MODULE 4

PROFIT PLANNING OR BUDGETING

Overview

Each firm exists for a purpose and has goals to accomplish. These are set by the firm’s
board of directors and are to be accomplished by the firm’s executive team, led by the
President and his operating officers. To ensure performance, the team must optimize the use of
all resources and appropriate techniques available at their disposal. Such resources include
money, manpower, materials, machines, methods, information and technology among others.
Managerial techniques include organizational structures, policies, strategies, standards and
operating procedures.

The president must be able to communicate effectively the firm’s goals and objectives,
show the direction or ways to achieve them, set the standards of performance, motivate the
firm’s people to act and establish the necessary controls or measures in order to get things
done with utmost efficiency and effectiveness. Success depends upon the commitment of each
employee, especially the managers at the different levels and different areas of the firm’s
operations. As such, the president must encourage, if not force, the participation or
involvement of the said stakeholders in every stage of the process of attaining the firm’s goals.
One of the techniques utilized to achieve this is the budgeting process.

The budget is a detailed plan for acquiring and using financial and other resources over
a specified time period. It represents the firm’s plans for the future expressed in quantitative
terms. The budget serves as a road map that guides the managers along the way and a chart
of the firm’s course of operations. Budgeting is the act of preparing a budget and budgetary
control is the use of budget to control a firm’s activities.

Purposes of Budgets

Budgets make the decision making process more effective by helping managers meet
uncertainties regarding the future. Its objective is to promote a deliberate, well-conceived
business judgment instead of accidental success in business management. When planning is
done well, many problems are anticipated before they arise and solutions can be sought
through deliberate study. Preparing a well-defined budget requires the concerted effort of all
management levels. Budgets serve a number of useful purposes, which includes:

Formalize the Planning Process.

Perhaps the foremost purpose of budgeting is to compel managers to think about the
future. This forces them to set goals, consider future problem areas and formulate strategies.
Budgeting motivates managers to anticipate opportunities, problems and actions rather than to
merely react. Budgeting helps the firm in defining broad objectives and goals and formulating
strategies to achieve such objectives.

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Create a Plan of Action

The planning process brings together ideas, forecasts, resource availability and financial
realities to create a course of action to achieve the firm’s goals and objectives. Build the plan,
and then use it!

Coordinate and Integrate Management‘s Efforts

The budgeting process opens the lines of communication within the firm (a) up and
down organizational lines of subordinates and superiors and (b) across organizational lines to
integrate functional tasks. It entails coordinating the activities of the various parts of the firm
and ensuring that the parts are in harmony with each other. Goal congruence refers to a
firm’s striving to achieve a common set of objectives.

Aid in Resource Allocation

Budgeting enables the firm to allocate its resources to where they can be used most
effectively.

Motivate managers

Managers are driven to achieve their budget targets because (a) they participated in its
making and thus take pride in achieving it; (b) thru the budget, they see clearly how their roles
fit together with the firm as a whole and (c) because their promotion and incentives are based
on performance, which include meeting their budget targets. By doing so, managers are
motivated to strive in achieving the firm’s goals since their respective budget targets are in line
with it.

Create a Basis for Performance Evaluation

Actual results lack meaning unless they are compared to some target or budgeted
performance. A budget serves as a benchmark or standard against which actual results are
measured and managers’ performance are evaluated. Significant variances between actual and
planned require explanations and often, corrective actions.

Promote Continuous Improvement

Budgeting quantifies and integrates into operational plans many improvement processes
such as redesigning processes, increasing productivity, eliminating non value adding activities
and minimizing quality problems.

Create an Aura of Control

A budget system serves as a fiscal disciplinarian and helps ensure that managers
understand their authority, responsibility and limitations. Budgeting forces managers to plan,
provides information for decision making, sets benchmarks for control and evaluation and
improves the process of communication and coordination.

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 A good budgeting system provides for both planning and control. Planning
involves developing objectives and preparing various budgets to achieve those objectives. In
here, the managers anticipate the future events, develop a plan of action and estimate future
revenues and costs. Control refers to the steps taken by management to increase the
likelihood of attaining the objectives set in the planning stage and that all parts of the
organization are working together toward that goal. In here, feedbacks on actual operating
results are used to compare with the plan, to evaluate performance and to make the necessary
changes. This planning and control system can be viewed as a cycle as shown below:

A planning and control system includes tools, methods and attitudes. Common elements
are:

1. Strategic planning process. This long range planning defines the firm’s mission (why
the firm exists), the long range goals (what level of achievement it expects) and
strategic plan (what markets, price policies, resource needs, and production capabilities
the firm will have)

2. Business plan and personal goal setting. Creating the annual business plan is the task
of evaluating the firm’s strengths and weaknesses, opportunities and tactics to build firm
wide priorities for the coming year. Each manager also develops a personal set of goals and
a plan of achievements that are consistent with the firm’s business plan.

3. Planning process and timetable. A budgeting schedule includes when to start the
Review
process, submit budgets, review and approve budgets at various management and
levels –
answers who, what and when.
Update Plan

4. Responsibility accounting system. A planning and control system that combines

responsibility centers, control reports, activity centers and cost drivers from activity based
costing.

5. Reward (incentive) system. Rewards are given to managers who achieve their unit’s
budget goals and or MBO targets. Tying performance to compensation is becoming an
increasingly common practice.

6. Financial modeling. Ability to evaluate alternative or “what if” scenarios are an expected
part of any financial planning system. Simulation can test a plan to assess goal achievement
and evaluate alternative actions.

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7. Participatory budgeting. It is assumed that every manager is involved in planning and
control. Often, budget objectives are set at the executive level but budgets are constructed
from the bottom up – sometimes called as “grass roots” budgeting.

Conflicting Roles of Budgets

Conflicts may arise when a single budget system is used to serve several purposes, such
as:

Planning vs. Motivation - demanding budgets that may not be achieved may be appropriate
to motivate maximum performance, but they are unsuitable for planning purposes. A budget
should be set based on easier targets that are expected to be met.

Planning vs. Performance Evaluation - in planning, budgets are set in advance of the
budget period based on an anticipated set of circumstances or environment. Performance
evaluation should be based on a comparison of actual performance with an adjusted budget to
reflect the actual circumstances under which managers operated.

