MANAGERIAL ACCOUNTING ASIACAREER COLLEGE/CPARCENTER

OPERATIONAL AND FINANCIAL BUDGETING DWM.REYNO,CPA,DBA

A. The Basic Budgeting Framework. A budget is a detailed plan outlining the acquisition and use of financial and other resources
over a specified time period.
1. Planning and control. A good budgeting system must provide for both planning and control. Planning involves developing
objectives and preparing various budgets to achieve those objectives. Control involves the steps taken by management to
ensure that the objectives set down at the planning stage are attained and that all parts of the organization work together
towards those objectives.
2. Advantages of budgeting. There are many advantages to budgeting, including:
✓ Budgeting provides managers with a vehicle for communicating their plans in an orderly way throughout the entire
organization.
✓ Budgeting requires managers to give planning top priority.
✓ Budgeting provides a means of allocating resources to those parts of the organization where they can be most
effectively used.
✓ Budgeting uncovers potential bottlenecks before they occur.
✓ Budgeting coordinates the activities of the entire organization by integrating the plans and objectives of the various
parts.
✓ Budgets provide benchmarks for evaluating subsequent performance.
3. Responsibility accounting. A manager should be held responsible for those items of revenues and costs—and only those
items—that the manager can actually control to a significant extent. The manager who is held responsible for a specific cost
should have a budget specifying a limit on how much can be spent. This limit may be adjusted, depending upon the activity
during the period.
4. Choosing a budget period. Budget periods vary in length. Some may be as short as a month, whereas others may cover
many years. The most common budgeting period, however, is a year.
✓ Operating budgets ordinarily cover a one-year period. Additionally, many companies divide their operating budgets
into quarterly or monthly periods.
✓ A continuous or perpetual budget is one that covers a 12-month period but which adds a new month on the end as the
current month is completed. This approach stabilizes the planning horizon at one year.
5. Self-imposed participative budget. The most successful budget programs involve lower-level managers in preparing their
own budgets. There are two basic reasons: 1) lower-level managers are more familiar with the details of their own
operations than top managers and 2) managers tend to be more committed to budgets that they have been able to
influence.
6. Human relations. Management must keep clearly in mind that budgeting involves coordinating and motivating people and
the human dimension is of primary importance.
a. Top managers must clearly convey the message in actions as well as in words that budgeting is important. If top
management appears to be ambivalent about the benefits of budgeting, others in the organization will be reluctant to
commit their own time and energy to the budgeting process.
b. If there is a preoccupation with getting every dollar and cent right or with placing blame, the budgeting process will be
resented and managers will attempt to “game the system.” Budgets should not be used as a club. They should be a way
of ensuring that everyone understands what is expected. Significant deviations from the budget should be investigated
so that managers understand changing conditions and their implications for the organization. Managers should not
ordinarily be punished for deviations from the budget.
7. Setting of Profit Objective
A. A posteriori method - procedure for setting profit objectives in which the determination of profit objectives is
subordinated to the planning, and the objectives emerge as the product of the planning itself.
B. A priori method - The procedure for setting profit objectives in which management specifies a given rate of return that
it seeks to realize in the long run by means of planning toward that end.

