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Learning Objective 1 The Basic Framework of Budgeting

A budget is a detailed quantitative plan for
acquiring and using financial and other resources
CHAPTER 4 Understand why over a specified forthcoming time period.
PROFIT PLANNING organizations budget 1. The act of preparing a budget is called
and the processes they budgeting.
use to create budgets. 2. The use of budgets to control an
organization’s activities is known
as budgetary control.

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Difference Between Planning and

Advantages of Budgeting Responsibility Accounting
Control
Planning – Control – Define goals
Managers should be held
and objectives
Planning involves Control involves Communicate Think about and responsible for those items -
developing goals gathering feedback to plans plan for the future and only those items - that
and preparing ensure that the plan is Advantages
they can actually control
various budgets being properly Coordinate Means of allocating to a significant extent.
to achieve those executed or modified activities resources Responsibility accounting
as circumstances enables organizations to react
goals Uncover potential
quickly to deviations from their
. change. bottlenecks
plans and to learn from
.
feedback.

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Choosing the Budget Period Self-Imposed Budget Advantages of Self-Imposed Budgets

1. Individuals at all levels of the organization are viewed as
Operating Budget Top Management members of the team whose judgments are valued by top
management.
2. Budget estimates prepared by front-line managers are
2014 2015 2016 2017 Middle Middle often more accurate than estimates prepared by top
Management Management managers.
Operating budgets ordinarily
A continuous budget is a 3. Motivation is generally higher when individuals participate
cover a one-year period
12-month budget that rolls in setting their own goals than when the goals are
corresponding to a company’s
forward one month (or quarter) Supervisor Supervisor Supervisor Supervisor imposed from above.
fiscal year. Many companies
as the current month (or quarter)
divide their annual budget A self-imposed budget or participative budget is a budget that is 4. A manager who is not able to meet a budget imposed
is completed.
into four quarters. prepared with the full cooperation and participation of managers from above can claim that it was unrealistic. Self-imposed
at all levels. budgets eliminate this excuse.
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Self-Imposed Budgets Human Factors in Budgeting The Master Budget: An Overview

Sales budget
The success of a budget program depends on three
Self-imposed budgets should be reviewed important factors: Selling and
by higher levels of management to 1.Top management must be enthusiastic and
Ending inventory
budget
Production budget administrative
budget
prevent “budgetary slack.” committed to the budget process.
2.Top management must not use the budget to
Most companies issue broad guidelines in pressure employees or blame them when
Direct materials
budget
Direct labor
budget
Manufacturing
overhead budget
terms of overall profits or sales. Lower something goes wrong.
level managers are directed to prepare 3.Highly achievable budget targets are usually Cash Budget
budgets that meet those targets. preferred when managers are rewarded based on
meeting budget targets. Budgeted
Budgeted
income
balance sheet
statement

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Seeing the Big Picture
To help you see the “big picture” keep in mind
that the 10 schedules in the master budget are
designed to answer the 10 questions shown on
the next screen.
Seeing the Big Picture The Master Budget: An Overview
1. How much sales revenue will we earn?
2. How much cash will we collect from customers?
A master budget is based on various estimates
3. How much raw material will we need to purchase?
4. How much manufacturing costs will we incur? and assumptions. For example, the sales
5. How much cash will we pay to our suppliers and our direct laborers, and how
budget requires three estimates/assumptions
much cash will we pay for manufacturing overhead resources?
6. What is the total cost that will be transferred from finished goods inventory to
as follows:
cost of good sold?
7. How much selling and administrative expense will we incur and how much 1. What are the budgeted unit sales?
cash will be pay related to those expenses?
8. How much money will we borrow from or repay to lenders – including
2. What is the budgeted selling price per unit?
interest? 3. What percentage of accounts receivable will
9. How much operating income will we earn?
10. What will our balance sheet look like at the end of the budget period? be collected in the current and subsequent
periods.

