Profit Planning: Chapter Nine

Profit Planning
Chapter Nine
McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

9-2
Learning Objective 1
Understand why
organizations budget and
the processes they use to
create budgets.

9-3
The Basic Framework of Budgeting
A budget is a detailed quantitative plan for

acquiring and using financial and other resources
over a specified forthcoming time period.
1. The act of preparing a budget is called
budgeting.
2. The use of budgets to control an
organization’s activity is known as
budgetary control.

9-4
Planning and Control
Planning – Control –
involves developing involves the steps
objectives and taken by
preparing various management that
budgets to achieve attempt to ensure
these objectives. the objectives are
attained.

9-5
Advantages of Budgeting
Define goal
and objectives
Communicate Think about and
plans plan for the future
Advantages
Coordinate Means of allocating
activities resources
Uncover potential
bottlenecks

9-6
Responsibility Accounting
Managers should be held responsible for those

items — and only those items — that
the manager can actually control
to a significant extent.

9-7
Choosing the Budget Period
Operating Budget
2005 2006 2007 2008
The annual operating budget A continuous budget is a

may be divided into quarterly 12-month budget that rolls
or monthly budgets. forward one month (or quarter)
as the current month (or quarter)
is completed.
9-8
Self-Imposed Budget
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
A budget is prepared with the full cooperation and

participation of managers at all levels. A participative
budget is also known as a self-imposed budget.
9-9
Advantages of Self-Imposed Budgets
1.
1. Individuals
Individuals at
at all
all levels
levels of
of the
the organization
organization are
are viewed
viewed
as
as members
members of of the
the team
team whose
whose judgments
judgments are
are valued
valued
by
by top
top management.
management.
2.
2. Budget
Budget estimates
estimates prepared
prepared by
by front-line
front-line managers
managers are
are
often
often more
more accurate
accurate than
than estimates
estimates prepared
prepared by
by top
top
managers.
managers.
3.
3. Motivation
Motivation isis generally
generally higher
higher when
when individuals
individuals
participate
participate in
in setting
setting their
their own
own goals
goals than
than when
when the
the
goals
goals are
are imposed
imposed from
from above.
above.
4.
4. AA manager
manager who
who is
is not
not able
able to to meet
meet aa budget
budget imposed
imposed
from
from above
above can
can claim
claim that
that itit was
was unrealistic.
unrealistic. Self-
Self-
imposed
imposed budgets
budgets eliminate
eliminate thisthis excuse.
excuse.
9-10
Self-Imposed Budgets
Most companies do not rely exclusively upon

self-imposed budgets in the sense that top
managers usually initiate the budget process
by issuing broad guidelines in terms of overall
profits or sales.

9-11
Human Factors in Budgeting
The success of budgeting depends upon three

important factors:
1. Top management must be enthusiastic and
committed to the budget process.
2. Top management must not use the budget to
pressure employees or blame them when
something goes wrong.
3. Highly achievable budget targets are usually
preferred when managers are rewarded based
on meeting budget targets.

9-12
The Budget Committee
A standing committee responsible for

 overall policy matters relating to the
budget
 coordinating the preparation of the
budget

9-13
The Master Budget: An Overview
Sales
Budget
Ending
Finished Goods
Budget Selling and
Production
Administrative
Budget
Budget
Direct Direct Manufacturing

Materials Labor Overhead
Budget Budget Budget
Cash
Budget
Budgeted Financial Statements

9-14
Prepare a sales budget,

including a schedule of
expected cash collections.

9-15
Budgeting Example
 Royal Company 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.

9-16
The Sales Budget
The individual months of April, May, and June are

summed to obtain the total projected sales in units
and dollars for the quarter ended June 30th

9-17
Expected Cash Collections
•• All
All sales
sales are
are on
on account.
account.
•• Royal’s
Royal’s 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% uncollectible.
uncollectible.
•• The
The March
March 3131 accounts
accounts receivable
receivable balance
balance of
of
$30,000
$30,000 will
will be
be collected
collected in
in full.
full.

9-18

9-19
From the Sales Budget for April.

9-20
From the Sales Budget for May.

9-21
Quick Check 
What will be the total cash collections for the

quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000

9-22
Quick Check 
What will be the total cash collections for the

quarter?
a. $700,000
b. $220,000
c. $190,000
d. $905,000

9-23

9-24
Prepare a
production budget.

9-25
The Production Budget
Sales Production
Budget Budget
ed
and l et
p
Expected
o m
C
Cash
Collections
Production must be adequate to meet budgeted

sales and provide for sufficient ending inventory.

