Introduction to Management Accounting: The Master Budget Chapter 20 HORNGREN ♦ HARRISON ♦ BAMBER ♦ BEST ♦ FRASER ♦ WILLETT

Objectives 1. Distinguish between financial accounting and management accounting, and use management accounting information for decision making. 2. Describe the value chain and classify costs by value-chain function 3. Distinguish direct costs from indirect costs 4. Distinguish among full product costs, inventoriable product costs and period costs

Objectives 5. Prepare the financial statements of a manufacturing company 6. Identify the benefits of budgeting 7. Prepare an operating budget for a company 8. Prepare the components of a financial budget 9. Use sensitivity analysis in budgeting.

The Functions of Management Planning Acting Controlling Feedback

Objective 1 Distinguish between financial accounting and management accounting, and use management accounting information for decision-making

Management Accounting and Financial Accounting Primary Users Internal managers of the business Investors, Creditors, Government authorities (ATO, ASIC etc.)

Management Accounting and Financial Accounting Purpose of Information Help managers plan and control business operations Help investors, creditors, and others make investment, credit, and other decisions

Management Accounting and Financial Accounting Focus and Time Dimension Relevance Reliability, objectivity, and focus on the past

Management Accounting and Financial Accounting Type of Report Internal reports not restricted by GAAP Financial statements restricted by GAAP

Management Accounting and Financial Accounting Verification No independent audit Annual independent audit

Management Accounting and Financial Accounting Scope of Information Detailed reports on parts of the company Summary reports primarily on the company as a whole

Management Accounting and Financial Accounting Behavioral Implications Concern about how reports will affect employees behavior Concern about adequacy of disclosure

Service, Retail, and Manufacturing Companies Service Company: provides intangible services, rather than tangible products Retail Company: resells products previously bought from suppliers

Service, Retail, and Manufacturing Companies Manufacturing Company: uses labour, plant, and equipment to convert raw materials into finished products Materials inventory Work in process inventory Finished goods inventory

Describe the value chain value-chain functions. Objective 2 Describe the value chain and classify costs by value-chain functions.

Value Chain Research and Development Design Production or Purchases Marketing Distribution Customer Services

Distinguish direct costs Objective 3 Distinguish direct costs from indirect costs.

Cost Objects, Direct Costs, and Indirect Costs Cost objects are anything for which a separate measurement of costs is desired. Cost drivers are any factors that affect cost.

Cost Objects, Direct Costs, and Indirect Costs What are examples of cost objects? individual products alternative marketing strategies geographic segments of the business departments

Cost Objects, Direct Costs, and Indirect Costs What are direct costs? Direct costs are those costs that can be specifically traced to the cost object. What are indirect costs? Indirect costs are costs that cannot be specifically traced to the cost object.

Distinguish among full product costs, inventoriable product Objective 4 Distinguish among full product costs, inventoriable product costs, and period costs.

Product Costs What are product costs? They are the costs to produce (or purchase) tangible products intended for sale. There are two types of product costs: Full product costs Inventoriable product costs

External Reporting Inventoriable product costs Period costs

Inventoriable Product Costs For external reporting, a retailers’ inventoriable product costs includes only costs that are incurred in the purchase of goods. Inventoriable costs are an asset. Period costs flow as expenses directly to the statement of financial performance.

Inventoriable Product Costs For external reporting, manufacturers’ inventoriable product costs include raw materials plus all other costs incurred in the manufacturing process. Inventoriable product costs are incurred only in the third element of the value chain. Costs incurred in other elements of the value chain are period costs.

Inventoriable Product Costs Direct Materials Direct Labour Indirect Labour Indirect Materials Other Manufacturing Overhead

Inventoriable Product Costs Direct Materials Direct Labour Prime Costs = Direct Materials + Direct Labour

Inventoriable Product Costs Direct Labour Indirect Labour Indirect Materials Other Conversion Costs = Direct Labour + Manufacturing Overhead

Prepare the financial statements of a manufacturing company. Objective 5 Prepare the financial statements of a manufacturing company.

