Week 3

Profit Planning and Activity-Based Budgeting

McGraw-Hill/Irwin

Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

Purposes of Budgeting Systems
Budget a detailed plan, expressed in quantitative terms, that specifies how resources will be acquired and used during a specified period of time.
1. Planning 2. Facilitating Communication and Coordination 3. Allocating Resources 4. Controlling Profit and Operations 5. Evaluating Performance and Providing Incentives
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Types of Budgets
Detail Budget
Detail Budget Detail Budget

Production

Master Budget
Covering all phases of a company’s operations.

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Types of Budgets
Income Statement

Budgeted Financial Statements

Balance Sheet

Statement of Cash Flows
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Types of Budgets
Capital budgets with acquisitions that normally cover several years. Financial budgets with financial resource acquisitions.

Long Range Budgets

Continuous or 1999Rolling Budget2000

2001

2002

This budget is usually a twelve-month budget that rolls forward one month as the current month is completed.

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Sales of Services or Goods Ending Inventory Budget
Work in Process and Finished Goods

Production Budget

Ending Inventory Budget
Direct Materials

Direct Materials Budget

Direct Labor Budget

Overhead Budget

Selling and Administrative Budget

Cash Budget

Budgeted Income Statement

Budgeted Balance Sheet
Budgeted Statement of Cash Flows
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Activity-Based Costing versus Activity-Based Budgeting
Resources
Activity-Based Costing (ABC)

Resources

Activities

Activities

Cost objects: products and services produced, and customers served.

Activity-Based Budgeting (ABB)

Forecast of products and services to be produced and customers served.
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Sales Budget
Breakers, Inc. is preparing budgets for the quarter ending June 30. Budgeted sales for the next five months are: April 20,000 units May 50,000 units June 30,000 units July 25,000 units August 15,000 units. The selling price is $10 per unit.
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Sales Budget
April Budgeted sales (units) 20,000 Selling price per unit $ 10 Total Revenue $ 200,000 May June Quarter

50,000 $ 10 $

30,000 10 $

100,000 10

$ 500,000

$ 300,000

$ 1,000,000

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Production Budget
The management of Breakers, Inc. wants ending inventory to be equal to 20% of the following month’s budgeted sales in units. On March 31, 4,000 units were on hand. Let’s prepare the production budget.

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Production Budget
From sales budget

May sales Desired percent Desired inventory

50,000 units 20% 10,000 units

Sales in units Add: desired end. inventory Total needed Less: beg. inventory Units to be produced

April 20,000 10,000 30,000 4,000 26,000

May 50,000

June 30,000

Quarter 100,000

56,000 10,000 46,000

Ending inventory becomes beginning inventory the next 6,000 5,000 5,000 month

35,000 6,000 29,000

105,000 4,000 101,000

March 31 ending inventory
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Direct-Material Budget
• At Breakers, 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. • On March 31, 13,000 pounds of material are on hand. Material cost $.40 per pound. Let’s prepare the direct materials budget.
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From our production budget

Direct-Material Budget
April 26,000 5 130,000 23,000 153,000 13,000 140,000 May 46,000 5 230,000 14,500 244,500 23,000 221,500 June 29,000 5 145,000 11,500 156,500 14,500 142,000 Quarter 101,000 5 505,000 11,500 516,500 13,000 503,500

Production in units Materials per unit Production needs Add: desired ending inventory Total needed Less: beginning inventory Materials to be purchased

10% of the following month’s production

March 31 inventory
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Direct-Material Budget
July Production

April 25,000 May Sales in units Add: Production desired ending inventory in units 26,000 3,000 46,000 TotalMaterials units needed per unit 528,000 5 Less:Production beginning inventory needs 130,000 5,000 230,000 Production in units 23,000

June 29,000 5 145,000

Quarter 101,000 5 505,000 11,500 516,500 13,000 503,500

Add: desired ending inventory 23,000 14,500 11,500 Total needed 153,000 244,500 156,500 Less: beginning June Ending Inventory inventory 13,000 23,000 14,500 July in units 23,000 Materials toproduction be Materials per unit 5 purchased 140,000 221,500 142,000 Total units needed 115,000 Inventory percentage 10% June desired ending inventory 11,500

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Direct-Labor Budget
• At Breakers, each unit of product requires 0.1 hours of direct labor.

