Chap009 Student

8/7/2019 Chap009 Student

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2010 The McGraw-Hill Companies, Inc.

Profit Planning

Chapter 9


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McGraw-Hill/Irwin Slide 2

The Basic Framework of Budgeting

A budget is a detailed quantitative plan foracquiring and using financial and other resources

over a specified forthcoming time period.

1. The act of preparing a budget is calledbudgeting.

2. The use of budgets to control an

organizations activities is knownas budgetary control.


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Planning and Control

PlanningPlanning

involves developinginvolves developingobjectives andobjectives and

preparing variouspreparing variousbudgets to achievebudgets to achievethose objectives.those objectives.

ControlControl

involves the steps taken byinvolves the steps taken bymanagement to increasemanagement to increase

the likelihood that thethe likelihood that theobjectives set down whileobjectives set down whileplanning are attained andplanning are attained andthat all parts of thethat all parts of the

organization are workingorganization are workingtogether toward that goal.together toward that goal.


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Advantages of Budgeting

Advantages

Define goalsDefine goalsand objectivesand objectives

Uncover potentialUncover potentialbottlenecksbottlenecks

CoordinateCoordinateactivitiesactivities

CommunicateCommunicate

plansplans

Think about andThink about and

plan for the futureplan for the future

Means of allocatingMeans of allocatingresourcesresources


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Responsibility Accounting

Managers should beManagers should beheld responsible forheld responsible for

those itemsthose items -- andand onlyonlythose itemsthose items -- that theythat they

can actually controlcan actually controlto a significant extent.to a significant extent.


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Choosing the Budget Period

Operating BudgetOperating Budget

2008 2009 2010 2011

Operating budgets ordinarilyOperating budgets ordinarilycover a onecover a one--year periodyear period

corresponding to a companyscorresponding to a companysfiscal year. Many companiesfiscal year. Many companiesdivide their annual budgetdivide their annual budget

into four quarters.into four quarters.

A continuous budget is aA continuous budget is a1212--month budget that rollsmonth budget that rolls

forward one month (or quarter)forward one month (or quarter)as the current month (or quarter)as the current month (or quarter)

is completed.is completed.


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Self-Imposed Budget

A self-imposed budget or participative budget is a budget that isprepared with the full cooperation and participation of managers

at all levels.

Supervisor Supervisor

iddle

anagement

Supervisor Supervisor

iddle

anagement

Top anagement


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Advantages ofSelf-Imposed Budgets

1. Individuals at all levels of the organization are viewed asmembers of the team whose judgments are valued by topmanagement.

2. Budget estimates prepared by front-line managers are

often more accurate than estimates prepared by topmanagers.

3. Motivation is generally higherwhen individuals participatein setting their own goals than when the goals are

imposed from above.

4. A manager who is not able to meet a budget imposedfrom above can claim that it was unrealistic. Self-imposedbudgets eliminate this excuse.


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Self-Imposed Budgets

SelfSelf--imposed budgets should be reviewedimposed budgets should be reviewedby higher levels of management toby higher levels of management to

prevent budgetary slack.prevent budgetary slack.

Most companies issue broad guidelines inMost companies issue broad guidelines interms of overall profits or sales. Lowerterms of overall profits or sales. Lowerlevel managers are directed to preparelevel managers are directed to prepare

budgets that meet those targets.budgets that meet those targets.


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Human Factors in Budgeting

The success of a budget program depends on threeimportant factors:

1.Top management must be enthusiastic andcommitted to the budget process.

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

3.Highly achievable budget targets are usually

preferred when managers are rewarded based onmeeting budget targets.


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The Budget Committee

A standing committee responsible forA standing committee responsible for

overall policy matters relating to the budgetoverall policy matters relating to the budget

coordinating the preparation of the budgetcoordinating the preparation of the budget

resolving disputes related to the budgetresolving disputes related to the budget

approving the final budgetapproving the final budget


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The Master Budget: An Overview

Production budget

Selling andadministrative

budget

Direct materialsbudget

Manufacturingoverhead budget

Direct laborbudget

Cash Budget

Sales budget

Ending inventorybudget

Budgeted

balance sheet

Budgetedincome

statement


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Budgeting Example

Royal Company is preparing budgets for thequarter 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.


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The Sales Budget

The individual months of April, May, and June aresummed to obtain the total budgeted sales in units

and dollars for the quarter ended June 30th


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Expected Cash Collections

All sales are on account.

`Royals collection pattern is:

70% collected in the month of sale,25% collected in the month following sale,

5% uncollectible.

`The March 31 accounts receivablebalance of $30,000 will be collected in full.


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From the Sales Budget for April.From the Sales Budget for April.


