Managerial Accounting, Fifth Edition CHAPTER 9 Budgetary Planning Managerial Accounting, Fifth Edition

Budgeting Basics Budget A formal written statement of management’s plans for a specified future time period, expressed in financial terms. Primary way to communicate agreed-upon objectives to all parts of the company. Promotes efficiency. Control device - important basis for performance evaluation once adopted.

Budgeting Basics – Role of Accounting Historical accounting data on revenues, costs, and expenses help in formulating future budgets. Accountants normally responsible for presenting management’s budgeting goals in financial terms. The budget and its administration are, however, entirely management’s responsibility.

Budgeting Basics - Benefits Requires all levels of management to plan ahead and formalize goals on a recurring basis. Provides definite objectives for evaluating performance at each level of responsibility. Creates an early warning system for potential problems. LO 1: Indicate the benefits of budgeting.

Budgeting Basics - Benefits Facilitates coordination of activities within the business. Results in greater management awareness of the entity’s overall operations and the impact of external factors. Motivates personnel throughout organization to meet planned objectives. LO 1: Indicate the benefits of budgeting.

The Budget Period May be prepared for any period of time. Most common - one year. Supplement with monthly and quarterly budgets. Different budgets may cover different time periods. Long enough to provide an attainable goal and minimize seasonal or cyclical fluctuations. Short enough for reliable estimates. Continuous twelve-month budget . Drop the month just ended and add a future month. Keeps management planning a full year ahead. LO 2: State the essentials of effective budgeting.

Budgeting Versus Long Range Planning Three basic differences between Budgeting and Long Range Planning: Time period involved, Emphasis, and Detail presented, Budgeting is short-term – usually one year. Long range planning - at least five years. LO 2: State the essentials of effective budgeting.

The Master Budget A set of interrelated budgets that constitutes a plan of action for a specified time period. Contains two classes of budgets: Operating budgets: Individual budgets that result in the preparation of the budgeted income statement – establish goals for sales and production personnel. Financial budgets: The capital expenditures budget, the cash budget, and the budgeted balance sheet – focus primarily on cash needs to fund operations and capital expenditures. LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Sales Budget First budget prepared. Derived from the sales forecast. Management’s best estimate of sales revenue for the budget period. Every other budget depends on the sales budget. Prepared by multiplying expected unit sales volume for each product by anticipated unit selling price. LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Sales Budget BE 9-2 Example – Mussatto Company Mussatto Company estimates that unit sales will be 10,000 in quarter 1; 12,000 in quarter 2; 14,000 in quarter 3 and 18,000 in quarter 4. Sales price: $80 per unit. Prepare the sales budget for quarters for the year ending Dec 31, 2011 Illustration 9-3 LO 3: Identify the budgets that comprise the master budget.

For the year ending Dec 31st, 2011 BE 9-2 continued Mussatto Company Sales Budget For the year ending Dec 31st, 2011 1 2 3 4 Year Expected unit Sales 10,000 12,000 14,000 18,000 54,000 Unit Selling price X 80.00 Total Sales 800,000 960,000 1,120,000 1,440,000 4,320,000

Prepare a Sales Budget for 2 quarters - Example Trusler Electronics Inc. produces and sells two models of pocket calculators, XQ -103 and XQ -104. The calculators sell for $12 and $25, respectively. Because of the intense competition Trusler faces, management budgets sales semi-annually. Its projections for the first 2 quarters of 2011 are as follows: Unit Sales per Quarter Product Qrt 1 Qrt 2 XQ -103 20,000 25,000 XQ -104 12,000 15,000 No changes in selling prices are anticipated. Instructions: Prepare a sales budget for the 2 quarters ending June 30th 2011. List the products and show for each quarter and for the 6 months, units, selling price and total sales by product and in total.

Solutions to Sales Example Quarter 1 Quarter 2 Six Months Product Units Price Total Sales Unit totals XQ 103 20,000 $12 $240,000 25,000 $300,000 45,000 540,000 XQ 104 12,000 $25 15,000 $375,000 27,000 675,000 Total $540,000 $675,000 72,000 1,215,000

Operating Budgets: Production Budget Shows the units that must be produced to meet anticipated sales. Derived from sales budget plus the desired change in ending finished goods (ending finished goods less the beginning finished goods units). Required production in units formula: Essential to have a realistic estimate of ending inventory. Illustration 9-4 LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Production Budget BE 9-3 Example – Mussatto Company Sales Budget data Mussatto Company are given in the last example (BE 9-2). Management desires to have an ending finished goods inventory equal to 20% of the next quarter’s expected unit sales. Prepare a production budget by quarters for the first 6 months of 2011 Illustration 9-5 LO 3: Identify the budgets that comprise the master budget.

