yo Shaguana Watson Loner Sownce TE BUDGETING Planning is the comerstone of effective management. Planning refers to the process of setting goals and objectives for a firm, Budgeting is the process of formalizing plans and committing them to written financial terms. The result of the process is a budget which is a financial plan for the future based on a single level of activity. ‘The use of budgets to control a firm’ s activities is known as budgetary control. A budgeting system must have elements of both planning and control. Planning involves developing objectives and preparing various budgets to achieve these objectives. Control involves the steps taken by management to attain the objectives that were set during the planning process and to ensure that all parts of the firm are working toward that goal, Planning and Time Plans can be identified by time horizons - short, medium and long-term. Strategic Plan - the most forward looking budget (long-term plan). It forms the basis for the development of programmes. It sets overall goals and objectives for the firm (SWOT analysis). This produces forecasted financial statements for five ten-year periods, including design and location of new plants, addition and deletion of product lines, and acquisition and disposal of equipment. Programme - a medium-term (2-5 yrs) statement of activities/ steps needed to accomplish a single-use plan. Budgeting - short-term planning process (12 mths) to co-ordinate and control the programmes identified. Objectives of Budgeting - (1) Planning, (2) Co-ordination, (3) Communication, (4) Motivation, (5) Control, (6) Performance Evaluation and (7) Authorization, Human factors in budgeting: Problems in budgeting: (1) lack of management commitment, (2) creation of inflexibility, (3) behavioural responses, (4) conflict between short-term and long-term objectives, and (5) goal incongruence. Budget Styles: (1) Imposed - key decisions made by top management. Top-down approach. Easy to implement, unbiased towards certain departments and facilitates co-ordination, Cuts out expertise of lower-level employees. (2) Participative - Bottoms up approach. Used in decentralized firms where budget is built upward. Leads to high degree of motivation, utilizes knowledge of what might or might not be feasible. It can ‘encourage bias and excessive claims from individuals. (3) Negotiated - a combination of the other two approaches. It attempts to achieve both imposed and participative styles while avoiding some of the obvious disadvantages. It is difficult and time- consuming. Budget Committee - responsible for overall policy matters relating to the budget programme and for coordinating the preparation of the budget. It includes the CEO, financial controller and heads of departments or divisions. The committee (1) resolves difficulties and disputes among the segments of the firm, with respect to budget, (2) approves the final budget and (3) receives the periodic report on the progress of the firm in reaching the budgeted goals. Preparing the Budget Master Budget - comprehensive set of all budgetary schedules and the pro forma financial statements of the firm, The master budget sets the target for sales, production, distribution and financing activities. Usually ends with a cash budget, a budgeted income Statement and a budgeted balance sheet. The sales budget is the starting point and its data is used to prepare the production budget, Some of the data from the sales budget goes directly to the budgeted income statement, cash budget and the selling and administrative budget. The production budget provides data for the raw materials budget, direct labour budget, manufacturing overheadbudget and the selling and administrative budget. These four budgets then provide data for the cash budget and the data from the cash budget is used in the budgeted balance sheet. ae SALES | BUDGET }~ Panta | | PRODUCTION BUDGET RAW DIRECT MANUFACTURING | | SELLING AND |_| MATERIALS LABOUR OVERHEAD ADMINISTRATIVE BUDGET | BUDGET | BUDGET BUDGET . , a “al CASH == BUDGET BUDGETED | ESE Uy INCOME |» BALANCE STATEMENT aoe ‘The diagram shows the interrelationships among components of the budget. ‘The Sales Budget ~ A detailed