In practice, many firms compare actual performance with the original budget (adjusted
to the actual level of activity Ex. flexible budget), but if the circumstances envisaged when the
original budget was set have changed then there will be a planning and evaluation conflict. The
ultimate objective must be to develop a realization that the budget is designed to be a positive
aid in achieving both individual and firm’s goals.

Limitations of Budgets

Budgets tend to simplify real situations by failing to consider variations in external or

qualitative factors.
1. Lack of understanding of the fundamentals of budget preparation and execution adversely
affects the motivation and commitment of higher and lower management.
2. Failure to realize that a budget is just a means to attaining profitable activity, and not the
end in itself, adversely affects the leadership styles of managers.
3. Budget reports usually emphasize results, not reasons.

Types of Budgetary Systems

A. As to Level of Performance Standard

1. Stretch level budget – based on idealistic conditions and has small chance of being
met.
2. Highly achievable budget – challenging but which can be met thru hard work
B. As to Flexibility of Budget

1. Flexible budget – projection of revenues and costs at different levels of activity. It

separate costs into fixed and variable components and uses standard costing to
prepare budgets at multiple activity levels. Actual costs are compared with budgeted
costs based on actual level of production to obtain and analyze variances.

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 2. Fixed (Static) budget – projection of revenues and costs at a particular or single level
of activity. It does not segregate costs into fixed and variable components. Actual
costs are compared with the budgeted costs regardless of actual level of production,
to obtain and analyze cost variances.

3. Activity Based budget – applies ABC principles and procedures to budgeting. It

requires three steps, namely: identification of activities, estimation of activity output
demands and estimating the costs of resources needed to provide the activity output
demanded.

4. Kaizen Budget – assumes “continues improvement” of products and processes, the

effects of improvement and the costs of their implementation.

C. As to Budget Period

A budget period is the length of time for which a budget is effective. Factors
affecting the budget period established includes purpose of the plan, reliability of
information and normal turnover periods or seasonal cycles.

1. Periodic (Annual) budget –covers 1 year only, usually divided in quarters or

months.

2. Continuous (Perpetual/Rolling/Progressive) budget – a 12 month budget that rolls

forward one month or quarter as the current month or quarter is completed.

Irrespective of whether the budget is prepared on an annual or a continuous

basis, it is important that monthly or four-weekly budgets be used for control
purposes.

3. Capital budget – a long term budget showing the planned financing, acquisition and
disposal of fixed assets.

4. Life Cycle budget – a product’s revenues and expenses are estimated over its
entire life cycle (from research and development to withdrawal of customer support).
It is useful in target costing & target pricing.

D. As to Base Amount

1. Zero based budget – a budget wherein managers are required to justify all
expenditures (costs) as if programs involved are being proposed for the first time.

2. Incremental (Traditional) budget – a budget prepared based on previous period’s

budget, adjusted based on changes expected to happen in the coming period.
Managers are required to justify only the changes (increments) made on the
previous budget.

E. As a Major Component of the Master Budget

1. Operating budget – a projection of revenues, expenses and results of operations

for a specific period of time.

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 2. Financial budget – a budget of the financial resources as reflected in the budgeted
balance sheet.

3. Capital budget – a budget for significant investments in projects that have long
term implications such as the purchase of property, plant and equipment.

Responsibility for Budgets

Budgetary administration refers the procedures used in preparing a budget, securing

its approval and disseminating it to the firm’s stakeholders. The primary responsibility
regarding budget administration rests with the chief executive of the firm. However, he may
delegate such responsibility to an individual (usually the Controller) or to a specific group called
the budget committee.

In order to ensure that the budget to be prepared will be compatible with the strategic
objectives of the firm and to minimize the possible budgetary slack, the top management must
provide the guidelines and the statistical inputs needed in preparing the budget. The top
management should also provide the reward system associated with budgetary system.

The Budget Committee, also known as management committee or executive

committee is a group of key management persons (president, vice presidents for sales,
production, research and development, human resources, administration and finance, and the
controller) who are responsible for overall policy matters relating to the budget program. It
oversees the preparation and administration of the budget. Its principal functions are:

1. To formulate and decide the general policies of the firm’s budgetary system.
2. To request, review and revise individual budgets from the different units of the firm.
3. To approve the budgets and subsequent revisions therein.
4. To receive, analyze and evaluate budget reports.
5. To recommend necessary actions to improve operational efficiency and effectiveness.

The chief executive of the firm may appoint the controller to serve as head of the committee
for two major reasons namely:

1. The controller’s position is independent from the operating parts of the firm
2. The controller has skills and experiences in coping with intricacies of setting up the
budget.

As the overall coordinator of the budgeting process, the controller recommends how
budgets should be prepared, assembles the budgets, prepares periodic reports showing
variances between actual and planned results, interprets the variances, and give
recommendations for improvement where possible.

It is to be noted that a well defined budget is a product of the concerted effort of all
management levels of the firm. Top management must support the budgeting process by
establishing a clearly delineated lines of authority and responsibility, involving the managers in
the planning process, setting appropriate goals and objectives that can be easily translated into
plans and actions at lower management levels, reviewing the budgets thoroughly before
approving it and by doing a follow up and review of budget reports with the intent of
encouraging budget updates and goal oriented actions. The middle management in turn must
make a careful and rigorous review of the budgets proposed by the lower level management.

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To do this function effectively, they must know the inner workings of the activities reporting to
them. Lastly, lower level management must make an honest and accurate projection of
revenues and expenses related to the future activities of their respective units. This mutual
cooperation of the different levels of management prevents or overcomes the common
budgetary problems such as budget slack (budgeting revenues too low and expenses too high
to cover anticipated budget cuts), misstatement of revenues and expenses to earn approval of
projects, hiding over spending on one project by charging expenses to another project, blaming
controllable budget variances on non-controllable events, and pressuring subordinates which
encourages them to act unethically to meet the budget.

A self imposed (participative) budget is a method of preparing budget in which

managers prepare their own budgets, reviewed by their superiors and any issues are resolved
by mutual agreement. It is generally considered as the most effective method of budget
preparation. In here managers are challenged to operate effectively and efficiently and find
satisfaction in attaining the goals of the budget to which they participated in the making.

Budget Period

The budget period is the length of time for which a budget is effective. It is determined
based on factors such as purpose of the budget, reliability of information and normal turnover
periods or seasonal cycles.

A budget usually covers one year and divided into quarters or months. In some cases,
the budget is prepared for a period beyond one year, depending on how the budget is used. A
budget may have no particular budget period but it should be complete and comprehensive.

