Budgetary Planning. Budget A formal written statement of management’s plans for a specified future...

Budgetary Planning

Budget

A formal written statement of management’s 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.

Unlike some chapters, most students are familiar with the theme of this chapter.

Also, most of the material is self explanatory.

Consequently, this presentation will only highlight the concepts of the book, focusing on problems.

Involve the department managers. Train. Have the budget forms build on one

another. Get the sequence of activities right. Document all calculations. Provide important assumptions on

inflation, volume growth and so on.

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Make reports provided during user friendly. Use graphics where possible. Make sure the account names are the

same. Hold department heads accountable.

Golden watch. Cut essential services—Mayor Koch. Claim someone above the reviewer

wants a line item. Pad each line just a little. Wait until the last minute to turn it

in so there can be no review.

Participative Budgeting

May inspire higher levels of performance or discourage additional effort.

Depends on how budget developed and administered.

Invite each level of management to participate.

This “bottom-to-top” approach is calledParticipative Budgeting

LO 2: State the essentials of effective budgeting.LO 2: State the essentials of effective budgeting.

A set of interrelated budgets that constitutes a plan of action for a specified time period

Contains two classes of budgets:

Operating budgets:Individual budgets that result in the preparation of the budgeted income statement – establish goals for sales and production personnel

Financial budgets:The capital expenditures budget, the cash budget, and the budgeted balance sheet – focus primarily on cash needs to fund operations and capital expenditures

LO 3: Identify the budgets that comprise the master budget.LO 3: Identify the budgets that comprise the master budget.

First budget prepared

Derived from the sales forecast

Management’s 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


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:

Essential to have a realistic estimate of ending inventory


Shows both the quantity and cost of direct materials to be purchased

Derived from the direct materials units required for production (from the production budget) plus the desired change in ending direct materials units

Budgeted cost of direct materials to be purchased = required units of direct materials X anticipated cost per unit


Shows both the quantity of hours and cost of direct labor necessary to meet production requirements

Critical in maintaining a labor force that can meet expected production

Total direct labor cost formula:


Shows the expected manufacturing overhead costs for the budget period

Distinguishes between fixed and variable overhead costs


Example – Hayes CompanyFixed cost amounts are assumedExpected variable costs per direct

labor hour:indirect materials:

$1.00indirect labor:

$1.40utilities:

$0.40maintenance:

$0.20

Important end-product of the operating budgets

Indicates expected profitability of operations

Provides a basis for evaluating company performance

Prepared from the operating budgetsSales Budget

Production BudgetDirect Materials BudgetDirect Labor BudgetManufacturing Overhead Budget

Selling and Administrative Expense Budget

LO 4: Describe the sources for preparing the budgeted income statement.LO 4: Describe the sources for preparing the budgeted income statement.

Example – Hayes Company

To find cost of goods sold:First, determine the unit cost of one Kitchen-mate

Second, determine Cost of Goods Sold by multiplying units sold times unit cost:

15,000 units X $44 = $660,000LO 4: Describe the sources for preparing the budgeted income statement.LO 4: Describe the sources for preparing the budgeted income statement.

LO 4: Describe the sources for preparing the budgeted income statement.LO 4: Describe the sources for preparing the budgeted income statement.

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

LO 5: Explain the principal sections of a cash budget.LO 5: Explain the principal sections of a cash budget.

Cash Receipts SectionIncludes expected receipts from the principal sources of revenue – usually cash sales and collections on credit salesShows expected interest and dividends receipts as well as proceeds from planned sales of investments, plant assets, and capital stock

Cash Disbursements SectionIncludes expected cash payments for direct materials and labor, taxes, dividends, plant assets, etc.

Financing SectionShows expected borrowings and repayments of borrowed funds plus interest


Must prepare in sequence.

Ending cash balance of one period is the beginning cash balance for the next.

Data obtained from other budgets and from management.

Often prepared for the year on a monthly basis.


A projection of financial position at the end of the budgeted period.

Developed from the budgeted balance sheet for the preceding year and the budgets for the current year.


Sales Budget: Starting point and key factor in developing the master budget

Use a purchases budget instead of a production budget

Does not use the manufacturing budgets (direct materials, direct labor, manufacturing overhead)

To determine budgeted merchandise purchases:

LO 6: Indicate the applicability of budgeting in nonmanufacturing companies.

Critical factor in budgeting is coordinating professional staff needs with anticipated services

Problems if overstaffed:Disproportionately high labor costsLower profits due to additional salariesIncreased staff turnover due to lack of challenging work

Problems if understaffed:Lost revenues because existing and future client needs for services cannot be metLoss of professional staff due to excessive work loads

LO 6: Indicate the applicability of budgeting in manufacturing companies.

