Budget (Master Planning)

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Budgets: a plan of action expressed in financial terms

when used for planning, a budget is a method for translating the goals and
strategies of an organization into operational terms.

Control: the process of setting standards, receiving feedback on actual

performance, and taking corrective action whenever actual performance deviates
significantly from planned perfomance.

The Master Budget and Its Interrelationship

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 Purposes of Budgeting
Serves as the comprehensive financial plan for the organization as a whole and
gives an organization several advantages.

 It forces managers to plan

 It provides resources information that can be used to improve decision making

 It aids in the use of resources and employees by setting a benchmark that can
be used for the subsequent evaluation of performance.

 It improves communication and coordination

Budgeting forces management to plan for the future - to develop an overall

direction for the organization, foresee problems, and develop future policies.

Budgets set standards for the use of a company's resources and help control
and motivate employees.

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 It is also used for communicaiton and coordination of employee efforts, so that
all employees can be aware of their role in achieving the organization's
objectives.

The Budgeting Process

Directing and Coordinating
Budget director: the individual responsible for coordinating and directing the
overall budgeting process.

Budget committee: a committee responsible for setting budgetary policies and

goals, reviewing and approving the budget, and resolving any differences that
may aries in the budgetary process.

Types of Budgets
Master budget: the collection of all area and activity budgets representing a firm's
comprehensive plan of action.

 Operating budgets: budgets associated with the income-producing

activities of an organization.

concerned with the income-generating activities of a firm: sales,

production, and finished goods inventories

 Financial budgets: that portion of the master budget that includes the cash
budget, the budgeted balance sheet, the budgeted statement of cash
flows, and the capital budget.

concerned with the inflows and outflows of cash and with financial
position.

Components of the Master Budget

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 Gathering Information for Budgeting
Forecasting Sales
the sales forecast is the basis for the sales budget

Preparing the Operating Budget

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 The following are the components of the operating budget:

 Sales budget

 Production budget

 Direct materials purchases budget

 Direct labor budget

 Overhead budget

 Ending finished goods inventory budget

 Cost of goods sold budget

 Marketing expense budget

 Research and development expense budget

 Administrative expense budget

 Budgeted income statement

Sales Budget
a budget that describes expected sales in units and dollars for the coming
period

is the projection approved by the budget committee that describes

expected sales for each product in units and dollars

Illustration:

ABT, Inc., manufactures and sells concrete block for residential and commercial
building. ABT expects to sell the following in 201

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 Required:

 Construct a sales budget for the ABT concrete block line for the coming
year. Show total sales by quarter and in total for the year.

2. What if there were two types of concrete block (type 1 and type 2 and 60
percent of the sales in each quarter were for type 1? Assume the selling price
for type 1 is $0.60 in the first quarter and $0.70 for the rest of the year. The
selling price of type 2 is $0.80 in Quarters 1 and 2 and is $0.90 per unit for the
rest of the year. Construct a sales budget for ABT showing sales for both types
and in total.

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 Quarter 1 = 2,000,000 x 60% = 1,200,000

Quarter 2 = 6,000,000 x 60% = 3,600,000

Quarter 3 = 6,000,000 x 60% = 3,600,000

Quarter 4 = 2,000,000 x 60% = 1,200,000

Total = 16,000,000 x 60% = 9,600,000

Production Budget
a budget that shows how many units must be produced to meet sales needs
and satisfying ending inventory requirements

describes how many units must be produced in order to meet sales needs and
satisfy ending inventory requirements

depends on the unit sales shown in the sales budget

Basic equation for the production budget

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 💡 Units to be produced = Unit sales + Desired units in ending inventory -
Units in beginning inventory

Illustration:
ABT expects the following unit sales and desired ending inventory in 201

Inventory on both January 1, 201, and January 1, 202, is expected to be 100,000

blocks.

Required:

 Construct a production budget for the ABT concrete block line for the
coming year. Show total units produced by quarter and in total for the year.

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 2. What if ABT did not provide the desired ending inventory in units, but instead
relied on an inventory rule—that the desired ending inventory of blocks was
equal to 5 percent of the next period's sales? Further, assume that the
budgeted unit sales in Quarter 1, 202, equaled 2,500,000, and that the
beginning inventory for Quarter 1, 201, met the inventory rule. Construct a
production budget for ABT showing units produced by quarter and in total for
the year.

