Chapter

22 Operational Budgeting

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 Budgeting:
Budgeting: The
The Basis
Basis for
for
Planning
Planning and
and Control
Control
A
A budget
budget isis aa comprehensive
comprehensive financial
financial
plan
plan for
for achieving
achieving thethe financial
financial and
and
operational
operational goals
goals of
of an
an organization.
organization.

Planning Control
Developing Steps taken by
objectives for management to
acquisition ensure that
and use of objectives are
resources. attained.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Benefits
Benefits Derived
Derived from
from Budgeting
Budgeting
Enhanced managerial
responsibility

Coordination Performance
of activities Benefits evaluation

Assignment of decision
making responsibilities

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 Establishing
Establishing Budgeted
Budgeted Amounts:
Amounts:
The
The “Behavioral”
“Behavioral” Approach
Approach
Budget Problems Solution
 Perceived unfair or  Reasonable and
unrealistic goals. achievable budgets.
 Poor management-  Employee participation
employee in budgeting process.
communications.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Participation
Participation in
in Budget
Budget Process
Process

Top M anagem ent

M id d le M id d le
M anagem ent M anagem ent

S u p e r v is o r S u p e r v is o r S u p e r v is o r S u p e r v is o r

Flow of Budget Data

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 The
The Budget
Budget Period
Period
The annual operating budget may be
divided into quarterly or monthly budgets.

2001 2002 2003 2004

Capital Budgets

A continuous budget is usually a twelve-month budget

that adds one month as the current month is completed.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Master
Master Budget
Budget

Cost of goods
Sales Production sold and ending
forecast schedule inventory
budgets

Budgeted
financial Capital Operating
budgets: expenditures expense
 cash
budget budgets
 income
 balance sheet

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Preparing
Preparing the
the Master
Master Budget:
Budget:
An
An Illustration
Illustration
That’s enough talking
about budgets, now
show me an example!

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 Preparing
Preparing the
the Master
Master Budget:
Budget:
An
An Illustration
Illustration
Sales
Budget

Estimated Estimated
Unit Sales Unit Price

Analysis of economic and market conditions

+
Forecasts of customer needs from marketing personnel
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Preparing
Preparing the
the Master
Master Budget:
Budget:
An
An Illustration
Illustration
Ellis Magnet Co. is preparing budgets for the quarter
ending June 30. The sales price is $10 per magnet.
Budgeted sales for the next four months are:
April 20,000 magnets @ $10 = $200,000
May 50,000 magnets @ $10 = $500,000
June 30,000 magnets @ $10 = $300,000
July 25,000 magnets @ $10 = $250,000

The Sales Budget

July is needed for June ending inventory computations.
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 The
The Production
Production Budget
Budget

Sales Production
Budget Budget

t ed
e
pl
om
C

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 The
The Production
Production Budget
Budget
Ellis wants ending inventory
to be 20 percent of the next month’s
budgeted sales in units.

4,000 units were on hand March 31.

Let’s prepare the production budget.

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 The
The Production
Production Budget
Budget
Production
Production must
must be
be adequate
adequate to
to meet
meet
budgeted
budgeted sales
sales and
and to
to provide
provide sufficient
sufficient
ending
ending inventory.
inventory.
Budgeted product sales in units
+ Desired product units in ending inventory
= Total product units needed
– Product units in beginning inventory
= Product units to produce

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Production
Production Budget
Budget
April May June
Budgeted unit sales 20,000 50,000 30,000
Desired ending inventory
Total units needed
Less beginning inventory
Units to produce

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Production
Production Budget
Budget
April May June
Budgeted unit sales 20,000 50,000 30,000
Desired ending inventory 10,000 6,000 5,000
Total units needed 30,000 56,000 35,000
Less beginning inventory
Units to produce

Ending inventory = 20% of next month's production needs.

June ending inventory = .20 × 25,000 July units = 5,000 units.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Production
Production Budget
Budget
April May June
Budgeted unit sales 20,000 50,000 30,000
Desired ending inventory 10,000 6,000 5,000
Total units needed 30,000 56,000 35,000
Less beginning inventory 4,000 10,000 6,000
Units to produce 26,000 46,000 29,000

Ending inventory = 20% of next month's production needs.

