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Budgeting and Profit Planning

FUNDAMENTALS OF MANAGEMENT ACCOUNTING


Understand why
organizations budget and
the processes they use to
create budgets.
BUDGETING BASICS
A formal written statement of managements
plans for a specified future time period,
expressed in financial terms
Primary way to communicate agreed-upon
objectives to all parts of the company
Promotes efficiency
Control device - important basis for performance
evaluation once adopted
Planning and Control

Planning Control
involves developing involves the steps taken
objectives and by management to
preparing various increase the likelihood
budgets to achieve that the objectives set
those objectives. down while planning are
attained and that all
parts of the organization
are working together
toward that goal.
BUDGETING BASICS
Benefits of Budgeting

Requires all levels of management to plan


ahead and formalize goals on a
recurring basis
Provides definite objectives for evaluating
performance at each level of
responsibility
Creates an early warning system
for potential problems
BUDGETING BASICS
Benefits of Budgeting

Facilitates coordination of activities


within the business
Results in greater management
awareness of the entitys overall
operations and the impact of
external factors
Motivates personnel throughout
organization to meet planned
objectives
BUDGETING BASICS
Role of Accounting
Historical accounting data on
revenues, costs, and expenses
help in formulating future
budgets
Accountants are normally
responsible for presenting
managements budgeting goals
in financial terms
The budget and its
administration are, however,
entirely managements
responsibility
The Basic Framework of Budgeting

Detail
Budget
Detail
Budget
Detail

Production
Budget
Master
Budget
Summary of
a companys
plans.
Advantages of Budgeting

Define goal
and objectives
Communicating Think about and
plans plan for the future

Advantages
Coordinate Means of allocating
activities resources

Uncover potential
bottlenecks
Choosing the Budget Period

Operating Budget

2008 2009 2010 2011

The annual operating budget


may be divided into monthly
or quarterly budgets.
The Perpetual Budget

Continuous or
Perpetual Budget

2008 2009 2010 2011

This budget is usually a twelve-month


budget that rolls forward one month
as the current month is completed.
Participative Budget System

Top Management

Middle Middle
Management Management

Supervisor Supervisor Supervisor Supervisor

Flow of Budget Data


Bottom-up and Top-down Budgeting
Bottom-up budgeting Top-down budgeting
(Self-imposed budget or
Participative budget )
Top Top
Management Management

Middle Middle
Management Management

Lower-level Lower-level
Management Management
Advantages of the Bottom-up
Budgeting (Self-Imposed Budgets)
1. Individuals at all levels of the organization are viewed as
members of the team whose judgments are valued by top
management.
2. Budget estimates prepared by front-line managers are
often more accurate than estimates prepared by top
managers.
3. Motivation is generally higher when individuals participate
in setting their own goals than when the goals are
imposed from above.
4. A manager who is not able to meet a budget imposed
from above can claim that it was unrealistic. Self-imposed
budgets eliminate this excuse.
How to overcome problems of
self-imposed budgets
Self-imposed budgets should be reviewed
by higher levels of management to prevent
budgetary slack (or budget padding).
Most companies issue broad guidelines in
terms of overall profits or sales. Lower level
managers are directed to prepare budgets
that meet those targets.
Advantages of the Top-down Budgeting

1. Avoid the potential budgetary slack (budget padding).


2. Provide a clearer performance goals and expectations
from the top management.
3. May provide better budget due to top managements
access to privileged/confidential market and organization
information .
4. Provide an efficient budgetary process.
Budget Lapsing
A popular method among government agencies, universities
and organizations relying on allocated funds.

Any unused funding at the end of the financial period cannot


be carried forward to the following year.

As a result, the following years budget may be cut because


of the under-expenditure in the previous year.
Budget Lapsing: Advantages
Budget lapsing helps ensure that the appropriate level of
resources is utilized in each period. Without budget lapsing,
risk-averse managers may unnecessarily accumulate funds and
this may adversely affect the performance of the organization.

It helps provide an opportunity for a clean cut-off of


expenditures and to reallocate any unused resources for other
more appropriate requirements.
Budget Lapsing: Potential Problem &
Solution
Budget lapsing can cause undesired behavior effects. For
example, managers may wastefully spend their entire
budget before the end of the period in order to avoid budget
cuts.

A system of reviewing the expenditures near end of the


period may uncover unnecessary expenditures and
discourage managers to wastefully spend because of budget
lapsing.
Incremental versus Zero-based
Budgets
Incremental method of budgeting is most commonly used
by companies. Companies start off one years budget by
referring back to the previous years figures. Adjustments
are then made to the budget to account for the expected
changes such as prices for the next year.