schedule showing the expected sales for the budget period. It is expressed in both dollars and units of product. Following the sales budget is the Schedule of Expected Cash Collection which is used to determine the amount of cash receipts from sales in a given month, according to the credit term given to customers. An example of the layout of the Sales Budget and Schedule of Expected Cash Collections, given that all sales are on account and that 50% of sales are collected in the month of sale and the remainder in the following month : X'Ine, Sales Budget (Schedule 1) for the Quarter ending 30 June 2009 April May June Total Expected unit sales 8 000 9.500 9.900 27 400 Unit selling price $40 $40 $40 $40 Total Sales $520000 —-$380000,- $396000, $1,096 000Schedule of Expected Cash Collections for units sold (Schedule 2) Month of sale Month of Collection April May June Total Accounts Receivable, beginning balance $110000 $ 8 $110 000 April Sales Cu . 160000 160000 320 000 May Sales 190 000 190000 380000 June Sales é 198.000 198.000 Total Cash Collections $270000 —-$350000 —-$388.000 $1008.00, The Production Budget ‘The production budget lists the number of units that must be produced each period based on the expected sales and the inventory policy of the firm. Production = Expected sales + desired ending inventory - beginning inventory An example of the layout of the Production Budget: X Ine. Production Budget (Schedule 3) for the Quarter ending 30 June 2009 April June Total Expected unit sales 8000 9900 27.400 Desired Ending Finished Goods Units 2.000 2.500 2.500 Total Required Units 10.000 12400 29.900 Less:(Beginning Finished Goods Units. 3.000 + 2.400 3.000 Required Production Units 7000 10.000 26.900 irect Materials Budget Tae production budget will determine the purchases of raw materials budget. Only manufacturing firms have direct materials budget, other firms have purchases budget. The Direct Materials budget is usually associated with a Schedule of Expected Cash Disbursements for raw materials, This data is used in preparing the overall cash budget. Payments for raw materials include amounts owing for purchases of ‘materials in prior periods and are currently due for payment. ‘Total Direct Materials Purchases = Desired Ending Materials Inventory + Materials required for Production An example of the layout of the Direct Materials Budget: X Ine. Direct Materials Budget (Schedule 4) for the Quarter ending 30 June 2009 April May June Total Expected production in units (Sched 3) 7 000 9.900 10 000 26 900 Direct Materials per unit (ke) x2 x2 oe x2 Total Kgneeded for Production vu 14000 19 800 20 000 53 800 ‘Add: Desired Ending Direct Materials (kg) 2.000 2.000 200 2200 Total Materials required . 16000 21 800 22.200 56 000 Less: Beginning Direct Materials (kg) 1800 2.000 2.000 1.800 Direct Materials Purchases 14200 19.800 20200 54.200 Cost per Kg - x5 xSS x$5_ x$5 Total Cost of Direct Materials Purchases $71.00 $99.000 101.000 $271,000*Schedule of Expected Cash Disbursements for Materials (Schedule 5) Accounts Payable, beginning balance $3000 $ $ $3 000 April Purchases samen 500), 35:50) 71 000 May Purchases, 49 500 49500 99.000 June Purchases. 50500 50 500 Total Cash Disbursements $38500 $85.000 $100000 $223 500 Yh of se minay io pid or prrchaacs virthe manh of purchases aul te amauntiy co paid neck ‘he ct Labour Budget ‘The Direct Labour budget is dependent on the production budget. Direct Labour Requirement = Units to be Produced x Number of Hours of labour required per unit Total Direct Labour Cost ~ Direct Labour Requirement x Wage Rate An example of the layout of the Direct Labour Budget: Xie.” Direct Labour Budget (Schedule 6) for the Quarter ending 30 June 2009 April May June Total Expected production in unit (Sched 3) 7000 9900 10 000 26 900 Direct Labour Hrs per unit x1 oo) at xl Total Required Direct Labour Hrs 7.000 9900 10 000 26 900 Direct Labour Cost per Hr x $10 x $10 x$10 x$10 Total Direct Labour Cost 570 000. $99.00 $100 000. $269 000 Manufacturing Overhead Budget Itis derived from the production budget. It provides a schedule of all costs of production other than direct labour and direct materials. It consists of both variable overhead as well as fixed overhead, An example of the layout of the Manufacturing Overhead Budget: X Ine, Manufacturing Overhead Budget (Schedule 7) for the Quarter ending 30 June 2009 April May June Total Budgeted Direct Labour Hrs 7000 9.900 10.000 26 900 Variable Overhead Rate i aes 82 $2 [stata Variable Manufacturing Overhead $14000 $19 800 $20000 $53 800 Fixed Manufacturing Overhead... 