June ending inventory = .20 × 25,000 July units = 5,000 units.
Beginning inventory is last month's ending inventory.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Production
Production Budget
Budget

Production Production
Budget Budget
Units Material
t ed Purchases
e
pl
om
C

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 The
The Production
Production Budget
Budget
Material
Material Purchases
Purchases
The
The material
material purchases
purchases budget
budget isis based
based on
on
production
production quantity
quantity and
and desired
desired material
material
inventory
inventory levels.
levels.
Units to produce
× Material needed per unit
= Material needed for units to produce
+ Desired units of material in ending inventory
= Total units of material needed
– Units of material in beginning inventory
= Units of material to purchase
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 The
The Production
Production Budget
Budget
Material
Material Purchases
Purchases
Five
Five pounds
pounds of
of material
material are
are needed
needed for
for each
each
unit
unit produced.
produced.
Ellis
Ellis wants
wants to to have
have materials
materials on
on hand
hand at
at the
the
end
end ofof each
each month
month equal
equal to
to 10
10 percent
percent ofof
the
the following
following month’s
month’s production
production needs.
needs.
The
The materials
materials inventory
inventory on
on March
March 31
31 isis
13,000
13,000 pounds.
pounds. JulyJuly production
production is
is
budgeted
budgeted forfor 23,000
23,000 units.
units.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Production
Production Budget
Budget
Material
Material Purchases
Purchases
April May June
Units to produce 26,000 46,000 29,000
Pounds per unit 5 5 5
Material needs (lbs.) 130,000 230,000 145,000
Desired ending inventory
Total material needs (lbs.)
Less beginning inventory
Material purchases (lbs.)

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Production
Production Budget
Budget
Material
Material Purchases
Purchases
April May June
Units to produce 26,000 46,000 29,000
Pounds per unit 5 5 5
Material needs (lbs.) 130,000 230,000 145,000
Desired ending inventory 23,000 14,500 11,500
Total material needs (lbs.) 153,000 244,500 156,500
Less beginning inventory
Material purchases (lbs.)

Ending inventory = 10% of next month's material needs.

June ending inventory = .10 × (23,000 units × 5 lbs. per unit).
June ending inventory = 11,500 lbs.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Production
Production Budget
Budget
Material
Material Purchases
Purchases
April May June
Units to produce 26,000 46,000 29,000
Pounds per unit 5 5 5
Material needs (lbs.) 130,000 230,000 145,000
Desired ending inventory 23,000 14,500 11,500
Total material needs (lbs.) 153,000 244,500 156,500
Less beginning inventory 13,000 23,000 14,500
Material purchases (lbs.) 140,000 221,500 142,000

Ending inventory = 10% of next month's material needs.

June ending inventory = .10 × (23,000 units × 5 lbs. per unit).
June ending inventory = 11,500 lbs.
Beginning inventory is last month's ending inventory.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Cash
Cash Payments
Payments for
for
Material
Material Purchases
Purchases
Materials
Materials used
used inin production
production cost cost $.40
$.40
per
per pound.
pound. One-half
One-half of of aa month’s
month’s
purchases
purchases areare paid
paid for
for in
in the
the month
month of of
purchase;
purchase; the
the other
other half
half isis paid
paid for
for in
in the
the
following
following month.
month.
No
No discount
discount terms
terms are
are available.
available.
The
The accounts
accounts payable
payable balance
balance on
on
March
March 31
31 is
is $12,000.
$12,000.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Payments
Payments for
for
Material
Material Purchases
Purchases
April May June
Material purchases (lbs.) 140,000 221,500 142,000
Cost per pound $ 0.40 $ 0.40 $ 0.40
Total cost $ 56,000 $ 88,600 $ 56,800
Payables from March $ 12,000
April purchases
May purchases
June purchases
Total payments in month

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Payments
Payments for
for
Material
Material Purchases
Purchases
April May June
Material purchases (lbs.) 140,000 221,500 142,000
Cost per pound $ 0.40 $ 0.40 $ 0.40
Total cost $ 56,000 $ 88,600 $ 56,800
Payables from March $ 12,000
April purchases 28,000 $ 28,000
May purchases
June purchases
Total payments in month