Firms are increasingly using a rolling budget, a budget that is always available for a
specific period of time by adding a month or quarter in the future as the month or quarter just
ended is dropped. The budgeting is a continuous process, and managers are encouraged to
constantly look ahead and review future plans. Furthermore, it is likely that actual performance
will be compared with a more realistic target, because budgets are being constantly reviewed
and updated.

The Master Budget

The master budget represents the summary of the management’s plans and outlines the
way to accomplish these plans. In here, specific targets are set for sales, production,
distribution and financing activities, culminating in the preparation of a cash budget, budgeted
income statement and budgeted balance sheet. Such budgets are separate but interdependent.

The starting point of budget effort should always be the most constraining variable,
which is generally, sales. Most managers work to generate more sales. However, other
constraining variables might be:
1. Machine capacity in a specialized area (Ex. Plastic extruding equipment in a plastic bottle
plant.)
2. Floor space in a retail outlet
3. Salesmen’s time to make calls on customers (Ex. Sales reps who must decide on which
client to visit)
4. Tables in a restaurant (where demand for reservations cannot be met)

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 When a variable other than sales limits growth, it becomes the starting point for
planning. But for most firms, sales units or revenue is the limiting resource.

A typical master budget diagram for a manufacturing firm follows.

Operating Expense Budget

Research & Development

Marketing & Distribution
Customer Services
Ad i i t ti

Direct Materials
Budget

Cos
Components of the Master Budget
A. Operating Budget

In
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Schedule of
Cash Payments
1. Sales budget

It is a schedule showing the expected sales (amount & units) over a specific time
period. It is “the key” to the budgeting process. It provides the basis for projected
cash receipts as well as for constructing the other budgets such as production,
operating expenses and capital expenditure budget. Accuracy of sales budget impacts
the whole budget.

The sales department prepares the sales
considering external and internal factors such
political conditions, purchasing power of peso,
promotion policies of the firm, projected plant
forecasting: sales department estimates, survey
opinions, statistical methods
budget based on sales forecast
as industry trends, economic and
customer preferences, pricing and
expansion and others. Methods of
of customers, survey of executive

2. Production budget

This is a detailed plan showing the number of units that must be produced during
a period to meet both sales and inventory requirements. It becomes the basis for
determining the budgets for direct materials, direct labor and factory overhead which
in turn becomes input for the cash expenditures budget.

3. Direct materials budget

This is a detailed plan showing the amount and number of units of raw materials
that must be purchased during a period to meet both production and inventory needs.

4. Direct labor budget

It is a detailed plan showing labor requirements over specific period of time.

Factors affecting this budget include level of skills of laborers, labor rate per hour, and
time requirements among others.

5. Manufacturing overhead budget

It is a detailed plan showing the production costs, other than direct materials and
direct labor, which will be incurred over specific period of time. Overhead costs can
either be fixed or variable, in which case the level of activity becomes relevant in
computing the total cost.

6. Ending Finished Goods inventory budget

This is a budget that shows the peso amount of cost expected to appear on the
balance sheet for unsold units at the end of a period

7. Purchases budget

It is a budget that shows the number of units and the amount of goods (raw
materials) to be purchased for the period.

8. Budgeted Cost of Sales

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 It is a budget that shows the cost of goods manufactured, cost of goods available
at the beginning and end of period, as well as the cost of goods sold for a specific time
period.

9. Selling and Administrative Expense budget

This is a detailed schedule of planned expenses that will be incurred in areas

other than production, over specific time period. Like manufacturing overhead, these
costs are made up of fixed and variable components in which case the level of activity
affects the total costs to be incurred.
10.Budgeted Income Statement

It is a detailed plan showing the overall result of operations over a specific time
period

B. Financial Budget

1. Cash budget

It is a detailed plan showing how cash resources will be acquired (cash

receipts budget) and used (cash disbursements budget) over specific time
period.

Normally, the bulk of cash receipts come from customers. Other sources of cash
are interest and dividends on investments, sale of investments and other assets, and
proceeds of borrowings. Cash disbursements are made to production and operating
expenses in the current year and accrued expenses last year, currently maturing
obligations and dividends.

The timing and amount of cash flows will show the available cash at a certain
period. This will indicate the timing and amount of investing activities if there is excess
cash or financing activities to meet the firm’s required minimum cash balance.

2. Capital Expenditure budget

It is a budget showing the planned financing, acquisition and disposal of fixed

assets.

3. Budgeted Balance Sheet

It is a detailed plan of the financial position and condition of the business over a
period of time. It is developed by beginning with the current balance sheet and
adjusting it for data contained in other budgets.

4. Budgeted Cash Flow Statement

It is similar to the cash budget but sources and uses of cash is specified whether
it is related to operating, investing or financing activities.

Some of the computational formats for budgets are presented below:

Budgeted Production Budgeted Materials Purchases

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Budgeted Sales xx Budgeted production (units) xx
Desired Inventory -end xx x Qty. of materials/unit xx
Total requirements xx Materials to be used xx
Expected inventory - beg (xx Desired materials invty – end xx
)
Budgeted production (units) xx Total requirements xx
Expected materials invty - beg (xx
)
Budgeted materials purchases xx

Budgeted merchandise purchases Cash Budget

Budgeted Sales xx Cash collections (receipts) Pxx
Desired merchandise Invty -end xx Cash payments (disbursements) (xx
)
Total requirements xx Net cash inflow (outflow) Pxx
Expected merchandise Invty - beg (xx Cash – beg xx
)
Budgeted merchandise purchases xx Total cash available Pxx
Desired (target) cash balance (xx
–end )
Cash surplus (deficit) Pxx

Target Cash balance – the desired cash balance that a firm plans to maintain in order
to conduct business operations. Cash surplus indicates the type of investments (usually
marketable securities) to acquire. Cash deficit indicates the external financing requirement.

Fixed and Flexible Budgeting

Fixed (Static) Budget

It is one that is based on a single level of activity. It can be used by a firm when it can
estimate its operating volume within close limits and if the cost behavior can be predicted
accurately. In here, the actual results are compared to budgeted costs at the original budgeted
activity level.

Flexible Budget

It is one that is based on multiple levels of activity. This budget adjusts revenues, costs
and expenses to the actual level of activity in which the firm operated in order to provide a
valid basis of comparison to actual costs. Thus, a budget for the firm can be prepared at
various levels of activity.