20.000 20000 20000 60.000 Total Manufacturing Overhead 34.000 39 800 40 000 113 800 Less: Depreciation 6.000 6.000 6.000 18.000, Cash Disbursements for MOH $28000 $33 800 34 000 95 800 [Unit MOH cost: $113 800/26 900 = $4.23] Selling and Administrat Budget It lists the budgeted expenses for areas other'than manufacturing, and it is the compilation of all selling and administrative costs within the firm. This budget also contains both variable and fixed costs. iS presentation is similar to that of the Manufacturing Overhead Budget. An example of the layout of the Selling and Administrative Budget: 4X Ine. Selling and Administrative Budget (Schedule 8), for the Quarter ending 30 June 2009 April May June Total Budgeted sales in unit 8.000 9500 9900 27400 Variable Selling & Admin Rate peas SL $1 Ss Variable Expenses $8,000 $9500 $9900 $27.400 Fixed Selling and Administrative Expenses: Advertising 5.000 5.000 5.000 15 000 Executive salaries 15 000 15.000 15 000 45.000 Depreciation 10 000 10.000 10.000 30.000 Total Fixed Selling & Admin 30.000 30.000 30.000 90.000 ‘Total Selling & Admin Expenses 38 000 39500 39 900 117400 Less: Depreciation .. 10000 10000 _ 10 000 30.000 Cash Disbursements for Selling &Admin $28.000 $29500 _$29900 $7400 Dapeiation ba noc sh payment hers fox must bot subtracted fr ui odor te te get the Kure oPthe cok, ‘The Cash Budget pulls all the operating budgets and schedules together. It is composed of four main sections: (1) the Receipts Section, (2) the Disbursement Section, (3) the Cash Excess or Deficiency Section, and (4) the Financing Section. The Receipts section consist of. listing of all the cash inflows except any borrowings during the budgeted petiod. The Disbursement section consists of a listing of all the cash payments for goods and services during the budgeted period. Non-cash expenses are not included in this section. The Excess or Deficiency section is calculated using the following formula: Excess/ Deficiency of Cash = Beginning Cash balance + Cash Receipts - Cash Disbursements The Financing section lists the borrowings and repayments projected for the budgeted period. This section will also contain any interest payments that will be made during the budgeted period An example of the layout of the Cash Budget, assuming a minimum balance of $10 000, borrowings in a 9f $000 and interest charged at 10% pia: eee i (nenb Cash Budget for the Quarter ending 30 June 2009 Schedule April May June Total Cash Balance, beginning, $10 000 10 500 10000 $10 000 Add Receipts: Collection from Customers 2 270000 350.000 = 388.000 1.008.000 Total Cash Available 280 000 360 500 398.000 1.018 090(!xa0F Less Disbursements: Direct Materials 5 38500 85.000 100000 223 500 Direct Labour 6 70000 99.000 100000 269.000 Manufacturing Overhead 7 28000 33 800 34.000 Selling and Administrative 8 28000 29 500 29900 Purchase of Equipment 42.000 79.200 18 800 Dividends 90 000 36.000 po Be Total Disbursements 296500 362500 282.700 Excess (Deficiency) of Cash Available over Dishursement(16 500) (2.000) 115 300 Finaneing Borrowing ..(at start of month). “27 000 12.000 0 39.000 Repayment ...(at end of month, 0 0 (39000) (39.000) Interest. oO ‘875¥ (875) ‘Total Financing 27.000 12.000 (9875) 875 Cash Balance, ending .... 10500, 000 75.425 75425 ¢ Cb 500+ 10 oon) = $2500 *497aD‘he Budgeted Income Stateme! ‘The budgeted income statement shows the company’s planned profit for the budget period. ‘An example of the layout of the Budgeted Income Statement: X Ine. Budgeted Income Statement for the Quarter ending 30 June 2009 Sales. ae $1 096 000 Cost of Goods Sold ....