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From the Sales Budget for May.From the Sales Budget for May.


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The Production Budget

ProductionProductionBudgetBudget

SalesSales

BudgetBudget

andandExpectedExpected

CashCash

CollectionsCollections

The production budget must be adequate toThe production budget must be adequate tomeet budgeted sales and to provide formeet budgeted sales and to provide for

the desired ending inventory.the desired ending inventory.


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`The management at Royal Company wantsThe management at Royal Company wantsending inventory to be equal toending inventory to be equal to 20%20% of theof thefollowing months budgeted sales in units.following months budgeted sales in units.

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

Lets prepare the production budget.Lets prepare the production budget.


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March 31March 31ending inventoryending inventory

Budgeted ay sales 50,000

Desired ending inventory % 20%

Desired ending inventory 10,000


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Assumed ending inventory.Assumed ending inventory.


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The Direct Materials Budget

`At Royal Company,At Royal Company, five poundsfive pounds of material areof material arerequired per unit of product.required per unit of product.

` Management wants materials on hand at theManagement wants materials on hand at the

end of each month equal toend of each month equal to 10%10% of theof thefollowing months production.following months production.

` On March 31, 13,000 pounds of material areOn March 31, 13,000 pounds of material are

on hand. Material cost ison hand. Material cost is $0.40$0.40per pound.per pound.

Lets prepare the direct materials budget.Lets prepare the direct materials budget.


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From production budgetFrom production budget


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Calculate the materials toCalculate the materials tobe purchased in May.be purchased in May.

March 31 inventoryMarch 31 inventory

10% of following monthsproduction needs.


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Assumed ending inventoryAssumed ending inventory


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Expected Cash Disbursement for Materials

` Royal paysRoyal pays $0.40$0.40per poundper poundfor its materials.for its materials.

` OneOne--halfhalfof a months purchases is paid for in theof a months purchases is paid for in themonth of purchase; the other half is paid in themonth of purchase; the other half is paid in the

following month.following month.` The March 31 accounts payable balance isThe March 31 accounts payable balance is

$12,000.$12,000.

Lets calculate expected cash disbursements.Lets calculate expected cash disbursements.


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140,000 lbs.140,000 lbs. $0.40/lb. = $56,000$0.40/lb. = $56,000

Compute the expected cashCompute the expected cash

disbursements for materialsdisbursements for materialsfor the quarter.for the quarter.


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The Direct Labor Budget

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

` The Company has a no layoff policy so all employeeswill be paid for 40 hours of work each week.

` For purposes of our illustration assume that Royal has ano layoff policy, workers are pay at the rate of $10 perhour regardless of the hours worked.

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

Lets prepare the direct labor budget.Lets prepare the direct labor budget.


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From production budget.From production budget.


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Greater of labor hours requiredGreater of labor hours requiredor labor hours guaranteed.or labor hours guaranteed.


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Manufacturing Overhead Budget

`At Royal, manufacturing overhead is applied to unitsAt Royal, manufacturing overhead is applied to unitsof product on the basis of direct labor hours.of product on the basis of direct labor hours.

` The variable manufacturing overhead rate is $20 perThe variable manufacturing overhead rate is $20 per

direct labor hour.direct labor hour.` Fixed manufacturing overhead is $50,000 per month,Fixed manufacturing overhead is $50,000 per month,

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

Lets prepare the manufacturing overhead budget.Lets prepare the manufacturing overhead budget.


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Direct Labor Budget.Direct Labor Budget.


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Total mfg. OH for quarter $251,000Total labor hours required 5,050

= $49.70 per hour *

** roundedrounded


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Depreciation is a noncash charge.Depreciation is a noncash charge.


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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 overhea 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 materialsDirect materialsbudget and information.budget and information.


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4.99$






Direct labor budget.Direct labor budget.


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4.99$




Ending finished goods inventory ?


Total mfg. OH for quarter $251,000Total labor hours required 5,050

= $49.70 per hour *


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4.99$






Production Budget.Production Budget.


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Selling and Administrative Expense Budget

` At Royal, the selling and administrative expense budget isAt Royal, the selling and administrative expense budget isdivided into variable and fixed components.divided into variable and fixed components.

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

` Fixed selling and administrative expenses are $70,000 perFixed selling and administrative expenses are $70,000 permonth.month.

` The fixed selling and administrative expenses includeThe fixed selling and administrative expenses include$10,000 in costs$10,000 in costs primarily depreciationprimarily depreciation that are not cashthat are not cashoutflows of the current month.outflows of the current month.

Lets prepare the companys selling and administrativeLets prepare the companys selling and administrativeexpense budget.expense budget.


