Bab 10

© 2012 McGraw-Hill Education (Asia)Garrison, Noreen, Brewer, Cheng & Yuen

Profit Planning

Chapter 10

McGraw-Hill Education (Asia) Garrison, Noreen, Brewer, Cheng & YuenMcGraw-Hill/Irwin Slide 2

Learning Objective 1

Understand why

organizations budget and

the processes they use to

create budgets.


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 activities is known

as budgetary control.


Planning and Control

Planning –involves developing

objectives and

preparing various

budgets to achieve

those objectives.

Control –involves the steps taken by

management to increase

the likelihood that the

objectives set down while

planning are attained and

that all parts of the

organization are working

together toward that goal.


Advantages of Budgeting

Advantages

Define goals

and objectives

Uncover potential

bottlenecks

Coordinate

activities

Communicate

plans

Think about and

plan for the future

Means of allocating

resources


Responsibility Accounting

Managers should be held responsible for

those items - and onlythose items - that they

can actually control to a significant extent.


Choosing the Budget Period

Operating Budget

2011 2012 2013 2014

Operating budgets ordinarily

cover a one-year period

corresponding to a company’s

fiscal year. Many companies

divide their annual budget

into four quarters.

A continuous budget is a

12-month budget that rolls

forward one month (or quarter)

as the current month (or quarter)

is completed.



Understand Basic

Budgeting Terms and the

Behavioral Aspects of

Budgeting.


Bottom-up and Top-down Budgeting

Bottom-up budgeting

(Self-imposed budget or

Participative budget )

Top-down budgeting

Top Management

Middle Management

Lower-level

Management

Top Management

Middle Management

Lower-level

Management


Advantages of the Bottom-up Budgeting

(Self-Imposed Budgets)

1. Individuals at all levels of the organization are viewed as

members of the team whose judgments are valued by top

management.

2. Budget estimates prepared by front-line managers are

often more accurate than estimates prepared by top

managers.

3. Motivation is generally higher when individuals participate

in setting their own goals than when the goals are

imposed from above.

4. A manager who is not able to meet a budget imposed

from above can claim that it was unrealistic. Self-imposed

budgets eliminate this excuse.


How to overcome problems of self-

imposed budgets

Self-imposed budgets should be reviewed

by higher levels of management to

prevent “budgetary slack (or budget

padding).”

Most companies issue broad guidelines in

terms of overall profits or sales. Lower

level managers are directed to prepare

budgets that meet those targets.


Advantages of the Top-down Budgeting

1. Avoid the potential budgetary slack (budget padding).

2. Provide a clearer performance goals and expectations

from the top management.

3. May provide better budget due to top management’s

access to privileged/confidential market and organization

information .

4. Provide an efficient budgetary process.


Budget Lapsing

• A popular method among government agencies,

universities and organizations relying on allocated funds.

• Any unused funding at the end of the financial period

cannot be carried forward to the following year.

• As a result, the following year’s budget may be cut because

of the under-expenditure in the previous year.


Budget Lapsing: Advantages

• Budget lapsing helps ensure that the appropriate level of

resources is utilized in each period. Without budget lapsing,

risk-averse managers may unnecessarily accumulate funds

and this may adversely affect the performance of the

organization.

• It helps provide an opportunity for a clean cut-off of

expenditures and to reallocate any unused resources for

other more appropriate requirements.


Budget Lapsing: Potential Problem &

Solution

• Budget lapsing can cause undesired behavior effects. For

example, managers may wastefully spend their entire

budget before the end of the period in order to avoid budget

cuts.

• A system of reviewing the expenditures near end of the

period may uncover unnecessary expenditures and

discourage managers to wastefully spend because of budget

lapsing.


Incremental versus Zero-based Budgets

• Incremental method of budgeting is most commonly

used by companies. Companies start off one year’s budget

by referring back to the previous year’s figures.

Adjustments are then made to the budget to account for

the expected changes such as prices for the next year.

• While incremental method of budgeting is practical and

fast, any inefficiency in the previous year’s figures may be

carried forward. For example, if all along the organization is

over staffed, then the budget will continually to be allowing

for the over staffing situation under this method.



• Zero-Based Budgets are prepared based on the

assumption that the company has just started. Therefore,

resources required have to be justified from scratch.

• For example, when budgeting for staff cost for a restaurant,

managers using the zero-based budgeting approach will

ignore the existing staff level and expenses, rather, they

will examine factors such as opening hours, number of

tables, expected patron numbers to work out the number of

staff required at each position and level, hence the

associate costs, to produce a budget.



• Companies using the zero-based method do not simply

ignore previous years’ figures. Figures generated by the

zero-based method are usually compared with previous

years’ figures. Any large differences are investigated.

