Problem 9-43

Budgeting; Financial Objectives; Ethics

(LO 9-1, 9-5, 9-6, 9-7)

2. Increase in sales: 11.5%

Healthful Foods Inc., a manufacturer of breakfast cereals and snack bars, has experienced several years of steady growth in sales, profits, and dividends while maintaining a relatively low level of debt. The board of directors has adopted a long-run strategy to maximize the value of the shareholders' investment. In order to achieve this goal, the board of directors established the following five-year financial objectives.

• Increase sales by 12 percent per year.
• Increase income before taxes by 15 percent per year.
• Maintain long-term debt at a maximum of 16 percent of assets.

These financial objectives have been attained for the past three years. At the beginning of last year, the president of Healthful Foods, Andrea Donis, added a fourth financial objective of maintaining cost of goods sold at a maximum of 70 percent of sales. This goal also was attained last year.

The budgeting process at Healthful Foods is to be directed toward attaining these goals for the forthcoming year, a difficult task with the economy in a prolonged recession. In addition, the increased emphasis on eating healthful foods has driven up the price of ingredients used by the company

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significantly faster than the expected rate of inflation. John Winslow, cost accountant at Healthful Foods, has responsibility for preparation of the profit plan for next year. Winslow assured Donis that he could present a budget that achieved all of the financial objectives. Winslow believed that he could overestimate the ending inventory and reclassify fruit and grain inspection costs as administrative rather than production costs to attain the desired objective. The actual statements for 20x1 and the budgeted statements for 20x2 that Winslow prepared are as follows:

HEALTHFUL FOODS INC.

Income Statement 20x1 Actual 20x2 Budgeted Sales

$850,000 $947,750 Less: Variable costs: Cost of goods sold

510,000 574,725 Selling and administrative

90,000 87,500 Contribution margin

$250,000 $285,525 Less: Fixed costs: Production

85,000 94,775 Selling and administrative

60,000 70,000 Income before taxes

$105,000 $120,750 HEALTHFUL FOODS INC.

Balance Sheet 20x1 Actual 20x2 Budgeted Assets: Cash

$ 10,000 $ 17,000 Accounts receivable

60,000 68,000 Inventory

300,000 365,000 Plant and equipment (net of accumulated depreciation)

1,630,000 1,600,000 Total

$2,000,000 $2,050,000 Liabilities: Accounts payable

$ 110,000 $ 122,000 Long-term debt

320,000 308,000 Stockholders' equity: Common stock

400,000 400,000 Retained earnings

1,170,000 1,220,000 Total

$2,000,000 $2,050,000

The company paid dividends of $27,720 in 20x1, and the expected tax rate for 20x2 is 34 percent.

Required:

1. Describe the role of budgeting in a firm's strategic planning.