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Chapter 6: Problem 17

Operating and financial budgets. Which of the following statements is correct regarding the drivers of operating and financial budgets? a. The sales budget will drive the cost of goods sold budget. b. The cost of goods sold budget will drive the units of production budget. c. The production budget will drive the selling and administrative expense budget. d. The cash budget will drive the production and selling and administrative expense budgets.

Short Answer

Expert verified
The correct statement is (a) The sales budget will drive the cost of goods sold budget.

Step by step solution

01

Statement (a)

: The sales budget will drive the cost of goods sold budget. This statement is true because the sales budget outlines the expected revenues and volume of sales for a given period. Knowing the expected volume of sales helps in determining the cost of goods sold budget, which entails planning for the costs associated with producing or purchasing the goods planned for sale.
02

Statement (b)

: The cost of goods sold budget will drive the units of production budget. This statement is incorrect. The relationship should be the other way around: the units of production budget will drive the cost of goods sold budget. The units of production budget determines how many units need to be produced to meet the expected sales and inventory levels. Once the required production level is determined, the cost of goods sold budget can be prepared by considering the costs associated with producing the necessary units.
03

Statement (c)

: The production budget will drive the selling and administrative expense budget. This statement is incorrect. While the production budget may have some influence on the selling and administrative expense budget (for example, changes in production volume can influence warehouse or sales expenses), it is not the primary driver. The selling and administrative expense budget is driven mainly by the company's overall sales and marketing strategy and its fixed and variable expenses related to the daily operations of the business. The production budget's primary influence is on the cost of goods sold budget rather than the selling and administrative expense budget.
04

Statement (d)

: The cash budget will drive the production and selling and administrative expense budgets. This statement is incorrect. The cash budget is an estimation of cash inflows and outflows to ensure that the company has enough cash to cover its short-term obligations. While the cash budget may influence the overall level of spending, it is not the primary driver of production and selling and administrative expense budgets. These budgets are mainly influenced by sales expectations, marketing and sales strategies, production needs, and operational expenses. From our analysis of the statements, the correct statement is:
05

Conclusion

: (a) The sales budget will drive the cost of goods sold budget.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Sales Budget
The sales budget is a fundamental component of both operating and financial budgets. It forecasts the revenue a company expects to generate from sales over a specific period. This budget is crucial as it serves as the starting point for other budgets within a company. By estimating future sales volumes and prices, a sales budget gives businesses the insight needed to plan accordingly.
Here is why the sales budget is pivotal:
  • **Forecasting Revenue:** By predicting sales figures, companies can forecast their income and make informed decisions about expenses and investments.
  • **Planning Production:** It determines how much product needs to be produced to meet sales targets.
  • **Cost Management:** Helps in planning for associated costs such as manufacturing and inventory carrying costs.
Essentially, the sales budget is the lifeblood of future planning, paving the way for businesses to efficiently manage resources and maximize profitability.
Cost of Goods Sold Budget
The cost of goods sold (COGS) budget represents the direct costs associated with the production of goods that a company sells. This budget is integral in determining the profitability of a company because it corresponds directly to the revenues from the sales budget.
Key components of COGS budget include:
  • **Materials Costs:** The cost of raw materials required to produce goods.
  • **Labor Costs:** Wages paid to employees directly involved in manufacturing.
  • **Overhead:** Other manufacturing costs that are not directly attributable to specific units produced, such as factory utilities and maintenance.
By understanding and controlling these costs, a company ensures it can maintain or improve its profit margins. The COGS budget is driven by the units of production determined from the sales budget and adjusted for any inventory levels.
Production Budget
The production budget is a detailed plan specifying the number of units that must be produced to meet sales needs and maintain inventory levels. Closely tied to both the sales and COGS budgets, the production budget ensures the company can meet its sales targets without over- or under-producing, which can lead to increased costs or missed sales, respectively.
The production budget focuses on:
  • **Demand Forecast:** Driven by the expected sales numbers, this determines how many units need to be produced.
  • **Inventory Planning:** Balancing how much inventory to keep on hand to meet future demands while minimizing storage costs.
  • **Capacity Constraint:** Takes into account the production capabilities and resource availability.
Having an effective production budget allows companies to align production levels with sales forecasts, optimizing cost efficiency and production scheduling.
Cash Budget
A cash budget is a financial plan that estimates cash inflows and outflows over a specific period. It's a crucial part of financial budgeting because it helps ensure that a company has sufficient cash to meet its short-term obligations. While it interlinks with various other budgets, its primary focus is on liquidity management.
The elements of a cash budget include:
  • **Cash Receipts:** Money expected to be received from sales, financing, and other sources.
  • **Cash Disbursements:** Expected cash outflows such as payments to suppliers and other operating expenses.
  • **Net Cash Flow:** The difference between cash inflows and outflows, indicating the surplus or deficit.
By closely monitoring cash flow, companies can ensure they have enough liquidity to operate smoothly, invest wisely, and avoid unnecessary borrowing. Cash budgets play a vital role in maintaining financial stability and supporting strategic decision-making.

