Profit Planning 1
PROFIT PLANNING
BASIC FRAMEWORK OF BUDGETING
A budget is a detailed plan for the future that is
usually expressed in formal quantitative terms.
Planning involves developing goals and preparing
various budgets to achieve those goals.
Control involves gathering feedback to ensure that
the plan is being properly executed or modified as
circumstances
change.
 ADVANTAGES OF BUDGETING
 Communicates management’s plans
throughout the organization.
 Forces managers to think about and
plan for the future.
 Provides a means of allocating
resources.
 Uncovers potential bottlenecks
before they occur.
 Coordinates the activities of the
entire organization.
 Helps to ensure that
everyone in the organization
is pulling in the same
direction.
 Defines goals and objectives that
can serve as benchmarks.
 Responsibility Accounting
Personalizes accounting information by holding
individuals responsible for revenues and cost
 Basic Idea
 A manager should be held
responsible for those items—and
only those items—that the manager
can actually control to a significant
extent.
 Point of an effective responsibility
accounting
 To not penalize individuals for
missing targets.
 Choosing a Budget Period
 Operating Budgets
BUDGET YEAR
FIRST QUARTER Monthly Budget
SECOND QUARTER Monthly Amounts
THIRD QUARTER Monthly Amounts
FOURTH QUARTER Monthly Amounts
Advantage:
Requiring periodic review and reappraisal of
budget data throughout the year.
 Can be prepared for periods that extend
over many years.
A continuous or perpetual budget is a 12-month
budget that rolls forward one month (or quarter)
as the current month (or quarter) is completed. In
other words, one month (or quarter) is added to
the end of the budget as each month (or quarter)
comes to a close. This approach keeps managers
focused at least one year ahead so that they do not
become too narrowly focused on short-term
results.
A self-imposed budget or participative budget , is
a budget that is prepared with the full cooperation
and participation of managers at all levels.
Advantages:
 Individuals at all levels of the organization
are recognized as members of the team
whose views and judgments are valued by
top management.

 Budget estimates prepared by front-line
managers are often more accurate and
reliable
 Creates commitment.
 Excuses are not available.
Limitations:
 Lower-level managers may allow too much
budgetary slack.
 The targets set by top managers may be
unrealistically high or may allow too much
slack.
 May lack sufficient strategic direction and
lower level managers may be tempted to
build slack into their budgets.
 Human Factors in Budgeting
Purpose of the budget:
To motivate people and to coordinate their
efforts.
Undermined if:
The technical aspects preoccupied the
managers or if the budget is used in a rigid and
inflexible manner to control people.
 The Budget Committee
Budget
Committee
President Vice President Controller
 Responsible for overall policy relating to the
budget program and for coordinating the
preparation of the budget itself.
 Resolves difficulties and disputes.
 Approves the final budget.
The master budget consists of a number of
separate but interdependent budgets that formally
Profit Planning 2
lay out the company’s sales, production, and
financial goals.
List of documents that would be a part of the master
budget:
1. A sales budget, including a schedule of expected
cash collections.
2. A production budget (a merchandise purchases
budget would be used in a merchandising
company).
3. A direct materials budget, including a schedule of
expected cash disbursements for
purchases of materials.
4. A direct labor budget.
5. A manufacturing overhead budget.
6. An ending finished goods inventory budget.
7. A selling and administrative expense budget.
8. A cash budget.
9. A budgeted income statement.
10. A budgeted balance sheet.
The Sales Budget
the starting point in preparing the master
budget.
= Budgeted unit sales x Selling price
Schedule of expected - Prepared after the sales
budget and is essential for the preparation of cash
budget.
cash collections =
Collections on credit sales made to customers in
prior periods
+
Collections on sales made in the current budget
period
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The Production Budget

Lists the number of units that must be
produced to satisfy sales needs and to provide for
the desired ending inventory.

Production needs can be determined as:

Disbursements for raw materials (or merchandise

purchases) consist of payments for purchases on
account in prior periods plus any payments for
purchases in the current budget period.

 INVENTORY PURCHASES - The Direct Labor Budget

MERCHANDISING CO.
The direct labor budget shows the direct labor-hours
 Merchandise Purchases Budget – shows required to satisfy the production
budget.
the amount of goods to be purchased from
suppliers during the period; for  Direct labor requirement for each quarter:
merchandising company

Format (based on dollars):

 Direct Labor Cost:

 Minimum direct labor cost for a quarter:

The Direct Materials Budget

details the raw materials that must be purchased to
fulfill the production budget and to provide for
adequate inventories.

The required purchases of raw materials are

computed as follows:
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The Manufacturing Overhead Budget  Methods of applying production costs to

products or services
Lists all costs of production other than direct materials  Variable costing
and direct labor Applies all direct costs as well as variable
manufacturing overhead costs to the end product.
 Variable component of manufacturing  Absorption costing
overhead: Applies all direct costs and
both fixed and variable manufacturing
overhead costs to the end product.

The Selling and Administrative

Expense Budget

 Total manufacturing overhead for the quarter:  Lists the budgeted expenses for areas other
than manufacturing

 Budgeted variable selling and administrative

expenses:

 Fixed cost (costs of supplying capacity to

make products, process purchase orders,
etc.) and amount of capacity (depends on
the expected level of activity for the period)  Total budgeted selling and administrative
expense:
 Conditions:
o Expected level of activity >
Company’s current capacity =
higher FC
o Expected level of activity <
Company’s current capacity =
lower FC  Cash disbursements for selling and
administrative items:
 Predetermined overhead rate for the year:

The Cash Budget

The Ending Finished Goods
Inventory Budget  Four major sections:
 Receipts section
Performed after completing the sales budget up to the  Disbursements section
manufacturing overhead budget for the data is  Cash excess or deficiency
needed to compute for the unit product costs section – computed as:

 Reasons why unit product costs is computed:

 To determine cost of goods sold on
the budgeted income statement
 To value ending inventories

 Financing section
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The Budgeted Income Statement

Is one of the key schedules in the budget process.

It shows the company’s planned profit and serves as
a benchmark against which subsequent company
performance can be measured.

The Budgeted Balance Sheet

The budgeted balance sheet is developed using data

from the balance sheet from the
beginning of the budget period and data contained in
the various schedules.