Just as important as for profit-oriented companyHowever, budget process differs significantly from that of a profit-oriented companyBudget on the basis of cash flows (expenditures and receipts), not on a revenue and expense basisThe starting point is usually expenditures, not receiptsManagement’s task is to find receipts needed to supportplanned expendituresBudget must be strictly followed,overspending often illegal

LO 6: Indicate the applicability of budgeting in nonmanufacturing companies.

XYZ, CPAs are preparing their service revenue (sales) budget for the coming year.

The practice is divided into three departments auditing, tax, and consulting.

Billable hours for each department, by quarter, are provided on the following slide.. Of a

Department

Quarter One

Quarter Two

Quarter Three

Quarter Four

Auditing 2200 1600 2000 2400

Tax 3000 2400 2000 2500

Consulting 1500 1500 1500 1500

Average hourly billing rates are: auditing $80, tax $90, and consulting $100.

Prepare a sales budget for 2008 by listing the departments and showing for each quarter and the year in total, billable hours, billable rate, and total revenue.

Department

Quarter One

Quarter Two

Quarter Three

Quarter Four

Total

Billable hours

2200 1600 2000 2400 8200

Rate $80 $80 $80 $80 $80

Revenue $176,000

$128,000

$160,000

$192,000

$656,000

Simple formula: hours x billing rate equals revenue.

Department

Quarter One

Quarter Two

Quarter Three

Quarter Four

Total

Billable hours

3000 2400 2000 2500 9900

Rate $90 $90 $90 $90 $90

Revenue $270,000

$216,000

$180,000

$225,000

$891,000

Department

Quarter One

Quarter Two

Quarter Three

Quarter Four

Total

Billable hours

1500 1500 1500 1500 6000

Rate $100 $100 $100 $100 $100

Revenue $150,000

$150,000

$150,000

$150,000

$600,000

Department

Quarter One

Quarter Two

Quarter Three

Quarter Four

Total

Auditing $176,000

$128,000

$160,000

$192,000

$656,000

Tax $270,000

$216,000

$180,000

$225,000

$891,000

Consulting

$150,000

$150,000

$150,000

$150,000

$600,000

Total $596,000

$494,000

$490,000

$567,000

$2,147,000

XYZ company has adopted the following production budget for the first four months of 2009.

Month Units Month Units

January 10,000 March 5,000

February 8,000 April 4,000

Each unit requires 3 pounds of raw materials costing $2.00 per pound.

On December 31, 2008, the ending raw material inventory was 9000 pounds.

Management wants to have a raw materials inventory at the end of the month equal to 30% of the next months production requirement.

Prepare a direct materials purchase budget by month for the first quarter.

January February March

Units to be producedDirect materials per unitTotal pounds needed for production

10,000X 3 30,000

8,000X 3 24,000

5,000X 3 15,000

First remember the formula:

Direct material

units required

for production

Desired ending direct

material units

Beginning direct

material units

Required direct

material units to be purchased

+ + =



10,000X 3 30,000

8,000X 3 24,000

5,000X 3 15,000

Thus, in this step we calculate the direct materials needed for production by multiplying the units to be

produced by the direct materials per unit.


Units to be producedDirect materials per unitTotal pounds needed for productionAdd: Desired ending direct materials

(pounds)*Total materials required

10,000X 3 30,000

7,200 37,200

8,000X 3 24,000

4,500 28,500

5,000X 3 15,000

3,600

18,600

To total pounds needed for production, we now add the desired ending inventory in pounds.




10,000X 3 30,000

7,200 37,200

8,000X 3 24,000

4,500 28,500

5,000X 3 15,000

3,600

18,600

This gives us the total materials required for the period.




10,000X 3 30,000

7,200 37,200

8,000X 3 24,000

4,500 28,500

5,000X 3 15,000

3,600

18,600

However, some of the material required for production can come from beginning inventory. Subtracting

inventorying will, therefore, be our next step.



(pounds)*Total materials requiredLess: Beginning direct materials

(pounds)Direct materials purchases

10,000X 3 30,000

7,200

37,200

9,000 28,200

8,000X 3 24,000

4,500

28,500

7,200 21,300

5,000X 3 15,000

3,600

18,600

4,500 14,100

Now we know how many pounds are needed, what we do not know is the cost.



(pounds)*Total materials requiredLess: Beginning direct materials

(pounds)Direct materials purchasesCost per pound

Total cost of direct materials purchases

10,000X 3 30,000

7,200 37,200

9,000

28,200X $2

$56,400

8,000X 3 24,000

4,500

28,500

7,200 21,300X $2

$42,600

5,000X 3 15,000

3,600

18,600

4,500 14,100X $2

$28,200

Multiply pounds by costs per pound to get total cost.

XYZ Company is preparing its manufacturing overhead budget for 2008.

Relevant cost data consists of the following:

Units to be produced (by quarters): 10,000, 12,000, 14,000, 16,000.

