Budgeting for Planning and Control Prepared by Douglas Cloud Pepperdine University

After studying this chapter, you should be able to: Objectives 1. Define budgeting, and discuss its role in planning, controlling, and decision making. 2. Prepare the operating budget, identify its major components, and explain the interrelationships of the various components. 3. Identify the components of the financial budget, and prepare a cash budget. 4. Describe the budgets for merchandise and service firms. After studying this chapter, you should be able to:

The Master Budget and Its Interrelationships Strategic Plan Planning: The Master Budget and Its Interrelationships Long-Term Objectives Control: Compare actual results with planned amounts F e edba ck Short-Term Objectives Budgets Production, Service, and Sales Operations

Purposes of Budgeting 1. It forces managers to plan. 2. It provides resource information that can be used to improve decision making. 3. It provides a standard for performance evaluation. 4. It improves communication and coordination.

Two Dimensions of Budgeting 1. How is the budget prepared? 2. How is the budget used to implement the organization’s plan?

Preparing the Operating Budget 1. Sales budget 2. Production budget 3. Direct materials purchases budget 4. Direct labor budget 5. Overhead budget 6. Ending finished goods inventory budget 7. Cost of goods sold budget 8. Marketing expense budget 9. Research and development budget 10. Administrative expense budget 11. Budgeted income statement

Schedule 1 (in thousands) For the Year Ended December 31, 2004 ABT, Inc. Sales Budget For the Year Ended December 31, 2004 Quarter 1 2 3 4 Year Units 2,000 6,000 6,000 2,000 16,000 Unit selling price x $0.70 x $0.70 x $0.80 x $0.80 x $0.75 Sales $ 1,400 $ 4,200 $ 4,800 $ 1,600 $12,000 The sales forecast is the basis for the sales budget. The accuracy of the sales forecast strongly affects the soundness of the entire master budget.

Computing Units to be Produced Expected unit sales + Units, ending inventory – Units, beginning inventory

Schedule 2 (in thousands) For the Year Ended December 31, 2004 ABT, Inc. Production Budget For the Year Ended December 31, 2004 Quarter 1 2 3 4 Year Sales (Schedule 1) 2,000 6,000 6,000 2,000 16,000 Desired ending inventory 500 500 100 100 100 Total needs 2,500 6,500 6,100 2,100 16,100 Less: Beginning inventory 100 500 500 100 100 Units to be produced 2,400 6,000 5,600 2,000 16,000

Continued Schedule 3 (in thousands) ABT, Inc. Direct Materials Purchases Budget For the Year Ended December 31, 2004 Quarter 1 2 3 4 Year Units to be produced (Schedule 2) 2,400 6,000 5,600 2,000 16,000 Direct materials per unit (lbs.) x 26 x 26 x 26 x 26 x 26 Production needs 62,400 156,000 145,600 52,000 416,000 Desired ending inventory (lbs.) 8,000 8,000 5,000 5,000 5,000 Total needs 70,400 164,000 150,600 57,000 421,000 Continued

Quarter 1 2 3 4 Year Total needs 70,400 164,000 150,600 57,000 421,000 Less beginning inventory 5,000 8,000 8,000 5,000 5,000 Direct materials to be purchased (lbs.) 65,400 156,000 142,600 52,000 416,000 Cost per pound x $0.01 x $0.01 x $0.01 x $0.01 x $0.01 Total purchase cost $ 654 $ 1,560 $ 1,426 $ 520 $ 4,160

Schedule 4 (in thousands) For the Year Ended December 31, 2004 ABT, Inc. Direct Labor Budget For the Year Ended December 31, 2004 Quarter 1 2 3 4 Year Units to be produced (Schedule 2) 2,400 6,000 5,600 2,000 16,000 Direct labor time per unit (hrs.) x 0.015 x 0.015 x 0.015 x 0.015 x 0.015 Total hours needed 36 90 84 30 240 Wage per hour x $8 x $8 x $8 x $8 x $8 Total direct labor cost $ 288 $ 720 $ 672 $ 240 $ 1,920

Schedule 5 (in thousands) For the Year Ended December 31, 2004 ABT, Inc. Overhead Budget For the Year Ended December 31, 2004 Quarter 1 2 3 4 Year Budgeted direct labor hours (Schedule 4) 36 90 84 30 240 Variable overhead rate x $8 x $8 x $8 x $8 x $8 Budgeted variable overhead $288 $ 720 $672 $240 $1,920 Budgeted fixed overhead 320 320 320 320 1,280 Total overhead $608 $1,040 $992 $560 $3,200

Finished goods: Concrete blocks 100 $0.58 $58 Schedule 6 (in thousands) ABT, Inc. Ending Finished Goods Inventory Budget For the Year Ended December 31, 2004 Unit-cost computation: Direct materials (26 lbs. @ $0.01) $0.26 Direct labor (0.015 hr. @ $8) 0.12 Overhead: Variable (0.015 hr. @ $8) 0.12 Fixed (0.015 hr. @ $5.33) 0.08 Total unit cost $0.58 Units Unit Cost Total Finished goods: Concrete blocks 100 $0.58 $58

Schedule 7 (in thousands) ABT, Inc. Cost of Goods Sold Budget For the Year Ended December 31, 2004 Direct materials used (Schedule 3) $4,160 Direct labor used (Schedule 4) 1,920 Overhead (Schedule 5) 3,200 Budgeted manufacturing costs $9,280 Beginning finished goods 55 Goods available for sale $9,335 Less: Ending finished goods (Schedule 6) 58 Budgeted cost of goods sold $9,277