Financial Statements for Service Companies There is no inventory and thus no inventoriable costs. The statement of financial performance does not include cost of goods sold. Revenues – Expenses = Net Profits

Financial Statements for Retail Companies Statement of Financial Position Statement of Financial Performance Inventoriable Costs Sales Revenue when sales occur deduct Purchases of Inventory plus Freight-In Inventory Cost of Goods Sold equals Gross Profit deduct Period Costs Operating Expenses equals Net Profit

Financial Statements for Manufacturing Companies Statement of Financial Performance Statement of Financial Position Inventoriable Costs Sales Revenue Materials Inventory when sales occur deduct Finished Goods Inventory Cost of Goods Sold equals Gross Profit deduct Work in Process Inventory Period Costs Operating Expenses equals Net Profit

Manufacturing Company Example Kendall Manufacturing Company: Beginning and ending work-in-process inventories were $20,000 and $18,000. Direct materials used were $70,000. Direct labour was $100,000. Manufacturing overhead incurred was $150,000.

Manufacturing Company Example What is the cost of goods manufactured? Beginning work in process $ 20,000 Direct labour $100,000 Direct materials 70,000 Mfg. overhead 150,000 320,000 Ending work in process 18,000 Cost of goods manufactured $322,000

Manufacturing Company Example Kendall Manufacturing Company’s beginning finished goods inventory was $60,000 and its ending finished goods inventory was $55,000. How much is the cost of goods sold?

Manufacturing Company Example Beg. finished goods inventory $ 60,000 + Cost of goods manufactured 322,000 = Cost of goods available for sale $382,000 – Ending finished goods 55,000 = Cost of goods sold $327,000

Manufacturing Company Example Kendall Manufacturing Company had sales of $627,000 for the period. How much is the gross profit? Sales $627,000 – Cost of goods sold 327,000 = Gross profit $300,000

Manufacturing Company Example Kendall Manufacturing Company had operating expenses as follows: Sales salaries and commissions $ 80,000 Delivery expense 10,000 Administrative expenses 30,000 Total $120,000 What is Kendall’s net profit?

Manufacturing Company Example Gross profit $300,000 – Operating expenses 120,000 = Net Profit $180,000

Flow of Costs through a Manufacturer’s Accounts Work in Process Inventory Beginning inventory Direct materials used Direct labour Manufacturing overhead Total manufacturing costs to account for Ending inventory Cost of goods manufactured Direct Materials Inventory Beginning inventory Purchases and freight-in Direct materials available for use Ending inventory Direct materials used

Flow of Costs through a Manufacturer’s Accounts Finished Goods Inventory Beginning inventory Cost of goods manufactured Cost of goods available for sale Ending inventory Cost of goods sold

Objective 6 Identify the benefits of budgeting.

requires managers to plan promotes coordination motivates employees to Benefits of Budgeting requires managers to plan promotes coordination and communication helps managers evaluate performance motivates employees to achieve company goals

Components of the Master Budget Inventory Budget ____ ____ Sales Budget ____ ____ Purchases Budget ____ ____ Cost of Goods Sold Budget ____ ____ Operating Expenses Budget ____ ____ Budgeted Statement of Financial Performance ____ ____ Operating Budget

Components of the Master Budget Cash Budget _____ _____ Budgeted Statement of Financial Performance _____ _____ Capital Expenditures Budget _____ _____ Financial Budget Budgeted Statement of Financial Position _____ _____ Budgeted Statement of Cash Flows _____ _____

Preparing the Master Budget (An expanded example in your textbook pages 838 – 45) Suppose you manage Whitewater Sporting Goods store No. 18. Selected parts of the master budget will be prepared for Store No. 18 for October, November, December and January.

Preparing the Master Budget Sales are 60% cash and 40% on credit. Credit sales are collected in the month following the sale. Accounts receivable on September 30 amounted to $16,000. How much were total sales in Sept.? $16,000 ÷ .40 = $40,000

Preparing the Master Budget Projected Sales October……………. $50,000 November……….… $80,000 December………..… $60,000 January……..……… $50,000

Preparing the Master Budget Whitewater maintains inventory equal to $20,000 plus 80% of the budgeted cost of goods sold for the following month. Cost of goods sold averages 70% of sales. What is the ending inventory on Sept. 31? $20,000 + (0.80 × 0.70 × October sales of $50,000) = $48,000

Preparing the Master Budget What is the beginning inventory in September? $20,000 + (0.80 × 0.70 × $40,000) = $42,400 Opening Inventory $ 42,400 Plus Purchases $ ? Minus Closing Inv. $ 48,000 Equals COGS (70% x $40,000) $ 28,000 ? = $ 33,600

Preparing the Master Budget Whitewater pays for inventory as follows: 50% during the month of purchase and 50% during the next month. September purchases were $33,600. How much was paid in September for September’s purchases? $33,600 × 50% = $16,800

Prepare an operating budget Objective 7 Prepare an operating budget for a company.