• As zero-based budgeting is time consuming and costly,

companies tend to use this method for the relatively large

items and the incremental method for the rest.


Top Management Attitude:

Human Factors in Budgeting

The success of a budget program depends on three important factors:

1. Top management must be enthusiastic and committed to the budget process.

2. Top management must not use the budget topressure employees or blame them when something goes wrong.

3. Budget targets should be challenging but achievable in order to have good motivational effects.


The Budget Committee

A standing committee responsible for

overall policy matters relating to the budget

coordinating the preparation of the budget

resolving disputes related to the budget

approving the final budget



Understand the Key

Components of Master

Budget in Manufacturing,

Merchandising and

Service Industries


Understand the key components of master budget in

Manufacturing, Merchandising, and Service Industries

The first step of budgeting for every business is to budget for the

revenue, whether it is a sales budget for providing goods or services or

a funding budget. Although operational budgets are adapted

according to the industries, they are very similar and typically comprise

of budgets for

• Income statement

• Cash

• Balance sheet.

The major differences of different industries include:

• Manufacturing: production budget is involved

• Merchandising: no production budget, only purchase budget of

merchandise is required.

• Service Industries: budget for revenue and cost of providing services

• Not-for-profit: expected funding available and plan usage of funding.



Prepare a Master Budget

for a Manufacturing

Company.


The Master Budget: An Overview

Production budget

Selling and

administrative

budget

Direct materials

budget

Manufacturing

overhead budgetDirect labor

budget

Cash Budget

Sales budget

Ending inventory

budget

Budgeted

balance sheet

Budgeted

income

statement


Learning Objective 4 (a)

Prepare a sales budget,

including a schedule of

expected cash collections.


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.


The Sales Budget

The individual months of April, May, and June are

summed to obtain the total budgeted sales in units

and dollars for the quarter ended June 30th


Expected Cash Collections

All sales are on account.

Royal’s collection pattern is:

70% collected in the month of sale,

25% collected in the month following sale,

5% uncollectible.

The March 31 accounts receivable

balance of $30,000 will be collected in full.



From the Sales Budget for April.



From the Sales Budget for May.


Quick Check

What will be the total cash collections for

the quarter?

a. $700,000

b. $220,000

c. $190,000

d. $905,000


What will be the total cash collections for

the quarter?

a. $700,000

b. $220,000

c. $190,000

d. $905,000

Quick Check


Learning Objective 4 (b)

Prepare a

production budget.


The Production Budget

Production

Budget

Sales

Budget

and

Expected

Cash

Collections

The production budget must be adequate to

meet budgeted sales and to provide for

the desired ending inventory.



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.



March 31

ending inventory

Budgeted May sales 50,000

Desired ending inventory % 20%

Desired ending inventory 10,000


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


What is the required production for May?

a. 56,000 units

b. 46,000 units

c. 62,000 units

d. 52,000 units

Quick Check



Assumed ending inventory.


Learning Objective 4 (c)

Prepare a direct materials

budget, including a

schedule of expected cash

disbursements for

purchases of materials.


The Direct Materials Budget

At Royal Company, five pounds of material are required per unit of product.

Management wants materials on hand at the end of each month equal to 10% of the following month’s production.

On March 31, 13,000 pounds of material are on hand. Material cost is $0.40 per pound.

Let’s prepare the direct materials budget.



From production budget



Calculate the materials to

be purchased in May.

March 31 inventory

10% of following month’s

production needs.


Quick Check

How much materials should be purchased in May?

a. 221,500 pounds

b. 240,000 pounds

c. 230,000 pounds

d. 211,500 pounds


How much materials should be purchased in May?

a. 221,500 pounds

b. 240,000 pounds

c. 230,000 pounds

d. 211,500 pounds

Quick Check



Assumed ending inventory


Expected Cash Disbursement for Materials

Royal pays $0.40 per pound for its materials.

One-half of a month’s purchases is paid for in the month of purchase; the other half is paid in the following month.

The March 31 accounts payable balance is $12,000.

Let’s calculate expected cash disbursements.



140,000 lbs. × $0.40/lb. = $56,000

Compute the expected cash

disbursements for materials

for the quarter.


Quick Check

What are the total cash disbursements for the

quarter?

a. $185,000

b. $ 68,000

c. $ 56,000

d. $201,400


What are the total cash disbursements for the

quarter?

a. $185,000

b. $ 68,000

c. $ 56,000

d. $201,400

Quick Check


Learning Objective 4 (d)

Prepare a direct

labor budget.


The Direct Labor Budget

At Royal, each unit of product requires 0.05 hours (3 minutes) of direct labor.

