C8

Chapter
Budgeting and
Profit Planning
BUDGETING BASICS
A formal written statement of managements
plans for a specified future time period, expressed

in financial terms
Primary way to communicate agreed-upon
objectives to all parts of the company

Promotes efficiency
Control device - important basis for performance
evaluation once adopted
BUDGETING BASICS
Benefits of Budgeting
Requires all levels of management to plan
ahead and formalize goals on a

recurring basis
Provides definite objectives for evaluating
performance at each level of

responsibility
Creates an early warning system
for potential problems
BUDGETING BASICS
Benefits of Budgeting
Facilitates coordination of activities
within the business
Results in greater management
awareness of the entitys overall

operations and the impact of
external factors
Motivates personnel throughout
organization to meet planned

objectives
BUDGETING BASICS
Role of Accounting
Historical accounting data on
revenues, costs, and expenses

help in formulating future
budgets
Accountants are normally
responsible for presenting

managements budgeting goals in
financial terms
The budget and its
administration are, however,

entirely managements
responsibility
The Basic Framework of Budgeting
Materials
Production
Sales
Master
Budget
Summary of
a companys
plans.
Detail
Budget
Detail
Budget
Detail
Budget
Advantages of Budgeting
Define goal
and objectives
Communicating
plans
Think about and

plan for the future
Advantages
Coordinate
activities
Means of allocating
resources
Uncover potential
bottlenecks
Choosing the Budget Period
Operating Budget
2008
2009
2010
The annual operating budget

may be divided into monthly
or quarterly budgets.
2011
The Perpetual Budget

Continuous or
Perpetual Budget
2008
2009
2010
This budget is usually a twelve-month

budget that rolls forward one month
as the current month is completed.
2011
Participative Budget System

Top M anagem ent
M id d le
M anagem ent
S u p e r v is o r
S u p e r v is o r
M id d le
M anagem ent
S u p e r v is o r
Flow of Budget Data
S u p e r v is o r
Responsibility Accounting
Managers should be held responsible for those items
and only those items that
the manager can actually control
to a significant extent.
The Budget Committee

A standing committee responsible for
overall policy matters relating to the budget
coordinating the preparation of the budget
Chapter 9 Quiz: Question 1

Which of the following is NOT true about the Master
Budget?
a)It is composed of many interrelated budgets.
b)It consists of 2 classes of budgets: Operating
Budgets and Financial Budgets.
c)Within the master budget the first budget to be
prepared is the sales budget.
d)It constitutes a plan of action for a specified period
of time.
e)All of the above are true.
The Master Budget

Sales
Budget
Ending
Inventory
Budget
Production
Budget
Selling and
Administrative
Budget
Direct
Materials
Budget
Direct
Labor
Budget
Manufacturing
Overhead
Budget
The Master Budget

Sales
Budget
Ending
Inventory
Budget
Production
Budget
Selling and
Administrative
Budget
Direct
Materials
Budget
Direct
Labor
Budget
Manufacturing
Overhead
Budget
Cash
Budget
Budgeted
Budgeted
Financial
Financial
Statements
Statements
The Sales Budget

A detailed schedule showing expected
sales for the budgeted periods
expressed in units and dollars.
The Sales Budget

First budget prepared
Derived from the sales forecast
Managements best estimate of sales revenue for the
budget period
Every other budget depends on the sales budget
Prepared by multiplying
expected unit sales volume for each product
times
anticipated unit selling price
The Sales Budget

Factors considered in Sales Forecasting:
General economic conditions
Industry trends
Market research studies
Anticipated advertising and promotion
Previous market share
Price changes
Technological developments
The Sales Budget - Example

Royal Company is preparing budgets for the
quarter ending June 30.

Budgeted sales for the next five months are:
April
May
June
July
August
20,000 units
50,000 units
30,000 units
25,000 units
15,000 units.
The selling price is $10 per unit.
The Sales Budget
Budgeted
sales (units)
Selling price
per unit
Total sales
April
May
June
20,000
50,000
30,000
Quarter
100,000
The Sales Budget
Budgeted
sales (units)
Selling price
per unit
Total sales
April
May
June
Quarter
20,000
50,000
30,000
100,000
$
10
$200,000
$
10
$500,000
$
10
$300,000
$
10
$1,000,000
The Production Budget

Sales
Budget
m
o
C
pl
ed
t
e
Production
Budget
Production must be adequate to meet budgeted

sales and provide for sufficient ending inventory.