½ × $56,000 = $28,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Payments
Payments for
for
Material
Material Purchases
Purchases
April May June
Material purchases (lbs.) 140,000 221,500 142,000
Cost per pound $ 0.40 $ 0.40 $ 0.40
Total cost $ 56,000 $ 88,600 $ 56,800
Payables from March $ 12,000
April purchases 28,000 $ 28,000
May purchases 44,300 $ 44,300
June purchases
Total payments in month

½ × $56,000 = $28,000
½ × $88,600 = $44,300

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Payments
Payments for
for
Material
Material Purchases
Purchases
April May June
Material purchases (lbs.) 140,000 221,500 142,000
Cost per pound $ 0.40 $ 0.40 $ 0.40
Total cost $ 56,000 $ 88,600 $ 56,800
Payables from March $ 12,000
April purchases 28,000 $ 28,000
May purchases 44,300 $ 44,300
June purchases 28,400
Total payments in month $ 40,000 $ 72,300 $ 72,700

½ × $56,000 = $28,000
½ × $88,600 = $44,300
½ × $56,800 = $28,400
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 The
The Production
Production Budget
Budget

Production Production
Budget Budget
Units Labor
Material d
e
l et
p
om
C

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Production
Production Budget
Budget
Direct
Direct Labor
Labor
Each unit produced requires 3 minutes (.05
hours) of direct labor. Ellis employs 30
persons for 40 hours each week at a rate of
$10 per hour. Any extra hours needed are
obtained by hiring temporary workers also
at $10 per hour.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Payments
Payments for
for
Direct
Direct Labor
Labor
April May June
Units to produce 26,000 46,000 29,000
Hours per unit 0.05 0.05 0.05
Total hours required 1,300 2,300 1,450
Wage rate per hour
Direct labor cost

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Payments
Payments for
for
Direct
Direct Labor
Labor
April May June
Units to produce 26,000 46,000 29,000
Hours per unit 0.05 0.05 0.05
Total hours required 1,300 2,300 1,450
Wage rate per hour $ 10 $ 10 $ 10
Direct labor cost $ 13,000 $ 23,000 $ 14,500

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Production
Production Budget
Budget

Production Production
Budget Budget
Units Manufacturing
Material Overhead
Labor ted
e
pl
om
C

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 The
The Production
Production Budget
Budget
Manufacturing
Manufacturing Overhead
Overhead
Variable manufacturing overhead is $1 per
unit produced and fixed manufacturing
overhead is $50,000 per month.
Fixed manufacturing overhead includes
$20,000 in depreciation which does not
require a cash outflow.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Payments
Payments for
for
Manufacturing
Manufacturing Overhead
Overhead
April May June
Units to produce 26,000 46,000 29,000
Variable overhead rate $ 1.00 $ 1.00 $ 1.00
Variable overhead cost $ 26,000 $ 46,000 $ 29,000
Fixed overhead
Total mfg. overhead cost
Deduct depreciation
Manufacturing overhead - cash

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 Cash
Cash Payments
Payments for
for
Manufacturing
Manufacturing Overhead
Overhead
April May June
Units to produce 26,000 46,000 29,000
Variable overhead rate $ 1.00 $ 1.00 $ 1.00
Variable overhead cost $ 26,000 $ 46,000 $ 29,000
Fixed overhead 50,000 50,000 50,000
Total mfg. overhead cost $ 76,000 $ 96,000 $ 79,000
Deduct depreciation
Manufacturing overhead - cash

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Payments
Payments for
for
Manufacturing
Manufacturing Overhead
Overhead
April May June
Units to produce 26,000 46,000 29,000
Variable overhead rate $ 1.00 $ 1.00 $ 1.00
Variable overhead cost $ 26,000 $ 46,000 $ 29,000
Fixed overhead 50,000 50,000 50,000
Total mfg. overhead cost $ 76,000 $ 96,000 $ 79,000
Deduct depreciation 20,000 20,000 20,000
Manufacturing overhead - cash $ 56,000 $ 76,000 $ 59,000

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 Selling
Selling and
and Administrative
Administrative
(S&A)
(S&A) Expense
Expense Budget
Budget