Solution:
Quarter 1 ending inventory = 6,000,000 x 0.05 = 300,000
Quarter 2 ending inventory = 6,000,000 x 0.05 = 300,000

Quarter 3 ending inventory = 2,000,000 x 0.05 = 100,000

Quarter 4 ending inventory = 2,500,000 x 0.05 = 125,000

Desired ending inventory for Q4 = 0.05 x 2,000,000 = 100,0000

Direct Materials Purchases Budget

a budget that outline the expected usage of materials production and
purchases of the direct materials required.

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 Purchases (in units) are computed as follows:

💡 Purchases = Expected usage + Desired ending inventory of direct

materials - Beginning inventory of direct materials

Illustration:
ABT makes concrete blocks. Each block requires 26 pounds of raw materials (a
mixture of cement, sand, gravel, shale, pumice, and water). ABT's raw materials
inventory policy is to have 5 million pounds in ending inventory for the third and
fourth quarters and 8 million pounds in ending inventory for the first and second
quarters. Thus, desired direct materials inventory on both January 1, 201, and
January 1, 202, is 5,000,000 pounds of materials. Each pound of raw materials
costs $0.01.

Required:

 Construct a direct materials purchases budget for the raw materials for the
ABT concrete block line for the coming year. Show total amounts by quarter
and in total for the year.

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 2. What if ABT did not provide the desired ending inventory in units, but instead
relied on an inventory rule—that the desired ending inventory of raw materials
was equal to 2 percent of the next period's production needs? Further, assume
that the budgeted production for Quarter 1, 202, equaled 2,200,000 concrete
blocks, and that the beginning inventory of materials for Quarter 1, 201, met
the inventory rule. Construct a direct materials purchases budget showing
pounds purchased and purchase cost by quarter and in total for the year.

Quarter 1 ending inventory = 0.02 x 26 x 6,000,000 = 3,120,000

Quarter 2 ending inventory = 0.02 x 26 x 5,600,000 = 2,912,000

Quarter 3 ending inventory = 0.02 x 26 x 2,000,000 = 1,040,000

Quarter 4 ending inventory = 0.02 x 26 x 2,200,000 = 1,144,000

Beginning inventory for Q1 = 0.02 x 26 x 2,4000,000 = 1,248,000

Q2 = 0.02 x 26 x 6,000,000 = 3,120,000

Q3 = 0.02 x 26 x 5,600,000 = 2,912,000
Q4 = 0.02 x 26 x 2,000,000 = 1,040,000

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 Direct Labor Budget
a budget showing the total direct labor hours needed and the associated cost
for the number of units in the production budget

Illustration:
ABT makes concrete blocks. Each block requires 0.015 direct labor hour; direct
labor is paid $14 per direct labor hour.
Recall from Cornerstone 8.2 that ABT budgeted 2,400,000 units in Quarter 1,
6,000,000 units in Quarter 2, 5,600,000 units in Quarter 3, and 2,000,000 units in
Quarter 4.

Required:

 Construct a direct labor budget for the ABT concrete block line for the
coming year. Show total amounts by quarter and in total for the year.

2. What if ABT required two types of direct labor—mixers and shapers. Each
concrete block requires 0.005 hour of mixing time at $10 per direct labor hour.
Each concrete block requires 0.01 hour of shaping time at $16 per direct labor
hour. Prepare a direct labor budget for each type of labor. Show hours and cost
for each quarter and in total for the year.

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 Overhead Budget
a budget that reveals the planned expenditures for all indirect manufacturing
items

Illustration:
ABT makes concrete blocks. Each block requires 0.015 direct labor hour. Variable
overhead is $8 per direct labor hour. Fixed overhead is budgeted at $320,000 per
quarter $100,000 for supervision, $200,000 for depreciation, and $20,000 for
rent). Recall from Cornerstone 8.4 that ABT budgeted 36,000 direct labor hours in
Quarter 1, 90,000 direct labor hours in Quarter 2, 84,000 direct labor hours in
Quarter 3, and 30,000 direct labor hours in Quarter 4.

Required:

 Construct an overhead budget for the ABT concrete block line for the
coming year. Show total amounts by quarter and in total for the year.

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  What if ABT's fixed overhead were $350,000 per quarter? How would that
affect variable overhead? Fixed overhead? Total overhead?
If fixed overhead increased to $350,000 per quarter, variable overhead would
be unaffected. However, the fixed overhead amounts would increase from
$320,000 to $350,000 per quarter, and the total overhead would increase by
$30,000 per quarter. The yearly overhead would increase by $120,000 4 ×
$30,000.