ILLUSTRATION:

WAIS CORPORATION manufactures and sells only one consumer good, product HOPE.
As of December 31,2015, the Statement of Financial Position of the firm shows the following:

Current Assets
Cash P111,216.80

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 Accounts Receivable (net) 327,283.20
Inventories 249,000.00
Other Current Assets 12,500.00 P700,000.00

Noncurrent Assets
Property, Plant and Equipment P4,000,000.0
0
Accumulated Depreciation (800,000.00) 3,200,000.00
Total Assets P3,900,000.0
0

Current liabilities
Accounts Payable P 21,582.40
Income tax payable 105,000.00
Property tax payable 10,000.00
Bonds Payable (10%) 400,000.00 P536,582.40

Noncurrent Liabilities
Bonds Payable (10%) 800,000.00
Total Liabilities P1,336,582.4
0

Shareholders’ Equity
Ordinary Share Capital (P100 par) P2,000,000
Accumulated Profits 563,417.60 2,563,417.60
Total Equities P3,900,000.0
0

During the last month of 2015 to the early weeks of January, 2016, the management has been
gathering data for preparing the 2016 budget. Data gathered by the controller are as follows:

a. Marketing department projected to sell 12, 500 units in the first quarter and expects to
increase it by 10% per quarter for the next two years. The sales price is expected to be at
P120/unit.

b. The company established some policies to guide operations throughout the year. For the
production department, enough goods must be produced such that 20% of the goods
expected to be sold in the next quarter will be on hand at end of each current quarter.
Direct materials at the end of each quarter must be 30% of the direct materials
requirement for the next quarter. Other data for production are as follows:

Direct materials / unit 400g @ P5 per 100g

Direct labor / unit 3 hrs @ P10 per hr
Indirect labor P2 / unit
Indirect materials P5/ unit
Utilities P3 / unit + P55, 000 per quarter
Property taxes P5, 000 per quarter
Depreciation (50% building, 50% on P50, 000 per quarter
equipments)

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c. To attract customers, the company will be selling on normal credit terms, as usual. The
company projected that 75 % of sales will be collected during the quarter of sale, and the
remaining will be collected in the following quarter, with 1% of total sales estimated as
uncollectible.

d. Projected operating costs to be incurred per quarter are as follows:

Administrative Salaries P50, 000

Office supplies 2, 500
Depreciation – office equipments 10, 000
Sales salaries 40, 000
Advertising 30, 000
Sales commission 3% of sales price
Store supplies 2, 000
Depreciation – store equipments 15, 000
Depreciation – building (60% office; 40% sales) 25, 000
Property taxes 5, 000

e. Expenses are paid in cash except for direct materials of which 10% is paid the next quarter
after it was purchased and property taxes which are paid in the quarter after the property
taxes are recognized. The company’s policy is to maintain a minimum cash balance of P50,
000 at all times, for any unforeseen cash requirements or any adjustments to be made.

f. Finished Goods of the last quarter of 2015 has a cost per unit of P69.

g. Other assets were all expensed in the first quarter of 2016.

h. Current portion of bonds payable matures every Dec. 31. The firm will declare P10/sh
dividends on Dec.1 payable on Jan. 31, 2017.

i. The firm is subject to 30% income tax which will be paid in the first week following each
quarter of operations.

REQUIRED: Prepare the Master Budget of WAIS Corporation for 2016 in a quarterly basis.

Schedule 1: Sales Budget

Quarter 1 Quarter 2 Quarter 3 Quarter 4
Budgeted sales in units 12,500 13,750 15,125 16,638
Sales price / unit P120 P120 P120 P120
P1,500,00 P1,650,00 P1,815,00 P1,996,56
Budgeted sales in pesos 0 0 0 0

Schedule 2: Production Budget

Quarter1 Quarter2 Quarter3 Quarter4

Budgeted sales in units 12,500 13,750 15,125 16,638
Desired Finished goods - end 2,750 3,025 3,328 3,661
Total needs 15,250 16,775 18,453 20,299
Finished goods - beg (2,500) (2,750) (3,025) (3,328)
Budgeted production units 12,750 14,025 15,428 16,971

Schedule 3: Direct Materials Budget

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 Quarter 1 Quarter 2 Quarter 3 Quarter 4
Budgeted production units 12,750 14,025 15,428 16,971
Std. materials / unit ( kg ) 0.4 0.4 0.4 0.4
Budgeted DM usage ( kg ) 5,100.00 5,610.00 6,171.20 6,788.40
Desired DM -end (kg) 1,683.00 1,851.36 2,036.52 2,240.16
Total needs 6,783.00 7,461.36 8,207.72 9,028.56
(1,530.00 (1,683.00 (1,851.36 (2,036.52
DM - beg ( kg ) ) ) ) )
Budgeted DM Purchases
(kg) 5,253.00 5,778.36 6,356.36 6,992.04
Purchase price / kg P50 P50 P50 P50
Budgeted DM Purchases (P) P262,650 P288,918 P317,818 P349,602

Schedule 4: Direct Labor Budget

Quarter 1 Quarter 2 Quarter 3 Quarter 4
Budgeted production units 12,750 14,025 15,428 16,971
Std. Direct labor hours/unit 3 3 3 3
Budgeted direct labor hours 38,250 42,075 46,284 50,913
DL rate/hour P10 P10 P10 P10
Budgeted Direct labor P382,500 P420,750 P462,840 P509,130
Schedule 5: Manufacturing Overhead Budget

Quarter 1 Quarter 2 Quarter 3 Quarter 4

Indirect labor P25,500 P28,050 P30,856 P33,942
Indirect materials 63,750 70,125 77,140 84,855
Utillities - variable 38,250 42,075 46,284 50,913
Utilities - fixed 55,000 55,000 55,000 55,000
Property taxes 5,000 5,000 5,000 5,000
Depreciation 50,000 50,000 50,000 50,000
Total Budgeted FOH P237,500 P250,250 P264,280 P279,710