While incremental method of budgeting is practical and fast,


any inefficiency in the previous years figures may be carried
forward. For example, if all along the organization is over
staffed, then the budget will continually to be allowing for
the over staffing situation under this method.
Incremental versus Zero-based
Budgets
Zero-Based Budgets are prepared based on the assumption
that the company has just started. Therefore, resources
required have to be justified from scratch.

For example, when budgeting for staff cost for a restaurant,


managers using the zero-based budgeting approach will
ignore the existing staff level and expenses, rather, they will
examine factors such as opening hours, number of tables,
expected patron numbers to work out the number of staff
required at each position and level, hence the associate costs,
to produce a budget.
Incremental versus Zero-based
Budgets

Companies using the zero-based method do not simply


ignore previous years figures. Figures generated by the
zero-based method are usually compared with previous
years figures. Any large differences are investigated.

As zero-based budgeting is time consuming and costly,


companies tend to use this method for the relatively large
items and the incremental method for the rest.
Top Management Attitude:
Human Factors in Budgeting
The success of a budget program depends on three
important factors:
1. Top management must be enthusiastic and
committed to the budget process.
2. Top management must not use the budget to
pressure employees or blame them when
something goes wrong.
3. Budget targets should be challenging but achievable
in order to have good motivational effects.
Responsibility Accounting

Managers should be held responsible for those


items and only those items that
the manager can actually control
to a significant extent.
The Budget Committee

A standing committee responsible for


overall policy matters relating to the budget
coordinating the preparation of the budget
Chapter Quiz: Question 1

Which of the following is NOT true about the Master


Budget?
a) It is composed of many interrelated budgets.
b) It consists of 2 classes of budgets: Operating
Budgets and Financial Budgets.
c) Within the master budget the first budget to be
prepared is the sales budget.
d) It constitutes a plan of action for a specified period
of time.
e) All of the above are true.
Understand the Key
Components of Master
Budget in Manufacturing,
Merchandising and
Service Industries
Understand the key components of master budget in
Manufacturing, Merchandising, and Service Industries
The first step of budgeting for every business is to budget for the
revenue, whether it is a sales budget for providing goods or services
or a funding budget. Although operational budgets are adapted
according to the industries, they are very similar and typically
comprise of budgets for
Income statement
Cash
Balance sheet.
The major differences of different industries include:
Manufacturing: production budget is involved
Merchandising: no production budget, only purchase budget of
merchandise is required.
Service Industries: budget for revenue and cost of providing
services
Not-for-profit: expected funding available and plan usage of
funding.
Prepare a Master Budget
for a Manufacturing
Company.
The Master Budget
Sales
Budget

Ending Selling and


Production
Inventory Administrative
Budget
Budget Budget

Direct Direct Manufacturing


Materials Labor Overhead
Budget Budget Budget
The Master Budget
Sales
Budget

Ending Selling and


Production
Inventory Administrative
Budget
Budget Budget

Direct Direct Manufacturing


Materials Labor Overhead
Budget Budget Budget

Cash
Budget Budgeted
Financial
Statements
Prepare a sales budget,
including a schedule of
expected cash collections.
The Sales Budget

A detailed schedule showing expected


sales for the budgeted periods
expressed in units and dollars.
The Sales Budget
First budget prepared
Derived from the sales forecast
Managements best estimate of sales revenue for the
budget period
Every other budget depends on the sales budget
Prepared by multiplying
expected unit sales volume for each product
times
anticipated unit selling price
The Sales Budget
Factors considered in Sales Forecasting:
General economic conditions
Industry trends
Market research studies
Anticipated advertising and promotion
Previous market share
Price changes
Technological developments
The Sales Budget - Example
Royal Company is preparing budgets for the
quarter ending June 30.
Budgeted sales for the next five months are:
April 20,000 units
May 50,000 units
June 30,000 units
July 25,000 units
August 15,000 units.
The selling price is $10 per unit.
The Sales Budget

April May June Quarter


Budgeted
sales (units) 20,000 50,000 30,000 100,000
Selling price
per unit
Total sales
The Sales Budget

April May June Quarter


Budgeted
sales (units) 20,000 50,000 30,000 100,000
Selling price
per unit $ 10 $ 10 $ 10 $ 10
Total sales $200,000 $500,000 $300,000 $1,000,000
Prepare a
production budget.
The Production Budget

Sales Production
Budget Budget

Production must be adequate to meet budgeted


sales and provide for sufficient ending inventory.
The Production Budget
Shows the units that must be produced to meet
anticipated sales
Derived from sales budget plus the desired change in
ending finished goods (ending finished goods less the
beginning finished goods units)
Required production in units formula:
The Production Budget

Royal Company wants ending inventory


to be equal to 20% of the following
months budgeted sales in units.

On March 31, 4,000 units were on hand.