• The Company has a “no layoff” policy so all employees will be paid for 40 hours of work each week.
• In exchange for the “no layoff” policy, workers agreed to a wage rate of $8 per hour regardless of the hours worked (No overtime pay). • For the next three months, the direct labor workforce will be paid for a minimum of 3,000 hours per month. Let’s prepare the direct labor budget.
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Direct-Labor Budget
Production in units Direct labor hours Labor hours required Guaranteed labor hours 3,000 Labor hours paid 3,000 Wage rate $ 8 Total direct labot cost $ 24,000 April 26,000 0.10 2,600 May 46,000 0.10 4,600 3,000 4,600 $ 8 $ 36,800 June 29,000 0.10 2,900 3,000 3,000 $ 8 $ 24,000 Quarter 101,000 0.10 10,100

10,600 $ 8 $ 84,800

From our production budget

This is the greater of labor hours required or labor hours guaranteed.
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Overhead Budget
Here is Breakers’ Overhead Budget for the quarter.
April Indirect labor Indirect material Utilities Rent Insurance Maintenance $ 17,500 7,000 4,200 13,300 5,800 8,200 56,000 $ May 26,500 12,600 8,400 13,300 5,800 9,400 76,000 $ June 17,900 8,600 5,200 13,300 5,800 8,200 59,000 $ Quarter 61,900 28,200 17,800 39,900 17,400 25,800 $ 191,000

$

$

$

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Selling and Administrative Expense Budget
• At Breakers, variable selling and administrative expenses are $0.50 per unit sold. • Fixed selling and administrative expenses are $70,000 per month. • The $70,000 fixed expenses include $10,000 in depreciation expense that does not require a cash outflows for the month.

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Selling and Administrative Expense Budget
Sales in units Variable S&A rate Variable expense Fixed S&A expense Total expense Less: noncash expenses Cash disbursements April 20,000 $ 0.50 $ 10,000 70,000 80,000 10,000 $ 70,000 May 50,000 $ 0.50 $ 25,000 70,000 95,000 10,000 $ 85,000 June 30,000 $ 0.50 $ 15,000 70,000 85,000 10,000 $ 75,000 Quarter 100,000 $ 0.50 $ 50,000 210,000 260,000 30,000 $ 230,000

From our Sales budget
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Cash Receipts Budget
• At Breakers, all sales are on account. • The company’s collection pattern is: 70% collected in the month of sale, 25% collected in the month following sale, 5% is uncollected. • The March 31 accounts receivable balance of $30,000 will be collected in full.

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Cash Receipts Budget
Accounts rec. - 3/31 April sales 70% x $200,000 25% x $200,000 May sales 70% x $500,000 25% x $500,000 June sales 70% x $300,000 Total cash collections April $ 30,000 140,000 $ 50,000 350,000 $ 125,000 210,000 $ 335,000 May June Quarter $ 30,000 140,000 50,000 350,000 125,000 210,000 $ 905,000

$ 170,000

$ 400,000

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Cash Disbursement Budget
• Breakers pays $0.40 per pound for its materials. • One-half of a month’s purchases are paid for in the month of purchase; the other half is paid in the following month. • No discounts are available.

• The March 31 accounts payable balance is $12,000.

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Cash Disbursement Budget
Accounts pay. 3/31 April purchases 50% x $56,000 50% x $56,000 May purchases 50% x $88,600 50% x $88,600 June purchases 50% x $56,800 Total cash payments for materials April $ 12,000 28,000 $ 28,000 44,300 $ 44,300 28,400 $ 40,000 $ 72,300 $ 72,700 May June Quarter $ 12,000 28,000 28,000 44,300 44,300 28,400 $ 185,000

140,000 lbs. × $.40/lb. = $56,000
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Cash Disbursement Budget
Breakers: – Maintains a 12% open line of credit for $75,000.

– Maintains a minimum cash balance of $30,000.
– Borrows and repays loans on the last day of the month.