Shows the units that must be produced to meet
anticipated sales
Derived from sales budget plus the desired change in
ending finished goods (ending finished goods less the

beginning finished goods units)
Required production in units formula:

Royal Company wants ending inventory
to be equal to 20% of the following

months budgeted sales in units.
On March 31, 4,000 units were on hand.
Lets prepare the production budget.

Budgeted sales
Add desired ending
inventory
Total needed
Less beginning
inventory
Required production
April
20,000
May
50,000
June
30,000
Quarter
100,000
10,000
30,000
4,000
26,000
Budgeted
Budgeted sales
sales
Desired
Desired percent
percent
Desired
Desired inventory
inventory
50,000
50,000
20%
20%
10,000
10,000

Budgeted sales
Add desired ending
inventory
Total needed
Less beginning
inventory
Required production
April
20,000
10,000
30,000
4,000
26,000
March
March 31
31
ending
ending inventory
inventory
May
50,000
June
30,000
Quarter
100,000
The Direct Materials Budget
At
At Royal
Royal Company,
Company, 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 $0.40
$0.40 per
per
pound.
pound.
Lets
Lets prepare
prepare the
the direct
direct materials
materials budget.
budget.
From
From production
production
budget
budget
10%
10% of
of the
the following
following
months
months production
production
March
March 31
31
inventory
inventory

The Willsey Merchandise Company has budgeted
$40,000 in sales for the month of December. The
company's cost of goods sold is 30% of sales. If the
company has budgeted to purchase $18,000 in
merchandise during December, then the budgeted
change in inventory levels over the month of
December is:
A. $ 6,000 increase.
B. $10,000 decrease.
C. $22,000 decrease.
D. $15,000 increase.
The Master Budget - Components
Expected Cash Collections
All
All sales
sales are
are on
on account.
account.
Royals
Royals 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 uncollectible.
uncollectible.
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.

Avril Company collects its A/R as follows:
30% in the month of sale
60% in the month following sale
8% in the 2nd month following sale
The following sales are expected:

Jan....$100,000 Feb....$120,000 Mar....$110,000
Cash collections in March should be budgeted at:
A. $110,000.
C. $105,000.
B. $110,800.
D. $113,000.
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 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.
The
The March
March 31
31 accounts
accounts payable
payable balance
balance
is
is $12,000.
$12,000.
Lets
Lets calculate
calculate expected
expected cash
cash
disbursements.
disbursements.

Accounts pay. 3/31
April purchases
50% x $56,000
50% x $56,000
May purchases
April
$ 12,000
May
28,000
$ 28,000
June purchases
Total cash
disbursements
$ 40,000
140,000 lbs. $.40/lb. = $56,000
June
Quarter
$ 12,000
28,000
28,000

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
Total cash
disbursements
April
$ 12,000
May
June
28,000
28,000
28,000
$ 28,000
44,300
$ 44,300
$ 40,000
$ 72,300
Quarter
$ 12,000
44,300
44,300

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
disbursements
April
$ 12,000
May
June
28,000
28,000
28,000
$ 28,000
44,300
$ 40,000
$ 72,300
Quarter
$ 12,000
$ 44,300
44,300
44,300
28,400
28,400
$ 72,700
$185,000
The Direct Labor Budget
At
At Royal,
Royal, each
each unit
unit of
of product
product requires
requires 0.05
0.05 hours
hours of
of
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 of
of work
work each
each week.
week.
In
In exchange
exchange for
for the
the no
no layoff
layoff policy,
policy, workers
workers agreed
agreed to
to
aa wage
wage rate
rate of
of $10
$10 per
per hour
hour regardless
regardless of
of the
the hours
hours
worked
worked (Overtime
(Overtime paid
paid as
as straight
straight time).
time).
For
For the
the next
next three
three months,
months, the
the 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.
Lets
Lets prepare
prepare the
the direct
direct labor
labor budget.
budget.
From production
budget
Higher
Higher of
of labor
labor hours
hours required
required
or
or labor
labor hours
hours guaranteed.
guaranteed.
Manufacturing Overhead Budget

Royal Company uses a variable
manufacturing overhead rate of $1 per unit

produced.
produced
Fixed manufacturing overhead is $50,000 per
month and includes $20,000 of noncash costs

(primarily depreciation of plant assets).
Lets prepare the manufacturing
overhead budget.

