Case Data

The management team for American Construction must prepare a budgeted income statement for the budget year ending March 31, 2009. Budgets for each profit center - commercial new construction, commercial remodel, and industrial retro-fit will be generated from the company budget. The company budget will be used to make decisions affecting company operations, control company overhead expenses, and project company cash needs. The profit center budgets will be used to establish overhead and profit mark-up rates for each type of work.

During the first three years of operations (2005 through 2007), the company experienced phenomenal growth thanks to sound financial backing from venture capitalists, good management expertise, a relatively high bonding capacity ($20,000,000 as of March 31, 2007), and a strong marketing effort in the commercial remodeling and industrial retro-fit sectors of the industry. The company pushed to obtain more of this work even though company labor balked at the effort. The company realized that profits were guaranteed and by performing well in these markets, the company could establish an inside track with clients when new construction projects arose.

The beginning of an economic recession was felt in 2008. Americans earnings decreased from $14,000,000 in 2007 to $10,000,000 in 2008. The lower volume of work coupled with extreme competition for the limited new construction market caused American to suffer a before-tax loss of $50,000.

The owners of American feel that Americans operations have not produced enough profit. The after-tax return-on-investment for the year ending 2007 was approximately 14% which fell to -4% for 2008. The owners expect a minimum return on investment (before tax) of 27.78% for 2009.

The economic outlook for 2009 is for the economic recession to deepen in the beginning of the period but recover toward the end of the period. Americans management is confident potential 2009 earnings level will fall short of the 2008 earnings amount. The surety company has reduced the amount of work the company may perform at any one time. This reduction translates into total earnings for 2009 not to exceed $8,000,000.

American does not expect to change the mode of operation for 2009. The companys own labor force will continue to be used for concrete formwork in commercial new work and civil construction activities for remodel and retro-fit work. Pricing will become more competitive in the commercial new construction market. Material cost is expected to decrease as vendors try to liquidate stock built during the earlier construction boom. The cost decrease should result in a decrease in relationship to revenue in the amount of 3%. Subcontract costs should also decrease as subcontractors scramble for work. The expected decrease in relationship to revenue is 2%.

A recent college graduate, the son of a principle owner of American, will start working for the company when, and if, he gets back from a wild three month spree in the Bahamas a graduation present. Thus, salaries will increase for the budget period by $45,000. Other cost increases include $1,000 to contribution, $2,000 to rent, $5,000 to auto and truck insurance, and $2,000 to other fixed cost.

PROBLEMS

1) Assuming the return on investment method is used to set the profit goal, calculate the before-tax goal for the budget period ending March 31, 2009, and fill the cell with purple question mark in Table 5.10. The beginning Net Worth amount on the balance sheet for the period ending March 31, 2008 is $924,000.

2) Forecast the cost structure for the budget period ending March 31, 2009. Use the actual income statement for the period ending March 31, 2008 in Table 5.10 with the case data above to forecast fixed cost in dollars and variable cost as a percent of revenue. List the beginning cost or ratio for each account, the adjustment to the cost or ratio, and the ending cost or ratio. Then, find the total fixed cost in dollars and the total variable cost as a percent of revenue, and fill the cells with blue question mark in Table 5.10.

Table 5.10. Income statements for American Construction, Inc.

	Actual 3/31/08		Adjustment	Budgeted 3/31/09
Account	$	%	$ or %	$	%
Earnings	10,000,000	100.00		?	?
Cost of Construction
Labor	1,600,000	16.00		?	?
Material	4,000,000	40.00	3% decrease	?	37
Subcontracts	3,200,000	32.00	?	?	?
Other Direct Cost (JOH)	200,000	2.00		?	?
Total Direct Cost	9,000,000	90.00		?	?
Gross Profit	1,000,000	10.00		?	?
Operating Expense
Variable Operating Expense
Auto and Truck	150,000	1.50		?	?
Communications	60,000	0.60		?	?
Interest (Work in progress)	100,000	1.00		?	?
Insurance (Work in progress)	237,000	2.37		?	?
Other Variable Expense	20,000	0.20		?	?
Total Variable Expense	567,000	5.67		?	?
Fixed Operating Expense
Contributions	5,000	0.05	$1,000 increase	6,000
Depreciation (Equipment)	72,000	0.72		?
Depreciation (Building)	3,000	0.03		?
Insurance (Equipment)	29,000	0.29	?	?
Interest (Equipment)	20,000	0.20		?
Rent	44,000	0.44	?	?
Salaries	300,000	3.00	?	?
Other Fixed Expense	10,000	0.10	?	?
Total Fixed Operating Exp.	483,000	4.83		?
Total Operating Expense	1,050,000	10.50		?
Net Profit (before tax)	<50,000>	-0.50		?

3) Calculate the earnings required (revenue) to generate the profit goal (Item #1) given the changes to the cost structure found in Item #2. Fill the cell with red question mark in Table 5.10.