(27 400 x $24.23) 663 902 Gross Profit 432 098 Operating Expenses: Selling & Administrative Expenses 117400 ‘Net operating income 314 698 Less: Interest Expense 875 Net Income 3.13 [Unit cost : 2kg x $5 = $10; Lab: Ihr x $10 = $10; MOH: Ihr x $4.23 ~ $4.23] ‘The Budgeted Balance Sheet The budgeted balance sheet is the Final step in the master budget and it projects each balance sheet item as expressed in the previous schedules. ‘The balance sheet serves to provide a picture ofthe firm atthe end of the budget period. ‘An example of the layout of the Budgeted Balance Sheet: X ine. Budgeted Balance Sheet, 30 June 2009 Current Assets Cash... pestis $75 425 Accounts receivable 198 000 Raw Materials Inventory (2200 x5) 11000 Finished Goods Inventory 2500x2423) 60.575 Total current assets $345 000 Fixed Assets Land 100 000 Buildings 200 000 Equipment 140 000 Furniture & Fittings 60.400 Total Fixed Assets 500.4 Total Assets $845 400 Liabilities & Stockholders’ Equity Current Liabilities: ‘Accounts Payable $50 500 Stockholders’ Equity: ‘Common Stock “$481 077 Retained Famings 313.823, Total Stockholders’ Equity 294.900 ‘Total Liabilities & Stockholders’ Equity $845.40EXERCISES ie Eller Co is preparing its master budget for 2006, Relevant data pertaining to its sales are given below. Sales for the year are expected to total 4 000 000 units. Quarterly sales are 25%, 30%, 15%, and 30%, respectively. The sales price is expected to be $1.50 per unit for the first quarter and then be increased to $1.75 per unit from the second quarter. Prepare a sales budget by quarters and in total for 2006 for Eller Co. H. G. Inc has budgeted sales for the year of 4 000 000 units. Quarterly sales are 25%, 30%, 15% and 30% respectively. ‘The inventory on hand at the beginning of the first quarter was 150 000 units. It is the company’s policy to maintain inventory on hand at the end of each quarter equal to 15% of the next quarter’s anticipated sales. The anticipated sales for th first quarter of the following year are 1 000000. Prepare a production report for the year by quarters and in total. Philmore Associates has budgeted the following unit sales: 2006 Month ___Units January 70,000 February 30,000 March 50,000 April 90,000 ‘The finished goods inventory on hand on December 31, 2005 was 7,000 units. It is the company’s policy to maintain a finished goods inventory at the end of each month equal to 10% of the next month’s anticipated sales Required: a. Prepare a production budget for the first quarter, 4, — Rupee Inc. Manufactures two products, ABC and XYZ. The budgeted units to be produced are as follows: 2006 ABC xz April 20,000 30,000 May 12,000 20,000 June 18,000, 28,000 July 16,000 24,000 It takes 2 pounds of direct materials to produce the ABC product and 4 pounds of direct materials to produce the XYZ product. Itis the company’s policy to maintain an inventory of direct materials on hand at the end of ‘each month equal to 20% of the next month’s production needs for the ABC product and 10% of the next month’s production needs for the XYZ. product. Direct materials inventory on hand at March 31 were 8,000 pounds for the ABC product and 6,000 pounds for the XYZ product. The cost per pound of raw materials is $5 ABC and $7 XYZ. ‘ Required: iL Prepare a direct material budget forthe ABC product for the second quater of 2006, 7— — _— l fi, Using the information provided above prepare direct materials budget for XYZ product for the second quarter of 2006. Ce ae Quarter Units 1 80,000 zi 40,000 3 60,000 4 100,000 Each unit requires 3 hours of direct labour at $10 per hour. The wage rate is scheduled to increase by 10% beginning at the fourth quarter. Required: i Prepare a direct labour budget for 2006, The direct labour budget for Eva Gordon Corporation for the upcoming year contains the following details concerning budgeted direct labour hours { “Quarter Pe Quarter pYQuarier [Quarter Budgeted direct labour hours 5,000 4,800| 5,200 5,400] ‘The company’s variable manufacturing overhead reate is $1.75 per direct labour hour and the company’s fixed ‘manufacturing overhead is $35,000 per quarter. The only non-cash item included in the fixed manufacturing overhead is depreciation which is $15,000 per quarter. Required: Compute the manufacturing overhead budget for the four quarters, 7. Emile Inc. is in the process of preparing a selling and administrative budget for the first quarter of 2006, 1, Sales: 22,500 units; unit selling price $ 30 2 Variable Costs per dollar of sales: . Sales commissions 8% . Delivery expenses 2% Advertising 5% 3. Fixed costs per quarter: Sales salaries 36,000 Office salaries 18,000 Depreciation 6,000 Insurance 4,000 Utilities 3,000 3Prepare a selling and administrative expense budget for the first quarter of 2006. 