CHAPTER XII

BUDGETING AND BUDGETARY CONTROL SYSTEM

SOLUTIONS TO BUSINESS APPLICATION CASES

Case 1. PARSHWA & COMPANY

1. a. Production budget units:

January February March Total
Sales in units 20,000 24,000 16,000 60,000
Plus: Ending inventory 12,000 8,000 9,000 9,000
Total units required 32,000 32,000 25,000 69,000
Less: Beginning inventory 10,000 12,000 8,000 10,000
Units to be produced 22,000 20,000 17,000 59,000

b. Direct labour budget (hours):

January February March Total
Units to be produced 22,000 20,000 17,000 59,000
Direct labour hours per unit  4.0  4.0  3.5  3.856
Total labour budget (hours)88,000 80,000 59,500 227,500*

c. Direct materials cost budget:

January February March Total
Units to be produced 22,000 20,000 17,000 59,000
Cost per unit  Rs.10  Rs.10  Rs.10  Rs.10
Total direct materials
cost Rs.220,000 Rs.200,000 Rs.170,000 Rs.590,000

d. Sales budget (dollars):

January February March Total
Sales in units 20,000 24,000 16,000 60,000
Sales price per unit  Rs.80  Rs.80  Rs.75  Rs.78.67
Total sales revenue Rs.1,600,000Rs.1,920,000Rs.1,200,000
Rs.4,720,000*
*Rounded
2. Parshwa & Company
Budgeted Contribution Margin
First Quarter, 2004
January February March Total
 Direct labour hours
per unit 4.0 4.0 3.5
Direct labour rate
per hour  Rs.15  Rs.15  Rs.16
Direct labour cost Rs. 60 Rs. 60 Rs. 56
Sales units  20,000  24,000  16,000 60,000
Direct labour cost Rs.1,200,000 Rs.1,440,000 Rs.896,000 Rs.
3,536,000
Sales revenue Rs.1,600,000 Rs.1,920,000 Rs.1,200,000 Rs.
4,720,000
Direct labour cost 1,200,000 1,440,000 896,000 3,536,000
Direct materials cost 200,000 240,000 160,000 600,000
Contribution margin Rs.200,000 Rs.240,000 Rs. 144,000 Rs. 584,000

Case 2 ANGEL COMPANY

Angel Company
a. Schedule 1: Sales budget (units in thousands)
Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total
Units 60 65 75 90 290
Unit price Rs.400 Rs.400 Rs.400 Rs.400  Rs.400
Total sales Rs.24,000 Rs.26,000 Rs.30,000 Rs.36,000
Rs.116,000

b. Schedule 2: Production budget

Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total
Sales (Sch. 1) 60,000 65,000 75,000 90,000 290,000
Desired ending
inventory 13,000 15,000 20,000 10,000 10,000
Total needs 73,000 80,000 95,000 100,000 300,000
Less: Beginning
inventory 0 13,000 15,000 20,000 0
Production 73,000 67,000 80,000 80,000 300,000

c. Schedule 3: Direct materials purchases budget (units in thousands)

Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total
Production 73.0 67.0 80.0 80.0 300.0
Materials/unit  3  3  3  3  3
Production needs 219.0 201.0 240.0 240.0 900.0
Desired ending
inventory 58.5 67.5 81.0 65.7 65.7
Total needs 277.5 268.5 321.0 305.7 965.7
Less: Beginning
 inventory 65.7 58.5 67.5 81.0 65.7
Purchases 211.8 210.0 253.5 224.7 900.0
Cost per unit  Rs.80  Rs.80  Rs.80  Rs.80  Rs.80
Purchase cost Rs.16,944 Rs.16,800 Rs.20,280 Rs.17,976 Rs.
72,000

d. Schedule 4: Direct labour budget (in thousands)

Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total
Production 73 67 80 80 300
Hours per unit  5  5  5  5  5
Hours needed 365 335 400 400 1,500
Cost per hour Rs.10 Rs.10 Rs.10 Rs.10  Rs.10
Total cost Rs.3,650 Rs.3,350 Rs.4,000 Rs.4,000 Rs.
15,000

e. Schedule 5: Overhead budget (in thousands)

Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total
Budgeted hours 365 335 400 400 1,500
Variable rate  Rs.6  Rs.6  Rs.6  Rs.6  Rs.6
Budgeted VOH Rs.2,190 Rs.2,010 Rs.2,400 Rs.2,400 Rs.
9,000
Budgeted FOH 1,000 1,000 1,000 1,000 4,000
Total OH Rs.3,190 Rs.3,010 Rs.3,400 Rs.3,400 Rs.
13,000

f. Schedule 6: Administrative expense budget (in thousands)

Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total
Planned sales 60 65 75 90 290
Variable rate Rs.10 Rs.10 Rs.10 Rs.10 
Rs.10
Variable expenses Rs.600 Rs.650 Rs.750 Rs.900 Rs.2,900
Fixed expenses 250 250 250 250 1,000
Total expenses Rs.850 Rs.900 Rs.1,000 Rs.1,150 Rs.3,900

g. Schedule 7: Ending finished goods inventory budget

Unit cost computation:
Direct materials (3 units  Rs.80) Rs.240.00
Direct labour (5 hours  Rs.10) 50.00
Variable overhead (5 hours  Rs.6) 30.00
Fixed overhead (Rs.4,000,000/300,000) 13.33
Total unit cost Rs.333.33
Units Cost per unit Total Amount
Finished goods inventory: 10,000 Rs.333.33 Rs.3,333,300
h. Schedule 8: Cost of goods sold budget
Direct materials used (Sch. 3) Rs. 72,000,000
Direct labour used (Sch. 4) 15,000,000
Overhead (Sch. 5) 13,000,000
Budgeted manufacturing costs Rs.100,000,000
Add: Beginning finished goods 0
Goods available for sale Rs.100,000,000
Less: Ending finished goods (Sch. 7) 3,333,300
Budgeted cost of goods sold Rs. 96,666,700

i. Cash budget (in thousands)

Qtr. 1 Qtr. 2 Qtr. 3 Qtr. 4 Total
Beginning cash bal. Rs. 250 Rs. 640 Rs.2,308 Rs.4,868 Rs. 250
Collections:
Credit sales:
Current quarter 20,400 22,100 25,500 30,600 98,600
Prior quarter 3,300 3,600 3,900 4,500 15,300
Cash available Rs.23,950 Rs.26,340 Rs.31,708 Rs.39,968
Rs.114,150
Less disbursements:
Materials:
Current quarter Rs.8,472 Rs.8,400 Rs.10,140 Rs.8,988 Rs.
36,000
Prior quarter 7,248 8,472 8,400
10,140 34,260
Direct labour 3,650 3,350 4,000
4,000 15,000
Overhead 2,840 2,660 3,050
3,050 11,600
Selling and admin. 800 850 950
1,100 3,700
Dividends 300 300 300300 1,200
Equipment 2,000 2,000
Total cash needs Rs.23,310 Rs.24,032 Rs.26,840Rs.29,578
Rs.103,760
Ending cash balance Rs. 640 Rs.2,308 Rs.4,868 Rs.10,390 Rs.
10,390

j. Pro Forma Income Statement

For the Year Ended December 31, 2007
Sales (Sch. 1).............................................................................. Rs.116,000,000
Less: Cost of goods sold (Sch. 8)............................................ 96,666,700
Gross margin.............................................................................. Rs. 19,333,300
Less: Selling & administrative expenses (Sch. 6).................. 3,900,000
Income before income taxes............................................... Rs. 15,433,300

k. Angel Company
 Pro Forma Balance Sheet
December 31, 2007
Assets
Cash............................................................................................. Rs.10,390,000
Accounts receivable.................................................................. 5,400,000
Inventory..................................................................................... 3,333,300
Materials...................................................................................... 5,256,000
Plant and equipment.................................................................. 33,900,000a
Total assets........................................................................... Rs.58,279,300

Liabilities and Stockholders’ Equity

Current liabilities:
Accounts payable................................................................. Rs.8,988,000
Stockholders’ equity:
Capital stock.......................................................................... 27,000,000
Retained earnings................................................................. 22,291,300b
Total liabilities and stockholders’ equity................................. Rs.58,279,300
a
Beginning plant and equipment................... Rs.33,500,000
Add: New equipment..................................... 2,000,000
Less: Depreciation expense......................... (1,600,000)
Ending plant and equipment.................... Rs.33,900,000
b
Beginning retained earnings........................ Rs.8,058,000
Add: Net income............................................ 15,433,300
Less: Dividends paid..................................... (1,200,000)
Ending retained earnings......................... Rs.22,291,300

Case 3 MAX Company

1. Overhead rate = Rs.423,167/13,446 = Rs.31.47 per machine hour

Month Predicted Overhead Actual Overhead Variance
January Rs.31,470 Rs.32,296 Rs.826 U
February 29,267 31,550 2,283 U
March 34,617 36,280 1,663 U
April 33,044 36,867 3,823 U
May 36,820 36,790 30 F
June 37,764 37,800 36 U
July 38,865 40,024 1,159 U
August 37,449 39,256 1,807 U
September 33,673 33,800 127 U
October 38,079 33,779 4,300 F
November 37,984 37,225 759 F
December 34,113 27,500 6,613 F
 Total Rs.423,145 Rs.423,167 Rs. 22 U