Production Selling
Budget and
Administrative
ed Expense
e t
pl Budget
om
C

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Selling
Selling and
and Administrative
Administrative
(S&A)
(S&A) Expense
Expense Budget
Budget
 Selling expense budgets contain both
variable and fixed items.
 Variable items: shipping costs and sales
commissions.
 Fixed items: advertising and sales salaries.
 Administrative expense budgets contain
mostly fixed items.
 Executive salaries and depreciation on company
offices.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Cash
Cash Payments
Payments for
for
(S&A)
(S&A) Expenses
Expenses
Variable selling and administrative
expenses are $.50 per unit sold and fixed
selling and administrative expenses are
$70,000 per month.
Fixed selling and administrative expenses
include $10,000 in depreciation which does
not require a cash outflow.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Payments
Payments for
for
(S&A)
(S&A) Expenses
Expenses
April May June
Budgeted unit sales 20,000 50,000 30,000
Variable S&A per unit $ 0.50 $ 0.50 $ 0.50
Variable S&A expense $ 10,000 $ 25,000 $ 15,000
Fixed S&A expense 70,000 70,000 70,000
Total S&A expense $ 80,000 $ 95,000 $ 85,000
Deduct depreciation
S&A expense - cash

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Payments
Payments for
for
(S&A)
(S&A) Expenses
Expenses
April May June
Budgeted unit sales 20,000 50,000 30,000
Variable S&A per unit $ 0.50 $ 0.50 $ 0.50
Variable S&A expense $ 10,000 $ 25,000 $ 15,000
Fixed S&A expense 70,000 70,000 70,000
Total S&A expense $ 80,000 $ 95,000 $ 85,000
Deduct depreciation 10,000 10,000 10,000
S&A expense - cash $ 70,000 $ 85,000 $ 75,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Receipts
Receipts Budget
Budget
I have seen a lot of cash
payments but no cash
receipts. Show me some
cash receipts!

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Receipts
Receipts Budget
Budget
All
All sales
sales are
are on
on account.
account.
Ellis’s
Ellis’s collection
collection pattern
pattern is:
is:
70
70 percent
percent collected
collected in
in month
month of
of sale
sale
25
25 percent
percent collected
collected in
in month
month after
after sale
sale
55 percent
percent will
will be
be uncollectible
uncollectible
Accounts
Accounts receivable
receivable onon March
March 3131 is
is
$30,000,
$30,000, all
all of
of which
which is
is collectible.
collectible.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Cash
Cash Receipts
Receipts Budget
Budget
April May June
Budgeted unit sales 20,000 50,000 30,000
Price per unit $ 10 $ 10 $ 10
Budgeted sales revenue $ 200,000 $ 500,000 $ 300,000
Receipts from March sales $ 30,000
Receipts from April sales
Receipts from May sales
Receipts from June sales
Total cash receipts

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Receipts
Receipts Budget
Budget
April May June
Budgeted unit sales 20,000 50,000 30,000
Price per unit $ 10 $ 10 $ 10
Budgeted sales revenue $ 200,000 $ 500,000 $ 300,000
Receipts from March sales $ 30,000
Receipts from April sales 140,000 $ 50,000
Receipts from May sales
Receipts from June sales
Total cash receipts $ 170,000

April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Receipts
Receipts Budget
Budget
April May June
Budgeted unit sales 20,000 50,000 30,000
Price per unit $ 10 $ 10 $ 10
Budgeted sales revenue $ 200,000 $ 500,000 $ 300,000
Receipts from March sales $ 30,000
Receipts from April sales 140,000 $ 50,000
Receipts from May sales 350,000 $ 125,000
Receipts from June sales
Total cash receipts $ 170,000 $ 400,000

April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000

May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Cash
Cash Receipts
Receipts Budget
Budget
April May June
Budgeted unit sales 20,000 50,000 30,000
Price per unit $ 10 $ 10 $ 10
Budgeted sales revenue $ 200,000 $ 500,000 $ 300,000
Receipts from March sales $ 30,000
Receipts from April sales 140,000 $ 50,000
Receipts from May sales 350,000 $ 125,000
Receipts from June sales 210,000
Total cash receipts $ 170,000 $ 400,000 $ 335,000

April: .70 × $200,000 = $140,000 and .25 × $200,000 = $50,000

May: .70 × $500,000 = $350,000 and .25 × $500,000 = $125,000
June: .70 × $300,000 = $210,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Comprehensive
Comprehensive Cash
Cash Budget
Budget

