Chapter 16

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

Discussion Questions receipts and disbursements permit effective and

continuous control of cash by signaling significant
1) A capital expenditure is an expenditure intended to deviations from the financial plans for the period.
benefit future periods. It is normally associated with 5) The budgeted balance sheet reveals the expected
the acquisition or improvement of plant assets. The financial condition at the end of a particular period.
real distinction between a capital and revenue One of the measures of the adequacy of proposed
expenditure is not the immediate charging of the operating and financial plans is the effect of the
expenditure to income, as opposed to its gradual execution of these plans on the financial condition of
amortization, but the length of time required for its the business. If the budgeted balance sheet shows a
recovery in cash. Recoveries of revenue potential unsatisfactory condition, proposed plans can
expenditures, such as product costs, are expected to be reviewed and perhaps revised to produce
take place in a matter of weeks or, at the most, satisfactory results.
months. The financial recovery of capital 6) Prospective information should be provided in
expenditures is measured in terms of years. external financial statements when it will enhance the
2) Purposes of a research and development program reliability of the user’s predictions.
are: (a) A planned search for new knowledge 7) (a) Nonmanufacturing businesses must plan for the
pertaining to the industry without reference to a future just as carefully as manufacturing concerns.
specific application. (b) Creation of a new product or Seasonal patterns in revenues and expenditures must
improvement of an existing product. (c) Invention of be provided for, and required equipment replacement
a new or improved process or machinery to make a and expansions must be budgeted. (b) Not-for-profit
finished product or component. Reasons for a organizations generally operate on relatively fixed
research and development program are: (a) To protect incomes that are received at one time. Such receipt
the sales dollar, that is, to meet competition. patterns are common for organizations that rely on
Improving the quality of performance of products or tax dollars for support. These funds must be allocated
achieving cost savings in either operating or capital throughout the year in order to maintain operations.
expenditures falls into this category. (b) To do Careful budget plans are a necessity for such
research to promote new sales dollars, either by allocations.
entering a new market or by significantly expanding 8) PPBS stand for Planning, Programming,
an existing market. (c) To investigate problems with Budgeting System, and is an analytical tool focused
respect to environmental protection, safety, working on the output or final results rather than input or
conditions, etc. initial dollars expended. The output is directly
3) Budgetary procedures for research and relatable to planned goals or objectives.
development expenditures are designed to: (a) force 9) Zero-base budgeting (ZBB) is a planning and
management to think about planned expenditures; (b) budgeting tool using cost-benefit analysis of projects
coordinate research and development plans with the and functions to improve an organization’s resource
immediate and long-range plans of the company; (c) allocation. Budget requests consist of decision
force the research and development staff to consider packages that are analyzed, evaluated, and ranked in
major nonfinancial aspects of the program, such as a priority order based on cost-benefit analysis.
personnel, equipment, and facilities requirements. Management can then evaluate possible activities for
4) A cash budget involves detailed estimates of the coming period, selecting those that will best
anticipated cash receipts and disbursements for a achieve organizational goals. Traditional budgeting
specified period of time. It is designed to assist tends to concentrate on the differential change from
management in coordinating cash flow from the prior year, assuming that existing activities are
operations as a basis for financial plans and control. essential, must be continued, are currently performed
The cash budget provides a systematic approach to in a cost-efficient and optimum manner, and will be
the synchronization of cash resources with needs. It cost-effective in the coming year. Costs are
assists management in making intelligent decisions developed more on a line-item rather than an activity
concerning capital expenditures, dividend policies, basis. ZBB organizes all budget costs in the form of
investments, and other financial matters, and often activities and/or operations (decision packages) and
exerts a cautionary influence on any of the above evaluates the effectiveness of each decision package
plans. Periodic reports comparing actual with planned as if it were a new activity.
10) Strengths: (1) all proposed activities (existing and 14) PERT/cost is really an extension of PERT. With
new) are identified, evaluated, and justified. (2) time-options available, it seems advisable to assign
Assumptions are systematically identified and related cost to time and activities, thereby providing total
to the activity. (3) Funding of activities is more financial planning and control by functional
systematic. (4) Flexible contingency planning is responsibility.
enhanced because all activities are ranked on a 15) Computer support offers distinct advantages to
priority basis. Weaknesses: (1) Time and cost to PERT users. PERT is a mathematically oriented
implement and maintain may outweigh benefits. (2) technique and is therefore ideally suited to the high-
Lack of commitment or gamesmanship by lower speed response of computers for deriving the critical
management, may dilute ZBB’S effectiveness. (3) path, slack times, and costs, and for storing and
Ranking of designer activities is difficult. reporting results to management. Revisions to all
11) The role of PERT in project development is in schedule elements, whether during the initial
estimating, scheduling, and controlling, with primary estimating phase or during the active project phase,
emphasis on the relative timing of a network of can be updated and the revised results promptly
interdependent tasks or activities necessary for reported. Computer support is helpful in dealing with
project completion. large, complex networks of interdependencies and
12) PERT is particularly appropriate as a scheduling when project control requires timely progress
and controlling technique for projects consisting of a reporting against the updated plan. Most program
large number of tasks, some of which cannot be packages offer a variety of reporting features and
started until others are complete, and some of which formats, including graphic network display as well as
can be undertaken concurrently. Conceptually, the printed reports at various summary levels. Current
reference is to a network of interdependent activities reporting provides information to project managers,
which, as a group, require considerable time to enabling quick reaction to deviations.
complete. There is usually substantial set-up time 16) See book page 476
(and cost) associated with analyzing, defining, and 17) The traditional budget focuses on one set of
estimating each discrete project activity; thus, the assumptions. The probabilistic budget provides for
benefit is in projects requiring a considerable amount evaluating several sets of assumptions, including the
of time and consisting of a relatively complex probability of each and a composite expected value,
network. PERT allows the user to update and revise range, and standard deviation for each budget
scheduled activities and thereby determine the effects element.
of changes on the overall project. It is particularly 18) The flexible budget (a) provides the monthly
appropriate when the timing of individual activities budget allowance regardless of the fluctuating
and the project completion date are critical to monthly volume of production; (b) permits not
success. having to estimate the operating activity of a month
13) Slack is computed by subtracting the earliest in advance of the period for which the budget is
expected time from the latest allowable time. The prepared; and (c) recognizes the fixed and variable
earliest expected time is the earliest time that an nature of costs, which leads to easy adjustments when
activity can be expected to start, because of its evaluating actual performance.
relationship to pending activities. The latest 19) See book page 481
allowable time is the latest time that an activity may 20) Self answer by student
begin and not delay completion of the project. Slack 21) See book page 485
is determinable only in relation to an entire path
through the network.
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 July
Units required to meet sales budget .......................... 50,000 30,000
Add desired ending inventory..................................... 3,000 3,000
Total units required ...................................................... 53,000 33,000
Less beginning inventory ............................................ 5,000 3,000
Planned production..................................................... 48,000 30,000