Schedule 8 (in thousands) ABT, Inc. Marketing Expense Budget For the Year Ended December 31, 2004 Quarter 1 2 3 4 Year Planned sales in units (Schedule 1) 2,000 6,000 6,000 2,000 16,000 Variable marketing expenses per unit x$0.05 x$0.05 x$0.05 x$0.05 x$0.05 Total variable expenses $ 100 $ 300 $ 300 $ 100 $ 800 Continued

Quarter 1 2 3 4 Year Fixed marketing expenses: Salaries $ 10 $ 10 $ 10 $ 10 $ 40 Advertising 10 10 10 10 40 Depreciation 5 5 5 5 20 Travel 3 3 3 3 12 Total fixed expenses $ 28 $ 28 $ 28 $ 28 $112 Total marketing expenses $128 $328 $328 $128 $912

Schedule 9 (in thousands) ABT, Inc. Research and Development Expenses Budget For the Year Ended December 31, 2004 Quarter 1 2 3 4 Year Sales $18 $18 $18 $18 $ 72 Prototype design and development 10 10 10 10 40 Total R & D expenses $28 $28 $28 $28 $112

Schedule 10 (in thousands) ABT, Inc. Administrative Expense Budget For the Year Ended December 31, 2004 Quarter 1 2 3 4 Year Salaries $25 $25 $25 $25 $100 Insurance --- --- 15 --- 15 Depreciation 10 10 10 10 40 Travel 2 2 2 2 8 Total administrative expenses $37 $37 $52 $37 $163

Schedule 11 (in thousands) ABT, Inc. Cost of Goods Sold Budget For the Year Ended December 31, 2004 Sales (Schedule 1) $12,000 Less: Cost of goods sold (Schedule 7) 9,277 Gross margin $ 2,723 Less: Marketing expenses (Schedule 8) -912 R & D expenses (Schedule 9) -112 Administrative expenses (Schedule 10) -163 Operating income $ 1,536 Less: Interest expense (Schedule 12) 42 Income before taxes $ 1,494 Less: Income taxes 600 Net income $ 894

Schedule 11 (in thousands) ABT, Inc. Cost of Goods Sold Budget For the Year Ended December 31, 2004 Sales (Schedule 1) $12,000 Less: Cost of goods sold (Schedule 7) 9,277 Gross margin $ 2,723 Less: Marketing expenses (Schedule 8) -912 R & D expenses (Schedule 9) -112 Administrative expenses (Schedule 10) -163 Operating income $ 1,536 Less: Interest expense (Schedule 12) 42 Income before taxes $ 1,494 Less: Income taxes 600 Net income $ 894

The Financial Budgets The usual financial budgets prepared are: The cash budget The budgeted balance sheet The budgeted statement of cash flows The budget for capital expenditures

The Cash Budget Beginning cash balance + Cash receipts Cash available - Cash disbursements - Minimum cash balance Excess or deficiency of cash - Repayments + Loans + Minimum cash balance Ending cash balance

Schedule 12 (in thousands) For the Year Ended December 31, 2004 ABT, Inc. Cash Budget For the Year Ended December 31, 2004 Quarter 1 2 3 4 Year Beginning cash balance $ 120 $ 113 $ 152 $1,334 $ 120 Cash collections 1,490 3,780 4,710 2,080 12,060 Total cash available $1,610 $3,893 $4,862 $3,414 $12,180 Total disbursements $2,097 $3,317 $3,310 $2,079 $10,803 Minimum cash balance 100 100 100 100 100 Total cash needs $2,197 $3,417 $3,410 $2,179 $10,903 Excess (deficiency) of cash -$ 587 $ 476 $1,452 $1,235 $ 1,277 Add: Borrowings 600 --- --- --- 600 Less: Repayments --- 400 200 --- 600 Less: Interest paid --- 24 18 --- 42 Ending cash balance $ 13 $ 52 $1,234 $1,235 $ 1,235 Plus: Minimum cash balance 100 100 100 100 100 Ending cash balance $ 113 $ 152 $1,334 $1,335 $ 1,335

Schedule of Cash Receipts (in thousands) ABT, Inc. Schedule of Cash Receipts (in thousands) Source Quarter 1 Quarter 2 Quarter 3 Quarter 4 Cash sales $ 700 $2,100 $2,400 $ 800 Received on account from sales in: Quarter 4, 2003 300 Quarter 1, 2004 490 210 Quarter 2, 2004 1,470 630 Quarter 3, 2004 1,680 720 Quarter 4, 2004 560 Total cash receipts $1,490 $3,780 $4,710 $2,080

Balance Sheet (in thousands) ABT, Inc. Balance Sheet (in thousands) December 31, 2003 Note that this is the actual balance sheet for 2003 Assets Current assets: Cash $ 120 Accounts receivable 300 Material inventory 50 Finished goods inventory 55 Total current assets $ 525 Property, plant, and equipment: Land $2,500 Building and equipment 9,000 Accumulated depreciation -4,500 Total property, plant, and equipment 7,000 Total assets $7,525 Continued

Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 100 Stockholders’ equity: Common stock, no par $ 600 Retained earnings 6,825 Total stockholders’ equity 7,425 Total liabilities and stockholders’ equity $7,525

Schedule 13 (in thousands) Budgeted Balance Sheet ABT, Inc. Budgeted Balance Sheet December 31, 2004 Assets Current assets: Cash $1,335 Accounts receivable 240 Material inventory 50 Finished goods inventory 58 Total current assets $1,683 Property, plant, and equipment: Land $2,500 Building and equipment 9,600 Accumulated depreciation -5,360 Total property, plant, and equipment 6,740 Total assets $8,423 Continued

Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 104 Stockholders’ equity: Common stock, no par $ 600 Retained earnings 7,719 Total stockholders’ equity 8,319 Total liabilities and stockholders’ equity $8,423

End of Chapter