With just a little

more information
we will be able to
prepare a
comprehensive
cash budget.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Comprehensive
Comprehensive Cash
Cash Budget
Budget
Additional
Additional Information
Information
Ellis Magnet Company:
 Has a $100,000 line of credit at its bank, with a zero
balance on April 1.
 Maintains a $30,000 minimum cash balance.
 Borrows at the beginning of a month and repays at the
end of a month.
 Pays interest at 16 percent when a principal payment is
made.
 Pays a $51,000 cash dividend in April.
 Purchases equipment costing $143,700 in May and
$48,800 in June.
 Has a $40,000 cash balance on April 1.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Comprehensive Cash Budget
April May June
Beginning cash balance $ 40,000
Cash receipts
Cash available
Cash payments:
Materials budget
Labor budget
Manufacturing OH budget
S&A expense budget
Equipment purchases
Dividends
Total cash payments
Balance before financing
Borrowing
Principal repayment
Interest
Ending cash balance
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Comprehensive Cash Budget
April May June
Beginning cash balance $ 40,000
Cash receipts 170,000 400,000 335,000
Cash available $ 210,000
Cash payments:
Materials budget
Labor budget
Manufacturing OH budget
S&A expense budget
Equipment purchases
Dividends
Total cash payments
Balance before financing
Borrowing
Principal repayment
Interest
Ending cash balance
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Comprehensive Cash Budget
April May June
Beginning cash balance $ 40,000
Cash receipts 170,000 400,000 335,000
Cash available $ 210,000
Cash payments:
Materials budget $ 40,000 $ 72,300 $ 72,700
Labor budget 13,000 23,000 14,500
Manufacturing OH budget 56,000 76,000 59,000
S&A expense budget 70,000 85,000 75,000
Equipment purchases 0 143,700 48,800
Dividends 51,000 0 0
Total cash payments $ 230,000 $ 400,000 $ 270,000
Balance before financing $ (20,000)
Borrowing
Principal repayment
Interest
Ending cash balance
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Comprehensive Cash Budget
April May June
Beginning cash balance $ 40,000 $ 30,000
Cash receipts 170,000 400,000 335,000
Cash available $ 210,000 $ 430,000
Cash payments:
Materials budget $ 40,000 $ 72,300 $ 72,700
Labor budget 13,000 23,000 14,500
Manufacturing OH budget 56,000 76,000 59,000
S&A expense budget 70,000 85,000 75,000
Equipment purchases 0 143,700 48,800
Dividends 51,000 0 0
Total cash payments $ 230,000 $ 400,000 $ 270,000
Balance before financing $ (20,000) $ 30,000
Borrowing 50,000
Principal repayment 0
Interest 0
Ending cash balance $ 30,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Comprehensive Cash Budget
April May June
Beginning cash balance $ 40,000 $ 30,000 $ 30,000
Cash receipts 170,000 400,000 335,000
Cash available $ 210,000 $ 430,000 $ 365,000
Cash payments:
Materials budget $ 40,000 $ 72,300 $ 72,700
Labor budget 13,000 23,000 14,500
Manufacturing OH budget 56,000 76,000 59,000
S&A expense budget 70,000 85,000 75,000
Equipment purchases 0 143,700 48,800
Dividends 51,000 0 0
Total cash payments $ 230,000 $ 400,000 $ 270,000
Balance before financing $ (20,000) $ 30,000 $ 95,000
Borrowing 50,000 0
Principal repayment 0 0
Interest 0 0
Ending cash balance $ 30,000 $ 30,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Comprehensive Cash Budget
April May June
Beginning cash balance $ 40,000 $ 30,000 $ 30,000
Cash receipts 170,000 400,000 335,000
Cash available $ 210,000 $ 430,000 $ 365,000
Cash payments:
Materials budget $ 40,000 $ 72,300 $ 72,700
Labor budget 13,000 23,000 14,500
Manufacturing OH budget 56,000 76,000 59,000
S&A expense budget 70,000 85,000 75,000
Equipment purchases 0 143,700 48,800
Dividends 51,000 0 0
Total cash payments $ 230,000 $ 400,000 $ 270,000
Balance before financing $ (20,000) $ 30,000 $ 95,000
Borrowing 50,000 0 0
Principal repayment 0 0 (50,000)
Interest $50,000 × .16 × 3/12
0 = $2,000
0 (2,000)
Ending cash balance $ 30,000 $ 30,000 $ 43,000
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 The
The Budgeted
Budgeted
Income
Income Statement
Statement