Lets prepare the production budget.


The Production Budget

April May June Quarter


Budgeted sales 20,000 50,000 30,000 100,000
Add desired ending
inventory 10,000
Total needed 30,000
Less beginning
inventory 4,000
Required production 26,000
Budgeted sales 50,000
Desired percent 20%
Desired inventory 10,000
The Production Budget

April May June Quarter


Budgeted sales 20,000 50,000 30,000 100,000
Add desired ending
inventory 10,000
Total needed 30,000
Less beginning
inventory 4,000
Required production 26,000

March 31
ending inventory
The Production Budget

April May June Quarter


Budgeted sales 20,000 50,000 30,000 100,000
Add desired ending
inventory 10,000 6,000
Total needed 30,000 56,000
Less beginning
inventory 4,000

Required production 26,000


The Production Budget

April May June Quarter


Budgeted sales 20,000 50,000 30,000 100,000
Add desired ending
inventory 10,000 6,000
Total needed 30,000 56,000
Less beginning
inventory 4,000 10,000

Required production 26,000 46,000


The Production Budget
April May June Quarter
Budgeted sales 20,000 50,000 30,000 100,000
Add desired ending
inventory 10,000 6,000 5,000 5,000
Total needed 30,000 56,000 35,000 105,000
Less beginning
inventory 4,000 10,000 6,000 4,000

Required production 26,000 46,000 29,000 101,000


Prepare a direct materials
budget, including a
schedule of expected cash
disbursements for
purchases of materials.
The Direct Materials Budget
At Royal Company, five pounds of material
are required per unit of product.
Management wants materials on hand at
the end of each month equal to 10% of the
following months production.
On March 31, 13,000 pounds of material
are on hand. Material cost $0.40 per
pound.
Lets prepare the direct materials budget.
The Direct Materials Budget

April May June Quarter


Production (units) 26,000 46,000 29,000 101,000
Mat'l per unit (lbs)
Production needs
Add desired
Ending Inv (lbs)
Total needed
Less beginning
inventory (lbs)
Materials to be
purchased (lbs)

From production
budget
The Direct Materials Budget

April May June Quarter


Production (units) 26,000 46,000 29,000 101,000
Mat'l per unit (lbs) 5 5 5 5
Production needs 130,000 230,000 145,000 505,000
Add desired
Ending Inv (lbs)
Total needed
Less beginning
inventory (lbs)
Materials to be
purchased (lbs)
The Direct Materials Budget

April May June Quarter


Production (units) 26,000 46,000 29,000 101,000
Mat'l per unit (lbs) 5 5 5 5
Production needs 130,000 230,000 145,000 505,000
Add desired
Ending Inv (lbs) 23,000
Total needed 153,000
Less beginning
inventory (lbs)
Materials to be
purchased
10% of the following
months production
The Direct Materials Budget

April May June Quarter


Production (units) 26,000 46,000 29,000 101,000
Mat'l per unit (lbs) 5 5 5 5
Production needs 130,000 230,000 145,000 505,000
Add desired
Ending Inv (lbs) 23,000
Total needed 153,000
Less beginning
inventory (lbs) 13,000
Materials to be
purchased 140,000

March 31
inventory
The Direct Materials Budget

April May June Quarter


Production (units) 26,000 46,000 29,000 101,000
Mat'l per unit (lbs) 5 5 5 5
Production needs 130,000 230,000 145,000 505,000
Add desired
Ending Inv (lbs) 23,000 14,500 11,500 11,500
Total needed 153,000 244,500 156,500 516,500
Less beginning
inventory (lbs) 13,000 23,000 14,500 13,000
Materials to be
purchased 140,000 221,500 142,000 503,500
The Direct Materials Budget

April May June Quarter


Production (units) 26,000 46,000 29,000 101,000
Mat'l per unit (lbs) 5 5 5 5
Production needs 130,000 230,000 145,000 505,000
Add desired
Ending July
Inv (lbs) 23,000 14,500
Production and Inventory
11,500 11,500
Total
Salesneeded
in units 153,000 244,500
25,000 156,500 516,500
Less beginning
Add desired ending inventory 3,000
inventory
Total (lbs)
units needed 13,000 23,000
28,000 14,500 13,000
Materials to be inventory
Less beginning 5,000
purchasedin units 140,000
Production 221,500
23,000 142,000 503,500
Pounds per unit 5
Total pounds 115,000
Desired percent 10%
Desired ending inventory 11,500
Chapter Quiz: Question 2

The Willsey Merchandise Company has budgeted


$40,000 in sales for the month of December. The
company's cost of goods sold is 30% of sales. If the
company has budgeted to purchase $18,000 in
merchandise during December, then the budgeted
change in inventory levels over the month of
December is:
A. $ 6,000 increase.
B. $10,000 decrease.
C. $22,000 decrease.
D. $15,000 increase.
The Master Budget - Components
Expected Cash Collections

All sales are on account.