9-26
• The management at Royal Company 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.

9-27

9-28
Budgeted May sales 50,000

Desired ending inventory % 20%
March 31
Desired ending inventory 10,000
ending inventory
9-29
Quick Check 
What is the required production for May?

a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units

9-30
Quick Check 
What is the required production for May?

a. 56,000 units
b. 46,000 units
c. 62,000 units
d. 52,000 units

9-31

9-32
Assumed ending inventory.

9-33
Prepare a direct materials

budget, including a
schedule of expected cash
disbursements for
purchases of materials.

9-34
The Direct Materials Budget
•• At
At Royal
Royal Company,
Company, fivefive 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% ofof the
the
following
following month’s
month’s 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 is
is $0.40
$0.40 per
per
pound.
pound.
Let’s
Let’s prepare
prepare the
the direct
direct materials
materials budget.
budget.
9-35
From production budget

9-36

9-37
March 31 inventory
10% of following month’s Calculate the materials to

production needs. be purchased in May.
9-38
Quick Check 
How
How much
much materials
materials should
should be
be purchased
purchased in
in May?
May?
a.
a. 221,500
221,500 pounds
pounds
b.
b. 240,000
240,000 pounds
pounds
c.
c. 230,000
230,000 pounds
pounds
d.
d. 211,500
211,500 pounds
pounds

9-39
Quick Check 
How
How much
much materials
materials should
should be
be purchased
purchased in
in May?
May?
a.
a. 221,500
221,500 pounds
pounds
b.
b. 240,000
240,000 pounds
pounds
c.
c. 230,000
230,000 pounds
pounds
d.
d. 211,500
211,500 pounds
pounds

9-40

9-41
Assumed ending inventory

9-42
Expected Cash Disbursement for Materials
•• Royal
Royal pays
pays $0.40
$0.40 per
per pound
pound for
for its
its materials.
materials.
•• One-half
One-half of of aa month’s
month’s purchases
purchases is is paid
paid for
for in
in
the
the month
month ofof purchase;
purchase; the
the other
other half
half is
is paid
paid
in
in the
the following
following month.
month.
•• The
The March
March 31 31 accounts
accounts payable
payable balance
balance is is
$12,000.
$12,000.

Let’s
Let’s calculate
calculate expected
expected cash
cash disbursements.
disbursements.

9-43

9-44
Compute the expected cash

disbursements for materials
for the quarter.
140,000 lbs. × $.40/lb. = $56,000

9-45
Quick Check 
What are the total cash disbursements for the

quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400

9-46
Quick Check 
What are the total cash disbursements for the

quarter?
a. $185,000
b. $ 68,000
c. $ 56,000
d. $201,400

9-47

9-48
Prepare a direct
labor budget.

9-49
The Direct Labor Budget
•• At
At Royal,
Royal, each
each unit
unit of
of product
product requires
requires 0.05
0.05 hours
hours (3
(3
minutes)
minutes) ofof direct
direct labor.
labor.
•• The
The Company
Company has has aa “no
“no layoff”
layoff” policy
policy so
so all
all employees
employees
will
will be
be paid
paid for
for 40
40 hours
hours ofof work
work each
each week.
week.
•• In
In exchange
exchange for for the
the “no
“no layoff”
layoff” policy,
policy, workers
workers agree
agree to
to
aa wage
wage rate
rate of
of $10
$10 perper hour
hour regardless
regardless of of the
the hours
hours
worked
worked (no(no overtime
overtime pay).
pay).
•• For
For the
the next
next three
three months,
months, thethe direct
direct labor
labor workforce
workforce will
will
be
be paid
paid for
for aa minimum
minimum of of 1,500
1,500 hours
hours per
per month.
month.
 Let’s
Let’s prepare
prepare the the direct
direct labor
labor budget.
budget.

9-50
From production budget.

9-51

9-52
Greater
Greater of
of labor
labor hours
hours required
required
or
or labor
labor hours
hours guaranteed.
guaranteed.
9-53

9-54
Quick Check 
What would be the total direct labor cost for the

quarter if the company follows its no lay-off policy,
but pays $15 (time-and-a-half) for every hour
worked in excess of 1,500 hours in a month?
a. $79,500
b. $64,500
c. $61,000
d. $57,000

9-55
Quick Check 
What would be the total direct labor cost for the

quarter if the company follows its no lay-off policy,
but pays $15 (time-and-a-half) for every hour
worked in excess of 1,500 hours Aprilin aMay
month?
June Quarter
Labor hours required 1,300 2,300 1,450
a. $79,500 Regular hours paid 1,500 1,500 1,500 4,500
b. $64,500 Overtime hours paid - 800 - 800
c. $61,000 Total regular hours 4,500 $10 $ 45,000

d. $57,000 Total overtime hours 800 $15 $ 12,000
Total pay $ 57,000

9-56
Prepare a
manufacturing
overhead budget.