Tee purchases budget:

June July
Units required for production:
48,000 × 3 ............................................................. 144,000
30,000 × 3 ............................................................. 90,000
Add desired ending inventory..................................... 14,000 11,000
158,000 101,000
Less beginning inventory ......................................... 20,000 14,000
Units to be purchased................................................ 138,000 87,000

Cash disbursements in July for purchases of Tee:

138,000 × $5 × 1/3 × .98 = $225,400
87,000 × $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 POOL
Budget Report for March
Monthly March (Over)
Budget Actual Under
Gasoline $ 5,513 $ 5,323 $190
Oil, minor repairs, parts, and supplies 378 380 (2)
Outside repairs 236 50 186
Insurance 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 = $300

Annual cost for 21 autos: 21 × $300 = $6,300
Monthly 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 = $1,320

Annual depreciation for 21 autos: $1,320 per auto × 21 = $27,720
Monthly depreciation: $27,720 ÷ 12 = $2,310
E-12

BASSTON COMPANY
Assembly Department
Flexible Budget—92% Level

Direct materials (92% × $20,000) $18,400

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

E-13

BIRCH COMPANY
Assembly Department
Flexible Budget for one month

60% Capacity 75% Capacity

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

Units 1,440 1,920 2,400
Direct labor hours 960 1,280 1,600
Direct materials $2,880 $3,840 $4,800
Direct labor 6,048 8,064 10,080
Fixed F.O.H 960 960 960
Supplies 240 320 400
Indirect labor 1,008 1,344 1,680
Other 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%) $103,500
June (12,1802 × $20 × 54%) 131,544 $235,044
Marketing, general, and administrative expenses:
May ($51,5503 × 46%) $23,713
June ($49,3004 × 54%) 26,622 50,335
Wages and salaries 37,9005
Total $323,279

1May 31 ending inventory (11,400 × 130%).................. 14,820 units

May production............................................................. 11,900
Materials needed in May .............................................. 26,720 units
April 30 ending inventory ($309,400 ÷ $20) ............... 15,470
May purchases..............................................................11,250 units

2June 30 ending inventory (12,000 × 130%) ................ 15,600 units

June production............................................................ 11,400
Materials needed in June............................................. 27,000 units
May 31 ending inventory.............................................. 14,820
June purchases ............................................................ 12,180 units

3($357,000 May sales × 15%) – $2,000 depreciation = $51,550

4($342,000 June sales × 15%) – $2,000 depreciation = $49,300

5Accrued payroll on June 1...........................$ 3,300

Payroll earned during June........................... 38,000
$41,300
Accrued payroll on June 30.......................... 3,400
Cash paid out for payroll ........................ $37,900

(2) Budgeted cash collections during May:

March sales ($354,000 × 9%) .............................. $ 31,860

April sales ($363,000 × 97% × 60%)................... 211,266
April sales ($363,000 × 25%) .............................. 90,750
Total ................................................................... $333,876
(3) Budgeted units of inventory to be purchased during July:

July 31 ending inventory (12,200 × 130%) ........ 15,860 units

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

P-3
MAYNE MANUFACTURING COMPANY
Cash Budget
For the Years Ending March 31

19B 19C

Balance of cash at beginning 0 $ 75,000

Cash generated from operations:
Collections from customers—
Schedule A $825,000 $1,065,000

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

Excess of cash collections over cash

disbursements from operations $ 75,000 210,000
Cash 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) 90,000 270,0002
Balance of cash at end $ 75,0001 $ 15,000

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

Schedule B — Disbursements for direct materials:

19B 19C
Direct materials required for production $200,000 $240,000
Required ending inventory 40,0003 50,0004
Total $240,000 $290,000
Less beginning inventory 0 40,000
Purchases $240,000 $250,000
Beginning accounts payable 0 20,000
Total $240,000 $270,000
Less ending accounts payable 20,000 25,000
Disbursements for direct materials $220,000 $245,000

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

415,000 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 Bal 10000

Discount 6000 Purchases 100,000

Bal 12000 ______

110,000 110,000

Oct

A/P

Cash 80,000 Bal 12000

Discount 3000 Purchases 80,000

Bal 9000 _____

92000 92000
P-5 (1)
TRIPLE-F HEALTH CLUB
Budgeted Statement of Income (Cash Basis)
For the Year Ending October 31, 19C
(000s omitted)

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

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

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

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

Cash surplus......................................................................................... $ 2.8

Beginning cash balance .......................................................................... 8.3
Cash 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.