Schedule 6: Cost of Goods Sold Budget

Quarter 1 Quarter 2 Quarter 3 Quarter 4

DM used (S3) P255,000 P280,500 P308,560 P339,420
Direct Labor (S4) 382,500 420,750 462,840 509,130
Factory OH (S5) 237,500 250,250 264,280 279,710
Cost of Goods
Manufactured P875,000 P951,500 P1,035,680 P1,128,260
F. Goods-beg 172,500 188,725.49 205,225.49 223,408.29
Goods Available
for Sale P1,047,500 P1,140,225.49 P1,240,905.49 P1,351,668.29
F.Goods - end (188,725.49) (205,225.49) (223,408.29) (243,389.30)
Cost of Goods
Sold P858,774.51 P935,000 P1,017,497.20 P1,108,278.98

Schedule 7: Budgeted Income Statement

Quarter 1 Quarter 2 Quarter 3 Quarter 4
Sales P1,500,000 P1,650,000 P1,815,000 P1,996,560
(858,774.51 (1,017,497.20
COGS ) (935,000) ) (1,108,278.98)

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Gross Profit P641,225.49 P715,000 P797,502.80 P888,281.02
Operating
Expenses
Sales Salaries (40,000) (40,000) (40,000) (40,000)
Advertising (30,000) (30,000) (30,000) (30,000)
Commissions (45,000) (49,500) (54,450) (59,897)
Store Supplies (2,000) (2,000) (2,000) (2,000)
Dep. - store (15,000) (15,000) (15,000) (15,000)
Dep. – bldg (25,000) (25,000) (25,000) (25,000)
Admin. salaries (50,000) (50,000) (50,000) (50,000)
Office supplies (2,500) (2,500) (2,500) (2,500)
Dep.– office (10,000) (10,000) (10,000) (10,000)
Property taxes (5,000) (5,000) (5,000) (5,000)
Other assets (12,500)
Bad Debts (15,000) (16,500) (18,150) (19,965.60)
Operating Income P389,225.49 P469,500.00 P545,402.80 P628,918.62
Finance Cost (30,000.00) (30,000.00) (30,000.00) (30,000.00)
Income b4 tax P359,225.49 P439,500.00 P515,402.80 P598,918.62
(107,767.65 (131,850.00
Income tax ) ) (154,620.84) (179,675.59)
Net income P251,457.84 P307,650.00 P360,781.96 P419,243.03
Schedule 8: Cash Budget

Quarter 1 Quarter 2 Quarter 3 Quarter 4

Cash – beg P111,216.80 P426,032.60 P799,473.75 P1,218,875.75
Receipts (S8a) 1,452,283.20 1,597,500.00 1,757,250.00 1,933,020.00
(1,137,467.40 (1,224,058.85 (1,337,848.00 (1,859,281.24
Payments(S8b) ) ) ) )
Cash - end P426,032.60 P799,473.75 P1,218,875.75 P1,292,614.51

Schedule 8a: Cash Receipts Budget

Quarter 1 Quarter 2 Quarter 3 Quarter 4
A/R Dec. 31,2014 P327,283.20 P0 P0 P0
Credit Sales 2015
Q1 : P1,500,000 1,125,000 360,000
Q2 : P1,650,000 1,237,500 396,000
Q3 : P1,815,000 1,361,250 435,600
Q4 : P1,996,560 1,497,420
P1,452,283.2
Total 0 P1,597,500 P1,757,250 P1,933,020

Schedule 8b: Cash Disbursements Budget

Quarter 1 Quarter 2 Quarter 3 Quarter 4

A/P - Dec. P0 P0 P0
31,2010 P21,582.40
Direct materials 236,385.00 286,291.20 314,928.00 346,423.60
Direct labor 382,500.00 420,750.00 462,840.00 509,130.00
Indirect labor 25,500.00 28,050.00 30,856.00 33,942.00
Indirect materials 63,750.00 70,125.00 77,140.00 84,855.00
Utilities 93,250.00 97,075.00 101,284.00 105,913.00

15
 Property taxes 10,000.00 10,000.00 10,000.00 10,000.00
Operating
expenses 169,500.00 174,000.00 178,950.00 184,396.80
Finance Cost 30,000.00 30,000.00 30,000.00 30,000.00
Income tax 105,000.00 107,767.65 131,850.00 154,620.84
Bonds Payable 400,000.00
P1,137,467.
Total 4 P1,224,058.85 P1,337,848 P1,859,281.24

Schedule 9: Budgeted Statement of Financial Position

WAIS Corporation
Statement of Financial Position
As of _____________, 2015
Mar. 31 June 30 Sept. 30 Dec. 31
P1,218,875.7 P1,292,614.5
Cash P426,032.60 P799,473.75 5 1
Accounts
Receivable 360,000.00 396,000.00 435,600.00 479,174.40
Inventories 272,875.49 297,793.49 325,234.29 355,397.30
P1,058,908.0 P1,493,267.2 P1,979,710.0 P2,127,186.2
Current Assets 9 4 4 2
PPE (net) 3,100,000.00 3,000,000.00 2,900,000.00 2,800,000.00
Total Assets P4,158,908.0 P4,493,267.2 P4,879,710.0 P4,927,186.2
9 4 4 2

Accounts Payable P26,265.00 P28,891.80 P31,781.80 P34,960.20

Income tax
payable 107,767.65 131,850.00 154,620.84 179,675.59
Property tax 10,000.00 10,000.00 10,000.00 10,000.00
Bonds Payable 400,000.00 400,000.00 400,000.00 400,000.00
Dividends Payable 200,000.00
Current Liabilities P544,032.65 P570,741.80 P596,402.64 P824,635.79
Bonds Payable 800,000.00 800,000.00 800,000.00 400,000.00
P1,344,032.6 P1,370,741.8 P1,396,402.6 P1,024,635.7
Total Liabilities 5 0 4 9
P2,000,000.0 P2,000,000.0 P2,000,000.0 P2,000,000.0
Share Capital 0 0 0 0
Accumulated
Profits 814,875.44 1,122,525.44 1,483,307.40 1,702,550.43
Shareholders' P2,814,875.4 P3,122,525.4 P3,483,307.4 P3,702,550.4
Equity 4 4 0 3

P4,158,908.0 P4,493,267.2 P4,879,710.0 P4,927,186.2

Total Equities 9 4 4 2

Schedule 9a: Inventories

Mar. 31 June 30 Sept. 30 Dec. 31

P101,826.0 P112,008.0
Raw Materials P84,150.00 P92,568.00 0 0
Finished Goods 188,725.49 205,225.49 223,408.29 243,389.30
Total P272,875.4 P297,793.4 P325,234.2 P355,397.3

