Problem:
Harvey & Company, a local accounting firm, has a formal budgeting system. The firm is comprised of five partners, two managers, four seniors, two secretaries, and two bookkeepers. The budgeting process has a bottom-line focus; that is, the budget and planning process= continues to iterate and evolve until an acceptable budgeted net income is obtained. The determination of an acceptable level of net income is based on two factors: (1) the amount of salary the partners could generate if they were employed elsewhere and (2) a reasonable return on the partners' investment in the firm's net assets. For 2001, after careful consideration of alternative employment opportunities, the partners agreed that
|
Partner 1
|
$150,000
|
|
Partner 2
|
225,000
|
|
Partner 3
|
110,000
|
|
Partner 4
|
90,000
|
|
Partner 5
|
125,000
|
|
Total
|
$700,000
|
The second input to determination of the desired net income level is more complex. This part of the desired net income is based on the value of the net assets owned by the accounting firm. The partners have identified two major categories of assets: tangible assets and intangible assets. The partners have agreed that the net tangible assets are worth $230,000. The intangible assets, consisting mostly of the accounting practice itself, are worth 1.1 times gross fees billed in 2000. In 2000, the firm's gross billings were $1,615,000. The partners have also agreed that a reasonable rate of return on the net assets of the accounting firm is 12 percent. Thus, the partners' desired net income from return on investment is as follows:
|
Tangible assets
|
$ 230,000
|
|
Intangible assets ($1,615,000 110%)
|
1,776,500
|
|
Total investment
|
$2,006,500
|
|
Times rate of return
|
0.12
|
|
Equals required dollar return
|
$ 240,780
|
The experience of the accounting firm indicates that other operating costs are incurred as follows:
|
Fixed Expenses (per year):
|
|
|
Salaries (other than partners)
|
$300,000
|
|
|
Overhead
|
125,000
|
|
|
Variable Expenses:
|
|
Overhead
|
15% of gross billings
|
|
Client service
|
5% of gross billings
|
|
|
|
|
a. Determine the minimum level of gross billings that would allow the partners to realize their net income objective. Prepare a budget of costs and revenues at that level. (continued)
b. If the partners believe that the level of billings you have projected in part (a) is not feasible given the time constraints at the partner, manager, and senior levels, what changes can they make to the budget to preserve the desired level of net income?