The Company has a “no layoff” policy so all employees will be paid for 40 hours of work each week.

For purposes of our illustration assume that Royal has a “no layoff” policy, workers are pay at the rate of $10 per hour regardless of the hours worked.

For the next three months, the direct labor workforce will be paid for a minimum of 1,500 hours per month.

Let’s prepare the direct labor budget.



From production budget.



Greater of labor hours required

or labor hours guaranteed.


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


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

Quick Check

April May June Quarter

Labor hours required 1,300 2,300 1,450

Regular hours paid 1,500 1,500 1,500 4,500

Overtime hours paid - 800 - 800

Total regular hours 4,500 $10 45,000$

Total overtime hours 800 $15 12,000$

Total pay 57,000$


Learning Objective 4 (e)

Prepare a

manufacturing

overhead budget.


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, which includes $20,000 of noncash costs (primarily depreciation of plant assets).

Let’s prepare the manufacturing overhead budget.



Direct Labor Budget.



Total mfg. OH for quarter $251,000

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

* rounded



Depreciation is a noncash charge.


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

4.99$

Budgeted finished goods inventory

Ending inventory in units 5,000

Unit product cost 4.99$

Ending finished goods inventory 24,950$

Ending Finished Goods Inventory Budget

Direct materials

budget and information.






4.99$






Direct labor budget.






4.99$




Ending finished goods inventory ?


Total mfg. OH for quarter $251,000

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






4.99$






Production Budget.


Learning Objective 4 (f)

Prepare a selling and

administrative

expense budget.


Selling and Administrative Expense Budget

At Royal, the selling and administrative expense budget is divided into variable and fixed components.

The variable selling and administrative expenses are $0.50 per unit sold.

Fixed selling and administrative expenses are $70,000 per month.

The fixed selling and administrative expenses include $10,000 in costs – primarily depreciation – that are not cash outflows of the current month.

Let’s prepare the company’s selling and administrative expense budget.


Selling and Administrative Expense Budget

Calculate the selling and administrative

cash expenses for the quarter.


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


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

Quick Check


Selling Administrative Expense Budget


Learning Objective 4 (g)

Prepare a cash

budget.


Format of the Cash Budget

The cash budget is divided into four sections:

1. Cash receipts section lists all cash inflows excluding cash

received from financing;

2. Cash disbursements section consists of all cash payments

excluding repayments of principal and interest;

3. Cash excess or deficiency section determines if the

company will need to borrow money or if it will be able to

repay funds previously borrowed; and

4. Financing section details the borrowings and repayments

projected to take place during the budget period.


The Cash Budget

Assume the following information for Royal:

Maintains a 16% open line of credit for $75,000

Maintains a minimum cash balance of $30,000

Borrows on the first day of the month and repays

loans on the last day of the month

Pays a cash dividend of $49,000 in April

Purchases $143,700 of equipment in May and

$48,300 in June (both purchases paid in cash)

Has an April 1 cash balance of $40,000


The Cash Budget

Schedule of Expected

Cash Collections.


The Cash Budget

Direct Labor

Budget.

Manufacturing

Overhead Budget.

Selling and Administrative

Expense Budget.

Schedule of Expected

Cash Disbursements.


The Cash Budget

Because Royal maintains

a cash balance of $30,000,

the company must borrow

$50,000 on its line-of-credit.


The Cash Budget

Ending cash balance for April

is the beginning May balance.

Because Royal maintains

a cash balance of $30,000,

the company must borrow

$50,000 on its line-of-credit.


The Cash Budget


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


What is the excess (deficiency) of cash

available over disbursements for June?

a. $ 85,000

b. $(10,000)

c. $ 75,000

d. $ 95,000

Quick Check


The Cash Budget

$50,000 × 16% × 3/12 = $2,000

Borrowings on April 1 and

repayment on June 30.


The Budgeted Income Statement

Cash

BudgetBudgeted

Income

Statement

With interest expense from the cash

budget, Royal can prepare the budgeted

income statement.


Learning Objective 4(h)

Prepare a budgeted

income statement.


The Budgeted Income Statement

Royal 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$

Sales Budget.

Ending Finished

Goods Inventory.

Selling and

Administrative

Expense Budget.

Cash Budget.


Learning Objective 4 (i)

Prepare a

budgeted balance

sheet.


