© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin

Planning for Profit and Cost Control Chapter 7

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Introduction Detail Budget Detail Budget Detail Budget Master Budget Combination of numerous specific budgets Sales Production Inventory

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin The Budget Committee A standing committee responsible for A standing committee responsible for overall policy matters relating to the budget. overall policy matters relating to the budget. coordinating the preparation of the budget. coordinating the preparation of the budget. A standing committee responsible for A standing committee responsible for overall policy matters relating to the budget. overall policy matters relating to the budget. coordinating the preparation of the budget. coordinating the preparation of the budget.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin The Planning Process  Planning -- involves developing objectives and preparing various budgets to achieve these objectives.  Control – involves the steps taken by management that attempt to ensure the objectives are attained.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Three Levels of Planning for Business Activity Strategic Planning Top management long-range decisions. Capital Budgeting Intermediate-range planning Operations Budgeting Direct firm’s activity in the short-range

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Three Levels of Planning for Business Activity Operating Budget The annual operating budget may be divided into quarterly or monthly budgets.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Three Levels of Planning for Business Activity Continuous or Perpetual Budget This budget is usually a twelve-month budget that rolls forward one month as the current month is completed. This budget is usually a twelve-month budget that rolls forward one month as the current month is completed

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Advantages of Budgeting Corrective Action Performance Measurement CoordinationCoordination PlanningPlanning

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Consideration for the Human Factor Flow of Budget Data Participative Budget System

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Information Flow in the Master Budget Cash Payments for S & A Cash Payments for Inventory Inventory Purchases Budget Income Statement S & A Expense Budget Balance Sheet Cash Receipts Sales Budget Cash Budget Statement of Cash Flows Cash Receipts and Payments Schedules Operating Budgets Pro forma Financial Statements Start

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Sales Budget Detailed schedule showing expected sales for the coming periods.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Sales Budget  Web Company is preparing budgets for the quarter ending June 30.  Budgeted sales for the next five months are: April $200,000 April $200,000 May $500,000 May $500,000 June $300,000 June $300,000 July $250,000 July $250,000 August $150,000. August $150,000.  Cash sales are 20% of the total and credit sales are 80%.  Web Company is preparing budgets for the quarter ending June 30.  Budgeted sales for the next five months are: April $200,000 April $200,000 May $500,000 May $500,000 June $300,000 June $300,000 July $250,000 July $250,000 August $150,000. August $150,000.  Cash sales are 20% of the total and credit sales are 80%.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Sales Budget $200,000 × 20% = $40,000 Accounts receivable at June 30 Accounts receivable at June 30

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Schedule of Cash Receipts Schedule of Cash Receipts Sales Budget Completed Cash receipts flow from expected sales.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Schedule of Cash Receipts  Web expects to collect its accounts receivable in the month following the month of sale.  On March 31, accounts receivable totaled $100,000. Let’s prepare the cash receipts budget. Let’s prepare the cash receipts budget.  Web expects to collect its accounts receivable in the month following the month of sale.  On March 31, accounts receivable totaled $100,000. Let’s prepare the cash receipts budget. Let’s prepare the cash receipts budget.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Schedule of Cash Receipts From the Sales Budget

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Inventory Purchases Budget The total amount of inventory needed for each month is equal to the amount of budgeted sales plus the desired ending inventory.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Inventory Purchases Budget  At Web, cost of sales is equal to 70% of total budgeted sales.  Management wants to maintain an ending inventory that is equal to 20% of the current month’s cost of budgeted sales.  The ending inventory at March 31 is $15,000. Let’s prepare the purchases budget. Let’s prepare the purchases budget.  At Web, cost of sales is equal to 70% of total budgeted sales.  Management wants to maintain an ending inventory that is equal to 20% of the current month’s cost of budgeted sales.  The ending inventory at March 31 is $15,000. Let’s prepare the purchases budget. Let’s prepare the purchases budget.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Inventory Purchases Budget Budgeted Cost of Sales $140,000 Desired Ending Inventory % 20% Desired Ending Inventory $ 28,000 Budgeted Cost of Sales $140,000 Desired Ending Inventory % 20% Desired Ending Inventory $ 28,000

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Inventory Purchases Budget The ending inventory for April is the beginning inventory for May. The ending inventory for April is the beginning inventory for May.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Now we can move on to the Schedule of Cash Payments for Inventory Purchases. Now we can move on to the Schedule of Cash Payments for Inventory Purchases. Inventory Purchases Budget