9-57
Manufacturing Overhead Budget
• At Royal, manufacturing overhead is applied to units

of product on the basis of direct labor hours.
• The variable manufacturing overhead rate is $20 per
direct labor hour.
• Fixed manufacturing overhead is $50,000 per month
and includes $20,000 of noncash costs (primarily
depreciation of plant assets).
 Let’s prepare the manufacturing overhead budget.

9-58
Direct Labor Budget.

9-59
Total mfg. OH for quarter $251,000

= $49.70 per hour *
Total labor hours required 5,050
* rounded

9-60
Depreciation
Depreciation is
is aa noncash
noncash charge.
charge.

9-61
Ending Finished Goods Inventory Budget
Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor
Manufacturing overhead
Budgeted finished goods inventory

Ending inventory in units
Unit product cost
Ending finished goods inventory
Direct materials
budget and information.

9-62

Direct labor 0.05 hrs. $10.00 0.50
Manufacturing overhead

Unit product cost
Ending finished goods inventory
Direct labor budget.

9-63

Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99
Unit product cost $ 4.99
Ending finished goods inventory ?
Total mfg. OH for quarter $251,000

= $49.70 per hour *
Total labor hours required 5,050

9-64

Direct labor 0.05 hrs. $10.00 0.50
Manufacturing overhead 0.05 hrs. $49.70 2.49
$ 4.99
Ending inventory in units 5,000
Unit product cost $ 4.99
Ending finished goods inventory $24,950
Production Budget.

9-65
Prepare a selling and

administrative
expense budget.

9-66
Selling and Administrative Expense Budget
•• At
At Royal,
Royal, thethe selling
selling and
and administrative
administrative expenses
expenses budget
budget is
is
divided
divided into
into variable
variable and
and fixed
fixed components.
components.
•• The
The variable
variable selling
selling and
and administrative
expenses are are $0.50
$0.50
per
per unit
unit sold.
sold.
•• Fixed
Fixed selling
selling and
and administrative
expenses are
are $70,000
$70,000 per
per
month.
month.
•• The
The fixed
fixed selling
selling and
and administrative
expenses include
include
$10,000
$10,000 in in costs
costs –– primarily
primarily depreciation
depreciation –– that
that are
are not
not cash
cash
outflows
outflows of of the
the current
current month.
month.
Let’s
Let’s prepare
prepare the
the company’s
company’s selling
selling and
and administrative
administrative
expense
expense budget.
budget.

9-67
Calculate the selling and administrative

cash expenses for the quarter.
9-68
Quick Check 
What are the total cash disbursements for selling

and administrative expenses for the quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000

9-69
Quick Check 
What are the total cash disbursements for selling

and administrative expenses for the quarter?
a. $180,000
b. $230,000
c. $110,000
d. $ 70,000

9-70

9-71
Prepare a cash
budget.

9-72
Format of the Cash Budget
The cash budget is divided into four sections:

1. Cash receipts listing all cash inflows excluding
borrowing;
2. Cash disbursements listing all payments
excluding repayments of principal and interest;
3. Cash excess or deficiency; and
4. The financing section listing all borrowings,
repayments and interest.

9-73
The Cash Budget
Royal:
Royal:
 Maintains
 Maintains aa 16%
16% 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 on
on the
the first
first day
day of
of the
the month
month 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 $49,000
$49,000 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 (both
(both purchases
purchases paid
paid in
in cash)
cash)
 Has
 Has an
an April
April 11 cash
cash balance
balance of
of $40,000
$40,000
9-74
The Cash Budget
Schedule
Schedule of
of Expected
Expected
Cash
Cash Collections.
Collections.

9-75
The Cash Budget
Schedule
Schedule of
of Expected
Expected
Cash
Cash Disbursements.
Disbursements.
Direct Labor
Budget.
Manufacturing
Overhead Budget.
Selling and Administrative

Expense Budget.

9-76
The Cash Budget
Because Royal maintains

a cash balance of $30,000,
the company must borrow
$50,000 on its line-of-credit.

9-77
The Cash Budget
Ending cash balance for April

is the beginning May balance.

