Topic 11 Budgeting and Decision Making

DISCUSSION QUESTIONS
Explain the main steps in the budgeting process.
The main steps in the budgeting process are:
1. a consideration of past performance;
2. an assessment of the expected trading and operating conditions;
3. preparation of initial budget estimates;
4. adjustment to estimates based on communication with and feedback from managers;
5. preparation of the budgeted statements and any sub-budgets;
6. monitoring of actual performance against the budget over the budget period; and
7. where necessary, adjusting the budget during the budget period

Explain the difference between planning and control.

Planning normally relates to the consideration of future events and preparation of the budgets
themselves. Control focuses on the comparison of budgeted with actual performance.

What is a master budget? Describe its role in relation to other budget

The master budget will normally represent a summary of the individual functional budgets of
the firm as a whole. It conventionally consists of a budgeted income statement, balance sheet
and cash flow statement (i.e. pro-forma or projected financial statements). This budget is
extremely useful for management as it clearly sets out the short-term objectives and targets for
the forthcoming budget period and is in a form that is easy to comprehend. It also provides a
basis for coordinating the individual functional budgets, including the sales, inventory,
production, administration, distribution and cash budgets.

Discuss the typical role of the accountant in the budget process.

The accountant would act as the facilitator to collect information from those within the entity
to develop the budgets and apply a monetary value.

Explain the meaning of the term ‘budgetary slack’.

While budgetary slack might be explained in a number of different ways, it essentially results in
targets that might be a little more easily achievable than might otherwise be the case. If a
number of managers engage in this practice, then the ultimate target and budget potentially
becomes meaningless. However, it should be noted that managers may not necessarily intend
to deceive, but it may be more a function of human behaviour and nature.

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PRACTICAL QUESTIONS
Question 1 Budget for a restaurant
Dorquay Hotel has a dining room which has the capacity to seat 50 guests. It is opened for
breakfast and lunch seven days a week. During January 2016, management has forecast the
seat turnover for breakfast to be 2.5 times and for lunch 2 times, with the average bill to be $20
for breakfast and $40 for lunch. Beverage revenue is usually 10 per cent of the breakfast
revenue and 25 per cent of the lunch revenue.

Required
a. Calculate budgeted total revenue of food and beverage for January 2016.
b. What actions could the dining room manager take to increase beverage sales?

a. Budgeted revenue for January 2016:

Food
Breakfast – 50 guests x 2.5x turnover x $20 = $2 500
Lunch – 50 guests x 2x turnover x $40 = $4 000 = $6 500

Beverage
Breakfast - $2500 x 10% = $ 250
Lunch - $4 000 x 25% = $1 000 = $1 250

b. Manager actions to increase beverage sales:

 increase beverage variety
 have staff check on any beverage order when taking a meal order
 reduce prices to drive volume
 special promotions

Question 2
The accountant for Roadrunner Food Services is preparing its cash budget for November and
December 2018. The accountant, Ross Leon, has collected the following information regarding
expected credit sales and expected purchases of inventory on credit:

Ross has analysed the accounts receivable records for the past few years and has determined
that customers normally pay 60 per cent in the month of sale, 30 per cent in the month
following the sale, and 8 per cent in the second month following sale. The remaining 2 per cent
is considered a bad debt and uncollectable.

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Foods R Us, the only supplier to Roadrunner Food Services, offers a 4 per cent discount if its
customers pay by the 15th day of the following month. Ross always takes advantage of this
discount. Cash payment for operating expenses are expected to be $85 000 per month for
November and December. The expected cash balance on 1 November is $10 000.
Required
a. Explain to the owner of Roadrunner why a cash budget is important for the business.
b. Prepare a cash budget for the months of November and December 2018.
c. Ross would like to purchase a new vehicle in December. Based on your cash budget what
recommendations would you make? The cost of the vehicle is $40 000.
a. The preparation of the cash budget is an important part of the planning process. Once
prepared, the cash budget can be used for monitoring cash performance, commonly
referred to as the control process. A cash budget prepared on a month-by-month basis is
much more useful for this purpose than one prepared on a quarterly or yearly basis.
b.
Roadrunner Food Services - Cash budget for November, December 2016
NOVEMBER DECEMBER
Cash receipts
Cash from customers $ 181,600.00 $ 197,400.00
Total $ 181,600.00 $ 197,400.00

Cash payments
Inventory purchases $ 91,200.00 $ 134,400.00
Operating expenses $ 85,000.00 $ 85,000.00
Total $ 176,200.00 $ 219,400.00

Cash increase/decrease $ 5,400.00 -$ 22,000.00

Opening cash balance $ 10,000.00 $ 15,400.00
Cash surplus/deficit $ 15,400.00 -$ 6,600.00

Schedule for expected collections from account receivable

NOVEMBER DECEMBER
SEPTEMBER $ 13,600.00
OCTOBER $ 54,000.00 $ 14,400.00
NOVEMBER $ 114,000.00 $ 57,000.00
DECEMBER $ 126,000.00
$ 181,600.00 $ 197,400.00

Schedule for expected payments to accounts payable (direct materials)

NOVEMBER DECEMBER
OCTOBER $ 91,200.00
NOVEMBER $ 134,400.00
DECEMBER
$ 91,200.00 $ 134,400.00

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c. Reference to the cash budget shows that the business will have a negative $6600 balance at
the end of December based on current cash projections. Given this the business would
need to look at how it could finance the purchase of the $40000 vehicle. Strategies that
could be adopted would be:
1. Internal sources of finance – increase cash flow from customers, reduce expenditure
2. External sources of finance – share capital injection, loan funds.

