Question

Problem 14-16 Behavioral impact of budgeting

Butler Corporation has three divisions, each operating as a responsibility center. To provide an incentive for divisional executive officers, the company gives divisional management a bonus equal to 15 percent of the excess of actual net income over budgeted net income. The following is French Division’s current year’s performance.

	Current Year
Sales revenue	$2,000,000
Cost of goods sold	1,250,000
Gross profit	750,000
Selling & admin. expenses	450,000
Net income	$  300,000

The president has just received next year’s budget proposal from the vice president in charge of French Division. The proposal budgets a 5 percent increase in sales revenue with an extensive explanation about stiff market competition. The president is puzzled. French has enjoyed revenue growth of around 10 percent for each of the past five years. The president had consistently approved the division’s budget proposals based on 5 percent growth in the past. This time, the president wants to show that he is not a fool. “I will impose a 15 percent revenue increase to teach them a lesson!” the president says to himself smugly.

Assume that cost of goods sold and selling, and administrative expenses remain stable in proportion to sales.

Required

a. Prepare the budgeted income statement based on French Division’s proposal of a 5 percent increase.

b. If growth is actually 10 percent as usual, how much bonus would French Division’s executive officers receive if the president had approved the division’s proposal?

c. Prepare the budgeted income statement based on the 15 percent increase the president imposed.

d. If the actual results turn out to be a 10 percent increase as usual, how much bonus would French Division’s executive officers receive since the president imposed a 15 percent increase?

e. Propose a better budgeting procedure for Butler Corporation.

Answer 1

Answer