8. T.Hamris nc, las budgeted sales revenue as follows: Bud; we January 97,500 February 135,000 March, 165,000 April 75,000 May 82,500 June 45,000 Approximately 80% of sales each month are on credit. In the past, the collection of credit sales has occurred as follows: 60% in the month of sale, 30% in the month following the sale, and 5% in the second month following, the sale, The other 5% is uncollectible, i, Prepare a schedule showing the distribution of credit sales and sash sales by month i Prepare a schedule which shows the expected cash receipts from sales for the months of April, May and June 9. S. Wilson Company has budgeted sales revenues as follows: December January February Credit Sales 54,000 58,000 36,000 Cash Sales 36,000 102,000 78,000 Total Sales 90,000 160,000 114,000, Past experience indicates that 60% of the credit sales will be collected in the month of sale and the remaining 40% will be collected in the following month. Purchases of inventory are all on credit and 50% is paid in the ‘month of purchase and 50% in the month following the purchase. Budgeted inventory purchases are: December $120,000 January 100,000 February 42,000 Other cash disbursements budgeted: i. Selling and administrative expenses of $19,000 each month, fi. Dividends of $41,400 will be paid in January iii, Purchase of a computer in February for $10,000 cash ‘The company wishes to maintain a minjmum cash balance of $20,000 at the end of each month. The company borrows money from the bank at 9% interest, if necessary, to maintain the cash balance, Borrowed money is repaid in months when there is an excess cash balance. The beginning cash balance on January 1 was $20,000. Assume that borrowed money in this case is for 1 month.10. aw 2. “SS The direct labour budget of Eva Gordon Corporation for the upcoming year contains the following details concerning budgeted direct labour hours: Prepare a cash budget for the month of January. TQuarter__[ 7 Quaner_[ 3" Quarter [4 Quarter Budgeted direct labour hours 5,000 4,800. 5,200 5,400. ‘The company's variable manufacturing overhead rate is $1.75 per direct labour hour and the company's fixed ‘manufacturing overhead is $35,000 per quarter. The only non-cash item included in the fixed manufacturing overhead is depreciation which is $15,000 per quarter. A) Compute the manufacturing overhead budget for the first quarter. B) Prepare the manufacturing overhead budget for the remaining quarters. David Mings, sole trader, estimates that credit sales for August, September, October and November will be $180,000, $120,000, $230,000 and $160,000, respectively. Experience has shown that collections are made as follows: inmonth of sale 3 jn first month 60 in second month after sale 103 Calculate the collections from customers for the months of October and November. Eversley Lawn Care needs a cash budget for the month of April 2006. The company’s management accountant has provided you with the following information. ‘The April 1, 2006 cash balance is expected to be $14,560. All sales are on account. Credit sales are collected over a three-month period ~ 60 per cent in the month of sale, 30 per cent in the month following sale, and 10 per cent in the second month following sale. Actual sales for February and March were $60,000 and $55,000, respectively. Aprils sales are budgeted at $70,000, Marketable securities are expected to be sold for $38,000 during the month of April The controler estimates that direct materials totalling $53,000 will be purchased during April. Fifty per cent of a month's ‘aw materials purchases are paid in the month of purchase withthe remaining SO per cent paid in the following month, ‘Accounts payable for March purchases total $16,150, which wil be paid in April During April, direct labour costs are estimated to be $28,000. “Manufacturing overhead is estimated