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The Master Budget: An Overview Learning Objective 2 Budgeting Example

 Royal Company is preparing budgets for the
When Microsoft Excel© is used to create a
quarter ending June 30th.
master budget, these types of assumptions
can be depicted in a Budget Assumptions Prepare a sales budget,  Budgeted sales for the next five months are:
tab, thereby enabling Excel-based budget to including a schedule of April 20,000 units
answer “what-if” questions. expected cash May 50,000 units
June 30,000 units
collections. July 25,000 units
August 15,000 units
 The selling price is $10 per unit.
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The Sales Budget Expected Cash Collections Expected Cash Collections

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
• 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.
• In April, the March 31st accounts receivable
balance of $30,000 will be collected in full.

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Expected Cash Collections Expected Cash Collections Expected Cash Collections

From the Sales Budget for April.

From the Sales Budget for May.

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Learning Objective 3 The Production Budget The Production Budget

• The management at Royal Company wants
Sales Production ending inventory to be equal to 20% of the
Budget Budget following month’s budgeted sales in units.
Prepare a production and
budget. Expected
• On March 31st, 4,000 units were on hand.
Cash
Collections
Let’s prepare the production budget.
The production budget must be adequate to
meet budgeted sales and to provide for
If Royal was a merchandising company it would prepare a
the desired ending inventory. merchandise purchase budget instead of a production budget.
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The Production Budget The Production Budget The Production Budget

Budgeted May sales 50,000

Desired ending inventory % 20%
March 31
Desired ending inventory 10,000
ending inventory.

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The Production Budget Learning Objective 4 The Direct Materials Budget

• At Royal Company, five pounds of material
Prepare a direct are required per unit of product.
materials budget, • Management wants materials on hand at the
including a schedule of end of each month equal to 10% of the
expected cash following month’s production.
disbursements for • On March 31, 13,000 pounds of material are
purchases of materials. on hand. Material cost is $0.40 per pound.

Let’s prepare the direct materials budget.

Assumed ending inventory.

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The Direct Materials Budget The Direct Materials Budget The Direct Materials Budget

March 31 inventory.

From production budget. 10% of following month’s Calculate the materials to

production needs. be purchased in May.
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Expected Cash Disbursement for

The Direct Materials Budget
The Direct Materials Budget 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.
Assumed ending inventory.

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Expected Cash Disbursement for Expected Cash Disbursement for Expected Cash Disbursement for
Materials Materials Materials

Compute the expected cash

disbursements for materials
for the quarter.

140,000 lbs. × $0.40/lb. = $56,000

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Learning Objective 5
Prepare a direct labor
budget.
The 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 paid 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.
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The Direct Labor Budget The Direct Labor Budget The Direct Labor Budget

Greater of labor hours required

or labor hours guaranteed.

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Learning Objective 6 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
Prepare a manufacturing per direct labor hour.
overhead budget. • 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.

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Manufacturing Overhead Budget Ending Finished Goods Inventory

Manufacturing Overhead Budget
Budget
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
Total mfg. OH for quarter $251,000
= $49.70 per hour *
Total labor hours required 5,050
Direct materials
budget and information.
Depreciation is a noncash charge.
* rounded
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Ending Finished Goods Inventory Ending Finished Goods Inventory Ending Finished Goods Inventory
Budget Budget Budget
Production costs per unit Quantity Cost Total Production costs per unit Quantity Cost Total Production costs per unit Quantity Cost Total
Direct materials 5.00 lbs. $ 0.40 $ 2.00 Direct materials 5.00 lbs. $ 0.40 $ 2.00 Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $ 10.00 0.50 Direct labor 0.05 hrs. $10.00 0.50 Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49 Manufacturing overhead 0.05 hrs. $49.70 2.49 Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99 $ 4.99 $ 4.99
Budgeted finished goods inventory Budgeted finished goods inventory Budgeted finished goods inventory
Ending inventory in units 5,000 Ending inventory in units 5,000 Ending inventory in units 5,000
Unit product cost $ 4.99 Unit product cost $ 4.99 Unit product cost $ 4.99
Ending finished goods inventory $ 24,950 Ending finished goods inventory $ 24,950
Ending finished goods inventory ?