– Pays a cash dividend of $25,000 in April.
– Purchases $143,700 of equipment in May and $48,300 in June paid in cash. – Has an April 1 cash balance of $40,000.
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From our Cash Receipts Budget

Cash Budget (Collections and Disbursements)
May June Quarter

April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends 25,000 Total disbursements 215,000 Excess (deficiency) of Cash available over disbursements $ (5,000)

From our Cash Disbursements Budget From our Direct Labor Budget From our Overhead Budget From our Selling and Administrative Expense Budget

To maintain a cash balance of $30,000, Breakers must borrow $35,000 on its line of credit. 1-25

Cash Budget (Collections and Disbursements)
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends 25,000 Total disbursements 215,000 Excess (deficiency) of Cash available over disbursements $ (5,000) May $ 30,000 400,000 430,000 72,300 36,800 76,000 85,000 143,700 413,800 June Quarter

Breakers must borrow an addition $13,800 to maintain a cash balance of $30,000.

$ 16,200
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Cash Budget (Collections and Disbursements)
April May Beginning $ 40,000 $ 30,000 At thecash endbalance of June, Breakers Add: cash collections 170,000 has enough cash to repay 400,000 Total cash available 210,000 430,000 the $48,800 loan plus interest Less: disbursements at 12%. 40,000 Materials 72,300 Direct labor 24,000 36,800 Mfg. overhead 56,000 76,000 Selling and admin. 70,000 85,000 Equipment purchase 143,700 Dividends 25,000 Total disbursements 215,000 413,800 Excess (deficiency) of Cash available over disbursements $ (5,000) $ 16,200 June $ 30,000 335,000 365,000 72,700 24,000 59,000 75,000 48,300 279,000 Quarter

$ 86,000
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Cash Budget (Collections and Disbursements)
April Beginning cash balance $ 40,000 Add: cash collections 170,000 Total cash available 210,000 Less: disbursements Materials 40,000 Direct labor 24,000 Mfg. overhead 56,000 Selling and admin. 70,000 Equipment purchase Dividends 25,000 Total disbursements 215,000 Excess (deficiency) of Cash available over disbursements $ (5,000) May $ 30,000 400,000 430,000 72,300 36,800 76,000 85,000 143,700 413,800 June $ 30,000 335,000 365,000 72,700 24,000 59,000 75,000 48,300 279,000 Quarter $ 40,000 905,000 945,000 185,000 84,800 191,000 230,000 192,000 25,000 907,800

$ 16,200

$ 86,000

$ 37,200
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Ending cash balance for April is the beginning May balance.

Cash Budget (Financing and Repayment)
April May June Quarter

Excess (deficiency) of Cash available over disbursements Financing: Borrowing Repayments Interest Total financing Ending cash balance

$ (5,000) 35,000 35,000 $ 30,000

$ 16,200 13,800 13,800 $ 30,000
Annual Interest $ 4,200 1,656

$ 86,000

$ 37,200 48,800 (48,800) (838) (838) $ 36,362
Interest Expense $ 700 138 $ 838

(48,800) (838) (49,638) $ 36,362

Borrowing $ 35,000 13,800

× ×

Rate 12% = 12% =

Months Outstanding × 2 mths = × 1 mth. =

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Cost of Goods Manufactured
April Direct material: Beg.material inventory $ 5,200 Add: Materials purchases 56,000 Material available for use 61,200 Deduct: End. material inventory 9,200 Direct material used 52,000 Direct labor 24,000 Manufacturing overhead 56,000 Total manufacturing costs 132,000 Add: Beg. Work-in-process inventory 3,800 Subtotal 135,800 Deduct: End.Work-in-process inventory 16,200 Cost of goods manufactured $ 119,600 $ May 9,200 88,600 97,800 5,800 92,000 36,800 76,000 204,800 16,200 221,000 9,400 $ 211,600 $ June 5,800 56,800 62,600 4,600 58,000 24,000 59,000 141,000 9,400 150,400 17,000 $ 133,400 Quarter $ 5,200 201,400 206,600 4,600 202,000 84,800 191,000 477,800 3,800 481,600 17,000 $ 464,600

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Cost of Goods Sold
April May $ 119,600 $ 211,600 $ 18,400 46,000 138,000 257,600 46,000 27,600 $ 92,000 $ 230,000 $ June Quarter 133,400 $ 464,600 27,600 18,400 161,000 483,000 23,000 23,000 138,000 $ 460,000