Direct labor: time is 1.5 hours per unit. Variable overhead costs per direct labor

hour; indirect materials $0.70; indirect labor $1.20: and maintenance $0.50.

Fixed overhead costs per quarter: supervisor salaries $35,000,;depreciation $16,000; and maintenance $12,000.

Prepare the manufacturing overhead budget for the year, showing quarterly data.

Things to remember when preparing an overhead budget: Overhead budgets are flexible budgets.

This means that variable costs vary with some unit of input (like direct hours) or some unit of output (like product produced).

The overhead rate is calculated by dividing the total overhead budget by the total base (direct labor hours, direct labor dollars, and so on).

Quarter

One Two Three Four Total

Units to be Produced

10,000

12,000

14,000

16,000

52,000

Direct Labor Hours

15,000

18,000

21,000

24,000

78,000

Direct hours = 1.5 x direct labor hours.

We will multiply direct labor hours by variable cost/hour on the next slide.

Variable Costs: Costs/Hour One Two Three Four Total

Indirect Materials $ 0.70

Indirect Labor $ 1.20

Maintenance $ 0.50

Total Variable Costs $ 2.40

Fixed Costs:

Supervisory Salaries

Depreciation

Maintenance

Total Fixed Costs

Total Manufacturing Overhead

Direct Labor Hours

Overhead Rate per Hour

Costs per hour are given in the problem

In the next slide we will multiply them by hours shown on previous slide to get variable costs.

Let’s do it!


Indirect Materials $ 0.70 $ 10,500 $ 12,600 $ 14,700 $ 16,800 $ 54,600

Indirect Labor $ 1.20 $ 18,000 $ 21,600 $ 25,200 $ 28,800 $ 93,600

Maintenance $ 0.50 $ 7,500 $ 9,000 $ 10,500 $ 12,000 $ 39,000

Total Variable Costs $ 2.40

Fixed Costs:


Depreciation

Maintenance

Total Fixed Costs


Direct Labor Hours


Let’s sum each quarter next!



Indirect Labor $ 1.20 $ 18,000 $ 21,600 $ 25,200 $ 28,800 $ 93,600

Maintenance $ 0.50 $ 7,500 $ 9,000 $ 10,500 $ 12,000 $ 39,000

Total Variable Costs $ 2.40 $ 36,000 $ 43,200 $ 50,400 $ 57,600 $ 187,200

Fixed Costs:


Depreciation

Maintenance

Total Fixed Costs


Direct Labor Hours


Fixed costs are easy, they are the same each month regardless of production volume or direct labor hours.



Indirect Labor $ 1.20 $ 18,000 $ 21,600 $ 25,200 $ 28,800 $ 93,600

Maintenance $ 0.50 $ 7,500 $ 9,000 $ 10,500 $ 12,000 $ 39,000


Fixed Costs:

Supervisory Salaries $ 35,000 $ 35,000 $ 35,000 $ 35,000 $ 140,000

Depreciation $ 16,000 $ 16,000 $ 16,000 $ 16,000 $ 64,000

Maintenance $ 12,000 $ 12,000 $ 12,000 $ 12,000 $ 48,000

Total Fixed Costs $ 63,000 $ 63,000 $ 63,000 $ 63,000 $ 252,000


Direct Labor Hours


Now we total fixed and variable overhead to get total overhead



Indirect Labor $ 1.20 $ 18,000 $ 21,600 $ 25,200 $ 28,800 $ 93,600

Maintenance $ 0.50 $ 7,500 $ 9,000 $ 10,500 $ 12,000 $ 39,000


Fixed Costs:


Depreciation $ 16,000 $ 16,000 $ 16,000 $ 16,000 $ 64,000

Maintenance $ 12,000 $ 12,000 $ 12,000 $ 12,000 $ 48,000


Total Manufacturing Overhead $ 99,000 $ 106,200 $ 113,400 $ 120,600 $ 439,200

Direct Labor Hours


Add hours for each quarter.

The suspense is killing me!



Indirect Labor $ 1.20 $ 18,000 $ 21,600 $ 25,200 $ 28,800 $ 93,600

Maintenance $ 0.50 $ 7,500 $ 9,000 $ 10,500 $ 12,000 $ 39,000


Fixed Costs:


Depreciation $ 16,000 $ 16,000 $ 16,000 $ 16,000 $ 64,000

Maintenance $ 12,000 $ 12,000 $ 12,000 $ 12,000 $ 48,000



Direct Labor Hours 15,000 18,000 21,000 24,000 78,000

Overhead Rate per Hour Last of all calculate rate (OH$/DLH)



Indirect Labor $ 1.20 $ 18,000 $ 21,600 $ 25,200 $ 28,800 $ 93,600

Maintenance $ 0.50 $ 7,500 $ 9,000 $ 10,500 $ 12,000 $ 39,000


Fixed Costs:


Depreciation $ 16,000 $ 16,000 $ 16,000 $ 16,000 $ 64,000

Maintenance $ 12,000 $ 12,000 $ 12,000 $ 12,000 $ 48,000



Direct Labor Hours 15,000 18,000 21,000 24,000 78,000

Overhead Rate per Hour $ 5.63

XYZ is preparing its annual budgets for the year ending 31/12/2009.