Cash Budgeted
Budget Income
Statement
t ed
e
pl
om
C

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 The
The Budgeted
Budgeted
Income
Income Statement
Statement
Ellis Magnet Company
Budgeted Income Statement
For the Three Months Ended June 30

Sales (100,000 units @ $10) $ 1,000,000

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 The
The Budgeted
Budgeted
Income
Income Statement
Statement
Ellis Magnet Company
Budgeted Income Statement
For the Three Months Ended June 30

Sales (100,000 units @ $10) $ 1,000,000

Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin $ 501,000

Computation of unit cost follows

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 The
The Budgeted
Budgeted
Income
Income Statement
Statement
Production costs per unit Quantity Cost Total
Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
Total unit cost $ 4.99

Total mfg. OH for quarter $251,000 = $49.70 per hr.

Total labor hours required 5,050 hrs.
From labor and Mfg. OH budgets
Labor Hours Mfg. OH
Manufacturing
April 1,300 $ 76,000
May 2,300 96,000 overhead is applied
June 1,450 79,000 based on
Total 5,050 $ 251,000 direct labor hours.

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 The
The Budgeted
Budgeted
Income
Income Statement
Statement
Ellis Magnet Company
Budgeted Income Statement
For the Three Months Ended June 30

Sales (100,000 units @ $10) $ 1,000,000

Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin $ 501,000
Selling and administrative expenses 260,000
Operating income $ 241,000
From S&A Expense Budget
April $ 80,000
May 95,000
June 85,000
Total $ 260,000
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 The
The Budgeted
Budgeted
Income
Income Statement
Statement
Ellis Magnet Company
Budgeted Income Statement
For the Three Months Ended June 30

Sales (100,000 units @ $10) $ 1,000,000

Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin $ 501,000
Selling and administrative expenses 260,000
Operating income $ 241,000
Interest expense 2,000
Net income $ 239,000

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 The
The Budgeted
Budgeted
Balance
Balance Sheet
Sheet

Budgeted Budgeted
Income Balance
Statement Sheet
t ed
e
pl
om
C

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 The
The Budgeted
Budgeted
Balance
Balance Sheet
Sheet

Ellis
Ellis 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 - $50,000
Land - $50,000
 Building (net) - $174,500
Building (net) - $174,500
 Common stock - $200,000
Common stock - $200,000
 Equipment (net) - $192,500
Equipment (net) - $192,500
 Retained earnings - $148,150
Retained earnings - $148,150
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 Ellis Magnet Company
Budgeted Balance Sheet 25% of June
June 30, 2002 sales of
Current assets $300,000
Cash $ 43,000
Accounts receivable 75,000 11,500 lbs.
Raw materials inventory 4,600
@ $.40 per lb.
Finished goods inventory 24,950
Total current assets $ 147,550
Property and equipment
Land $ 50,000
5,000 units
Building 174,500 @ $4.99 each
Equipment 192,500
Total property and equipment $ 417,000
Total assets $ 564,550 50% of June
Liabilities and Equities
purchases
Accounts payable $ 28,400 of $56,800
Common stock 200,000
Retained earnings 336,150
Total liabilities and equities $ 564,550
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Ellis Magnet Company
Budgeted Balance Sheet
June 30, 2002
Current assets
Cash $ 43,000
Accounts receivable 75,000
Raw materials inventory 4,600
Finished goods inventory 24,950
Total current assets $ 147,550
Property and equipment
Beginning balance $ 148,150
Land $ 50,000
Add: net income
Building 239,000 174,500
Deduct: dividends
Equipment (51,000) 192,500
Ending balance
Total property and$ 336,150
equipment $ 417,000
Total assets $ 564,550

Liabilities and Equities

Accounts payable $ 28,400
Common stock 200,000
Retained earnings 336,150
Total liabilities and equities $ 564,550
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 Flexible
Flexible Budgeting
Budgeting

Let’s
change
topics.