Sales Budget (Schedule A) Sales revenue is the key measure of business activity. The budgeted total sales revenue for each product is the sales price multiplied by the expected number of units sold.

Sales Budget (Schedule A) Oct. Nov. Dec. Jan. Cash sales 60% $30,000 $48,000 $36,000 $30,000 Credit sales 40% 20,000 32,000 24,000 20,000 Total $50,000 $80,000 $60,000 $50,000 Total sales Oct through Jan = $240,000

Purchases, Cost of Goods Sold, and Inventory Budget Cost of goods sold = 70% × sales How much are the cost of goods sold for November? 70% × $80,000 = $56,000 What is the desired ending inventory for October? $20,000 + (80% × $56,000) = $64,800

Purchases, Cost of Goods Sold, and Inventory Budget Beginning inventory + Purchases – Ending inventory = Cost of goods sold Cost of goods sold + Ending inventory – Beginning inventory = Purchases

Schedule B Oct. Nov. Dec. Jan. Cost of goods sold (70% × sales) $35,000 $56,000 $42,000 $35,000 Desired ending inventory 64,800 53,600 48,000 42,400 Total required $99,800 109,600 90,000 77,400 Beginning inv. 48,000 64,800 53,600 48,000 Purchases $51,800 $44,800 $36,400 $29,400

Operating Expenses Budget Assume that Whitewater incurs $5,200 of fixed expenses every month and that commissions and other variable expenses equal 20% of sales. What is the operating expenses budget (Schedule C)?

Operating Expenses Budget (Schedule C) Oct. Nov. Dec Jan. Variable expenses (From Schedule A) 20% of sales $ 10,000 $ 16,000 $12,000 $10,000 Fixed expenses 5,200 5,200 5,200 5,200 Total $15,200 $21,200 $17,200 $15,200 Total wages and commission: $68,800

Budgeted Statement of Financial Performance Whitewater Sporting Goods Store No. 18 Budgeted Statement of Financial Performance Four Months Ending January 31, 2005 Amount Source Sales $240,000 Schedule A Cost of goods sold 168,000 Schedule B Gross profit $ 72,000 Operating expense 68,800 Schedule C Net profit $ 3,200

Prepare the components Objective 8 Prepare the components of a financial budget.

Preparing the Financial Budget The financial budget includes: Cash budget Budgeted Statement of Financial Position

Preparing the Cash Budget The cash budget has the following major parts: cash collections from customers (Schedule D) cash disbursements for purchases (Schedule E) cash disbursements for operating expenses (Schedule F) capital expenditures (not illustrated in this chapter)

Cash Collections from Customers (Schedule D) From Schedule A Oct. Nov. Dec. Jan. Cash sales $30,000 $48,000 $36,000 $30,000 Collections of last month’s credit sales 16,000* 20,000 32,000 24,000 Total $46,000 $68,000 $68,000 $54,000 Total collections: $236,000 *16,000 = September 30 accounts receivable

Cash Disbursements for Purchases (Schedule E) From Schedule B Oct. Nov. Dec. Jan. Payment of last month’s purchases $18,800 $25,900 $22,400 $18,200 Payment of this month’s purchases 25,900 22,400 18,200 14,700 Total $42,700 $48,300 $40,600 $32,900 Total disbursements: $164,500

Cash Disbursements for Operating Expenses (Schedule F) From Schedule C Oct. Nov. Dec. Jan. Payment of last month’s expenses $ 4,250 $ 5,000 $7,250 $ 5,750 Payment of this month’s expenses 5,000 7,250 5,750 5,000 Rent and Misc. 4,500 6,000 5,000 4,500 Total $13,750 $18,250 $18,000 $15,250 Total disbursements: $65,250

Cash Budget Whitewater Sporting Goods Store No. 18 Cash Budget Four Months Ending January 31, 2005 Budgeted cash receipts $236,000 Budgeted cash disbursements Purchases $164,500 Operating expenses 65,250 229,750 Budgeted cash increase $ 6,250

Preparing the Budgeted Statement of Financial Position Assets, liabilities, and owners’ equity are projected based upon the previous schedules. Assume that the cash balance on September 30 was $15,000. What is the budgeted cash balance on January 31? $15,000 + $6,250 expected increase = $21,250

Use sensitivity analysis Objective 9 Use sensitivity analysis in budgeting.

Budgeting and Sensitivity Analysis Sensitivity analysis helps managers plan for different courses of action. This type of “what if” analysis shows the result of changing an underlying assumption in the budgeting process. Sensitivity analysis may affect very specific plans.

End of Chapter 20