As an alternative the owner could look at the option of leasing a vehicle rather than purchasing
outright.

Question 3
Production, labour, materials and sales budgets
Bullen & Company makes and sells upmarket carry bags for laptop computers. John Crane is
responsible for preparing Bullen & Company’s master budget, and he has assembled the data
below for 2018.

The direct labour rate includes wages, all employee-related benefits, and the employer’s share
of payroll tax. Labour-saving machinery will be fully operational by March. Also, as of 1 March,
the company’s enterprise agreement calls for an increase in direct labour wages; this has been
included in the direct labour rate.

Bullen & Company expects to have 10 000 bags in inventory at 31 December 2017, and has a
policy of carrying 50 per cent of the following month’s projected sales in inventory.

Required
Prepare the following budgets for Bullen & Company for the first quarter of 2018. Be sure to
show supporting calculations.
a. Production budget
b. Direct labour budget
c. Direct materials budget
d. Sales budget

Notice that the first quarter is the first three months. April’s information is needed for some of
March’s budget calculations.

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 a. Production budget (units)
January February March Quarter
Sales units (a) 20 000 24 000 16 000 60 000
Plus ending inventory (b) 12 000 8 000 9 000 9 000
Total units needed 32 000 32 000 25 000 69 000
Less beginning inventory 10 000 12 000 8 000 10 000
Total units to be produced 22 000 20 000 17 000 59 000

(a) Current month’s sales

(b) 50% of following month’s sales

b. Direct labour budget (hours)

January February March Total
Units to be produced 22 000 20 000 17 000 59 000
Direct labour hours per unit 4 4 3.5
Total labour budget (hours) 88 000 80 000 59 500 227 500
Cost per hour $15 $15 $16
Total direct labour cost $1 320 000 $1 200 000 $952 000 $3 472 000

c. Direct materials budget (dollars)

January February March Total
Units to be produced 22 000 20 000 17 000 59 000
Cost per unit $10 $10 $10
Total direct material cost $220 000 $200 000 $170 000 $590 000

d. Sales budget (dollars)

January February March Total
Sales units 20 000 24 000 16 000 60 000
Sales price per unit $80 $80 $75
Total sales revenue budget $1 600 000 $1 920 000 $1 200 000 $4 720 000

Question 4 Purchase, cost of sales, and cash collection budgets

The Zeal Company operates antique and second-hand goods stores throughout Victoria. Such
stores are currently very popular and sales are increasing each month. It has budgeted the
following sales for the indicated months.

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Zeal Company’s success in this specialty market is due in large part to the extension of credit
terms and the budgeting techniques implemented by the firm’s owner, Barbara Zeal. All
merchandise is marked up to sell at its invoice cost plus 25 per cent. Stated differently, cost is
80 per cent of selling price. Merchandise inventories at the beginning of each month are 30 per
cent of that month’s forecasted cost of sales. With respect to sales on account, 40 per cent of
receivables are collected in the month of sale, 50 per cent are collected in the month following,
and 10 per cent are never collected.
Required
a. What is the anticipated cost of sales for June?
b. What is the beginning inventory for July expected to be?
c. What are the July purchases expected to be?
d. What are the forecasted July cash collections?

a. Cost of sales (June) = Total sales (June) × 0.80

= $3 253 000 × 0.80
= $2 602 400
Check: $2 602 400 × 1.25 = $3 253 000

b. The policy is to have 30% of that month’s forecasted cost of sales.

Cost of sales (July) = $3 363 000 × 0.80
= $2 690 400
Beginning inventory (July) = $2 690 400 × 0.30
= $807 120

c. Purchases (July) = (Anticipated cost of sales for July + Ending inventory) – Opening inventory
Cost of sales (July) = $2 690 400 (from part b)
Ending inventory = $3 473 000 (August sales) × 0.80 × 0.30
= $833 520 (August opening inventory which is July closing inventory)
Purchases (July) = ($2 690 400 + $833 520) – $807 120 (from part b)
= $2 716 800

d. The collection policy is 40% in the month of sale, 50% in the following month and 10% is never
collected.

Cash collections
Credit sales – June ($2 730 000 × 0.50) $1 365 000
Credit sales – July ($2 830 000 × 0.40) 1 132 000
Cash sales – July 533 000
Total cash collections – July $3 030 000

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