Accounting assistants furnish the data show on the next slide.

An accounting assistant has prepared the detailed manufacturing overhead budgets and the selling and administrative expense budget.

The latter shows selling expenses of $660,000 for product JB 50 and $360,000 for product JB 60, and administrative expenses of $540,000 for product JB 50 and $340,000 for JB 60.

Income taxes are expected to be 30%.

Prepare the budgets asked for in the textbook.

Product JB 50 Product JB 60

Sales Budget:

Anticipated volume in units 400,000 200,000

Unit selling price $20 $25

Production Budget:

Desired ending finished goods units

25,000 15,000

Beginning finished good units 30,000 10,000

Direct materials budget:

Direct materials per unit (pounds) 2 3

Desired ending direct material pounds

30,000 15,000

Beginning direct material pounds 40,000 10,000

Cost per pound $3 $4

Product JB 50 Product JB 60

Direct labor budget:

Direct labor time per unit 0.4 0.6

Direct labor rate per hour $12 $12

Budgeted income statement:

Total unit cost $12 $21

JB 50 JB 60 Total

Expected unit salesUnit selling priceTotal sales

400,000 X $20$8,000,000

200,000 X $25$5,000,000 $13,000,000

Simple calculation: units x sales price = total sales dollars.

There is a generic formula we use in many of the budgets, it is:

Transferred out + ending inventory – beginning inventory = transferred in.

Converting this generic formula to terms consistent with the production budget:

Units sold + ending inventory – beginning inventory = units to be produced.

Knowing the generic formula will help you if you get a “brain cramp” on the test and forget a specific formula.

We use the formula:

Sales + ending inventory – beginning inventory = production in units

JB 50 JB 60 Total

Expected unit salesAdd: Desired ending finished

goods units

Total required unitsLess: Beginning finished goods

units

Required production units

400,000

25,000425,000

30,000

395,000

200,000

15,000215,000

10,000

205,000 600,000

JB 50 JB 60 Total


395,000 X 2

790,000

205,000 X 3

615,000

Direct Materials BudgetFor the Year Ending December 31, 2009

__

Our first step is to calculate total pounds needed for production by multiplyingunits to be produced (calculated in the sales budget) by the direct materials per unit given in the problem.

JB 50 JB 60 Total

Units to be producedDirect materials per unitTotal pounds needed for productionAdd: Desired ending direct

materials (pounds)

Total materials requiredLess: Beginning direct

materials (pounds)

Direct materials purchases

395,000 X 2

790,000

30,000 820,000

40,000

780,000

205,000 X 3

615,000

15,000 630,000

10,000

620,000


__

Now we use the formula we learned earlier: units transferred out + ending inventory – beginning inventory = units transferred in.

Once we have the direct material in pounds, we need to calculate the dollar amount.

JB 50 JB 60 Total

Units to be producedDirect materials per unitTotal pounds needed for productionAdd: Desired ending direct

materials (pounds)

Total materials requiredLess: Beginning direct

materials (pounds)

Direct materials purchases

Cost per poundTotal cost of direct materials purchases

395,000 X 2 790,000

30,000 820,000

40,000

780,000 X $3

$2,340,000

205,000 X 3 615,000

15,000 630,000

10,000

620,000 X $4

$2,480,000 $4,820,000


__

JB 50 JB 60 Total

Units to be producedDirect labor time (hours) per unitTotal required direct labor hoursDirect labor cost per hourTotal direct labor cost

395,000

X .4

158,000 X $12$1,896,000

205,000 X .6

123,000

X $12$1,476,000

650,000

301,000X $10

$3,372,000

Direct Labor BudgetFor the Year Ending December 31, 2009

Two steps: Calculate hours first and then calculate dollar amount.

JB 50 JB 60 Total

SalesCost of goods soldGross profitOperating expenses Selling expenses Administrative expenses Total operating expensesIncome before income taxesIncome tax expense (30%)Net income

$8,000,000 4,800,000 3,200,000

660,000

540,000

1,200,000

$2,000,000

(

1

)

$5,000,000 4,200,000 800,000

360,000

340,000

700,000

$ 100,000

(

2

)

$13,000,000 9,000,000 4,000,000

1,020,000

880,000

1,900,000

2,100,000

630,000$ 1,470,000

Now all we have to do is put this all together in the form of an income statement!

Budgetary Planning. Budget A formal written statement of management’s plans for a specified future...

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