9-78
The Cash Budget

9-79
Quick Check 
What is the excess (deficiency) of cash available

over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000

9-80
Quick Check 
What is the excess (deficiency) of cash available

over disbursements for June?
a. $ 85,000
b. $(10,000)
c. $ 75,000
d. $ 95,000

9-81
The Cash Budget
$50,000 × 16% × 3/12 = $2,000

Borrowings on April 1 and
repayment on June 30.

9-82
The Budgeted Income Statement
Cash Budgeted
Budget Income
Statement
t ed
e
pl
om
C
After we complete the cash budget,

we can prepare the budgeted income
statement for Royal.

9-83
Prepare a budgeted
income statement.

9-84
The Budgeted Income Statement
Sales
Sales Budget.
Budget.
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
Ending
Ending Finished
Finished
Sales (100,000 units @ $10) $ 1,000,000 Goods
Cost of goods sold (100,000 @ $4.99) 499,000
Goods Inventory.
Inventory.
Gross margin 501,000
Selling and administrative expenses 260,000 Selling
Selling and
and
Operating income 241,000 Administrative
Administrative
Interest expense 2,000
Expense
Expense Budget.
Budget.
Net income $ 239,000
Cash
Cash Budget.
Budget.

9-85
Prepare a
budgeted balance
sheet.

9-86
The Budgeted Balance Sheet
Royal
Royal reported
reported the
the following
following account
account
balances
balances prior
prior to
to preparing
preparing its
its budgeted
budgeted
financial
financial statements:
statements:
•• Land
Land -- $50,000
$50,000
•• Common
Common stock
stock -- $200,000
$200,000
•• Retained
Retained earnings
earnings -- $146,150
$146,150
•• Equipment
Equipment -- $175,000
$175,000

9-87
Royal Company
Budgeted Balance Sheet 25%
25% of
of June
June
June 30 sales
sales of
of
Current assets $300,000.
$300,000.
Cash $ 43,000
Accounts receivable 75,000 11,500
11,500 lbs.
lbs.
Raw materials inventory 4,600 at
at $0.40/lb.
$0.40/lb.
Finished goods inventory 24,950
Total current assets 147,550 5,000
5,000 units
units
Property and equipment at
at $4.99
$4.99 each.
each.
Land 50,000
Equipment 367,000
Total property and equipment 417,000
Total assets $ 564,550
50%
50% ofof June
June
Accounts payable $ 28,400
purchases
purchases
Common stock 200,000
of
of $56,800.
$56,800.
Retained earnings 336,150
Total liabilities and equities $ 564,550
9-88
Royal Company
Budgeted Balance Sheet
June 30
Current assets
Cash $ 43,000
Accounts receivable Beginning balance
75,000 $146,150
Add: net income 239,000
Raw materials inventory 4,600
Deduct: dividends (49,000)
Finished goods inventory 24,950
Ending balance $336,150
Total current assets 147,550
Property and equipment
Land 50,000
Equipment 367,000
Total property and equipment 417,000
Total assets $ 564,550
Accounts payable $ 28,400

Common stock 200,000
Retained earnings 336,150
Total liabilities and equities $ 564,550
9-89
End of Chapter 9

Profit Planning: Chapter Nine

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Profit Planning: Chapter Nine

Uploaded by

Copyright:

Available Formats

Profit Planning

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

The Basic Framework of Budgeting

A budget is a detailed quantitative plan for

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Planning and Control

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Managers should be held responsible for those

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Choosing the Budget Period

2005 2006 2007 2008

The annual operating budget A continuous budget is a

Top M anagem ent

A budget is prepared with the full cooperation and

Advantages of Self-Imposed Budgets

Most companies do not rely exclusively upon

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Human Factors in Budgeting

The success of budgeting depends upon three

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

The Budget Committee

A standing committee responsible for

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

The Master Budget: An Overview

Direct Direct Manufacturing

Budgeted Financial Statements

Prepare a sales budget,

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

 Royal Company is preparing budgets for the

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

The Sales Budget

The individual months of April, May, and June are

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Expected Cash Collections

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Expected Cash Collections

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Expected Cash Collections

From the Sales Budget for April.

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Expected Cash Collections

From the Sales Budget for May.

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

What will be the total cash collections for the

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

What will be the total cash collections for the

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

Expected Cash Collections

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

The Production Budget

Production must be adequate to meet budgeted

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

The Production Budget

• The management at Royal Company wants

• On March 31, 4,000 units were on hand.

 Let’s prepare the production budget.

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

The Production Budget

McGraw-Hill/Irwin Copyright © 2008, The McGraw-Hill Companies, Inc.

The Production Budget