Royals collection pattern is:
70% collected in the month of sale,
25% collected in the month following sale,
5% is uncollectible.
The March 31 accounts receivable
balance of $30,000 will be collected in
full.
Expected Cash Collections
April May June Quarter
Sales $ 200,000 $ 500,000 $ 300,000

Accounts rec. - 3/31 $ 30,000 $ 30,000

Total cash collections $ 30,000 $ -


Expected Cash Collections
April May June Quarter
Sales $ 200,000 $ 500,000 $ 300,000

Accounts rec. - 3/31 $ 30,000 $ 30,000


April x 70% 140,000 140,000
x 25% $ 50,000 50,000

Total cash collections $ 170,000 $ 50,000 $ 220,000


Expected Cash Collections
April May June Quarter
Sales $ 200,000 $ 500,000 $ 300,000

Accounts rec. - 3/31 $ 30,000 $ 30,000


April x 70% 140,000 140,000
x 25% $ 50,000 50,000
May x 70% 350,000 350,000
x 25% $ 125,000 125,000

Total cash collections $ 170,000 $ 400,000 $ 125,000 $ 695,000


Expected Cash Collections
April May June Quarter
Sales $ 200,000 $ 500,000 $ 300,000

Accounts rec. - 3/31 $ 30,000 $ 30,000


April x 70% 140,000 140,000
x 25% $ 50,000 50,000
May x 70% 350,000 350,000
x 25% $ 125,000 125,000
June x 70% 210,000 210,000

Total cash collections $ 170,000 $ 400,000 $ 335,000 $ 905,000


Expected Cash Collections
April May June Quarter
Accounts rec. - 3/31 $ 30,000 $ 30,000
April sales
70% x $200,000 140,000 140,000
25% x $200,000 $ 50,000 50,000
May sales
70% x $500,000 350,000 350,000
25% x $500,000 $ 125,000 125,000
June sales
70% x $300,000 210,000 210,000
Total cash collections $ 170,000 $ 400,000 $ 335,000 $ 905,000
Chapter Quiz: Question 3

Avril Company collects its A/R as follows:


30% in the month of sale
60% in the month following sale
8% in the 2nd month following sale
The following sales are expected:
Jan....$100,000 Feb....$120,000 Mar....$110,000
Cash collections in March should be budgeted at:
A. $110,000. C. $105,000.
B. $110,800. D. $113,000.
Expected Cash Disbursement for Materials

Royal pays $0.40 per pound for its


materials.
One-half of a months purchases are paid
for in the month of purchase; the other
half is paid in the following month.
The March 31 accounts payable balance
is $12,000.
Lets calculate expected cash
disbursements.
Expected Cash Disbursement for Materials

April May June Quarter


Accounts pay. 3/31 $ 12,000 $ 12,000
April purchases

May purchases

June purchases

Total cash
disbursements
Expected Cash Disbursement for Materials
April May June Quarter
Accounts pay. 3/31 $ 12,000 $ 12,000
April purchases
50% x $56,000 28,000 28,000
50% x $56,000 $ 28,000 28,000
May purchases

June purchases

Total cash
disbursements $ 40,000

140,000 lbs. $.40/lb. = $56,000


Expected Cash Disbursement for Materials
April May June Quarter
Accounts pay. 3/31 $ 12,000 $ 12,000
April purchases
50% x $56,000 28,000 28,000
50% x $56,000 $ 28,000 28,000
May purchases
50% x $88,600 44,300 44,300
50% x $88,600 $ 44,300 44,300
June purchases

Total cash
disbursements $ 40,000 $ 72,300
Expected Cash Disbursement for Materials
April May June Quarter
Accounts pay. 3/31 $ 12,000 $ 12,000
April purchases
50% x $56,000 28,000 28,000
50% x $56,000 $ 28,000 28,000
May purchases
50% x $88,600 44,300 44,300
50% x $88,600 $ 44,300 44,300
June purchases
50% x $56,800 28,400 28,400
Total cash
disbursements $ 40,000 $ 72,300 $ 72,700 $185,000
Prepare a direct
labor budget.
The Direct Labor Budget
At Royal, each unit of product requires 0.05 hours of
direct labor.
The Company has a no layoff policy so all employees
will be paid for 40 hours of work each week.
In exchange for the no layoff policy, workers agreed to
a wage rate of $10 per hour regardless of the hours
worked (Overtime paid as straight time).
For the next three months, the direct labor workforce will
be paid for a minimum of 1,500 hours per month.
Lets prepare the direct labor budget.
The Direct Labor Budget