Ending Finished Goods Inventory Budget

A budget that describes planned ending inventory of finished goods in units
and dollars

Illustration:
ABT makes concrete blocks. Cornerstone 8.3 shows that each unit (block)
requires 26 pounds of raw materials costing $0.01 per pound. Therefore, each unit
has budgeted direct materials cost of $0.26. Cornerstone 8.4 shows the budgeted
direct labor hours per unit 0.015 hour) and wage rate $14 per direct labor hour).
Cornerstone 8.5 shows the budgeted variable overhead per unit $8 × 0.015 direct
labor hour) and total fixed overhead for the year $1,280,000. Recall from
Cornerstone 8.2 that 16,000,000 units were expected to be produced during the
year and that 100,000 units were budgeted for ending finished goods inventory.

Required:

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  Prepare an ending finished goods inventory budget for ABT for the year.

Total ending inventory cost = Units ending inventory x Unit cost

= 100,000 x $0.67 = $67,000

2. What if the ending inventory of blocks increased to 120,000? How would that
affect the ending finished goods inventory budget?

If the number of units in ending inventory increases, the cost of ending inventory
will also increase. If there are 120,000 units in ending inventory, the cost of ending
finished goods inventory will be $80,400 120,000 × $0.67.

Cost of Goods Sold Budget

Illustration
ABT makes concrete blocks. Cornerstone 8.3 shows the total budgeted direct
materials cost $4,160,000. Cornerstone 8.4 shows the budgeted total direct
labor cost $3,360,000. Cornerstone 8.5 shows the budgeted total overhead for
the year $3,200,000. Recall from Cornerstone 8.6 that the cost of ending
finished goods inventory is budgeted at $67,000. ABT also provided the
information that beginning finished goods inventory is $55,000.

Required:

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  Prepare a cost of goods sold budget for ABT for the year.

 What if the beginning inventory of finished goods was $60,000? How would
that affect the cost of goods sold budget?
If the cost of beginning inventory of finished goods increases, the cost of
goods sold will also increase. If the cost of beginning inventory of finished
goods is $60,000, the cost of goods sold would increase to $10,713,000.

Marketing Expense Budget

A budget that outlines planned expenditures for selling and distribution
activities

Outlines planned expenditures for selling and distribution activities

Illustration:

ABT's only variable marketing expense is a $0.05 commission per unit (block) sold.
Fixed marketing expenses for each quarter include the following:

Advertising expense is $10,000 in Quarters 1, 3, and 4. However, at the beginning

of the summer building season, ABT increases advertising; in Quarter 2,
advertising expense is $15,000.

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 Required:

 Construct a marketing expense budget for the ABT concrete block line for
the coming year. Show total amounts by quarter and in total for the year.

 What if ABT's variable marketing expense per unit increased to $0.06? How
would that affect variable marketing expense? Fixed marketing expense?
Total marketing expense?
If the sales commission rises to $0.06, total variable marketing expense for the
year will increase to $960,000 $0.06 × 16,000,000 units). Fixed marketing
expense will be unaffected. Total marketing expense will increase to
$1,117,000.

The Cash Budget

Components of the Cash Budget

Cash Budget: a detailed plan that outlines all sources and uses of cash
Five main sections:

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  Total cash available

 Cash disbursements

 Cash excess or deficiency

 Financing

 Cash balance

Total cash available: consist of the

beginning cash balance and the
expected cash receipts
Expected cash receipts: include all
sources of cash for the period being
considered.

Illustration:
Recall from Cornerstone 8.1 that in 201 ABT sales are Quarter 1, $1,400,000;
Quarter 2, $4,200,000; Quarter 3, $4,800,000; and Quarter 4, $1,600,000. In
ABT's experience, 50 percent of sales are paid in cash. Of the sales on account,
70 percent are collected in the quarter of sale; the remaining 30 percent are
collected in the quarter following the sale. Total sales for the fourth quarter of
200 totaled $2,000,000.

Required:

 Calculate cash sales expected in each quarter of 201.

Solution:

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 Quarter 1, 201, Cash sales = 0.50 x $1,400,000 = $700,000

Quarter 2 = 0.50 x $4,200,000 = $2,100,000

Quarter 3 = 0.50 x $4,800,000 = $2,400,000
Quarter 4 = 0.50 x $1,600,000 = $800,000

 Construct a cash receipts budget including an accounts receivable aging

schedule for ABT, Inc., for each quarter of the coming year.

 What if ABT determined that the percentage received in the quarter after
the quarter of sale was 25 percent and that the remaining 5 percent was
never collected? How would that affect cash received in each quarter?

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