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Most popular questions from this chapter

Sales budget, service setting. In 2017 , Hart \(\&\) Sons, a small environmental-testing firm, performed 11,400 radon tests for \(260\) each and 15,000 lead tests for \(210\) each. Because newer homes are being built with lead-free pipes, lead-testing volume is expected to decrease by \(12 \%\) next year. However, awareness of radon-related health hazards is expected to result in a \(5 \%\) increase in radon-test volume each year in the near future. Jim Hart feels that if he lowers his price for lead testing to \(200\) per test, he will have to face only a \(4 \%\) decline in lead-test sales in 2018 . 1\. Prepare a 2018 sales budget for Hart \(\&\) Sons assuming that Hart holds prices at 2017 levels. 2\. Prepare a 2018 sales budget for Hart \(\&\) Sons assuming that Hart lowers the price of a lead test to \( 200\). Should Hart lower the price of a lead test in 2018 if the company's goal is to maximize sales revenue?

Cash budget (continuation of \(6-40\) ). Refer to the information in Problem \(6-40\) Assume the following: Animal Gear (AG) does not make any sales on credit. AG sells only to the public and accepts cash and credit cards; \(90 \%\) of its sales are to customers using credit cards, for which AG gets the cash right away, less a \(2 \%\) transaction fee. Purchases of materials are on account. AG pays for half the purchases in the period of the purchase and the other half in the following period. At the end of March, AG owes suppliers \( 8,000\). AG plans to replace a machine in April at a net cash cost of \( 13,000\). Labor, other manufacturing costs, and nonmanufacturing costs are paid in cash in the month incurred except of course depreciation, which is not a cash flow. Depreciation is \( 25,000\) of the manufacturing cost and \( 10,000\) of the nonmanufacturing cost for April. AG currently has a \( 2,000\) loan at an annual interest rate of \(12 \%\). The interest is paid at the end of each month. If AG has more than \( 7,000\) cash at the end of April it will pay back the loan. AG owes \( 5,000\) in income taxes that need to be remitted in April. AG has cash of \( 5,900\) on hand at the end of March. 1\. Prepare a cash budget for April for Animal Gear. 2\. Why do Animal Gear's managers prepare a cash budget in addition to the revenue, expenses, and operating income budget?

Explain how the choice of the type of responsibility center (cost, revenue, profit, or investment) affects behavior.

Production budget. Superior Industries sales budget shows quarterly sales for the next year as follows: Quarter \(1-10,000 ;\) Quarter \(2-8,000 ;\) Quarter \(3-12,000 ;\) Quarter \(4-14,000\). Company policy is to have a target finished- goods inventory at the end of each quarter equal to \(20 \%\) of the next quarter's sales. Budgeted production for the second quarter of next year would be: 1\. 7,200 units; 2.8,800 units; 3.12,000 units; 4.10,400 units

Comprehensive operating budget. Skulas, Inc., manufactures and sells snowboards. Skulas manufactures a single model, the Pipex. In late 2017 , Skulas's management accountant gathered the following data to prepare budgets for January 2018 : Skulas's CEO expects to sell 2,900 snowboards during January 2018 at an estimated retail price of \(650\) per board. Further, the CEO expects 2018 beginning inventory of 500 snowboards and would like to end January 2018 with 200 snowboards in stock. Variable manufacturing overhead is \( 7\) per direct manufacturing labor-hour. There are also \( 81,000\) in fixed manufacturing overhead costs budgeted for January \(2018 .\) Skulas combines both variable and fixed manufacturing overhead into a single rate based on direct manufacturing labor-hours. Variable marketing costs are allocated at the rate of \( 250\) per sales visit. The marketing plan calls for 38 sales visits during January 2018\. Finally, there are \( 35,000\) in fixed nonmanufacturing costs budgeted for January 2018 Other data include: The inventoriable unit cost for ending finished-goods inventory on December \(31,2017,\) is \( 374.80 .\) Assume Skulas uses a FIF0 inventory method for both direct materials and finished goods. Ignore work in process in your calculations. 1\. Prepare the January 2018 revenues budget (in dollars). 2\. Prepare the January 2018 production budget (in units). 3\. Prepare the direct material usage and purchases budgets for January 2018 4\. Prepare a direct manufacturing labor costs budget for January 2018 5\. Prepare a manufacturing overhead costs budget for January 2018 6\. What is the budgeted manufacturing overhead rate for January \(2018 ?\) 7\. What is the budgeted manufacturing overhead cost per output unit in January \(2018 ?\) 8\. Calculate the cost of a snowboard manufactured in January 2018 . 9\. Prepare an ending inventory budget for both direct materials and finished goods for January 2018. 10\. Prepare a cost of goods sold budget for January 2018 11\. Prepare the budgeted income statement for Skulas, Inc., for January 2018 12\. What questions might the CEO ask the management team when reviewing the budget? Should the CEO set stretch targets? Explain briefly. 13\. How does preparing the budget help Skulas's management team better manage the company?
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