The Budgeted Balance Sheet

Royal reported the following account balances prior to preparing its budgeted

financial statements:

• Land - $50,000

• Common stock - $200,000

• Retained earnings - $146,150 (April 1)

• Equipment - $175,000


Royal Company

Budgeted Balance Sheet

June 30

Assets:

Cash 43,000$

Accounts receivable 75,000

Raw materials inventory 4,600

Finished goods inventory 24,950

Land 50,000

Equipment 367,000

Total assets 564,550

Liabilities and Stockholders' Equity

Accounts payable 28,400$

Common stock 200,000

Retained earnings 336,150

Total liabilities and stockholders' equity 564,550$

11,500 lbs.

at $0.40/lb.

5,000 units

at $4.99 each.

50% of June

purchases

of $56,800.

25% of June

sales of

$300,000.


Royal Company

Budgeted Balance Sheet

June 30

Assets:

Cash 43,000$

Accounts receivable 75,000

Raw materials inventory 4,600

Finished goods inventory 24,950

Land 50,000

Equipment 367,000

Total assets 564,550

Liabilities and Stockholders' Equity

Accounts payable 28,400$

Common stock 200,000

Retained earnings 336,150

Total liabilities and stockholders' equity 564,550$

Beginning balance 146,150$

Add: net income 239,000

Deduct: dividends (49,000)

Ending balance 336,150$



Prepare Budget on

the Key

Components for the

Service Industry


Key Budget Components for the Service Industry

Wonder World, a hypothetical theme park, has the following data:

Main Sources of

Revenue

Major

ExpensesDepartments

• Ticketing

• Food &

Beverages

• Souvenir Shop

• Salaries

• Rent

• Cost of Sales

• Advertising

• Maintenance

• Depreciation

• Utilities

• Finance & Administration

• Operations

• Marketing

• Souvenir Shop

• Food and Beverages

• Maintenance


Learning Objective 5 (a)

Prepare a

Visitorship Budget


Visitorship Budget

Number of Visitors

Adults 750,000

Children 250,000

Total Visitors 1,000,000

Based on historical records, economic outlook, tourist

arrival expectations, the following visitorship budget for the

coming year is prepared:


Learning Objective 5 (b)

Prepare a Revenue

Budget


Revenue Budget

Revenue per visitor

Gate Collections : Adults $13

Gate Collections : Children $9

Souvenir Shop $4

Food and Beverages $6

Based on the average price charged by Wonder World and

other historical data, the following revenues per visitor are

budgeted and approved by the top management:


Revenue Budget

Revenue

Gate Collections : Adults1 $9,750,000

Gate Collections : Children2 $2,250,000

Souvenir Shop3 $4,000,000

Food and Beverages4 $6,000,000

Total Revenue $22,000,000

With the budgeted number of visitors and revenues per visitor

from each category, the budgeted revenues are computed:

Note1 750,000 X $132 250,000 X $93 1,000,000 X $44 1,000,000 X $6


Learning Objective 5 (c)

Prepare a Cost of

Sales Budget and

Expense Budget


Cost of Sales Budget

Cost of Sales

Souvenir Shop $2,000,000

Food and Beverage $3,000,000

Total $5,000,000

For cost of sales on souvenirs and food and beverages, the

company normally makes use of the historical cost of sales

% and takes into account of any expected price changes

from the suppliers. For the coming year, the expected cost of

sales % is 50% on sales for both the souvenir shop and food

and beverages.


Expenses BudgetHow the items are budgeted will depend on the nature of the items.

Nature of expense Amount Budget approach

Rental $1,100,000 5% of revenue as agreed with the landlord.

Salaries $3,500,000

Zero based approach by reviewing the

actual requirement of each position and its

suitable rate of pay.

Advertising $1,200,000 Proposed by marketing manager.

Maintenance $980,000 Proposed by maintenance manager.

Depreciation $890,000

Computed by the finance manager by

taking into account of existing assets and

proposed new assets.

Utilities $580,000 Computed by maintenance manager based

on the rates and usage expectations.

Other operating expenses $490,000 Based on judgment and any specific

requirements such as legal expenses.

Total $8,740,000


Learning Objective 5 (d)

Prepare a

Budgeted Income

Statement




Revenue $22,000,000

Cost of goods sold $5,000,000

Expenses $8,740,000

Net income $8,260,000

Budgeted Income Statement can be prepared by putting all

previous budgeted information together.



Explain the Costs

and Benefits of

Budgeting


Costs and Benefits of Budgeting

• Budgeting is time-consuming and costly.

• Budgetary slack or padding is an inherent problem of

budgeting.

• Despite the drawbacks of budgeting, most companies are

still using budgets to plan, communicate, set objectives

and allocate resources etc.

• Since budgets are still commonly used, benefits of

budgeting are high and drawbacks of budgeting can be

minimized by having a good budgeting system.

• For a good budgeting system, it is critical to have effective

communication and mutual trust between the top

management and its staff.


End of Chapter 10

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