The Basic Framework of Budgeting

A budget is a detailed quantitative plan for

acquiring and using financial and other resources
Master Budgeting over a specified forthcoming time period.
1 The act of preparing a budget is called
1.
budgeting.
2. The use of budgets to control an
organization’s activity is known as
budgetary control.

1 2

Planning and Control Advantages of Budgeting

Pl i –
Planning C t l–
Control Define goal
involves developing involves the steps and objectives
objectives and taken by C
Communicate
i t Thi k about
Think b t and d
plans plan for the future
preparing various management that
budgets to achieve attempt to ensure Advantages
Coordinate Means of allocating
these objectives.
j the objectives
j are activities resources
attained.
Uncover potential
bottlenecks

3 4
 Choosing the Budget Period The Master Budget: An Overview

Sales
Budget
Ending
Finished Goods
Operating
O ti Budget
B d t B d t
Budget Selling and
Production
Administrative
Budget
Budget
g

2005 2006 2007 2008 Direct Direct Manufacturing

Materials Labor Overhead
Budget Budget Budget
The annual operating budget A continuous budget is a
may be divided into quarterly 12
12--month budget that rolls
Cash
or monthly budgets. forward one month (or quarter) Budget
as the current month (or quarter)
is completed.
Budgeted Financial Statements
5 6

Budgeting Example The Sales Budget

n Royal
R lC
Company iis preparing
i b budgets
d t ffor th
the
quarter ending June 30.
o 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
15,000 units.
p The selling price is $10 per unit.

7 8
 Expected Cash Collections Expected Cash Collections

• All sales are on account.

• Royal’s
Royal s collection pattern is:
70% collected in the month of sale,
25% collected in the month following sale
sale,
5% uncollectible.
• Th
The March
M h 31 accounts t receivable
i bl bbalance
l off
$30,000 will be collected in full.
From the Sales Budget for May.

9 10

The Production Budget The Production Budget

• The management at Royal Company wants

Sales Production ending inventory to be equal to 20% of the
Budget B d t
Budget f ll i month’s
following th’ bbudgeted
d t d sales
l iin units.
it
and
Expected
Cash
• On March 31, 4,000 units were on hand.
Collections
Let’s prepare the production budget.
Production must be adequate to meet budgeted
sales and provide for sufficient ending inventory.

11 12
 The Production Budget The Production Budget

A
Assumed
d ending
di iinventory.
t
13 14

The Direct Materials Budget The Direct Materials Budget

• At Royal Company
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 month’s production.
• O
On MMarch
h 31
31, 13
13,000
000 pounds
d off material
i l
are on hand. Material cost is $0.40 per
pound.
Let’s p
prepare
p the direct materials budget.
g Ass med ending inventory
Assumed in entor
15 16
 The Direct Materials Budget Expected Cash Disbursement for Materials

• Royal pays $0.40

$0 40 per pound for its materials.
materials
• One-
One-half of a month’s purchases is paid for in
the month of purchase; the other half is paid
g month.
in the following
• The March 31 accounts payable balance is
$12 000
$12,000.

Let’s calculate expected cash disbursements.

17 18

Expected Cash Disbursement for Materials The Direct Labor Budget

• At Royal,
Royal each unit of product requires 0.05
0 05 hours (3
minutes) of direct labor.
• Th
The Company
C has
h a “no
“ llayoff”
ff” policy
li so allll employees
l
will be paid for 40 hours of work each week.
• In exchange for the “no layoff” policy, workers agree to
a wage rate of $10 per hour regardless of the hours
worked (no overtime pay)
pay).
Compute the expected cash
disbursements for materials • For the next three months, the direct labor workforce will
for the quarter. b paid
be id for
f a minimum
i i off 1
1,500
500 h
hours per month.
th
Let’s prepare the direct labor budget.
140,000 lbs. × $.40/lb. = $56,000
19 20
 The Direct Labor Budget Manufacturing Overhead Budget

• At Royal,
Royal manufacturing overhead is applied to units
of product on the basis of direct labor hours.
• The
Th variable
i bl manufacturing
f t i overhead
h d rate
t iis $20 per
direct labor hour.
• Fixed manufacturing overhead is $50,000 per month
and includes $20,000 of noncash costs (primarily
depreciation of plant assets)
assets).