16
 9 9 9 0

Schedule 9b: Property, Plant and Equipment (PPE)

Mar. 31 June 30 Sept. 30 Dec. 31

4,000,000.0
Cost 0 4,000,000.00 4,000,000.00 4,000,000.00
(1,000,000.00 (1,100,000.00 (1,200,000.00
Acc. Dep. (900,000.00) ) ) )
3,100,000.0
Book Value 0 3,000,000.00 2,900,000.00 2,800,000.00

Schedule 9c: Accounts Payable

Mar. 31 June 30 Sept. 30 Dec. 31

262,650.0 288,918.0 317,818.0 349,602.0
DM Purchases 0 0 0 0
Unpaid 0.10 0.10 0.10 0.10
A/P – end 26,265.00 28,891.80 31,781.80 34,960.20

Schedule 9d: Accumulated Profits

Mar. 31 June 30 Sept. 30 Dec. 31

P563,417.6 P1,122,525.4 P1,483,307.4
AP - beg 0 P814,875.44 4 0
Net Income 251,457.84 307,650.00 360,781.96 419,243.03
Dividends (200,000.00)
P814,875.4 P1,122,525.4 P1,483,307.4 P1,702,550.4
AP-end 4 4 0 3

DISCUSSION QUESTIONS

1. Define budgeting. Briefly explain the major purposes of budgets.

2. Briefly describe the different types of budgets.

3. Briefly discuss the features of a good planning and control system?

4. How does a firm prepare a good budget? Who is responsible for preparing and administering
them?

5. Define master budget? Briefly explain its purpose.

6. Briefly describe the contents of each component of the master budget.

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Name: _____________________________ Date: ________ Score: _____

Professor:___________________________ Schedule: _______________

Exercise 7-1: TRUE OR FALSE

Write the word TRUE if the statement is correct or the word FALSE if it is incorrect.

______1. The major objectives of any budget system are to foster the planning of operations
and provide a framework for performance evaluation.

______2. One of the weaknesses of budgets is that they are of little value in uncovering
potential bottlenecks in an organization

______3. Budgeting is a trade-off between planning and control in that increased use of
budgeting will usually improve planning but will weaken control.

______4. The managerial functions of planning, coordinating and performance evaluation can
all be associated with budgeting.

18
______5. Top management needs to be involved in the budgeting process, including using the
budget process to communicate goals.

______6. In zero-based budgeting, only changes from the prior budget must be justified.

______7. One of the advantages of a self-imposed budget is that the person directly involved
in an activity is more likely to be in a position to make good budget estimates.

______8. The budgeting system that focuses on improving operations is called operational
budgeting.

______9. The basic difference between master budget and flexible budget is that the former is
based on one specific level of production while the latter can be prepared for any
production level within a relevant range.

______10. A flexible budget is appropriate for direct material usage budget.

______11. The use of standard costs in the budgeting process signifies that an organization
has most likely implemented a flexible budget.
______12. The first, and most critical, step in constructing a set of pro forma financial
statements is establishing the sales forecast.

______13. Desired ending inventory figures appear on both budgeted income statement and
budgeted balance sheet.

______14. The idea behind preparing cash budgets is to avoid unnecessary cash surplus or
deficit.

______15. Accounts receivable and income tax generally vary directly with sales.
Name: _____________________________ Date: ________ Score: _____

Professor:___________________________ Schedule: _______________

Exercise 7-2: MULTIPLE CHOICE:

Write the letter of the best answer on the space provided.

_______ 1. The process of creating a formal plan and translating goals into a quantitative
format:
a) activity based costing c) process costing
b) budgeting d) variance analysis

_______ 2. Which is not a primary purpose of preparing a budget?

19
 a) To provide a basis for comparison of actual performance
b) To communicate the company’s plans throughout the entire organization
c) To control income and expenditures in a given period
d) To make sure the company expands its operations.

_______ 3. Generally speaking, budgets are not used to:

a) identify a firm's most profitable products
b) evaluate performance
c) create a plan of action
d) assist in the control of profit and operations
e) facilitate communication and coordinate activities.

_______ 4. These statements are proper to the budgeting process except:

a) It is part of management’s responsibility to plan the use of its resources
b) It is a tool to orchestrate the various functions of operations in a business
c) The involvement of various levels of individuals in the company is necessary
to gain acceptance and attain its goals
d) Actual results need not be compared with plan, since the process ends after
the budget is approved

_______ 5. Which statement about budgeting is valid?

a) Responsibility budget identifies revenue and costs with the individual
responsibilities for their incurrence
b) The best way to establish budget figures is to use last year’s actual cost and
activity data as this year’s budget estimates
c) A sales budget and a sales forecast are the same thing
d) The primary purpose of the cash budget is to show the expected cash balance
at the end of budget period.

_______ 6. A difference between standard costs used for cost control and budgeted costs can
exist because:
a) because standard costs represent what costs should be while budgeted costs
represent expected actual costs
b) standard costs must be determined after the budget is completed
c) because costs are historical whereas standard costs are based on engineering
studies
d) none of the above

_______ 7. Which of the following is an output of a financial planning model?

a) strategic plan c) projected financial statements
b) actual financial results d) variance analysis.

_______ 8. A budget manual, which enhances the operation of budget system, is most likely
to include:
a) a chart of accounts
b) distribution instructions for budget schedules
c) employee hiring policies
d) documentation of the accounting system software
e) company policies regarding the authorization of transactions

_______ 9. The budget method that maintains a constant twelve month planning horizon by
adding a new month on the end as the current month is completed is called a/an

20
 :
a) operating budget c) continuous budget
b) capital budget d) master budget

_______ 10. Which statement/s about zero based budgeting is true?

I. All activities in the company are organized into break up units called
packages.
II. All costs have to be justified every budgeting period.
III. The process is not time consuming since justification of costs can be done as
a routine matter.
a) I only c) II and III only
b) I and II only d) I, II, and III

_______ 11. Zero based budgeting:

a) divides the activities of individual responsibility centers into a series of
packages that are prioritized
b) classifies the budget by the prior year’s activity and estimates the benefits
arising from each activity
c) present planned activities for a period of time but does not present a firm
commitment
d) commence with either the current level of spending or projected whichever is
lower.

