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Demonstration Problem Accounting What the Numbers Mean 10e Demonstration Problem Chapter 14 – Exercise 9 Purchases Budget

Problem Definition Each gallon of Old Guard, a popular after-shave lotion, requires 6 ounces of ocean scent. Budgeted production of Old Guard for the first three quarters of 2013 is: Quarter I 10,000 gallons Quarter II 18,000 gallons Quarter III 11,000 gallons Management’s policy is to have on hand at the end of every quarter enough ocean scent inventory to meet 30% of next quarter’s production needs. At the beginning of Quarter I, 18,000 ounces of ocean scent were on hand.

Problem Requirements Calculate the number of ounces of ocean scent to be purchased in each of the first two quarters of 2013. Explain why management plans for an ending inventory instead of planning to purchase each quarter the amount of raw materials needed for that quarter’s production.

Problem Solution Calculate the number of ounces of ocean scent to be purchased in each of the first two quarters of 2013:

Problem Solution Calculate the number of ounces of ocean scent to be purchased in each of the first two quarters of 2013: Step 1: Set up the “raw material inventory / usage” model and enter all known amounts.

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory

18,000 beginning inventory amount was given Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Calculation: 18,000 beginning inventory amount was given

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Add: Purchases

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Add: Purchases ?

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Add: Purchases ? Raw material available for use

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Add: Purchases ? Raw material available for use ?

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Add: Purchases ? Raw material available for use ? Less: Ending inventory

30% of next quarter’s usage = 6 ounces * 18,000 gallons * 30% Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Add: Purchases ? Raw material available for use ? Less: Ending inventory (32,400) Calculation: 30% of next quarter’s usage = 6 ounces * 18,000 gallons * 30%

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Add: Purchases ? Raw material available for use ? Less: Ending inventory (32,400) Usage

6 ounces * 10,000 gallons to be produced in Quarter I Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Add: Purchases ? Raw material available for use ? Less: Ending inventory (32,400) Usage 60,000 Calculation: 6 ounces * 10,000 gallons to be produced in Quarter I

Problem Solution Step 1: Set up the “raw material inventory / usage” model and enter all known amounts. Step 2: Working backwards (up the model): - calculate raw materials available for use; - calculate purchases.

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Add: Purchases ? Raw material available for use 92,400 Less: Ending inventory (32,400) Usage 60,000 Calculation: Raw material available for use = Usage + Ending Inventory = 32,400 + 60,000

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Add: Purchases 74,400 Raw material available for use 92,400 Less: Ending inventory (32,400) Usage 60,000 Calculation: Purchases = Raw material available for use - Beginning Inventory = 92,400 - 18,000

Next, repeat Step 1 and Step 2 for Quarter II. Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Add: Purchases 74,400 Raw material available for use 92,400 Less: Ending inventory (32,400) Usage 60,000 Next, repeat Step 1 and Step 2 for Quarter II.

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 Add: Purchases 74,400 Raw material available for use 92,400 Less: Ending inventory (32,400) Usage 60,000

QI Ending Inventory becomes QII Beginning Inventory Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 32,400 Add: Purchases 74,400 Raw material available for use 92,400 Less: Ending inventory (32,400) Usage 60,000 Calculation: QI Ending Inventory becomes QII Beginning Inventory

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 32,400 Add: Purchases 74,400 Raw material available for use 92,400 Less: Ending inventory (32,400) Usage 60,000

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 32,400 Add: Purchases 74,400 ? Raw material available for use 92,400 Less: Ending inventory (32,400) Usage 60,000

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 32,400 Add: Purchases 74,400 ? Raw material available for use 92,400 Less: Ending inventory (32,400) Usage 60,000

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 32,400 Add: Purchases 74,400 ? Raw material available for use 92,400 ? Less: Ending inventory (32,400) Usage 60,000

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 32,400 Add: Purchases 74,400 ? Raw material available for use 92,400 ? Less: Ending inventory (32,400) Usage 60,000

30% of next quarter’s usage = 6 ounces * 11,000 gallons * 30% Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 32,400 Add: Purchases 74,400 ? Raw material available for use 92,400 ? Less: Ending inventory (32,400) (19,800) Usage 60,000 Calculation: 30% of next quarter’s usage = 6 ounces * 11,000 gallons * 30%

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 32,400 Add: Purchases 74,400 ? Raw material available for use 92,400 ? Less: Ending inventory (32,400) (19,800) Usage 60,000

6 ounces * 18,000 gallons to be produced in Quarter II Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 32,400 Add: Purchases 74,400 ? Raw material available for use 92,400 ? Less: Ending inventory (32,400) (19,800) Usage 60,000 108,000 Calculation: 6 ounces * 18,000 gallons to be produced in Quarter II

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 32,400 Add: Purchases 74,400 ? Raw material available for use 92,400 127,800 Less: Ending inventory (32,400) (19,800) Usage 60,000 108,000 Calculation: Raw material available for use = Usage + Ending Inventory = 108,000 + 19,800

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 32,400 Add: Purchases 74,400 95,400 Raw material available for use 92,400 127,800 Less: Ending inventory (32,400) (19,800) Usage 60,000 108,000 Calculation: Purchases = Raw material available for use - Beginning Inventory = 127,800 - 32,400

Problem Solution Raw material inventory / usage model: Qtr I Qtr II Beginning Inventory 18,000 32,400 Add: Purchases 74,400 95,400 Raw material available for use 92,400 127,800 Less: Ending inventory (32,400) (19,800) Usage 60,000 108,000 The number of ounces of ocean scent to be purchased in each of the first two quarters of 2013

Problem Requirements Calculate the number of ounces of ocean scent to be purchased in each of the first two quarters of 2013. Explain why management plans for an ending inventory instead of planning to purchase each quarter the amount of raw materials needed for that quarter’s production.

Problem Solution Why does management plan for an ending inventory instead of planning to purchase each quarter the amount of raw materials needed for that quarter’s production? Because inventory provides a “cushion” for delivery delays or production needs in excess of the production forecast.

You should now have a better understanding of budgeting for purchases. Accounting What the Numbers Mean 10e You should now have a better understanding of budgeting for purchases. Remember that there is a demonstration problem for each chapter that is here for your learning benefit. David H. Marshall Wayne W. McManus Daniel F. Viele