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Chapter 9

Profit Planning
and
Activity-Based
Budgeting

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

Learning
Objective
1

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

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

Types of Budgets

Materials

Production

Covering all
phases of
a companys
operations.

Sales

Master
Budget

Detail
Budget

Detail
Budget

Detail
Budget

Types of Budgets
Income
Statement

Budgeted
Financial
Statements
Balance
Sheet

Statement of
Cash Flows

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

Long Range Budgets


Continuous or
1999Rolling Budget2000

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

2001

2002

Learning
Objective
2

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

Sales of Services or Goods


Ending
Inventory
Budget

Production
Budget

Work in Process
and Finished
Goods

Ending
Inventory
Budget

Direct Materials

Direct
Materials
Budget

Direct
Labor
Budget

Overhead
Budget

Cash Budget
Budgeted Balance
Sheet
Budgeted Statement
of Cash Flows

Selling and
Administrative
Budget

Budgeted Income
Statement

Learning
Objective
3

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

Activity-Based Costing versus


Activity-Based Budgeting
Resources
Resources

Resources
Resources
Activity-Based
Activity-Based
Costing
Costing (ABC)
(ABC)

Activities
Activities

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

Activities
Activities
Activity-Based
Activity-Based
Budgeting
Budgeting (ABB)
(ABB)

Forecast
Forecast of
of products
products
and
and services
services to
to be
be
produced
produced and
and
customers
customers served.
served.

Learning
Objective
4

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

Sales Budget

Breakers,
Breakers, Inc.
Inc. is
is preparing
preparing budgets
budgets for
for the
the quarter
quarter
ending
ending June
June 30.
30.

Budgeted
Budgeted sales
sales for
for the
the next
next five
five months
months are:
are:
April
20,000
April
20,000 units
units
May
50,000
May
50,000 units
units
June
30,000
June
30,000 units
units
July
25,000
July
25,000 units
units
August
15,000
August
15,000 units.
units.

The
The selling
selling price
price is
is $10
$10 per
per unit.
unit.

Sales Budget

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

From
sales
budget

Production Budget

Ending inventory becomes


beginning inventory the next
month

March 31
ending inventory

Direct-Material Budget
At
At Breakers,
Breakers, five
five pounds
pounds of
of material
material are
are required
required
per
per unit
unit of
of product.
product.
Management
Management wants
wants materials
materials on
on hand
hand at
at the
the end
end
of
of each
each month
month equal
equal to
to 10%
10% of
of the
the following
following
months
months production.
production.
On
On March
March 31,
31, 13,000
13,000 pounds
pounds of
of material
material are
are on
on
hand.
hand. Material
Material cost
cost $.40
$.40 per
per pound.
pound.
Lets
Lets prepare
prepare the
the direct
direct materials
materials budget.
budget.

From our
production
budget

Direct-Material Budget

10% of the following


months production

March 31
inventory

Direct-Material Budget

June Ending Inventory


July production in units
23,000
Materials per unit
5
Total units needed
115,000
Inventory percentage
10%
June desired ending inventory
11,500

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.
Lets prepare the direct labor budget.

Direct-Labor Budget

From our
production
budget

This is the greater of


labor hours required or
labor hours guaranteed.

Overhead Budget
Here is Breakers Overhead Budget for the quarter.

Selling and Administrative


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

Selling and Administrative


Expense Budget

From our
Sales budget

Cash Receipts Budget

At
At Breakers,
Breakers, all
all sales
sales are
are on
on account.
account.
The
The companys
companys collection
collection pattern
pattern is:
is:
70%
70% collected
collected in
in the
the month
month of
of sale,
sale,
25%
25% collected
collected in
in the
the month
month following
following sale,
sale,
5%
5% is
is uncollected.
uncollected.
The
The March
March 31
31 accounts
accounts receivable
receivable balance
balance of
of
$30,000
$30,000 will
will be
be collected
collected in
in full.
full.

Cash Receipts Budget

Cash Disbursement Budget

Breakers
Breakers pays
pays $0.40
$0.40 per
per pound
pound for
for its
its materials.
materials.
One-half
One-half of
of aa months
months purchases
purchases are
are paid
paid for
for in
in the
the
month
month of
of purchase;
purchase; the
the other
other half
half is
is paid
paid in
in the
the
following
following month.
month.
No
No discounts
discounts are
are available.
available.
The
The March
March 31
31 accounts
accounts payable
payable balance
balance is
is
$12,000.
$12,000.

Cash Disbursement Budget

140,000 lbs. $.40/lb. = $56,000

Cash Disbursement Budget


Breakers:
Breakers:
Maintains
Maintains aa 12%
12% open
open line
line of
of credit
credit for
for $75,000.
$75,000.
Maintains
Maintains aa minimum
minimum cash
cash balance
balance of
of $30,000.
$30,000.
Borrows
Borrows and
and repays
repays loans
loans on
on the
the last
last day
day of
of the
the
month.
month.
Pays
Pays aa cash
cash dividend
dividend of
of $25,000
$25,000 in
in April.
April.
Purchases
Purchases $143,700
$143,700 of
of equipment
equipment in
in May
May and
and
$48,300
$48,300 in
in June
June paid
paid in
in cash.
cash.
Has
Has an
an April
April 11 cash
cash balance
balance of
of $40,000.
$40,000.

From our Cash


Receipts Budget

Cash Budget

(Collections and Disbursements)


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.

Cash Budget

(Collections and Disbursements)

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

Cash Budget

(Collections and Disbursements)


At the end of June, Breakers
has enough cash to repay
the $48,800 loan plus interest
at 12%.

Cash Budget

(Collections and Disbursements)

Ending cash
balance for April
is the beginning
May balance.

Cash Budget

(Financing and Repayment)

Cost of Goods Manufactured

Cost of Goods Sold

Budgeted Income Statement

Budgeted Statement of Cash Flows

Budgeted Balance Sheet


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

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

Learning
Objective
5

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

Sales of Services or Goods


Ending
Inventory
Budget

Production
Budget

Work in Process
and Finished
Goods

When the interactions of the elements


Ending
Direct budget
Directare Overhead
of the master
expressedSelling
as and
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

Learning
Objective
6

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

Budget Administration
The Budget Committee is a standing
committee responsible for . . .
overall
overall policy
policy matters
matters relating
relating to
to the
the budget.
budget.

coordinating
coordinating the
the preparation
preparation of
of the
the budget.
budget.

International Aspects of Budgeting


Firms
Firms with
with international
international operations
operations face
face special
special problems
problems
when
when preparing
preparing aa budget.
budget.
1.
1. Fluctuations
Fluctuations in
in foreign
foreign currency
currency exchange
exchange
2.
2.
3.
3.

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

Learning
Objective
7

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

Budgeting Product Life-Cycle


Costs
Product
Product planning
planning
and
and concept
concept
Design.
Design.
Distribution
Distribution
and
and customer
customer
service.
service.

Preliminary
Preliminary
design.
design.

Production.
Production.

Detailed
Detailed design
design
and
and testing.
testing.

Learning
Objective
8

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All

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.

Participative Budgeting
Top M anagem ent
M id d le
M anagem ent
S u p e rv is o r

S u p e rv is o r

M id d le
M anagem ent
S u p e rv is o r

Flow of Budget Data

S u p e rv is o r

End of Chapter 9