Cost of goods manufactured Add: Beg. finished-goods inventory Cost of goods available for sale Deduct: End. finished-goods inventory Cost of goods sold

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Budgeted Income Statement
Breakers, Inc. Budgeted Income Statement For the Three Months Ended June 30 Revenue (100,000 × $10) Cost of goods sold Gross margin Operating expenses: Selling and admin. expenses Interest expense Total operating expenses Net income $ 1,000,000 460,000 540,000 $ 260,000 838 $ 260,838 279,162

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Budgeted Statement of Cash Flows
April Cash flows from operating activities: Cash receipts from customers Cash payments: To suppliers of raw material For direct labor For manufacturing-overhead expenditures For selling and administrative expenses For interest Total cash payments Net cash flow from operating activities Cash flows from investing activities: Purchase of equipment Net cash used by investing activities Cash flows from financing activities: Payment of dividends Principle of bank loan Repayment of bank loan Net cash provided by financing activities Net increase in cash Balance in cash, beginning Balance in cash. end of month $ $ 170,000 $ (40,000) (24,000) (56,000) (70,000) (190,000) (20,000) $ $ May 400,000 $ (72,300) (36,800) (76,000) (85,000) (270,100) 129,900 $ (143,700) June 335,000 $ (72,700) (24,000) (59,000) (75,000) (838) (231,538) 103,462 $ (48,300) (48,300) $ (48,800) (48,800) $ 6,362 $ 30,000 36,362 $ Quarter 905,000 (185,000) (84,800) (191,000) (230,000) (838) (691,638) 213,362 (192,000) (192,000) (25,000) 48,800 (48,800) (3,638) 40,000 36,362

- $ (143,700) $ (25,000) 35,000 13,800 13,800 $ - $ 30,000 30,000 $

$ $ $

10,000 $ (10,000) $ 40,000 30,000 $

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Budgeted Balance Sheet
Breakers reports the following account balances on June 30 prior to preparing its budgeted financial statements: • Land - $50,000 • Building (net) - $148,000 • Common stock - $217,000 • Retained earnings - $46,400

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25%of June sales of $300,000 11,500 lbs. at $.40 per lb. 5,000 units at $4.60 per unit. 50% of June purchases of $56,800
Beginning balance Add: net income Deduct: dividends Ending balance

Breakers, Inc. Budgeted Balance Sheet June 30 Current assets Cash Accounts receivable Raw materials inventory Work-in-process inventory Finished goods inventory Total current assets Property and equipment Land Building Equipment Total property and equipment Total assets $ 36,362 75,000 4,600 17,000 23,000 155,962 50,000 148,000 192,000 390,000 545,962 28,400 217,000 300,562 545,962

$ 46,400 279,162 (25,000) Accounts payable $300,562 Common stock

$ $

Retained earnings Total liabilities and equities

$

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Sales of Services or Goods Ending Inventory Budget
Work in Process and Finished Goods

Production Budget

When the interactions of the elements Selling Ending Direct budget Directare expressed of the master as and Overhead Inventory Materials Labor Administrative Budget a set of mathematical relations, it Budget Budget Budget Budget Direct Materials becomes a financial planning model that can be used to answer “what if” Cash Budget questions about unknown variables. Budgeted Income
Statement

Budgeted Balance Sheet
Budgeted Statement of Cash Flows
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Budget Administration
The Budget Committee is a standing committee responsible for . . .
overall policy matters relating to the budget.  coordinating the preparation of the budget.

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International Aspects of Budgeting
Firms with international operations face special problems when preparing a budget.
1. Fluctuations in foreign currency exchange

rates. 2. High inflation rates in some foreign countries. 3. Differences in local economic conditions.

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Budgeting Product Life-Cycle Costs
Product planning and concept Design. Distribution and customer service.

Preliminary design.

Production.

Detailed design and testing.

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Behavioral Impact of Budgets
Budgetary Slack: Padding the Budget
People often perceive that their performance will look better in their superiors’ eyes if they can “beat the budget.”

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Participative Budgeting

Flow of Budget Data
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