April
Production in units
26,000
Variable mfg. OH rate
$
1
Variable mfg. OH costs $ 26,000
Fixed mfg. OH costs
Total mfg. OH costs
Less noncash costs
Cash disbursements
for manufacturing OH
May
46,000
$
1
$ 46,000
June
29,000
$
1
$ 29,000
From production
budget
Quarter
101,000
$
1
$ 101,000

April
Production in units
26,000
$
1
Fixed mfg. OH costs
50,000
Total mfg. OH costs
76,000
Less noncash costs
Cash disbursements
for manufacturing OH
May
46,000
$
1
$ 46,000
50,000
96,000
June
29,000
$
1
$ 29,000
50,000
79,000
Quarter
101,000
$
1
$ 101,000
150,000
251,000

April
Production in units
26,000
$
1
Fixed mfg. OH costs
50,000
Total mfg. OH costs
76,000
Less noncash costs
20,000
Cash disbursements
for manufacturing OH $ 56,000
May
46,000
$
1
$ 46,000
50,000
96,000
20,000
June
29,000
$
1
$ 29,000
50,000
79,000
20,000
Quarter
101,000
$
1
$ 101,000
150,000
251,000
60,000
$ 76,000
$ 59,000
$ 191,000
Depreciation
Depreciation is
is aa noncash
noncash charge.
charge.
Ending Finished Goods Inventory Budget

Now, Royal can complete the ending
finished goods inventory budget.

At Royal, manufacturing overhead is
applied to units of product on the basis of

direct labor hours.
Lets
Lets calculate
calculate ending
ending finished
finished goods
goods
inventory.
inventory.

Production costs per unit Quantity
Cost
Direct materials
5.00 lbs. $ 0.40
Direct labor
Manufacturing overhead
Budgeted finished goods inventory
Ending inventory in units
Unit product cost
Ending finished goods inventory
Direct materials
budget and information
Total
2.00

Cost
Direct materials
5.00 lbs. $ 0.40
Direct labor
0.05 hrs. $10.00
Unit product cost
Direct labor
budget
Total
2.00
0.50

Cost
Direct materials
5.00 lbs. $ 0.40
Direct labor
0.05 hrs. $10.00
0.05 hrs. $49.70
Unit product cost
Total
2.00
0.50
2.49
4.99
4.99
Predetermined Overhead Rate:

Total mfg. OH for quarter $251,000
Total labor hours required 5,050 hrs. = $49.70 per hr.
(rounded)

Cost
Direct materials
5.00 lbs. $ 0.40
Direct labor
0.05 hrs. $10.00
0.05 hrs. $49.70
$
Unit product cost
Production
Budget
Total
2.00
0.50
2.49
4.99
5,000
$ 4.99
$24,950
Selling and Administrative Expense Budget
At
At Royal,
Royal, 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 fixed
fixed selling
selling and
and administrative
administrative expenses
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.
Lets
Lets prepare
prepare the
the companys
companys selling
selling and
and
administrative
administrative expense
expense budget.
budget.

Budgeted sales
Variable selling
and admin. rate
Variable expense
Fixed selling and
admin. expense
Total expense
Less noncash
expenses
Cash disbursements for
selling & admin.
April
20,000
May
50,000
June
30,000
Quarter
100,000
$ 0.50
$10,000
$ 0.50
$25,000
$ 0.50
$15,000
$
0.50
$ 50,000
70,000
80,000
70,000
95,000
70,000
85,000
210,000
260,000

Budgeted sales
Variable selling
and admin. rate
Variable expense
Fixed selling and
admin. expense
Total expense
Less noncash
expenses
Cash disbursements for
selling & admin.
April
20,000
May
50,000
June
30,000
Quarter
100,000
$ 0.50
$10,000
$ 0.50
$25,000
$ 0.50
$15,000
$
0.50
$ 50,000
70,000
80,000
70,000
95,000
70,000
85,000
210,000
260,000
10,000
10,000
10,000
30,000
$70,000
$85,000
$75,000
$230,000
The Cash Budget