April May June Quarter


Production 26,000 46,000 29,000 101,000
Direct labor hours
Labor hours required
Guaranteed labor hours
Labor hours paid
Wage rate
Total direct labor cost From production
budget
The Direct Labor Budget

April May June Quarter


Production 26,000 46,000 29,000 101,000
Direct labor hours 0.05 0.05 0.05 0.05
Labor hours required 1,300 2,300 1,450 5,050
Guaranteed labor hours
Labor hours paid
Wage rate
Total direct labor cost
The Direct Labor Budget

April May June Quarter


Production 26,000 46,000 29,000 101,000
Direct labor hours 0.05 0.05 0.05 0.05
Labor hours required 1,300 2,300 1,450 5,050
Guaranteed labor hours 1,500 1,500 1,500
Labor hours paid 1,500 2,300 1,500 5,300
Wage rate
Total direct labor cost
Higher of labor hours required
or labor hours guaranteed.
The Direct Labor Budget

April May June Quarter


Production 26,000 46,000 29,000 101,000
Direct labor hours 0.05 0.05 0.05 0.05
Labor hours required 1,300 2,300 1,450 5,050
Guaranteed labor hours 1,500 1,500 1,500
Labor hours paid 1,500 2,300 1,500 5,300
Wage rate $ 10 $ 10 $ 10 $ 10
Total direct labor cost $ 15,000 $ 23,000 $ 15,000 $ 53,000
Quick Check

What would be the total direct labor cost for


the quarter if the company follows its no lay-
off policy, but pays $15 (time-and-a-half) for
every hour worked in excess of 1,500 hours
in a month?
a. $79,500
b. $64,500
c. $61,000
d. $57,000
Quick Check
What would be the total direct labor cost for the
quarter if the company follows its no lay-off
policy, but pays $15 (time-and-a-half) for every
hour worked in excess of 1,500 April hours
May in June
a month?
Quarter
Labor hours required 1,300 2,300 1,450
a. $79,500 Regular hours paid 1,500 1,500 1,500 4,500
b. $64,500 Overtime hours paid - 800 - 800

c. $61,000 Total regular hours 4,500 $10 $ 45,000


Total overtime hours 800 $15 $ 12,000
d. $57,000 Total pay $ 57,000
Prepare a
manufacturing
overhead budget.
Manufacturing Overhead Budget

Royal Company uses a variable


manufacturing overhead rate of $1 per unit
produced.
Fixed manufacturing overhead is $50,000 per
month and includes $20,000 of noncash costs
(primarily depreciation of plant assets).

Lets prepare the manufacturing


overhead budget.
Manufacturing Overhead Budget

April May June Quarter


Production in units 26,000 46,000 29,000 101,000
Variable mfg. OH rate $ 1 $ 1 $ 1 $ 1
Variable mfg. OH costs $ 26,000 $ 46,000 $ 29,000 $ 101,000
Fixed mfg. OH costs
Total mfg. OH costs
Less noncash costs
Cash disbursements
for manufacturing OH
From production
budget
Manufacturing Overhead Budget

April May June Quarter


Production in units 26,000 46,000 29,000 101,000
Variable mfg. OH rate $ 1 $ 1 $ 1 $ 1
Variable mfg. OH costs $ 26,000 $ 46,000 $ 29,000 $ 101,000
Fixed mfg. OH costs 50,000 50,000 50,000 150,000
Total mfg. OH costs 76,000 96,000 79,000 251,000
Less noncash costs
Cash disbursements
for manufacturing OH
Manufacturing Overhead Budget

April May June Quarter


Production in units 26,000 46,000 29,000 101,000
Variable mfg. OH rate $ 1 $ 1 $ 1 $ 1
Variable mfg. OH costs $ 26,000 $ 46,000 $ 29,000 $ 101,000
Fixed mfg. OH costs 50,000 50,000 50,000 150,000
Total mfg. OH costs 76,000 96,000 79,000 251,000
Less noncash costs 20,000 20,000 20,000 60,000
Cash disbursements
for manufacturing OH $ 56,000 $ 76,000 $ 59,000 $ 191,000

Depreciation is a noncash charge.


Ending Finished Goods Inventory Budget

Now, Royal can complete the ending


finished goods inventory budget.

At Royal, manufacturing overhead is


applied to units of product on the basis of
direct labor hours.