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 Flexible
Flexible Budgeting
Budgeting
Hmm! Comparing
Consider
Consider the
the following
following costs at different
condensed
condensed example
example levels of activity
from
from the
the Cheese
Cheese is like comparing
Company
Company .. .. .. apples with oranges.

Performance
evaluation is difficult
when actual activity
differs from the activity
originally budgeted.
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 Flexible
Flexible Budgeting
Budgeting
Original Actual
Budget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs
Indirect labor $ 40,000 $ 34,000 $6,000 F
Indirect materials 30,000 25,500 4,500 F
Power 5,000 3,800 1,200 F
Fixed costs
Depreciation 12,000 12,000 0
Insurance 2,000 2,000 0
Total overhead costs $ 89,000 $ 77,300 $11,700 F

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 Flexible
Flexible Budgeting
Budgeting
Original Actual
Budget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs
IndirectUlabor
= Unfavorable variance$ –34,000
$ 40,000 Cheese $6,000 F
Company was
Indirect materials unable to achieve
30,000 25,500 4,500 F
Power the budgeted5,000
level of activity.
3,800 1,200 F
Fixed costs
Depreciation 12,000 12,000 0
Insurance 2,000 2,000 0
Total overhead costs $ 89,000 $ 77,300 $11,700 F

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Flexible
Flexible Budgeting
Budgeting
Original Actual
Budget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs
Indirect labor $ 40,000 $ 34,000 $6,000 F
Indirect materials 30,000 25,500 4,500 F
Power 5,000 3,800 1,200 F
F costs
Fixed = Favorable variance: actual costs
are less than budgeted
Depreciation 12,000 costs.
12,000 0
Insurance 2,000 2,000 0
Total overhead costs $ 89,000 $ 77,300 $11,700 F

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Flexible
Flexible Budgeting
Budgeting
Original Actual
Budget Results Variances
Units of Activity 10,000 8,000 2,000 U
Variable costs
Indirect labor $ 40,000 $ 34,000 $6,000 F
Indirect materials 30,000 25,500 4,500 F
Power 5,000 3,800 1,200 F
Since
Fixed cost variances are favorable, have
costs
we done a good job controlling
Depreciation 12,000 costs?
12,000 0
Insurance 2,000 2,000 0
Total overhead costs $ 89,000 $ 77,300 $11,700 F

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Flexible
Flexible Budgeting
Budgeting
How much of
I don’t think I can the favorable cost
answer the question variance is due to lower
using the original activity, and how much is due
budget. to good cost control?

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Flexible
Flexible Budgeting
Budgeting
How much of
I don’t think I can the favorable cost
answer the question variance is due to lower
using the original activity, and how much is due
budget. to good cost control?

To answer the question, we must

the budget to the actual level of activity.
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 Flexible
Flexible Budgeting
Budgeting
Central Concept

If you can tell me what your activity was

for the period, I will tell you what your costs
and revenue should have been.

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 Flexible
Flexible Budgeting
Budgeting
Show expenses that should have
occurred at the actual level of
activity.

May be prepared for any activity

level in the relevant range.

Reveal variances due to good cost

control or lack of cost control.

Improve performance evaluation.

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 Flexible
Flexible Budgeting
Budgeting
To a budget for different activity
levels, we must know how costs behave
with changes in activity levels.
 Total variable costs change
in direct proportion to
changes in activity.
ble
 Total fixed costs remain r i a
Va
unchanged within the Fixed
relevant range.

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 Flexible
Flexible Budgeting
Budgeting
Let’s prepare
budgets for the
Cheese Company.

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 Flexible
Flexible Budgeting
Budgeting
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs are expressed as
Variable costs a constant amount per hour.
Indirect labor 4.00 $ 32,000
Indirect material 3.00 In the24,000
original budget, indirect
Power 0.50
labor 4,000
was $40,000 for 10,000
Total variable cost $ 7.50 $ 60,000
hours resulting in a rate of
Fixed costs $4.00 per hour.
Depreciation $12,000
Insurance 2,000
Total fixed cost
Total overhead costs

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Flexible
Flexible Budgeting
Budgeting
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 $ 32,000 $ 40,000 $ 48,000
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost $ 7.50 $ 60,000 $ 75,000 $ 90,000

