new activity. 10) Strengths: (1) all proposed activities (existing and new) are identified, evaluated, and justified. (2) Assumptions are systematically identified and related to the activity. (3) Funding of activities is more systematic. (4) Flexible contingency planning is enhanced because all activities are ranked on a priority basis. Weaknesses: (1) Time and cost to implement and maintain may outweigh benefits. (2) Lack of commitment or gamesmanship by lower management, may dilute ZBB’S effectiveness. (3) Ranking of designer activities is difficult. 11) The role of PERT in project development is in estimating, scheduling, and controlling, with primary emphasis on the relative timing of a network of interdependent tasks or activities necessary for project completion. 12) PERT is particularly appropriate as a scheduling and controlling technique for projects consisting of a large number of tasks, some of which cannot be started until others are complete, and some of which can be undertaken concurrently. Conceptually, the reference is to a network of interdependent activities which, as a group, require considerable time to complete. There is usually substantial set-up time (and cost) associated with analyzing, defining, and estimating each discrete project activity; thus, the benefit is in projects requiring a considerable amount of time and consisting of a relatively complex network. PERT allows the user to update and revise scheduled activities and thereby determine the effects of changes on the overall project. It is particularly appropriate when the timing of individual activities and the project completion date are critical to success. 13) Slack is computed by subtracting the earliest expected time from the latest allowable time. The earliest expected time is the earliest time that an activity can be expected to start, because of its relationship to pending activities. The latest allowable time is the latest time that an activity may begin and not delay completion of the project. Slack

is determinable only in relation to an entire path through the network.14) PERT/cost is really an extension of PERT. With time-options available, it seems advisable to assign cost to time and activities, thereby providing total financial planning and control by functional responsibility.15) Computer support offers distinct advantages to PERT users. PERT is a mathematically oriented technique and is therefore ideally suited to the high-speed response of computers for deriving the critical path, slack times, and costs, and for storing and reporting results to management. Revisions to all schedule elements, whether during the initial estimating phase or during the active project phase, can be updated and the revised results promptly reported. Computer support is helpful in dealing with large, complex networks of interdependencies and when project control requires timely progress reporting against the updated plan. Most program packages offer a variety of reporting features and formats, including graphic network display as well as printed reports at various summary levels. Current reporting provides information to project managers, enabling quick reaction to deviations.16) See book page 47617) The traditional budget focuses on one set of assumptions. The probabilistic budget provides for evaluating several sets of assumptions, including the probability of each and a composite expected value, range, and standard deviation for each budget element.18) The flexible budget (a) provides the monthly budget allowance regardless of the fluctuating monthly volume of production; (b) permits not having to estimate the operating activity of a month in advance of the period for which the budget is prepared; and (c) recognizes the fixed and variable nature of costs, which leads to easy adjustments when evaluating actual performance.19) See book page 48120) Self answer by student21) See book page 485

E-1

Cash Receipts

For the month of April

$

February sale (12%) 4800

March (60% after discount 40740

25%) 17500

Total 63040

E-2

(1)

Cash collection

For the month of May

$

March (25%) 25,000

April (50%) 90,000

May (20%) 30,000

Total 145,000

(2)

Balance of account receivable at April, 30

$

February (5%) 8,000

March (30%) 30,000

April (80%) 144,000

Total 254,000

(3)

Balance of account receivable on May 31

$

March (5%) 5,000

April (30%) 54,000

May (80%) 120,000

Total 179,000

Ex-3

Cash Disbursement

For the month of June

$

Cost of goods sold (700,000 x 70%) 490,000

Inventory increase 10,000

Total purchases 500,000

S, G, & A Expenses

71,000+ (700,000×15/100)

176,000

Less: uncollectibles

(700,000×1/100) 7000

Depreciation 40000 129000

Total 629,000

Ex-4

Par production budget:

June JulyUnits required to meet sales budget .......................... 50,000 30,000Add desired ending inventory..................................... 3,000 3,000Total units required ...................................................... 53,000 33,000Less beginning inventory ............................................ 5,000 3,000Planned production..................................................... 48,000

30,000

Tee purchases budget:June July

Units required for production:48,000 × 3 ............................................................. 144,00030,000 × 3 ............................................................. 90,000Add desired ending inventory..................................... 14,000 11,000

158,000 101,000Less beginning inventory ......................................... 20,000 14,000Units to be purchased................................................ 138,000 87,000

Cash disbursements in July for purchases of Tee:138,000 × $5 × 1/3 × .98 = $225,40087,000 × $5 × 2/3 × .98 = 284,200

$509,600

Ex-5 (1)

Cash Budget

For the month of July,

$ $

Balance Jul, 1 5000

Cash collection from receivables

June (48%) 14,400

July (50%) 20000 34400

Total cash available 39400

Cash Disbursements

Income Tax for Jun

(4000×40/100) 1600

Payment to creditors

Jun (75%) 7500

Jul (25%) 3750

Marketing & Admin expenses 10000

Dividend 15,000 37850

1550

Financing

Borrow 3450

Repayment -------

Closing Balance 5000

(2) Since the desired minimum cash balance is $5,000, arrangements should be made to borrow $3,450 ($5,000 – $1,550).