Lets calculate ending finished goods


inventory.
Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total


Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor
Manufacturing overhead

Budgeted finished goods inventory


Ending inventory in units
Unit product cost
Ending finished goods inventory

Direct materials
budget and information
Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total


Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $10.00 0.50
Manufacturing overhead

Budgeted finished goods inventory


Ending inventory in units
Unit product cost
Ending finished goods inventory

Direct labor
budget
Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total


Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $10.00 0.50
Manufacturing overhead 0.05 hrs. $49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units
Unit product cost $ 4.99
Ending finished goods inventory

Predetermined Overhead Rate:


Total mfg. OH for quarter $251,000
= $49.70 per hr.
Total labor hours required 5,050 hrs.
(rounded)
Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total


Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $10.00 0.50
Manufacturing overhead 0.05 hrs. $49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units 5,000
Unit product cost $ 4.99
Ending finished goods inventory $24,950

Production
Budget
Prepare a selling and
administrative
expense budget.
Selling and Administrative Expense Budget

At Royal, variable selling and administrative


expenses are $0.50 per unit sold.
Fixed selling and administrative expenses are
$70,000 per month.
The fixed selling and administrative expenses
include $10,000 in costs primarily depreciation
that are not cash outflows of the current month.

Lets prepare the companys selling and


administrative expense budget.
Selling and Administrative Expense Budget

April May June Quarter


Budgeted sales 20,000 50,000 30,000 100,000
Variable selling
and admin. rate $ 0.50 $ 0.50 $ 0.50 $ 0.50
Variable expense $10,000 $25,000 $15,000 $ 50,000
Fixed selling and
admin. expense 70,000 70,000 70,000 210,000
Total expense 80,000 95,000 85,000 260,000
Less noncash
expenses
Cash disburse-
ments for
selling & admin.
Selling and Administrative Expense Budget

April May June Quarter


Budgeted sales 20,000 50,000 30,000 100,000
Variable selling
and admin. rate $ 0.50 $ 0.50 $ 0.50 $ 0.50
Variable expense $10,000 $25,000 $15,000 $ 50,000
Fixed selling and
admin. expense 70,000 70,000 70,000 210,000
Total expense 80,000 95,000 85,000 260,000
Less noncash
expenses 10,000 10,000 10,000 30,000
Cash disburse-
ments for
selling & admin. $70,000 $85,000 $75,000 $230,000
Prepare a cash
budget.
The Cash Budget

Shows anticipated cash flows


Often considered to be the most important output
in preparing financial budgets
Contains three sections:
Cash receipts
Cash disbursements
Financing
Shows beginning and ending cash balances
The Cash Budget
Royal:
Maintains a 16% open line of credit for $75,000.
Maintains a minimum cash balance of $30,000.
Borrows on the first day of the month and repays
loans on the last day of the month.
Pays a cash dividend of $49,000 in April.
Purchases $143,700 of equipment in May and
$48,300 in June paid in cash.
Has an April 1 cash balance of $40,000.
The Cash Budget
April May June Quarter
Beginning cash balance$ 40,000
Add cash collections 170,000
Total cash available 210,000
Less disbursements
Materials 40,000
Direct labor
Mfg. overhead
Selling and admin.
Equipment purchase
Dividends
Total disbursements
Excess (deficiency) of
cash available over Schedule of Expected
disbursements Cash Collections
The Cash Budget
April May June Quarter
Beginning cash balance$ 40,000
Add cash collections 170,000
Total cash available 210,000
Less disbursements
Materials 40,000
Direct labor
Mfg. overhead
Selling and admin.
Equipment purchase Schedule of Expected
Dividends Cash Disbursements
Total disbursements
Excess (deficiency) of
cash available over Schedule of Expected
disbursements Cash Collections
The Cash Budget
April May June Quarter
Beginning cash balance $ 40,000
Add cash collections 170,000 Direct Labor
Total cash available 210,000 Budget
Less disbursements
Materials 40,000
Direct labor 15,000
Manufacturing
Mfg. overhead 56,000
Selling and admin. 70,000 Overhead Budget
Equipment purchase
Dividends
Total disbursements
Excess (deficiency) of Selling and Administrative
cash available over
disbursements
Expense Budget
The Cash Budget
April May June Quarter
Beginning cash balance $ 40,000
Add cash collections 170,000
Total cash available 210,000
Less disbursements
Materials 40,000
Because Royal maintains
Direct labor 15,000 a cash balance of $30,000,
Mfg. overhead 56,000 the company must
Selling and admin. 70,000 borrow on its
Equipment purchase -
line-of-credit
Dividends 49,000
Total disbursements 230,000
Excess (deficiency) of
cash available over
disbursements $ (20,000)
Financing and Repayment
April May June Quarter
Excess (deficiency)
of Cash available
over disbursements $ (20,000)
Financing:
Borrowing 50,000
Repayments -
Interest -
Total financing 50,000
Ending cash balance $ 30,000 $ 30,000 $ - $ -

