Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 9 Profit Planning, Activity-Based Budgeting and e- Budgeting

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 1

Purposes of Budgeting Systems Budget a detailed plan, expressed in quantitative terms, that specifies how resources will be acquired and used during a specified period of time.Budget ÊPlanning ËFacilitating Communication and Coordination ÌAllocating Resources ÍControlling Profit and Operations ÎEvaluating Performance and Providing Incentives

Types of Budgets DetailBudget DetailBudget DetailBudget MasterBudget Covering all phases of a company’s operations. Sales Production Materials

Types of Budgets Budgeted Financial Statements Balance Sheet Income Statement Statement of Cash Flows

Types of Budgets Continuous or Rolling 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. L o n g R a n g e B u d g e t s Capital budgets with acquisitions that normally cover several years. Financial budgets with financial resource acquisitions.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 2

Budgeted Income Statement Cash Budget Sales of Services or Goods Ending Inventory Budget Work in Process and Finished Goods Ending Inventory Budget Work in Process and Finished Goods Production Budget Production Budget Direct Materials Budget Direct Materials Budget Selling and Administrative Budget Selling and Administrative Budget Direct Labor Budget Direct Labor Budget Overhead Budget Overhead Budget Ending Inventory Budget Direct Materials Ending Inventory Budget Direct Materials Budgeted Balance Sheet Budgeted Statement of Cash Flows

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 3

Activity-Based Costing versus Activity-Based Budgeting Resources Cost objects: products and services produced, and customers served. Activities Resources Forecast of products and services to be produced and customers served. Activities Activity-Based Costing (ABC) Activity-Based Budgeting (ABB)

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 4

Sales Budget ÊBreakers, Inc. is preparing budgets for the quarter ending June 30. ËBudgeted sales for the next five months are: April 20,000 units May 50,000 units June 30,000 units July 25,000 units August 15,000 units. ÌThe selling price is $10 per unit. ÊBreakers, Inc. is preparing budgets for the quarter ending June 30. ËBudgeted sales for the next five months are: April 20,000 units May 50,000 units June 30,000 units July 25,000 units August 15,000 units. ÌThe selling price is $10 per unit.

Sales Budget

Production Budget SalesBudget ProductionBudget Completed Production must be adequate to meet budgeted sales and provide for sufficient ending inventory. Production must be adequate to meet budgeted sales and provide for sufficient ending inventory.

Production Budget The management of Breakers, Inc. wants ending inventory to be equal to 20% of the following month’s budgeted sales in units. On March 31, 4,000 units were on hand. Let’s prepare the production budget. The management of Breakers, Inc. wants ending inventory to be equal to 20% of the following month’s budgeted sales in units. On March 31, 4,000 units were on hand. Let’s prepare the production budget.

Production Budget From sales budget

Production Budget

March 31 ending inventory

Production Budget

Direct-Material Budget At Breakers, five pounds of material are required per unit of product. Management wants materials on hand at the end of each month equal to 10% of the following month’s production. On March 31, 13,000 pounds of material are on hand. Material cost $.40 per pound. Let’s prepare the direct materials budget. At Breakers, five pounds of material are required per unit of product. Management wants materials on hand at the end of each month equal to 10% of the following month’s production. On March 31, 13,000 pounds of material are on hand. Material cost $.40 per pound. Let’s prepare the direct materials budget.

Direct-Material Budget From our production budget

10% of the following month’s production Direct-Material Budget

March 31 inventory Direct-Material Budget

Direct-Labor Budget At Breakers, each unit of product requires 0.1 hours of direct labor. The Company has a “no layoff” policy so all employees will be paid for 40 hours of work each week. In exchange for the “no layoff” policy, workers agreed to a wage rate of $8 per hour regardless of the hours worked (No overtime pay). For the next three months, the direct labor workforce will be paid for a minimum of 3,000 hours per month. Let’s prepare the direct labor budget. At Breakers, each unit of product requires 0.1 hours of direct labor. The Company has a “no layoff” policy so all employees will be paid for 40 hours of work each week. In exchange for the “no layoff” policy, workers agreed to a wage rate of $8 per hour regardless of the hours worked (No overtime pay). For the next three months, the direct labor workforce will be paid for a minimum of 3,000 hours per month. Let’s prepare the direct labor budget.

From our production budget Direct-Labor Budget

This is the greater of labor hours required or labor hours guaranteed. Direct-Labor Budget

Overhead Budget Here is Breakers’ Overhead Budget for the quarter.

Selling and Administrative Expense Budget At Breakers, variable selling and administrative expenses are $0.50 per unit sold. Fixed selling and administrative expenses are $70,000 per month. The $70,000 fixed expenses include $10,000 in depreciation expense that does not require a cash outflows for the month. At Breakers, variable selling and administrative expenses are $0.50 per unit sold. Fixed selling and administrative expenses are $70,000 per month. The $70,000 fixed expenses include $10,000 in depreciation expense that does not require a cash outflows for the month.