2. The regression for overhead costs as a function of machine hours gives the
following formula:
Overhead cost = Rs.8,699.64 + Rs.23.71 MHrs.
Month Predicted Overhead Actual Overhead Variance
January Rs.32,410 Rs.32,296 Rs.114 F
February 30,750 31,550 800 U
March 34,781 36,280 1,499 U
April 33,595 36,867 3,272 U
May 36,440 36,790 350 U
June 37,152 37,800 648 U
July 37,981 40,024 2,043 U
August 36,915 39,256 2,341 U
September 34,069 33,800 269 F
October 37,389 33,779 3,610 F
November 37,318 37,225 93 F
December 34,401 27,500 6,901 F
Total Rs.423,201 Rs.423,167 Rs. 34 F
The flexible budget based on machine hours is better than the budget using
only the plantwide overhead rate because the flexible budget divides
overhead costs into fixed and variable components. This division would at
least give the controller the ability to make a rough calculation of the marginal
cost of running additional machine hours at the factory. However, the
regression equation on which the flexible budget is based is not particularly
good (adjusted R2 of 0.345).

3. The multiple regression for overhead cost gives the following formula:
Overhead cost = Rs.6,035.99 + Rs.4.56 MHrs. + Rs.771.10 setups + Rs.29.94
PO
Month Predicted Overhead Actual Overhead Variance
January Rs.32,485 Rs.32,296 Rs.189 F
February 31,642 31,550 92 F
March 36,227 36,280 53 U
April 36,643 36,867 224 U
May 36,868 36,790 78 F
June 37,971 37,800 171 F
July 39,583 40,024 441 U
August 39,041 39,256 215 U
September 33,972 33,800 172 F
October 34,356 33,779 577 F
November 37,359 37,225 134 F
December 27,037 27,500 463 U
 Total Rs.423,184 Rs.423,167 Rs.17 F
The flexible budget based on multiple regression is much better than the one
based on simple regression. Multiple regression enables the controller to use
three independent variables, each based on a different driver. We can see that
the R2 has improved considerably (to 0.99). In addition, if we compare the
monthly variances of the two budgets, the flexible budget using three
variables shows a much smaller monthly variation. As a result, this budget
will be more useful to the controller for planning and decision making. Finally,
the use of the three independent variables moves the factory closer to the
more powerful technique of activity-based budgeting.

The multiple regression for overhead cost gives the following formula:
OH = Rs.5,715.47 + Rs.3.74 MHrs. + Rs.767.03 setups + Rs.34.68 PO +
Rs.887 Party
Month Predicted Overhead Actual Overhead Variance
January Rs.32,287 Rs.32,296 Rs. 9 U
February 31,670 31,550 120 F
March 36,341 36,280 61 F
April 36,648 36,867 219 U
May 36,850 36,790 60 F
June 37,702 37,800 98 U
July 40,150 40,024 126 F
August 39,083 39,256 173 U
September 33,901 33,800 101 F
October 33,878 33,779 99 F
November 37,235 37,225 10 F
December 27,364 27,500 136 U
Total Rs.423,109 Rs.423,167 Rs.58 U
The flexible budget based on multiple regression with the four variables is
better than the one using multiple regression with three variables. The R 2 for
both regressions is 0.99, so that is not the deciding factor. Instead, we see
that the addition of the “Party” variable begins to move the budget even more
in the direction of activity-based budgeting, since the throwing of the parties
is an activity. In this case, we see that each party costs the factory about
Rs.887. Now, managers can begin to balance the cost of the parties with the
benefits (probably improved morale).

Case 4 Gurudev Ltd.

1. a. The flexible budget for May is based on 4,800 units.

Revenue (4,800  Rs.240)............................... Rs.1,152,000
Less variable costs:
 Direct material (Rs.60  4,800).................. Rs.288,000
Direct labour (Rs.44  4,800).................... 211,200
Variable overhead (Rs.36  4,800)........... 172,800
Variable selling (Rs.12  4,800)................ 57,600
Total variable costs.............................. 729,600
Contribution margin........................................ Rs.422,400
Less fixed costs:
Factory overhead....................................... Rs.180,000
General and administrative...................... 120,000 300,000
Operating income............................................ Rs.122,400

b. Flexible
Actual Budget
Variance
Revenue Rs.1,152,000 Rs.1,152,000 —
Less variable costs:
Direct material 320,000 288,000 Rs.32,000
U
Direct labour 192,000 211,200 (19,200) F
Variable overhead 176,000 172,800 3,200 U
Selling expense 92,000 57,600 34,400 U
Contribution margin Rs.372,000 Rs.422,400 Rs.50,400
U
Less fixed costs:
Factory overhead 180,000 180,000 —
General & administrative 115,000 120,000 (5,000) F
Operating income Rs. 77,000 Rs.122,400 Rs.45,400
U

2. Ram Chandra may be encouraged by the revised data as most of the variable
cost variance is not his responsibility. The direct labour variance is favorable,
indicating that the cost-cutting measures that he implemented in the
manufacturing area have been effective. The report shows unfavorable
budget variances for direct materials and variable selling expense. He may be
encouraged to work with the people responsible for these areas to control
costs.