Ending cash balance for April


is the beginning May balance.
CASH BUDGET

Contributes to more effective cash


management
Shows managers need for additional
financing before actual need arises
Indicates when excess cash will be
available
The Cash Budget
April May June Quarter
Beginning cash balance $ 40,000 $ 30,000
Add cash collections 170,000 400,000
Total cash available 210,000 430,000
Less disbursements
Materials 40,000 72,300
Direct labor 15,000 23,000
Mfg. overhead 56,000 76,000
Selling and admin. 70,000 85,000
Equipment purchase - 143,700
Dividends 49,000 -
Total disbursements 230,000 400,000
Excess (deficiency) of
cash available over
disbursements $ (20,000) $ 30,000
Financing and Repayment
April May June Quarter
Excess (deficiency)
of Cash available
over disbursements $ (20,000) $ 30,000
Financing:
Borrowing 50,000 -
Repayments - -
Interest - -
Total financing 50,000 -
Ending cash balance $ 30,000 $ 30,000

Because the ending cash balance is


exactly $30,000, Royal will not repay
the loan this month.
The Cash Budget
April May June Quarter
Beginning cash balance $ 40,000 $ 30,000 $ 30,000 $ 40,000
Add cash collections 170,000 400,000 335,000 905,000
Total cash available 210,000 430,000 365,000 945,000
Less disbursements
Materials 40,000 72,300 72,700 185,000
Direct labor 15,000 23,000 15,000 53,000
Mfg. overhead 56,000 76,000 59,000 191,000
Selling and admin. 70,000 85,000 75,000 230,000
Equipment purchase - 143,700 48,300 192,000
Dividends 49,000 - - 49,000
Total disbursements 230,000 400,000 270,000 900,000
Excess (deficiency) of
cash available over
disbursements $ (20,000) $ 30,000 $ 95,000 $ 45,000
The Cash Budget
April May June Quarter
Beginning cash balance $ 40,000 $ 30,000 $ 30,000 $ 40,000
Add cash collections 170,000 400,000 335,000 905,000
Total cash available 210,000 430,000 365,000 945,000
Less disbursements
Materials 40,000 72,300 72,700 185,000
Direct labor 15,000 23,000 15,000 53,000
Mfg. overhead 56,000 76,000 59,000 191,000
At the end70,000
Selling and admin. of June, Royal
85,000 has75,000
enough 230,000
cash
Equipment purchase -
to repay the $50,000 143,700
loan plus 48,300 192,000
interest at 16%.
Dividends 49,000 - - 49,000
Total disbursements 230,000 400,000 270,000 900,000
Excess (deficiency) of
cash available over
disbursements $ (20,000) $ 30,000 $ 95,000 $ 45,000
Financing and Repayment
April May June Quarter
Excess (deficiency)
of Cash available
over disbursements $ (20,000) $ 30,000 $ 95,000 $ 45,000
Financing:
Borrowing 50,000 - - 50,000
Repayments - - (50,000) (50,000)
Interest - - (2,000) (2,000)
Total financing 50,000 - (52,000) (2,000)
Ending cash balance $ 30,000 $ 30,000 $ 43,000 $ 43,000

$50,000 16% 3/12 = $2,000


Borrowings on April 1 and
repayment of June 30.
Prepare a budgeted
income statement.
The Budgeted Income Statement

Cash Budgeted
Budget Income
Statement

After we complete the cash budget,


we can prepare the budgeted income
statement for Royal.
The Budgeted Income Statement
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30

Sales (100,000 units @ $10) $ 1,000,000


Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin 501,000
Selling and administrative expenses 260,000
Operating income 241,000
Interest expense 2,000
Net income $ 239,000
Chapter Quiz: Question 4

The Stacy Company makes and sells a single


product, Product R. Budgeted sales for April are
$300,000. Gross Margin is budgeted at 30% of sales
dollars. If the net income for April is budgeted at
$40,000, the budgeted selling and administrative
expenses are:
A. $133,333.
B. $50,000.
C. $102,000.
D. $78,000.
Prepare a
budgeted balance
sheet.
The Budgeted Income Statement

Stacy Company
Budgeted Income Statement
For the Month Ended April 30

Sales (Product R) $ 300,000


Cost of goods sold (@ 70%) 210,000
Gross margin (@ 30%) 90,000
Selling and administrative expenses
Net income $ 40,000
The Budgeted Balance Sheet