Fixed costs
Depreciation $12,000 $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000 $ 14,000
Total overhead costs $ 74,000 $ 89,000 $ 104,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Flexible
Flexible Budgeting
Budgeting
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs
Indirect labor 4.00 $ 32,000 $ 40,000 $ 48,000
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 4,000 5,000 6,000
Total variable cost $ 7.50 $ 60,000 $ 75,000 $ 90,000

Fixed costs
Depreciation $12,000 $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000 $ 14,000
Totaloverhead
Total variable cost
costs = $7.50 per unit × budget
$ 74,000 level
$ 89,000 in$ 104,000
units
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002
 Flexible
Flexible Budgeting
Budgeting
Cost Total Flexible Budgets
Formula Fixed 8,000 10,000 12,000
Per Hour Cost Hours Hours Hours
Units of Activity 8,000 10,000 12,000
Variable costs Fixed costs are expressed as a
Indirect labor 4.00
total$ 32,000
amount $that
40,000
does $not
48,000
Indirect material 3.00 24,000 30,000 36,000
Power 0.50 change within the
4,000 relevant6,000
5,000
Total variable cost $ 7.50 $range
60,000 of$activity.
75,000 $ 90,000

Fixed costs
Depreciation $12,000 $ 12,000 $ 12,000 $ 12,000
Insurance 2,000 2,000 2,000 2,000
Total fixed cost $ 14,000 $ 14,000 $ 14,000
Total overhead costs $ 74,000 $ 89,000 $ 104,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Flexible
Flexible Budgeting
Budgeting
Performance
Performance Report
Report
Now let’s prepare a
budget performance
report
at 8,000 actual mach
ine
hours for the Cheese
Co.

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 Flexible
Flexible Budgeting
Budgeting
Performance
Performance Report
Report
Cost Total
Formula Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Variable costs
Indirect labor $ 4.00 $ 32,000 $ 34,000 $ 2,000 U
Indirect material 3.00 24,000 25,500 1,500 U
Power 0.50 4,000 3,800 200 F
Total variable costs $ 7.50 $ 60,000 $ 63,300 $ 3,300 U
Fixed Costs
Depreciation $12,000 $ 12,000 $ 12,000 0
Insurance 2,000 2,000 2,000 0
Total fixed costs $ 14,000 $ 14,000 0
Total overhead costs $ 74,000 $ 77,300 $ 3,300 U

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Flexible
Flexible Budgeting
Budgeting
Performance
Performance Report
Report
Cost Total
Formula Fixed Flexible Actual
Indirectlabor and Costs
Per Hour Budget Results Variances
indirect
Units of Activity material have 8,000 8,000 0
unfavorable variances
Variable costs
because
Indirect labor actual costs
$ 4.00 $ 32,000 $ 34,000 $ 2,000 U
are
Indirect more than3.00
material the 24,000 25,500 1,500 U
Power 0.50
flexible budget costs. 4,000 3,800 200 F
Total variable costs $ 7.50 $ 60,000 $ 63,300 $ 3,300 U
Fixed Costs
Depreciation $12,000 $ 12,000 $ 12,000 0
Insurance 2,000 2,000 2,000 0
Total fixed costs $ 14,000 $ 14,000 0
Total overhead costs $ 74,000 $ 77,300 $ 3,300 U

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2002

 Flexible
Flexible Budgeting
Budgeting
Performance
Performance Report
Report
Cost Total
Formula Fixed Flexible Actual
Per Hour Costs Budget Results Variances
Units of Activity 8,000 8,000 0
Power has a favorable
Variable costs
variance
Indirect labor because
$ 4.00the $ 32,000 $ 34,000 $ 2,000 U
actualmaterial
Indirect cost is less than
3.00 24,000 25,500 1,500 U
the flexible budget0.50
Power cost. 4,000 3,800 200 F
Total variable costs $ 7.50 $ 60,000 $ 63,300 $ 3,300 U
Fixed Costs
Depreciation $12,000 $ 12,000 $ 12,000 0
Insurance 2,000 2,000 2,000 0
Total fixed costs $ 14,000 $ 14,000 0
Total overhead costs $ 74,000 $ 77,300 $ 3,300 U

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 End
End of
of Chapter
Chapter 22
22
I would be happy to assist
you with your cash budget!

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