Shows anticipated cash flows
Often considered to be the most important output
in preparing financial budgets
Contains three sections:
Cash receipts
Cash disbursements
Financing
Shows beginning and ending cash balances
The Cash Budget

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 paid
paid in
in cash.
cash.
Has
Has an
an April
April 11 cash
cash balance
balance of
of $40,000.
$40,000.
The Cash Budget

April
$ 40,000
170,000
210,000
May
Beginning cash balance

Add cash collections
Total cash available
Less disbursements
Materials
40,000
Direct labor
Mfg. overhead
Selling and admin.
Equipment purchase
Dividends
Total disbursements
Excess (deficiency) of
Schedule of
of Expected
Expected
cash available over Schedule
Cash
disbursements
Cash Collections
Collections
June
Quarter
The Cash Budget

April
$ 40,000
170,000
210,000
May
June
Quarter

Less disbursements
Materials
40,000
Direct labor
Mfg. overhead
Selling and admin.
Schedule
Equipment purchase
Schedule of
of Expected
Expected
Dividends
Cash
Cash Disbursements
Disbursements
Total disbursements
Schedule of
of Expected
Expected
cash available over Schedule
Cash
disbursements
Cash Collections
Collections
The Cash Budget

Less disbursements
Materials
Direct labor
Mfg. overhead
Selling and admin.
Equipment purchase
Dividends
Total disbursements
cash available over
disbursements
April
$ 40,000
170,000
210,000
40,000
15,000
56,000
70,000
May
June
Quarter
Direct Labor
Budget
Manufacturing
Overhead Budget
Selling and Administrative

Expense Budget
The Cash Budget

Less disbursements
Materials
Direct labor
Mfg. overhead
Selling and admin.
Equipment purchase
Dividends
Total disbursements
cash available over
disbursements
April
$ 40,000
170,000
210,000
40,000
15,000
56,000
70,000
49,000
230,000
$ (20,000)
May
June
Quarter
Because Royal maintains

a cash balance of $30,000,
the company must
borrow on its
line-of-credit
Financing and Repayment

April
Excess (deficiency)
of Cash available
over disbursements
Financing:
Borrowing
Repayments
Interest
Total financing
Ending cash balance
May
June
Quarter
$ (20,000)
50,000
50,000
$ 30,000
$ 30,000
Ending cash balance for April

is the beginning May balance.
CASH BUDGET
Contributes to more effective cash
management
Shows managers need for additional
financing before actual need arises
Indicates when excess cash will be
available
The Cash Budget

Less disbursements
Materials
Direct labor
Mfg. overhead
Selling and admin.
Equipment purchase
Dividends
Total disbursements
cash available over
disbursements
April
$ 40,000
170,000
210,000
May
$ 30,000
400,000
430,000
40,000
15,000
56,000
70,000
49,000
230,000
72,300
23,000
76,000
85,000
143,700
400,000
$ (20,000)
$ 30,000
June
Quarter

Excess (deficiency)
of Cash available
over disbursements
Financing:
Borrowing
Repayments
Interest
Total financing
Ending cash balance
April
May
$ (20,000)
$ 30,000
50,000
50,000
$ 30,000
$ 30,000
June
Because the ending cash balance is

exactly $30,000, Royal will not repay
the loan this month.
Quarter
The Cash Budget
The Cash Budget
At
At the
the end
end of
of June,
June, Royal
Royal has
has enough
enough cash
cash
to
to repay
repay the
the $50,000
$50,000 loan
loan plus
plus interest
interest at
at 16%.
16%.

Excess (deficiency)
of Cash available
over disbursements
Financing:
Borrowing
Repayments
Interest
Total financing
Ending cash balance
April
May
June
Quarter
$ (20,000)
$ 30,000
$ 95,000
$ 45,000
50,000
50,000
$ 30,000
$ 30,000
(50,000)
(2,000)
(52,000)
$ 43,000
50,000
(50,000)
(2,000)
(2,000)
$ 43,000
$50,000 16% 3/12 = $2,000

Borrowings on April 1 and
repayment of June 30.
The Budgeted Income Statement

Cash
Budget
m
o
C
pl
ed
t
e
Budgeted
Income
Statement
After we complete the cash budget,

we can prepare the budgeted income
statement for Royal.