Direct labor budget. Total mfg. OH for quarter $251,000

= $49.70 per hour
Production Budget.
Total labor hours required 5,050

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Selling and Administrative Expense Selling and Administrative Expense

Learning Objective 7
Budget Budget
• At Royal, the selling and administrative expense budget is
divided into variable and fixed components.
Prepare a selling and • The variable selling and administrative expenses are $0.50
per unit sold.
administrative expense
• Fixed selling and administrative expenses are $70,000 per
budget. 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

Calculate the selling and administrative
expense budget.
cash expenses for the quarter.

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Selling Administrative Expense Budget
Learning Objective 8 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;
Prepare a cash budget.
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.
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The Cash Budget The Cash Budget The Cash Budget

Assume the following information for Royal:
 Maintains a 16% open line of credit for $75,000. Schedule of Expected
 Maintains a minimum cash balance of $30,000. Schedule of Expected Cash Disbursements.
Cash Collections. Direct Labor
 Borrows on the first day of the month and repays
loans on the last day of the month. Budget.

 Pays a cash dividend of $49,000 in April. Manufacturing

Overhead Budget.
 Purchases $143,700 of equipment in May and
$48,300 in June (both purchases paid in cash). Selling and Administrative
Expense Budget.
 Has an April 1 cash balance of $40,000.

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The Cash Budget The Cash Budget The Cash Budget

Because Royal maintains Because Royal maintains

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

Ending cash balance for April

is the beginning May balance.

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The Cash Budget The Budgeted Income Statement Learning Objective 9

Cash Budgeted
Budget Income Prepare a budgeted
$50,000 × 16% × 3/12 = $2,000 Statement income statement.
Borrowings on April 1 and
repayment on June 30.

With interest expense from the cash

budget, Royal can prepare the budgeted
income statement.
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The Budgeted Income Statement Learning Objective 10 The Budgeted Balance Sheet
Sales Budget. Royal reported the following account
Royal Company
Budgeted Income Statement
balances prior to preparing its budgeted
For the Three Months Ended June 30
Ending Finished financial statements:
Goods Inventory. Prepare a budgeted
Sales (100,000 units @ $10)
Cost of goods sold (100,000 @ $4.99)
$ 1,000,000
499,000
balance sheet. • Land - $50,000
Gross margin
Selling and administrative expenses
501,000
260,000
Selling and • Common stock - $200,000
Administrative
Operating income
Interest expense
241,000
2,000 Expense Budget.
• Retained earnings - $146,150 (April 1)
Net income $ 239,000 • Equipment - $175,000
Cash Budget.

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Royal Company Royal Company

Budgeted Balance Sheet 25% of June Budgeted Balance Sheet
June 30 sales of June 30
Assets: $300,000. Assets:
Beginning balance $146,150
Add: net income 239,000
Cash $ 43,000 Cash $ 43,000 dividends
Deduct: (49,000)
Accounts receivable 75,000 11,500 lbs. Accounts receivable 75,000balance
Ending $336,150
Raw materials inventory 4,600 at $0.40/lb. Raw materials inventory 4,600
Finished goods inventory 24,950 Finished goods inventory 24,950
Land 50,000 5,000 units Land 50,000
Equipment 367,000 at $4.99 each. Equipment 367,000
Total assets 564,550 Total assets 564,550

Liabilities and Stockholders' Equity 50% of June Liabilities and Stockholders' Equity
Accounts payable $ 28,400 Accounts payable $ 28,400
Common stock 200,000
purchases Common stock 200,000
Retained earnings 336,150 of $56,800. Retained earnings 336,150
Total liabilities and stockholders' equity $ 564,550 Total liabilities and stockholders' equity $ 564,550