Selling and Administrative Expense Budget From our Sales budget

Selling and Administrative Expense Budget

At Breakers, all sales are on account. The company’s collection pattern is: 70% collected in the month of sale, 25% collected in the month following sale, 5% is uncollected. The March 31 accounts receivable balance of $30,000 will be collected in full. At Breakers, all sales are on account. The company’s collection pattern is: 70% collected in the month of sale, 25% collected in the month following sale, 5% is uncollected. The March 31 accounts receivable balance of $30,000 will be collected in full. Cash Receipts Budget

Cash Disbursement Budget Breakers pays $0.40 per pound for its materials. One-half of a month’s purchases are paid for in the month of purchase; the other half is paid in the following month. No discounts are available. The March 31 accounts payable balance is $12,000. Breakers pays $0.40 per pound for its materials. One-half of a month’s purchases are paid for in the month of purchase; the other half is paid in the following month. No discounts are available. The March 31 accounts payable balance is $12,000.

140,000 lbs. × $.40/lb. = $56,000 Cash Disbursement Budget

Breakers: –Maintains a 12% open line of credit for $75,000. –Maintains a minimum cash balance of $30,000. –Borrows and repays loans on the last day of the month. –Pays a cash dividend of $25,000 in April. –Purchases $143,700 of equipment in May and $48,300 in June paid in cash. –Has an April 1 cash balance of $40,000. Breakers: –Maintains a 12% open line of credit for $75,000. –Maintains a minimum cash balance of $30,000. –Borrows and repays loans on the last day of the month. –Pays a cash dividend of $25,000 in April. –Purchases $143,700 of equipment in May and $48,300 in June paid in cash. –Has an April 1 cash balance of $40,000.

From our Cash Receipts Budget Cash Budget (Collections and Disbursements)

From our Cash DisbursementsBudget Cash Budget (Collections and Disbursements)

From our Direct Labor Budget Cash Budget (Collections and Disbursements)

From our Overhead Budget Cash Budget (Collections and Disbursements)

From our Selling and Administrative Expense Budget Cash Budget (Collections and Disbursements)

To maintain a cash balance of $30,000, Breakers must borrow $35,000 on its line of credit. Cash Budget (Collections and Disbursements)

Ending cash balance for April is the beginning May balance. Cash Budget (Financing and Repayment)

Cash Budget (Collections and Disbursements) Breakers must borrow an addition $13,800 to maintain a cash balance of $30,000.

Cash Budget (Financing and Repayment)

At the end of June, Breakers has enough cash to repay the $48,800 loan plus interest at 12%. Cash Budget (Collections and Disbursements)

Cash Budget (Financing and Repayment)

Cash Budget (Collections and Disbursements)

Cash Budget (Financing and Repayment)

Cost of Goods Manufactured

Cost of Goods Sold

Budgeted Income Statement Cost of Goods Manufact- ured and Sold BudgetedIncomeStatement Completed After we complete the cost of goods manufactured and sold schedules, we can prepare the budgeted income statement for Breakers.

Budgeted Income Statement

Budgeted Statement of Cash Flows

Budgeted Balance Sheet Breakers reports the following account balances on June 30 prior to preparing its budgeted financial statements: Land - $50,000 Building (net) - $148,000 Common stock - $217,000 Retained earnings - $46,400 Breakers reports the following account balances on June 30 prior to preparing its budgeted financial statements: Land - $50,000 Building (net) - $148,000 Common stock - $217,000 Retained earnings - $46,400

25%of June sales of $300,000 11,500 lbs. at $.40 per lb. 5,000 units at $4.60 per unit.

50% of June purchases of $56,800

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 5

Budgeted Income Statement Cash Budget Sales of Services or Goods Ending Inventory Budget Work in Process and Finished Goods Ending Inventory Budget Work in Process and Finished Goods Production Budget Production Budget Direct Materials Budget Direct Materials Budget Selling and Administrative Budget Selling and Administrative Budget Direct Labor Budget Direct Labor Budget Overhead Budget Overhead Budget Ending Inventory Budget Direct Materials Ending Inventory Budget Direct Materials Budgeted Balance Sheet Budgeted Statement of Cash Flows When the interactions of the elements of the master budget are expressed as a set of mathematical relations, it becomes a financial planning model that can be used to answer “what if” questions about unknown variables.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 6

Budget Administration The Budget Committee is a standing committee responsible for... l overall policy matters relating to the budget. l coordinating the preparation of the budget. The Budget Committee is a standing committee responsible for... l overall policy matters relating to the budget. l coordinating the preparation of the budget.

E-Budgeting Employees throughout an organization can submit and retrieve budget information electronically. This tends to streamline the entire budgeting process.

Firewalls and Information Security Budget information is extremely sensitive and confidential. A firewall is a computer or router placed between a company’s internal network and the internet to control all information between the outside world and the company’s local network.

Zero-Base Budgeting To receive funding during the budgeting process, each activity must be justified in terms of its continued usefulness.

International Aspects of Budgeting Firms with international operations face special problems when preparing a budget. Ê Fluctuations in foreign currency exchange rates. Ë High inflation rates in some foreign countries. Ì Differences in local economic conditions. Firms with international operations face special problems when preparing a budget. Ê Fluctuations in foreign currency exchange rates. Ë High inflation rates in some foreign countries. Ì Differences in local economic conditions.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 7

Budgeting Product Life-Cycle Costs Product planning and concept Design. Product planning and concept Design. Preliminary design. Preliminary design. Detailed design and testing. Detailed design and testing. Production. Distribution and customer service. Distribution and customer service.

Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Learning Objective 8

Behavioral Impact of Budgets Budgetary Slack: Padding the Budget People often perceive that their performance will look better in their superiors’ eyes if they can “beat the budget.”

Participative Budgeting Flow of Budget Data

End of Chapter 9