Royal reported the following account


balances on March 31 prior to preparing
its budgeted financial statements:
Land - $50,000
Building (net) - $175,000
Common stock - $200,000
Retained earnings - $146,150
Royal Company
Budgeted Balance Sheet
25%of June
June 30
sales of
Current assets $300,000
Cash $ 43,000
Accounts receivable 75,000
11,500 lbs.
Raw materials inventory 4,600
at $0.40/lb.
Finished goods inventory 24,950
Total current assets 147,550
Property and equipment
5,000 units
Land 50,000 at $4.99 each
Building 175,000
Equipment 192,000
Total property and equipment 417,000
Total assets $ 564,550
50% of June
Accounts payable $ 28,400 purchases
Common stock 200,000 of $56,800
Retained earnings 336,150
Total liabilities and equities $ 564,550
Royal Company
Budgeted Balance Sheet
June 30
Current assets
Cash $ 43,000
Accounts receivable 75,000
Beginning balance $146,150
Raw materials inventory 4,600
Add: net income 239,000
Finished goods inventory 24,950
Deduct: dividends (49,000)
Total current assets Ending balance
147,550 $336,150
Property and equipment
Land 50,000
Building 175,000
Equipment 192,000
Total property and equipment 417,000
Total assets $ 564,550

Accounts payable $ 28,400


Common stock 200,000
Retained earnings 336,150
Total liabilities and equities $ 564,550
Zero-Base Budgeting

Managers are required to justify all budgeted


expenditures, not just changes in the budget
from the previous year. The baseline is zero
rather than last years budget.
International Aspects of Budgeting

Multinational companies face special


problems when preparing a budget.
Fluctuations in foreign currency exchange rates.
High inflation rates in some foreign countries.
Differences in local economic conditions.
Local governmental policies.
Prepare Budget on
the Key
Components for the
Service Industry
Key Budget Components for the Service Industry

Wonder World, a hypothetical theme park, has the following data:

Main Sources of Major


Departments
Revenue Expenses
Ticketing Salaries Finance & Administration
Food & Rent Operations
Beverages Cost of Sales Marketing
Souvenir Shop Advertising Souvenir Shop
Maintenance Food and Beverages
Depreciation Maintenance
Utilities
Prepare a
Visitorship Budget
Visitorship Budget
Based on historical records, economic outlook, tourist
arrival expectations, the following visitorship budget for the
coming year is prepared:

Number of Visitors
Adults 750,000
Children 250,000
Total Visitors 1,000,000
Prepare a Revenue
Budget
Revenue Budget
Based on the average price charged by Wonder World and
other historical data, the following revenues per visitor are
budgeted and approved by the top management:

Revenue per visitor


Gate Collections : Adults $13
Gate Collections : Children $9
Souvenir Shop $4
Food and Beverages $6
Revenue Budget
With the budgeted number of visitors and revenues per visitor
from each category, the budgeted revenues are computed:
Revenue
Gate Collections : Adults1 $9,750,000
Gate Collections : Children2 $2,250,000
Souvenir Shop3 $4,000,000
Food and Beverages4 $6,000,000
Total Revenue $22,000,000
Note
1 750,000 X $13

2 250,000 X $9

3 1,000,000 X $4

4 1,000,000 X $6
Prepare a Cost of
Sales Budget and
Expense Budget
Cost of Sales Budget
For cost of sales on souvenirs and food and beverages, the
company normally makes use of the historical cost of sales
% and takes into account of any expected price changes
from the suppliers. For the coming year, the expected cost of
sales % is 50% on sales for both the souvenir shop and food
and beverages.

Cost of Sales
Souvenir Shop $2,000,000
Food and Beverage $3,000,000
Total $5,000,000
Expenses Budget
How the items are budgeted will depend on the nature of the items.

Nature of expense Amount Budget approach

Rental $1,100,000 5% of revenue as agreed with the landlord.

Zero based approach by reviewing the


Salaries $3,500,000 actual requirement of each position and its
suitable rate of pay.
Advertising $1,200,000 Proposed by marketing manager.
Maintenance $980,000 Proposed by maintenance manager.
Computed by the finance manager by
Depreciation $890,000 taking into account of existing assets and
proposed new assets.

Computed by maintenance manager based


Utilities $580,000
on the rates and usage expectations.

Based on judgment and any specific


Other operating expenses $490,000
requirements such as legal expenses.
Total $8,740,000
Prepare a
Budgeted Income
Statement
Budgeted Income Statement

Budgeted Income Statement can be prepared by putting all


previous budgeted information together.

Budgeted Income Statement


Revenue $22,000,000
Cost of goods sold $5,000,000
Expenses $8,740,000
Net income $8,260,000
Explain the Costs
and Benefits of
Budgeting
Costs and Benefits of Budgeting
Budgeting is time-consuming and costly.
Budgetary slack or padding is an inherent problem of
budgeting.
Despite the drawbacks of budgeting, most companies are
still using budgets to plan, communicate, set objectives
and allocate resources etc.
Since budgets are still commonly used, benefits of
budgeting are high and drawbacks of budgeting can be
minimized by having a good budgeting system.
For a good budgeting system, it is critical to have effective
communication and mutual trust between the top
management and its staff.
End of Budget