Problem 7-16B Behavioral impact of budgeting

Melissa Putnam, the director of Kelso Corporations Mail-Order Division, is preparing the divisions budget proposal for next year. The companys president will review the proposal for approval. Ms. Putnam estimates the current year final operating results will be as follows:

	Current Year
Sales revenue	$3,000,000
Cost of goods sold	1,800,000
Gross profit	1,200,000
Selling & admin. expenses	480,000
Net income	$ 720,000

Ms. Putnam believes that the cost of goods sold as well as selling and administrative expenses will continue to be stable in proportion to sales revenue.

Kelso has an incentive policy to reward division managers whose performance exceeds their budget. Division directors receive a 10 percent bonus based on the excess of actual net income over the divisions budget. For the last two years, Ms. Putnam has proposed a 4 percent rate of increase, which proved accurate. However, her honesty and accuracy in forecasting caused her to receive no year-end bonus at all. She is pondering whether she should do something differently this time. If she continues to be honest, she should propose an 8 percent growth rate because of robust market demand. Alternatively, she can propose a 4 percent growth rate as usual and thereby expect to receive some bonus at year-end.

Required

Round all computations to the nearest whole dollar.

Prepare a pro forma income statement, assuming a 4 percent estimated increase.

Prepare a pro forma income statement, assuming an 8 percent increase.

Assume the president eventually approves the divisions proposal with the 4 percent growth rate. If growth actually is 8 percent, how much bonus would Ms. Putnam receive?

Propose a better budgeting procedure for Kelso Corporation.