BE9-3 continued Mussatto Company Production Budget First two quarters in 2011 1 2 6 Month Totals Expected Unit Sales 10,000 12,000 ADD: Desired Finished Goods Units 2,400 2,800 Total Required Units 12,400 14,800 LESS: Beginning Finished Goods Inventory 2,000 Required production units 10,400 22,800

Operating Budgets: Direct Materials Budget Shows both the quantity and cost of direct materials to be purchased. Derived from the direct materials units required for production (from the production budget) plus the desired change in ending direct materials units. Budgeted cost of direct materials to be purchased = required units of direct materials × anticipated cost per unit. Illustration 9-6 LO 3: Identify the budgets that comprise the master budget.

BE 9-4 Direct Materials Budget Example Hannon Company has 1,600 pound of raw materials in its December 31,2011 ending inventory. Required production for January and February 2012 are 4,000 and 5,500 units respectively. Two pounds of raw materials are needed for each unit, and the estimated cost per pound is $6. Management desires an ending inventory equal to 20% of month’s material requirements. Prepare the direct material budget for January.

BE 9-4 solution Hannon Company Direct Materials Budget For the Month Ending January 31st, 2012 Units to be produced 4,000 Direct materials per unit X 2 Total pounds required for production 8,000 Add: Desired ending inventory (20% X 5,500 X 2) 2,200 Total materials required 10,200 Less: Beginning materials inventory 1,600 Direct materials purchases 8,600 Cost per pound X $6 Total cost of direct materials purchases $51,600

Production & Materials Budget Example On January 1, 2012 the Lovell Company budget has reached agreement on the following data for the 6 months ending June 30th 2010 Unit Sales First Qtr 5,000; Second Qtr 6,000; Third Qtr 7,000; Ending Raw Materials inventory: 50% of the next quarters production requirements Ending finished goods inventory: 30% of the next quarter’s expected sales units Third Quarter Production: 7,250 The ending raw materials and finished goods inventories at Dec 31, 2011, follow the same percentage relationships to production and sales that occur in 2012. Three pounds of raw materials are required to make each unit of finished goods. Raw materials purchased are expected to cost $4 per pound.

Production & Materials Budget Example Instructions: Prepare a production budget by quarters for the 6 – month period ended June 30th 2012. QRT 1 QRT 2 Six Months Expected unit sales 5,000 6,000 Add: Desired ending finished goods units 1,800 2,100 Total required units 6,800 8,100 Less: Beg finished goods units 1,500 Required production units 5,300 6,300 11,600

Production Budget Example Instructions: Prepare a direct materials budget by quarters for the 6 – month period ended June 30th 2012 QRT 1 QRT 2 Six Months Units to be produced X Direct Materials per unit = total pounds needed for production 5,300 X 3 15.900 6,300 X 3 18,900 Add: Desired ending direct materials (pound) = total pounds 9,450 25,350 10,875 29,775 Less: Beginning direct materials (pounds) = Direct materials purchased 7,950 17,400 20,325 Cost per pound X $4 Total cost of direct material purchased $69,600 $81,300 $150,900