_______ 12. Which is an advantage of implementing a self-imposed budgeting system?

a) Budgeting is quick and easy because only a few individuals are involved in the
budgeting process
b) Upper level management does not have to review budget estimates
c) Motivation to meet budget estimates is usually enhanced
d) All of the above

_______ 13. Which budget is most appropriate for a firm facing a significant level of
uncertainty in unit sales for next year:
a) flexible budget c) operating budget
b) life cycle budget d) rolling budget

_______ 14. S1: A flexible budget provides cost allowances for different levels of activity
S2: The only difference between a flexible and static budget is that a flexible
budget does not contain fixed costs.
a) Only S1 is true c) both S1 and S2 are true
b) Only S2 is true d) both S1 and S2 are false

_______ 15. S1: Flexible budget is often used as basis for preparing the pre-determined
overhead rate.
S2: Variances will always be larger with flexible budget than with static budget.
a) Only S1 is true c) both S1 and S2 are true
b) Only S2 is true d) both S1 and S2 are false

_______ 16. S1: Although it is effective in measuring production control, static budget is not
effective in measuring cost control.

21
 S2: A flexible budget primarily is prepared for planning purposes while static
budget is for performance evaluation

a) Only S1 is true c) both S1 and S2 are true

b)Only S2 is true d) both S1 and S2 are false

_______ 17. When production levels are expected to increase within a relevant range, and a
flexible budget is used, what would be the anticipated effect on fixed costs/unit
and variable costs/unit, respectively?
a) no change, no change c) no change, decrease
b) decrease, decrease d) decrease, no change

_______ 18. A budget that describes the long term position, goals and objectives of an entity
within its environment:
a) capital budget c) operating budget
b) cash management budget d) strategic budget

_______ 19. Budgetary slack can best be described as:

a) the elimination of certain expenses to enhance budgeted income
b) the planned overestimation of budgeted expenses
c) a plug number used to achieve a level of operating income
d) the planned underestimation of budgeted expenses

_______ 20. In
preparing a master budget, top management is generally best able to:
a)prepare detailed departmental-level budget figures
b)provide a perspective on the company as a whole
c)point out the particular persons who are to blame for inability to meet budget
goals
d) all of the above.
Name: _____________________________ Date: ________ Score: _____

Professor:___________________________ Schedule: _______________

PROBLEM 7-A SALES BUDGET

Sales volume for the year 2017 has been estimated for Queennie Apparels as follows:
Products
Quarters Shirts Dresses Pants
First 18,000 32,000 46,000
Second 21,000 35,000 49,000
Third 24,000 31,000 43,000
Fourth 20,000 29,000 40,000
Total 83,000 127,000 178,000

Selling prices for these products are: Shirts – P65; Dresses – P100; Pants – P180. An
estimated 5% of sales is expected for sales returns and allowances. 80% of sales are on
account and 20% is cash sales. 75% of credit sales is collected in the same quarter of the sale
while 25% is collected in the following quarter.

Required:

22
Prepare a sales budget for the year 2017 with a schedule of expected cash collections.

PROBLEM 7-B PRODUCTION BUDGET

The TESS Company has budgeted sales for the year as follows:
Quarter 1 Quarter 2 Quarter 3 Quarter 4
Sales in units 10,000 12,000 14,000 16,000

The ending inventory of finished goods for each quarter should equal 25% of the next quarter's
budgeted sales in units. The finished goods inventory at the start of the year is 2,500 units.
Four pounds of raw materials are required for each unit produced. Raw materials on hand at the
start of the year total 4,200 pounds. The raw materials inventory at the end of each quarter
should equal 10% of the next quarter's production needs in material.

Required:
1. How many units should be produced in the third quarter?
2. How many pounds of materials should be purchased for the second quarter?

PROBLEM 7-C PURCHASES BUDGET

The following are budgeted data for the Emerald Company, a merchandising company:
Budgeted Sales (at retail): January - P300,000; February - P340,000; March - P400,000; April -
P350,000. Cost of goods sold as a percentage of sales is 60%. The desired ending inventory is
75% of next month's sales.

Required:
1. Assuming that the company had inventory on hand of P70,000 (at cost) on January 1, how
much must be the purchases for January (at cost)?
2. How much is the desired ending inventory (at cost) for the month of February?
3. Assume that all purchases are paid for in the month following the month of purchase. How
much cash disbursements for purchases would appear in the April cash budget?

PROBLEM 7-D RAW MATERIALS PURCHASES BUDGET

Faye Co. manufactures a product using 3 kg of raw materials. Production and inventory
budgets for June 2016 are as follows:

Opening Inventories Closing

Inventories

Raw materials 11,000 kg 12,400 kg

Finished goods 15,150 units 11,400 units

Budgeted sales for June amounted to 18,000 units. During the production process, it is usually
found that 5% of production units are scrapped as defective and this loss occurs after the raw
materials have been placed in process.

23
Required:
1. How many kilograms of raw materials will be purchased in June?
2. Assume that the cost of a kilogram of raw material is P16 and that 60% of purchases is paid
in the month of purchase while the remaining in the month after the purchase, how much is
the cash payment for the June?

PROBLEM 7-E BUDGETED OPERATING INCOME

Janniel Inc. is preparing its budget for 2016. Income statement for 2015 is presented
below:

Sales (100,000 units) P1,000,00

0

Cost of sales 600,000

Gross Profit P400,000

Operating expenses 240,000

Operating Income P160,000

Operating expenses includes depreciation of P40,000. For the year 2016, the company plans to
increase selling price by 10% which is expected to decrease sales volume in units by 5%. The
cost of sales as a percent of sales will increase to 62%. Other than depreciation, all operating
costs are variable.

Required:
What is the budgeted income for 2016?

PROBLEM 7-F BUDGETED NET INCOME

Reima Inc. 2016 income statement is presented below.

Sales P3,500,00
0

Operating Costs 2,500,000

Earnings before interest and P1,000,00

taxes 0

Interest expense 200,000

Earnings before taxes P800,000

24
 Income tax (40%) 320,000

Net Income P480,000

Dividends (40%) P192,000

Addition to retained earnings P288,000
For 2017, the firm is forecasting a 40% increase in sales and that its year end
operating costs will decline to 60% of sales. Tax rate, interest expense and dividend payout
ratio are expected to remain constant.

Required:
What is the projected 2017 net income?