Let’ss prepare the manufacturing overhead budget

Let budget.

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Manufacturing Overhead Budget Manufacturing Overhead Budget

Depreciation is a noncash charge.

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Ending Finished Goods Inventory Budget Selling and Administrative Expense Budget

• At Royal, the selling and administrative expenses budget is

di id d iinto
divided t variable
i bl andd fifixed
d components.
t
Production costs per unit Quantity Cost Total
Direct materials 5.00 lbs. $ 0.40 $ 2.00 • The variable selling and administrative expenses are $0.50
Direct labor 0.05 hrs. $10.00 0.50 per unit
nit sold
sold.
Manufacturing overhead 0.05 hrs. $49.70 2.49
• Fixed selling and administrative expenses are $70,000 per
$ 4.99
month
month.
Budgeted finished goods inventory
Ending inventory in units 5,000 • The fixed selling and administrative expenses include
Unit product cost $ 4.99
4 99 $10 000 in costs – primarily depreciation – that are not cash
$10,000
Ending finished goods inventory $24,950 outflows of the current month.

Production Budget. Let’s prepare the company’s selling and administrative

expense budget.

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Selling and Administrative Expense Budget Selling and Administrative Expense Budget

Calculate the selling and administrative

cashh expenses ffor th
the quarter.
t
27 28
 The Cash Budget The Cash Budget

Royal:
z Maintains a 16% open line of credit for $75,000
z Maintains a minimum cash balance of $30,000
z Borrows on the first day of the month and repays $50,000
$50 000 × 16% × 3/12 = $2,000
$2 000
Borrowings on April 1 and
loans on the last day of the quarter.
repayment on June 30.
z Pays a cash dividend of $49,000 in April
z Purchases $$143,700
, of equipment
q p in Mayy and
$48,300 in June (both purchases paid in cash)
z Has an April 1 cash balance of $40,000
$40 000
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The Budgeted Income Statement The Budgeted Income Statement

S l B
Sales Budget.
d
Cash Budgeted Royal Company
Budgeted Income Statement
Budget Income For the Three Months Ended June 30
Ending Finished
Statement Sales (100,000 units @ $10) $ 1,000,000 Goods Inventory.
Cost of goods sold (100,000
(100 000 @ $4.99)
$4 99) 499 000
499,000
Gross margin 501,000
Selling and administrative expenses 260,000 Selling and
p
Operating g income 241,000
, Administrative
Interest expense 2,000
Expense Budget.
Net income $ 239,000
After we complete the cash budget
budget,
we can prepare the budgeted income Cash Budget.
statement for Royal.
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 The Budgeted Balance Sheet Royal Company
Budgeted Balance Sheet 25% of June
June 30 sales of
Current assets $300,000.
Royal reported the following account C h
Cash $ 43,000
43 000
11,500 lbs.
balances prior to preparing its budgeted Accounts receivable
Raw materials inventoryy
75,000
4,600 at $0.40/lb.
financial statements: Finished goods inventory 24,950
Total current assets 147,550 5,000 units
• Land - $50
$50,000
000 Property and equipment at $4.99
$4 99 each
each.
• Common stock - $200,000 Land
Equipment
50,000
367,000
• Retained earnings - $146,150
$146 150 T
Totall property and
d equipment
i 41 000
417,000
Total assets $ 564,550
• Equipment - $175,000
50% of June
Accounts payable $ 28,400 purchases
Common stock 200,000
of $56,800.
Retained earnings 336 150
336,150
Total liabilities and equities $ 564,550
33 34

Royal Company
Budgeted Balance Sheet
June 30
Current assets
C h
Cash $ 43 000
43,000
Accounts receivable Beginning balance
75,000 $146,150
Add: net income 239,000
Raw materials inventoryy 4,600
Deduct: dividends (49 000)
(49,000)
Finished goods inventory 24,950
Ending balance $336,150
Total current assets 147,550
Property and equipment
Land 50,000
Equipment 367,000
T
Totall property and
d equipment
i 41 000
417,000
Total assets $ 564,550

Accounts payable $ 28,400

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