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Identifying Variances in Budgets

Well you made it and you have hung up your shingle that your are a CPA and are prepared to take on new clients. You sit down at your desk, turn on your shiny new Dell Laptop with wireless connection, take a sip of your steamy hot Starbucks Coffee and gaze at that beautiful shiny new wooden desk (that set you back $1000). Just then the door flies open and this big 6'4" man with a ten gallon hat steps into your office. He has big old cowboy boots caked in in dirt and a shiny rhinestone jacket and new Levi Dungarees. He sits down leans back and puts his dirty boots on that shiny new desk (size 14 of course).
He says, "My name is Tex A. Slong, my business is cattle, and you have to have to help me. They are running all over the place." You look at Mr. Slong bewildered, "what is running all over the place, also could you please take your boots down I can not see your face." "Oh, sorry , little lady (or son), the cattle, the cattle are everywhere, my wife says if I don't do something she'll leave me. Got one in my bedroom." So you ask, "what happened? " Tex answers,
"I don't know, and my business is going to pots, I never have any cash to pay my creditors, I really need your help." You ask Tex is he brought anything for your too look at and he pulls this crumply piece of paper from his wallet. "Here, I put this together in the car coming over here."
This is what the paper looked like:

Balance Sheet As of Dec 31
2008 2007

ASSETS
Cash 2,500 500,000
Investments 1,000,000 1,000,000
Accounts Rec. 500,000 200,000
Total 1,502,500 1,700,000

INVENTORY
Machinery 2,000,000 2,000,000
Less Deprec. -1,100,000 -1,000,000
Cattle 3,000,000 2,500,000
3,900,000 3,500,000

LIABILITIES
Long Term Debt 500,000 500,000
Short Term Debt 100,000 100,000

EQUITY
Retained Earnings 3,400,000 3,000,000

Income Statement
2008 2007
Gross Sales 2,000,000 2,500,000
Cost of Good Sold 1,300,000 1,500,000
Net Sales 700,000 1,000,000

Expenses
650,000 600,000

Net Income 50,000 400,000

#1
Using the knowledge of ratios, look at the numbers above and see if you can identify Tex's problems. Assume all sales are credit Net 30 sales. What advice would you offer Tex in order to help out the situation. Should Tex liquidate some of his investments to pay his bills until something changes? How is he going to get the money to pay his creditors?
#2
Now that you have solved Tex's issues, what would you suggest he plan for the next fiscal year? Should Tex wait until December 31st every year to see his numbers? What would you advise Tex to do? Why? Would your ideas change if Tex sold oil, or cars, or ladies handbags? What types of budgets is your analysis going to focus on? What budget should you start with first?

#3
What is the purpose of identifying variances in budgets? Does have a favorable variance always mean a positive situation? How about negative? Can you share two examples where a favorable variance could have a negative underlying affect.

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Question 1
First, in order to assess Tex A. Slong's capacity to pay off the company's short term debt of $100,000, I reorganized the balance sheet he presented into the following:
2008 2007
ASSETS
Cash 2,500 500,000
Investments 1,000,000 1,000,000
Accounts Rec. 500,000 200,000
Cattle 3,000,000 2,500,000
Total current assets 4,502,500 4,200,000

Property, plant and equipment
Machinery 2,000,000 2,000,000
Less: Accumulated Depreciation -1,100,000 -1,000,000
Total PPE 900,000 1,000,000
Total assets 5,402,500 5,200,000

LIABILITIES
Short Term Debt 100,000 100,000
Long Term Debt 500,000 500,000
Total liabilities 600,000 600,000

EQUITY
Tex A. Slong, capital 1,402,500 1,600,000
Retained Earnings 3,400,000 3,000,000
Total owner's equity 4,802,500 4,600,000
Total liabilities and owner's equity 5,402,500 5,200,000

The account, Tex A. Slong capital, was interpolated from the available information. This account is the difference between the total assets and total liabilities plus retained ...

Solution Summary

The solution identifies variances in budgets. The expert uses the knowledge of ratios to identify Tex's problems.

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