PROBLEM 7-G COLLECTIONS BUDGET

Marga Corporation has the following historical pattern of credit sales

70% during the month of sale 4% in the third month after sale
15% in the first month after sale 1% uncollectible
10% in the second month after sale

Sales on account for the last six months of the year were reported as follows:

July P120,000 October P180,000

August 140,000 November 200,000

Septembe 160,000 December 170,000

r

Required:

1. Compute for the total cash collections during the 4th calendar quarter.
2. A/R balance on the Balance Sheet as of Dec. 31

PROBLEM 7-H CASH DISBURSEMENTS BUDGET

A 2016 cash budget is being prepared for the purchase of TOBI, a merchandise item.
Budgeted data are: Cost of goods sold for 2016 P300,000 Accounts payable 1/1/16 P20,000
Inventory—1/1/16 P30,000 12/31/16 P42,000. Purchases will be made in twelve equal
monthly amounts and paid for in the following month.

Required:

How much is the 2003 budgeted cash payment for purchases of TOBI?

25
PROBLEM 7-I CASH BUDGET

The Francine Company, a merchandising firm, has planned the following sales for the next four
months:

March April May June

Total budgeted sales 50,000 70,000 90,000 60,000

Sales are made 40% for cash and 60% on account. From experience, the company has learned
that a month’s sales on account are collected according to the following pattern:

Month of sale 70%

First month following month of sale 20%

Second month following month of sale 8%

Uncollectible 2%

The company requires a minimum cash balance of $4,000 to start a month.

Required:

A. Compute the budgeted cash receipts for June.

B. Assume the following budgeted data for June:
Purchases P52,000

Selling and administrative expenses 10,000

Depreciation 8,000

Equipment purchases 15,000

Cash balance, beginning of June 6,000

Using this data, along with your answer to part (1) above, prepare a cash budget in good
form for June. Clearly show any borrowing needed during the month. The company can
borrow in any dollar amount, but will not pay any interest until the following month.

PROBLEM 7-J CASH BUDGET

DEMI Company has the following cash budget for the 1st quarter of operations for 2016:

January February March

Credit sales P800,00 P700,00 P860,00

0 0 0

Credit purchases 340,000 320,000 400,000

Cash disbursements

26
 Salaries 40,000 35,000 42,000

Rent 15,000 15,000 15,000

Equipment 250,000 20,000

The company estimates that 10% of its credit sales will never be collected. Of those that will be
collected, 50% will be in the month of sale and the balance in the following month. Purchases
on account will all be paid for in the month following purchase. December 2015 sales were
P900,000. Cash balance as of December 31, 2015 is P1,000,000.

Required:

What is the opening balance of cash for the 2nd quarter of 2016?

PROBLEM 7-K CASH BUDGET

The following information were made available for Narnia Inc.

a. September 30 cash balance : P200,000

b. Dividends paid on December: P140,000
c. Cash expenditures during the 4th quarter for operating expenses: P536,000.
d. Depreciation expense for the 4th quarter: P90,000
e. Cash collections during the 4th quarter: P1,850,000
f. Merchandise purchases paid in cash during the 4th quarter: P1,124,000
g. Purchased equipment for cash in December, P350,000.

The company’s policy is to keep a minimum cash balance of P200,000.

Required:
How much must the firm borrow at the end of December?

PROBLEM 7-L: CASH BUDGET

Oprah Inc., began operations on July 1 with P12,000 cash balance. Forty percent of
sales are collected in the month of sale; 60% are collected in the month following sale.
Similarly, 20% of purchases are paid in the month of purchase, and 80% are paid in the month
following purchase. Data for July and August are:

July August

Sales P35,00 P55,00

0 0

Purchases 30,000 40,000

Operating expenses 7,000 9,000

Required:

27
 If operating expenses are paid in the month incurred and include monthly depreciation
charges of P2,500, how much is the cash balance as of end of August?

PROBLEM 7-M COMPREHENSIVE BUDGET - MERCHANDISING BUSINESS

Dilbert Farm Supply has the following data regarding its store's operations: (ignore
taxes)

a. Budgeted sales are: November: P260,000 December: P230,000 January: P210,000

b. Collections are expected to be 80% in the month of sale, 19% in the following month,
and 1% uncollectible.
c. The cost of goods sold is 65% of sales.
d. The company purchases 60% of its merchandise in the month prior to month of sale and
40% in the month of sale. Merchandise is paid in the month following the purchase.
e. Other monthly expenses to be paid in cash are P20,300.
f. Monthly depreciation is P20,000.

Statement of Financial Position

October 31
Cash P 27,000
Accounts receivable (net) 79,000
Inventory 101,400
PPE (net of P574,000 accumulated depreciation) 1,082,000
Total assets P1,289,400

Accounts payable P 169,000

Common stock 740,000
Retained earnings 380,400
Total liabilities and stockholders’ equity P1,289,400

Required:

1. Prepare a budgeted income statement for the month of December.

2. Prepare a budgeted statement of financial position as of November 30.

PROBLEM 7-N COMPREHENSIVE BUDGET - MERCHANDISING BUSINESS

Weldon Industrial Gas Corporation supplies acetylene and other compressed gases to industry.
Data regarding the store's operations follow:

● Sales are budgeted at P360,000 for November, P380,000 for December, and P350,000 for
January.
● Collections are expected to be 75% in the month of sale, 20% in the month following the
sale, and 5% uncollectible.
● The cost of goods sold is 65% of sales.
● The company purchases 60% of its merchandise in the month prior to the month of sale

28
 and 40% in the month of sale. Payment for merchandise is made in the month following
the purchase.
● Other monthly expenses to be paid in cash are P21,900.
● Monthly depreciation is P20,000.
Statement of Financial Position

October 31

Assets

Cash P 16,000

Accounts receivable
(net of allowance for uncollectible accounts) 74,000

Inventory 140,400

Property, plant and equipment

(net of P500,000 accumulated depreciation) 1,066,000

Total assets P1,296,400

Liabilities and Stockholders’ Equity

Accounts payable P 240,000

Ordinary share Capital 640,000

Accumulated Profits 416,400

Total liabilities and shareholders’ equity P1,296,400

Required:

1. Prepare a Schedule of Expected Cash Collections for November and December.

2. Prepare a Merchandise Purchases Budget for November and December.
3. Prepare Cash Budgets for November and December.
4. Prepare Budgeted Income Statements for November and December.
5. Prepare a Budgeted Balance Sheet for the end of December

29
30