Chapter 14, Problem 16P

Problem 7-16A Behavioral impact of budgeting

Amherst 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 Atlantic Division’s current year’s performance:

	Current Year
Sales revenue	$1,000,000
Cost of goods sold	625,000
Gross profit	375,000
Selling & admin. expenses	225,000
Net income	$ 150,000

The president has just received next year’s budget proposal from the vice president in charge of Atlantic Division. The proposal budgets a 5 percent increase in sales revenue with an extensive explanation about stiff market competition. The president is puzzled. Atlantic 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

1. a. Prepare the budgeted income statement based on Atlantic Division’s proposal of a 5 percent increase.
2. b. If growth is actually 10 percent as usual, how much bonus would Atlantic Division’s executive officers receive if the president had approved the division’s proposal?
3. c. Prepare the budgeted income statement based on the 15 percent increase the president imposed.
4. d. If the actual results turn out to be a 10 percent increase as usual, how much bonus would Atlantic Division’s executive officers receive since the president imposed a 15 percent increase?
5. e. Propose a better budgeting procedure for Amherst Corporation.