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Selling and Administrative Expense Budget

Calculate the selling and administrativeCalculate the selling and administrativecash expenses for the quarter.cash expenses for the quarter.


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Selling Administrative Expense Budget


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Format of the Cash Budget

The cash budget is divided into four sections:The cash budget is divided into four sections:

1.1. Cash receipts section lists all cash inflows excluding cashCash receipts section lists all cash inflows excluding cashreceived from financing;received from financing;

2.2. Cash disbursements section consists of all cash paymentsCash disbursements section consists of all cash paymentsexcluding repayments of principal and interest;excluding repayments of principal and interest;

3.3. Cash excess or deficiency section determines if theCash excess or deficiency section determines if thecompany will need to borrow money or if it will be able tocompany will need to borrow money or if it will be able to

repay funds previously borrowed; andrepay funds previously borrowed; and4.4. Financing section details the borrowings and repaymentsFinancing section details the borrowings and repayments

projected to take place during the budget period.projected to take place during the budget period.


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The Cash Budget

Assume the following information forRoyal:Assume the following information forRoyal:

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

Maintains a minimum cash balance of $30,000Maintains a minimum cash balance of $30,000

Borrows on the first day of the month and repaysBorrows on the first day of the month and repaysloans on the last day of the monthloans on the last day of the month

Pays a cash dividend of $49,000 in AprilPays a cash dividend of $49,000 in April

Purchases $143,700 of equipment in May andPurchases $143,700 of equipment in May and$48,300 in June (both purchases paid in cash)$48,300 in June (both purchases paid in cash)

Has an April 1 cash balance of $40,000Has an April 1 cash balance of $40,000


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The Cash Budget

Schedule of ExpectedSchedule of Expected

Cash Collections.Cash Collections.


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The Cash Budget

Direct LaborDirect LaborBudget.Budget.

ManufacturingManufacturing

Overhead Budget.Overhead Budget.

Selling and AdministrativeSelling and AdministrativeExpense Budget.Expense Budget.

Schedule of ExpectedSchedule of ExpectedCash Disbursements.Cash Disbursements.


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The Cash Budget

Because Royal maintainsBecause Royal maintains

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


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The Cash Budget

Ending cash balance for AprilEnding cash balance for Aprilis the beginning May balance.is the beginning May balance.

Because Royal maintainsBecause Royal maintainsa cash balance of $30,000,a cash balance of $30,000,

the company must borrowthe company must borrow$50,000 on its line$50,000 on its line--ofof--credit.credit.


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The Cash Budget


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The Cash Budget

$50,000$50,000 16%16% 3/12 = $2,0003/12 = $2,000Borrowings on April 1 andBorrowings on April 1 and

repayment on June 30.repayment on June 30.


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The Budgeted Income Statement

Cash

BudgetBudgeted

Income

Statement

With interest expense from the cash

budget, Royal can prepare the budgeted

income statement.


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The Budgeted Income Statement

Royal Company

udgeted 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.Sales Budget.

Ending FinishedEnding Finished

Goods Inventory.Goods Inventory.

Selling andSelling andAdministrativeAdministrative

Expense Budget.Expense Budget.

Cash Budget.Cash Budget.


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The Budgeted Balance Sheet

Royal reported the following accountRoyal reported the following accountbalances prior to preparing its budgetedbalances prior to preparing its budgeted

financial statements:financial statements:

LandLand -- $50,000$50,000 Common stockCommon stock -- $200,000$200,000 Retained earningsRetained earnings -- $56,150 (April 1)$56,150 (April 1)

EquipmentEquipment -- $175,000$175,000


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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 277,000

Total assets 474,550

Liabilities and Stockholders' Equity

Accounts payable 28,400$

Common stock 200,000

Retained earnings 246,150

Total liabilities and stockholders' equity 474,550$

11,500 lbs.11,500 lbs.at $0.40/lb.at $0.40/lb.

11,500 lbs.11,500 lbs.at $0.40/lb.at $0.40/lb.

5,000 units5,000 unitsat $4.99 each.at $4.99 each.5,000 units5,000 unitsat $4.99 each.at $4.99 each.

50% of June50% of June

purchasespurchasesof $56,800.of $56,800.

50% of June50% of June

purchasespurchasesof $56,800.of $56,800.

25% of June25% of Junesales ofsales of

$300,000.$300,000.

25% of June25% of Junesales ofsales of

$300,000.$300,000.


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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 277,000

Total assets 474,550

Liabilities and Stockholders' Equity

Accounts payable 28,400$

Common stock 200,000

Retained earnings 246,150

Total liabilities and stockholders' equity 474,550$

RE, beg 56,150

+Net Inc. 239,000

-Div (49,000)

=RE, end 246,150

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