to be 50 per cent of direct labour costs. Further, the management accountant «estimates that approximately 10 per cent of the manufacturing overhead is depreciation on the factory building and equipment. Selling and administrative expenses are budgeted at $34,000 for April. Of this amount, $16,000 is depreciation, During April, Eversley Lawn Care plans to buy a new lawn mower costing $17,300. The company will pay cash forthe lawn mower. {o Eversley Lawn Care owes $9,000 in income tax, which must be paid in AprilEversely Lawn Care must maintain a minimum cash balance of $10,000, To bolster the cash position as needed, an open line of credit is available from the bank. Prepare the following i. Aschedule of cash collections fi, A schedule of cash payments for raw materials and Ii A cash budget forthe month of April, Indiate in the financing section any borrowings that will be necessary during the month. 15, RA Chad Associates, a manufacturing company, prepares its master budget on a quarterly basis. The following data have been assembled to assist in preparation of the master budget for the final quarter. L 4s of Sentember 30, 2005, the company’s balance sheet showed the following account balances: ah $15 000] FAccounts receivable 95,009) Javentory 25,200) Building and equipment inet) 28,2 Wecounts payable $36,60( apitl 380,004 tained earnings 150.0 $567,400 $567.40 |i, Actual sales for September and budgeted sales for the final quarter are as follows eptember (actual) $120, \ctober 140,004 ioverber 170,006 jecember 180, january 100,06 Sales are 20% for eash and 80% for credit. All payments on credit sales are collected in the month following the sale. ‘The accounts receivable at September 30 are a result of September credit sales ‘The company’s gross profit rate is 40% of sales. The cast af goods sold is 60% of sales. Monthly expenses are budgeted as follows: salaries and wages, $15,000 per month, shipping 6% of sales, advertising $12,000 er month, other expenses 4% of sales, Depreciation of equipment will be $12,000 forthe quarter. Vi. Atthe end of each month, inventory is to be on hand equal 30% of the following month's cost of goods sold. '. Half ofa month’s inventory purchases are paid for in the month of purchase and half in the following month, ‘ii. Equipment purchases during the quarter wil be as follows: October $23,000 and November $6,000. Dividends totalling ‘$6,000 will be paid in December. ‘ix The company must maintain a minimum cash balance of $15,000. An open line of credit is available at First Bank. All borrowing is done atthe beginning of the month and repayments are made atthe end of the month, Borrowings and ‘payments of principal must be in multiples of $1,000. Interest is paid only atthe time of payment of principal. ‘The annual interest rate is 12%, ‘ Using the data above, complete the following statement and schedule for the final quarter, The first month is completed as an example. yfA B. c ‘Schedule of collections Saber November | Decernber vash sales $28,006 redit sales 96,00 otal collections 324.0 Inventory budget ‘October lovember Pecember Total idgeted cost of goods sold $8400 $102,001 dd desired ending inventory 30,600) otal needs 7146 ss beginning inventory 25,2 Required purchases 25,4 ‘Budgeted cost of goods sold Is 60% of sales (140,000 x 60%). Desired ending inventory is 30% of next month cast of goods sold (170,000 x 30%). Beginning inventory is last month’s closing inventory, Cash disbursements for purchases October November scember Total ptember purchases 35.5 36 \ctober purchases WT 348,701 29,404 jovember purchases December purchases ash disbursements 81,30 ‘Schedule of cash disbursements for operating expenses October November jecember salaries and wages $15 00% Shippin 8,40 vertising 12,004 ther expenses x fotal $420 ash budget ‘October November jecember Total a ish balance $18 0 Rad collections: 124, al fotal cash available $142,006 fess disbursements Javentory purchases BEI jperating expenses 41,06 Equipment 23,006 Dividends fotal disbursements 145,304 cess (deficiency) (2,200) Financing lorrowing 19 004 iepayment interest losing balance F. Prepare the budgeted income statement and budgeted balance sheet. 4