The Stacy Company makes and sells a single
product, Product R. Budgeted sales for April are
$300,000. Gross Margin is budgeted at 30% of sales
dollars. If the net income for April is budgeted at
$40,000, the budgeted selling and administrative
expenses are:
A. $133,333.
B. $50,000.
C. $102,000.
D. $78,000.
The Budgeted Balance Sheet

Royal
Royal reported
reported the
the following
following account
account
balances
balances on
on March
March 31
31 prior
prior to
to preparing
preparing
its
its budgeted
budgeted financial
financial statements:
statements:
Land
Land -- $50,000
$50,000
Building
Building (net)
(net) -- $175,000
$175,000
Common
Common stock
stock -- $200,000
$200,000
Retained
Retained earnings
earnings -- $146,150
$146,150
Royal Company
Budgeted Balance Sheet
June 30
Current assets
Cash
Accounts receivable
Raw materials inventory
Finished goods inventory
Total current assets
Property and equipment
Land
Building
Equipment
Total property and equipment
Total assets
Accounts payable
Common stock
Retained earnings
Total liabilities and equities
43,000
75,000
4,600
24,950
147,550
50,000
175,000
192,000
417,000
$ 564,550
$
28,400
200,000
336,150
$ 564,550
25%of
25%of June
June
sales
sales of
of
$300,000
$300,000
11,500
11,500 lbs.
lbs.
at
at $0.40/lb.
$0.40/lb.
5,000
5,000 units
units
at
at $4.99
$4.99 each
each
50%
50% of
of June
June
purchases
purchases
of
of $56,800
$56,800
Royal Company
Budgeted Balance Sheet
June 30
Current assets
Cash
Accounts receivable
Raw materials inventory
Finished goods inventory
Total current assets
Property and equipment
Land
Building
Equipment
Total property and equipment
Total assets
Accounts payable
Common stock
Retained earnings
Total liabilities and equities
43,000
75,000
Beginning balance
4,600
Add:
net income
24,950
Deduct: dividends
Ending balance
147,550
50,000
175,000
192,000
417,000
$ 564,550
$
28,400
200,000
336,150
$ 564,550
$146,150
239,000
(49,000)
$336,150
Zero-Base Budgeting
Managers are required to justify all budgeted
expenditures, not just changes in the budget
from the previous year. The baseline is zero
rather than last years budget.
International Aspects of Budgeting

Multinational companies face special problems
when preparing a budget.
Fluctuations in foreign currency exchange rates.
High inflation rates in some foreign countries.
Differences in local economic conditions.
Local governmental policies.
End of Chapter 9

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plans for a specified future time period, expressed

objectives to all parts of the company

evaluation once adopted

ahead and formalize goals on a

Provides definite objectives for evaluating

performance at each level of

Creates an early warning system

for potential problems

within the business

Results in greater management

awareness of the entitys overall

Motivates personnel throughout

organization to meet planned

revenues, costs, and expenses

Accountants are normally

responsible for presenting

The budget and its

administration are, however,

The Basic Framework of Budgeting

Think about and

Choosing the Budget Period

The annual operating budget

The Perpetual Budget

This budget is usually a twelve-month

Participative Budget System

Flow of Budget Data

The Budget Committee

Chapter 9 Quiz: Question 1

The Master Budget

The Master Budget

The Sales Budget

The Sales Budget

expected unit sales volume for each product

The Sales Budget

The Sales Budget - Example

quarter ending June 30.

The selling price is $10 per unit.

The Sales Budget

The Sales Budget

The Production Budget

Production must be adequate to meet budgeted

The Production Budget

Derived from sales budget plus the desired change in

ending finished goods (ending finished goods less the

Required production in units formula:

The Production Budget

to be equal to 20% of the following

Lets prepare the production budget.

The Production Budget

The Production Budget

The Production Budget

The Production Budget

The Production Budget

The Direct Materials Budget

The Direct Materials Budget

The Direct Materials Budget

The Direct Materials Budget

The Direct Materials Budget

The Direct Materials Budget

The Direct Materials Budget

Chapter 9 Quiz: Question 2