B. Preparing the Master Budget. The master budget consists of a number of separate, but interrelated budgets.
1. The Sales Budget. The sales budget is a detailed schedule showing the expected sales for the coming period. It is typically
expressed in both pesos and units of the product. The sales budget is usually accompanied by a schedule of expected cash
receipts.
2. The Production Budget. The budgeted production for each period can be determined by adding together the budgeted
sales and the desired ending inventory and then subtracting the beginning inventory. The desired ending inventory in units
for each period is usually a predetermined percentage of budgeted unit sales for the following period. The production
budget is typically expressed in terms of physical units rather than in dollars.
3. The Direct Materials Budget. Once production needs have been determined, a direct materials budget should be prepared.
This budget details the materials that will be required to fulfill the production budget and to ensure adequate inventory
levels. Materials purchases can be determined by adding together the materials required for production needs and the
desired ending materials inventories and then subtracting the beginning inventory. The desired ending inventory in units is
usually a predetermined percentage of the number of units that are expected to be used in production the following
period.
4. The Direct Labor Budget. Once production needs are known, the direct labor budget must be prepared so that the company
will know whether sufficient labor time is available to meet those needs. The direct labor budget is typically expressed in
both direct labor-hours and in pesos.
5. The Manufacturing Overhead Budget. The manufacturing overhead budget lists all production costs other than direct
materials and direct labor. Manufacturing overhead costs should be broken down by cost behavior for budgeting purposes.
Typically, the variable portion of manufacturing overhead is assumed to be proportional to budgeted activity and the fixed
portion is assumed to be constant in total.
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MANAGERIAL ACCOUNTING ASIACAREER COLLEGE/CPARCENTER
OPERATIONAL AND FINANCIAL BUDGETING DWM.REYNO,CPA,DBA
6. Ending Finished Goods Inventory Budget. This budget details the amount and value of ending inventory on the budgeted
balance sheet. The unit product cost from this budget is also used to compute the cost of goods sold for the budgeted
income statement. Managers often want budgets on an absorption costing basis since that is the basis that will ordinarily
be used to report results to outsiders. Data for the computations in this schedule are found in the direct materials, direct
labor, and manufacturing overhead budgets.
7. The Selling and Administrative Expense Budget. The selling and administrative budget lists the anticipated non-
manufacturing expenses for the budget period. In practice this budget is usually made up of many smaller individual
budgets negotiated with various managers having sales and administrative responsibilities.
8. The Cash Budget. The cash budget should be broken down into time periods that are as short as feasible in order to alert
management to problems that may occur due to fluctuations in cash flows. The cash budget is composed of four major
sections:
a. The receipts section.
b. The disbursements section.
c. Cash receipts, plus the beginning cash balance, less cash disbursements results in cash excess or deficiency. If a
deficiency exists, additional funds must be arranged for. If an excess exists, previous borrowing can be repaid or short-
term investments made.
d. The financing section of the cash budget provides a detailed account of the borrowing and repayments projected to
take place during the budget period. It also includes a detailing of interest payments.
9. Budgeted Financial Statements. The last components of the master budget consist of the budgeted income statement and
the budgeted statement of financial position.

C. Zero-Based Budgeting. Zero-based budgeting requires managers to start at zero budget levels every year and justify all costs as
if all programs were being proposed for the first time. This process differs from traditional budgeting, in which changes in
budgets from one year to the next are subject to the greatest scrutiny.

EXERCISES
1. Down Under Products Ltd., of Australia has budgeted sales of its popular boomerang for the next four months as follows:
Sales in Units
April 50,000
May 75,000
June 90,000
July 80,000
The company is now in the process of preparing a production budget for the second quarter. Past experience has shown that
end-of-month inventory levels must equal 10% of the following month’s sales. The inventory at the end of March was 5,000
units.
Requirement:
Calculate the number of units to be produced each month and for the quarter in total.

2. Three grams of musk oil are required for each bottle of Mink Caress, a very popular perfume made by a small company in Ilocos.
The cost of the Musk oil is P150 per kilogram. Budgeted production of Mink Caress is given below by quarters for Year 2 and for
the first quarter of Year 3.
Year 2 Year 3
First Second Third Fourth First
Budgeted production, in bottles 60,000 90,000 150,000 100,000 70,000

Musk oil has become so popular as a perfume ingredient that it has become necessary to carry large inventories as a precaution
against stock-outs. For this reason, the inventory of musk oil at the end of a quarter must be equal to 20% of the following
quarter’s production needs. Some 36,000 grams of musk oil will be on hand to start the first quarter of Year 2.
Requirement:
How much raw materials (musk oil) are to be purchased in grams and in pesos for Year 2 by quarter and for the year in total?