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Payments for Inventory Purchases  Web pays 80% of inventory purchases in the month of acquisition and the remaining 20% in the month following acquisition.  On March 31, Web owed $14,000 for purchases of inventory. Let’s prepare the Cash Payments for Inventory Purchases schedule.  Web pays 80% of inventory purchases in the month of acquisition and the remaining 20% in the month following acquisition.  On March 31, Web owed $14,000 for purchases of inventory. Let’s prepare the Cash Payments for Inventory Purchases schedule.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Payments for Inventory Purchases March 31 accounts payable for inventory purchases March 31 accounts payable for inventory purchases

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Payments for Inventory Purchases April Inventory Purchases $153,000 Percent Paid in Following Month 20% May Payment for April Purchases $ 30,600 April Inventory Purchases $153,000 Percent Paid in Following Month 20% May Payment for April Purchases $ 30,600

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Payments for Inventory Purchases June Inventory Purchases $182,000 Percent Paid in July 20% Accounts Payable at June 30 $ 36,400 June Inventory Purchases $182,000 Percent Paid in July 20% Accounts Payable at June 30 $ 36,400

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Selling and Administrative Expense Budget  Sales commissions are 2% of sales and are paid in the month after they are earned.  Supplies expense is 1% of sales.  Utilities are paid the month after they are used.  On March 31, Web owed $3,000 in sales commissions and $1,200 in utilities. Web has developed the selling and administrative expense budget shown on the next screen.  Sales commissions are 2% of sales and are paid in the month after they are earned.  Supplies expense is 1% of sales.  Utilities are paid the month after they are used.  On March 31, Web owed $3,000 in sales commissions and $1,200 in utilities. Web has developed the selling and administrative expense budget shown on the next screen.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Selling and Administrative Expense Budget $200,000 Sales × 2% = $4,000

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Selling and Administrative Expense Budget Let’s see how these expenses translate into cash payments for selling and administrative expenses. $200,000 Sales × 1% = $2,000

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Selling and Administrative Expense Budget Let’s see how these expenses translate into cash payments for selling and administrative expenses.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Payments for S&A Expenses Depreciation Expense is a non-cash expense. March 31 Sales Commissions and Utilities. March 31 Sales Commissions and Utilities.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Payments for S&A Expenses April Sales Commissions and Utilities. April Sales Commissions and Utilities.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Payments for S&A Expenses Of the total quarterly expenses of $141,700, Web will pay $133,700 in cash and record liabilities of $6,000 for June sales commissions and $1,700 for June utilities.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Budget  Web wants to maintain a $10,000 balance in its cash account before any interest payments.  The company has a $100,000 line-of-credit that requires 12% interest on any outstanding balance payable monthly.  Web plans to purchase $50,000 of equipment on April 1.  On March 31, Web’s cash balance is $18,000. Let’s put together the information developed so far and prepare Web’s cash budget.  Web wants to maintain a $10,000 balance in its cash account before any interest payments.  The company has a $100,000 line-of-credit that requires 12% interest on any outstanding balance payable monthly.  Web plans to purchase $50,000 of equipment on April 1.  On March 31, Web’s cash balance is $18,000. Let’s put together the information developed so far and prepare Web’s cash budget.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Budget Cash Receipts Budget Payment for Inventory Purchases Schedule Cash Payments for S&A Schedule

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Budget

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Budget ($78,600 + $128,900) × 1% = $2,075

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Pro Forma Income Statement CashBudgetCashBudget Pro Forma IncomeStatement IncomeStatement Completed After we complete the cash budget, we can prepare the pro forma income statement for Web.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Pro Forma Income Statement S&A Expense Budget

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Pro Forma Balance Sheet On March 31, Web had the following account balances: Equipment $100,000, Equipment $100,000, Capital stock $200,000, and Capital stock $200,000, and Retained earnings $19,300. Retained earnings $19,300. On March 31, Web had the following account balances: Equipment $100,000, Equipment $100,000, Capital stock $200,000, and Capital stock $200,000, and Retained earnings $19,300. Retained earnings $19,300. With this data and the information developed in our budgets, we can prepare Web’s Pro Forma Balance Sheet.

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Receipts Budget

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Sales Budget Purchases Budget Cash Payments for S&A Cash Payments for Inventory

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Beginning retained earnings $ 19,300 Net income for quarter 155,439 Ending retained earnings $174,739 Beginning retained earnings $ 19,300 Net income for quarter 155,439 Ending retained earnings $174,739

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Payments for S&A Cash Payments for S&A Cash Receipts Budget Cash Receipts Budget Cash Payment for Inventory Cash Payment for Inventory

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin Cash Budget

© The McGraw-Hill Companies, Inc., 2003 McGraw-Hill/Irwin End of Chapter 7