Operating Budgets: Direct Labor Budget Shows both the quantity of hours and cost of direct labor necessary to meet production requirements. Critical in maintaining a labor force that can meet expected production. Total direct labor cost formula: Illustration 9-8 LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Direct Labor Budget Example – Cobb Company BE9-5 For Cobb Company, units to be produced are 5,000 in quarter 1 and 6,000 in quarter 2. It takes 1.5 hours to make a finished unit, and the expected hourly wage rate is $14 per hour. Prepare a direct labor budget by quarters for the 6 months ending June 30, 2011 LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Direct Labor Budget Example – Cobb Company BE9-5 Cobb Company Direct Labor Budget Quarters 1 and 2 Ending June 30, 2011 Quarters   1 2 Six Months Units to be produced 5,000 6,000 11,000 DL time/unit X 1.5 hrs X 1.5 X 1.5hrs Total DL hours 7,500 9,000 16,500 Direct Labor/hour $14.00 $14.00 $14.00 Direct labor cost $105,000 $126,000 $231,000 LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Manufacturing Overhead Shows the expected manufacturing overhead costs for the budget period. Distinguishes between fixed and variable overhead costs. BE9-6 For Eckert Inc., variable manufacturing overhead costs are expected to be $20,000 in the first quarter of 2011, with $4,000 increments in each of the remaining three quarters. Fixed overhead costs are estimated to be $35,000 in each quarter. Prepare the manufacturing overhead budget by quarters and in total for the year. LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Manufacturing Overhead BRIEF EXERCISE 9-6 ECKERT INC. Manufacturing Overhead Budget For the Year Ending December 31, 2011 Quarter 1 2 3 4 Year Variable costs Fixed costs Total manufacturing overhead $20,000  35,000 $55,000 $24,000 $59,000 $28,000 $63,000 $32,000 $67,000 $104,000  140,000 $244,000 Illustration 9-10 LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Budgeted Income Statement Important end-product of the operating budgets. Indicates expected profitability of operations. Provides a basis for evaluating company performance. Prepared from the operating budgets: Sales Budget, Production Budget, Direct Materials Budget, Direct Labor Budget, Manufacturing Overhead Budget, and Selling and Administrative Expense Budget. LO 4: Describe the sources for preparing the budgeted income statement.

Prepare a Budgeted Income Statement: Example BE 9-8 Paige company has completed all of its operating budgets. The sales budgets for the year shows 50,000 units and total sales of $2,000,000. The total unit cost of making one unit of sales is $22. Selling and administrative expenses are expected to be $300,000. Income taxes are estimated to be $150,000. Prepare a budgeted income statement for the year ending December 31, 2011

Budgeted Income Statement For the Year Ending December 31, 2011 BE 9-8 CONTINUED PAIGE COMPANY Budgeted Income Statement For the Year Ending December 31, 2011 Sales $2,000,000 Cost of goods sold (50,000 X $22)  1,100,000 Gross profit    900,000 Selling and administrative expenses    300,000 Income before income taxes    600,000 Income tax expense    150,000 Net income $  450,000

Financial Budgets: Cash Budget Shows anticipated cash flows. Often considered to be the most important output in preparing financial budgets. Contains three sections: Cash Receipts, Cash Disbursements, and Financing. Shows beginning and ending cash balances. LO 5: Explain the principal sections of a cash budget.

Financial Budgets: Cash Budget Cash Receipts Section: Includes expected receipts from the principal sources of revenue – usually cash sales and collections on credit sales. Shows expected interest and dividends receipts as well as proceeds from planned sales of investments, plant assets, and capital stock. Cash Disbursements Section: Includes expected cash payments for direct materials and labor, taxes, dividends, plant assets, etc. Financing Section: Shows expected borrowings and repayments of borrowed funds plus interest. LO 5: Explain the principal sections of a cash budget.

Budgeting: Merchandisers Sales Budget: Starting point and key factor in developing the master budget. Use a purchases budget instead of a production budget. Does not use the manufacturing budgets (direct materials, direct labor, manufacturing overhead). To determine budgeted merchandise purchases: LO 6: Indicate the applicability of budgeting in nonmanufacturing companies.

Budgeting: Service Companies Critical factor in budgeting is coordinating professional staff needs with anticipated services. Problems if overstaffed: Disproportionately high labor costs, Lower profits due to additional salaries, and / or Increased staff turnover due to lack of challenging work. Problems if understaffed: Lost revenues because existing and future client needs for services cannot be met, and / or Loss of professional staff due to excessive work loads. LO 6: Indicate the applicability of budgeting in manufacturing companies.

Budgeting: Not-for-Profit Companies Just as important as for profit-oriented company. However, budget process differs significantly from that of a profit-oriented company. Budget on the basis of cash flows (expenditures and receipts), not on a revenue and expense basis. The starting point is usually expenditures, not receipts. Management’s task is to find receipts needed to support planned expenditures. Budget must be strictly followed, overspending often illegal. LO 6: Indicate the applicability of budgeting in nonmanufacturing companies.

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