E- 6 to E-10 PERT topic dropped

E-11 (1)UNIVERSITY MOTOR POOLBudget Report for March

Monthly March (Over)

Budget Actual Under

Gasoline $ 5,513 $ 5,323 $190Oil, minor repairs, parts, and supplies 378 380

(2)Outside repairs 236 50 186Insurance 525 525 —Salaries and benefits 2,500 2,500 —Depreciation 2,310 2,310 — Total $11,462 $11,088 $374

Number of automobiles 21 21 —Total miles 63,000 63,000 —Cost per mile $.1819 $.1760 $.0059

(2) Supporting calculations for monthly budget amounts:

Gasoline: 63,000 miles × $1.40 per gallon = $5,512.50 16 miles per gal.

Oil, minor repairs, parts, and supplies: 63,000 × $.006 per mile = $378

Outside repairs: $135 per auto × 21 autos 12 months

= $236.25

Insurance: Annual cost for one auto: $6,000 ÷ 20 autos = $300Annual cost for 21 autos: 21 × $300 = $6,300Monthly cost: $6,300 ÷ 12 = $525

Salaries and benefits: No change$30,000 annual cost = $2,500 per month

12 months

Depreciation: Annual depreciation per auto: $26,400 ÷ 20 autos = $1,320Annual depreciation for 21 autos: $1,320 per auto × 21 = $27,720Monthly depreciation: $27,720 ÷ 12 = $2,310

E-12

BASSTON COMPANYAssembly Department

Flexible Budget—92% Level

Direct materials (92% × $20,000) $18,400Direct labor (92% × $11,250) 10,350Supervision 500Indirect materials ($250 + (92% × ($1,750 – $250))) 1,630Property tax 300Maintenance ($600 + (92% × ($1,600 – $600))) 1,520Power ($200 + (92% × ($300 – $200))) 292Insurance 175Depreciation 1,600Total $34,767

E-13

BIRCH COMPANYAssembly Department

Flexible Budget for one month

60% Capacity 75% CapacityUnits 2,280 2,850Direct labor hours 1,920 2,400Direct materials $2,856 $3,570Direct labor 17,280 21,600Fixed F.O.H 670 670Supplies 441.60 552Indirect labor 2,160 2,700Other charges 345.60 432

Total $23,753.20 $29,524 Cost per unit $10.42 $10.36

E-14

ALBANESE INC.Flexible Budget for one month

60% Capacity 80% Capacity 100% CapacityUnits 1,440 1,920 2,400Direct labor hours 960 1,280 1,600Direct materials $2,880 $3,840 $4,800Direct labor 6,048 8,064 10,080Fixed F.O.H 960 960 960Supplies 240 320 400Indirect labor 1,008 1,344 1,680Other charges 432 576 720

Total Cost $11,568 $15,104 $18,640

Cost per unit $8.03 $7.87 $7.77

PROBLEMS

P-1

(1) Budgeted cash disbursements during June:

Purchase of materials:May (11,2501 × $20 × 46%) $103,500June (12,1802 × $20 × 54%) 131,544 $235,044

Marketing, general, and administrative expenses:May ($51,5503 × 46%) $23,713June ($49,3004 × 54%) 26,622 50,335Wages and salaries 37,9005

Total $323,279

1May 31 ending inventory (11,400 × 130%).................. 14,820 unitsMay production............................................................. 11,900Materials needed in May .............................................. 26,720 unitsApril 30 ending inventory ($309,400 ÷ $20) ............... 15,470May purchases..............................................................11,250 units

2June 30 ending inventory (12,000 × 130%) ................ 15,600 unitsJune production............................................................ 11,400Materials needed in June............................................. 27,000 unitsMay 31 ending inventory.............................................. 14,820June purchases ............................................................ 12,180 units

3($357,000 May sales × 15%) – $2,000 depreciation = $51,5504($342,000 June sales × 15%) – $2,000 depreciation = $49,300

5Accrued payroll on June 1...........................$ 3,300Payroll earned during June........................... 38,000

$41,300Accrued payroll on June 30.......................... 3,400Cash paid out for payroll ........................ $37,900

(2) Budgeted cash collections during May:

March sales ($354,000 × 9%) .............................. $ 31,860April sales ($363,000 × 97% × 60%)................... 211,266April sales ($363,000 × 25%) .............................. 90,750Total ................................................................... $333,876

(3) Budgeted units of inventory to be purchased during July:

July 31 ending inventory (12,200 × 130%) ........ 15,860 unitsJuly production.................................................... 12,000Materials needed in July:.................................... 27,860 unitsJune 30 ending inventory (12,000 × 130%) ....... 15,600July purchases.................................................. 12,260 units