3. The production manager of Rordan Corporation has submitted the following forecast of units to be produced by quarter for the
upcoming fiscal year:
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Units to be produced 8,000 6,500 7,000 7,500

Each unit requires 0.35 direct labor hours, and direct laborers are paid P12 per hour.
Requirements:
1. Construct the company’s direct labor budget for the upcoming fiscal year, assuming that the direct labor workforce is
adjusted each quarter to match the number of hours required to produce the forecasted number of units produced.
2. Construct the company’s direct labor budget for the upcoming fiscal year, assuming that the direct labor workforce is not
adjusted each quarter. Instead, assume that the company’s direct labor workforce consists of permanent employees who
are guaranteed to be paid for at least 2,600 hours of work each quarter. If the number of required direct labor-hours is less
than this number, the workers are paid for 2,600 hours anyway. Any hours worked in excess of 2,600 hours in a quarter are
paid at a rate of 1.5 times the normal hourly rate for direct labor.

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MANAGERIAL ACCOUNTING ASIACAREER COLLEGE/CPARCENTER
OPERATIONAL AND FINANCIAL BUDGETING DWM.REYNO,CPA,DBA
4. The direct labor budget of Yuvwell Corporation for the upcoming fiscal year contains the following details concerning budgeted
direct-labor hours:
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Budgeted direct-labor hours 8,000 8,200 8,500 7,800

The company’s variable manufacturing overhead rate is P3.25 per direct-labor hour and the company’s fixed manufacturing
overhead is P48,000 per quarter. The only non-cash item included in fixed manufacturing overhead is depreciation, which is
P16,000 per quarter.

Requirements:
1. Compute the cash disbursement for manufacturing overhead per quarter and for the year in total.
2. Compute the company’s manufacturing overhead rate (including both variable and fixed manufacturing overhead) for the
upcoming fiscal year.

5. The budgeted unit sales of Weller Company for the upcoming fiscal year are provided below:
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
Budgeted sales 15,000 16,000 14,000 13,000

The company’s variable selling and administrative expense per unit is P2.50. Fixed selling and administrative expenses include
advertising expenses of P8,000 per quarter, executive salaries of P35,000 per quarter, and depreciation of P20,000 per quarter.
In addition, the company will make insurance payments of P5,000 in the first quarter and P5,000 in the third quarter. Finally,
property taxes of P8,000 will be paid in the second quarter.

Requirement:
Compute the cash disbursements for selling and administrative expenses for each quarter and for the year in total.

6. Bernard Creigh is the controller for Creigh Hardware Store. In putting together the cash budget for the fourth quarter of the
year, he has assembled the following data:
1. Sales
a. July (actual) P100,000
b. August (actual) 120,000
c. September(estimated) 90,000
d. October (estimated) 100,000
e. November (estimated) 135,000
f. December(estimated) 150,000
2. Each month, 20 percent of sales are for cash, and 80 percent are on credit. The collection pattern for credit sales is 20
percent in the month of sale, 50 percent in the following month, and 30 percent in the second month following the sale.
3. Each month, the ending inventory exactly equals 40 percent of the cost of the next month’s sales. The markup on goods is
33.33 percent of cost.
4. Inventory purchases are paid for in the month following purchase.
5. Recurring monthly expenses are as follows:
a. Salaries and wages P10,000
b. Depreciation on plant & equipment 4,000
c. Utilities 1,000
d. Other 1,700
6. Property taxes of P15,000 are due and payable on September 15.
7. Advertising fees of P6,000 must be paid on October 20.
8. A lease on a new storage facility is scheduled to begin on November 2. Monthly payments are P5,000.
9. The company has a policy to maintain a minimum cash balance of P10,000. If necessary, it will borrow to meet its short-
term needs. All borrowing is done at the beginning of the month. All payments on principal and interest are made at the
end of the month. The annual interest rate is 9 percent. The company must borrow in multiples of P1,000.
10. A partially completed balance sheet as of August 31 is given below. (Accounts payable is for inventory purchases only.)
Assets Liab& OE
Cash P ?
Accounts receivable P ?
Inventory P ?
Plant and equipment 431,750
Accounts payable P ?
Common stock 220,000
Retained earnings . . 268,750
Total ? ?
Requirements:
1. Compute the missing values in the balance sheet as of August 31.
2. How much will be the cash balance as of November 30?
3. How much will be the balance of accounts receivable as of November 30?
4. How much will be the total cash collections for three months, September – November?