P-3

MAYNE MANUFACTURING COMPANYCash Budget

For the Years Ending March 31

19B 19C

Balance of cash at beginning 0 $ 75,000Cash generated from operations:Collections from customers—Schedule A $825,000 $1,065,000

Disbursements:Direct materials—Schedule B $220,000 $ 245,000Direct labor 300,000 360,000Variable overhead 100,000 120,000Fixed costs 130,000 130,000Total disbursements $750,000 $855,000

Excess of cash collections over cashdisbursements from operations $ 75,000 210,000Cash available from operations $ 75,000 $285,000

Cash received from liquidation of existing accounts receivable and inventories . 90,000 0 Total cash available $165,000 $285,000

Payments to general creditors(liquidation proceeds) 90,000 270,0002Balance of cash at end $ 75,0001 $ 15,000

1This amount could have been used to pay general creditors or carried forward to the beginning of the next year.

2($600,000 × 60%) – $90,000

Schedule A — Collections from customers:19B 19C

Sales $900,000 $1,080,000Beginning accounts receivable 0 75,000Total $900,000 $1,155,000Less ending accounts receivable 75,000 90,000Collections from customers $825,000 $1,065,000

Schedule B — Disbursements for direct materials:19B 19C

Direct materials required for production $200,000 $240,000Required ending inventory 40,0003 50,000 4Total $240,000 $290,000Less beginning inventory 0 40,000Purchases $240,000 $250,000Beginning accounts payable 0 20,000Total $240,000 $270,000Less ending accounts payable 20,000 25,000Disbursements for direct materials $220,000 $245,000

312,000 units × 2/12 = 2,000; 2,000 × $20 per unit = $40,000415,000 units × 2/12 = 2,500; 2,500 × $20 per unit = $50,000

P -4

Cash Budget

For September & October

Sep Oct

$ $

Opening Balance 13000 (8750)

Cash Collection

Cash sales 40000 60000

Collection from A/R

Jul 10000 -

Aug 48000 12000

Sep 38750 31000

Oct - 47500

Total 136750 136750

Total cash available 149750 149750

Cash Disbursements

Cash purchases 20,000 20,000

Payment to creditors 92000 80,000

Operating exp 46,500 10,000

Total Cash Disbursements 158500 110,000

Closing Balance (8750) 31750

Working

Sep

A/P

Cash purchases 92000

Discount 6000

Bal 12000

110,000

Bal 10000

Purchases 100,000

______

110,000

Oct

A/P

Cash 80,000

Discount 3000

Bal 9000

92000

Bal 12000

Purchases 80,000

_____

92000

P-5 (1)

TRIPLE-F HEALTH CLUBBudgeted Statement of Income (Cash Basis)

For the Year Ending October 31, 19C(000s omitted)

Cash revenue:Annual membership fees, $355 × 1.1 × 1.03...................................... $402.2Lesson and class fees, $234 × $234 .................................................. 304.2 $180Miscellaneous, $2.0 × $2..................................................................... 2.7 $1.5Total cash revenue...................................................................... $709.1

Cash expenses:Manager’s salary and benefits, $36 × 1.15 ........................................ $ 41.4Regular employees’ wages and benefits, $190 × 1.15...................... 218.5Lesson and class employee wages and benefits, $195 × 1.3 × 1.15 291.5Towels and supplies, $16 × 1.25......................................................... 20.0Utilities (heat and light), $22 × 1.25.................................................... 27.5Mortgage interest, $360 ×.09............................................................... 32.4Miscellaneous, $2 × 1.25 ..................................................................... 2.5Total cash expenses ................................................................... $633.8

Cash income ...................................................................................... $ 75.3

Cash payments:Mortgage payment............................................................................... $ 30.0Accounts payable balance at 10/31/B................................................ 2.5Accounts payable on equipment at 10/31/B...................................... 15.0Planned new equipment purchase..................................................... 25.0Total cash payments................................................................... $ 72.5

Cash surplus......................................................................................... $ 2.8Beginning cash balance .......................................................................... 8.3Cash available for working capital and to acquire property ................... 10.1

(2) Operating problems that Triple-F Health Club could experience in 20C include: (a) The lessons and classes contribution to cash will decrease because the projected wage increase for lesson and class employees is not made up by the increased volume of lessons and classes. (b) Operating expenses are increasing faster than revenues from membership fees. (c) Triple-F seems to have a cash management problem. Although there appears

to be enough cash generated for the club to meet its obligations, past due amounts occur. Perhaps the cash balance may not be large enough for day-to-day operating purposes.

(3) Jane Crowe’s concern with regard to the board’s expansion goals are justified. The 19C budget projections show only a minimal increase of $2.8 in the cash balance. The total cash available is well short of the $60.0 annual additional cash needed for the land purchase over and above the club’s working capital needs; however, it appears that the new equipment purchases can be made on an annual basis. If the board desires to purchase the adjoining property, it is going to have to consider significant increases in fees or other methods of financing, such as membership bonds or additional mortgage debt.