Budgetary Planning and Control CHAPTER 10 Budgetary Planning and Control

Components of the Master Budgeting Basics Components of the Master Budget.

Preparing the Operating Budget Illustration – Hayes Company manufactures and sells a single product, Kitchen-Mate. The budgets are prepared by quarters for the year ending December 31, 2011. Hayes company begins its annual budgeting process on September 1, 2010, and it completes the budget for 2011 by December 1, 2010. Expected sales volume: 3,000 units in the first quarter with 500-unit increments for each following quarter. Sales price: $60 per unit.

Preparing the Operating Budgets Production Budget Shows units that must be produced to meet anticipated sales. Derived from sales budget plus the desired change in ending finished goods. Required production in units formula: Essential to have a realistic estimate of ending inventory.

Preparing the Operating Budgets Illustration – Hayes Company Hayes Co. believes it can meet future sales needs with an ending inventory of 20% of next quarter’s sales.

Preparing Operating Budgets Direct Materials Budget Shows both the quantity and cost of direct materials to be purchased. Formula for direct materials quantities. Budgeted cost of direct materials to be purchased = required units of direct materials x anticipated cost per unit.

Preparing Operating Budgets Illustration – Hayes Company Inadequate inventories could result in temporary shutdowns of production. Because of its close proximity to suppliers, Hayes Company maintains an ending inventory of raw materials equal to 10% of the next quarter’s production requirements. The manufacture of each Kitchen-Mate requires 2 pounds of raw materials, and the expected cost per pound is $4. Assume that the desired ending direct materials amount is 1,020 pounds for the fourth quarter of 2011. Prepare a Direct Materials Budget.

Preparing Operating Budgets Illustration – Hayes Company

Preparing Operating Budget 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:

Preparing Operating Budget Illustration: Direct labor hours are determined from the production budget. At Hayes Company, two hours of direct labor are required to produce each unit of finished goods. The anticipated hourly wage rate is $10.

Preparing Operating Budgets Selling and Administrative Expense Budget Projection of anticipated operating expenses. Distinguishes between fixed and variable costs. Illustration: Variable expense rates per unit of sales are sales commissions $3 and freight-out $1. Variable expenses per quarter are based on the unit sales from the sales budget (Illustration 9-3). Hayes expects sales in the first quarter to be 3,000 units. Fixed expenses are based on assumed data. Prepare a selling and administrative expense budget.

Preparing Operating Budgets Selling and Administrative Expense Budget

Preparing 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: Manufacturing Overhead Selling and Administrative Expense Sales Direct Materials Direct Labor

Preparing Operating Budgets Budgeted Income Statement Illustration: To find the cost of goods sold, it is first necessary to determine the total unit cost of producing one Kitchen-Mate, as follows. Second, determine Cost of Goods Sold by multiplying units sold times unit cost: 15,000 units X $44 = $660,000

Preparing Operating Budgets Illustration: All data for the income statement come from the individual operating budgets except the following: (1) interest expense is expected to be $100, and (2) income taxes are estimated to be $12,000.

Preparing 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 Financing Shows beginning and ending cash balances.

Preparing Financial Budgets Cash Budget - Basic Format

Preparing Financial Budgets Cash Receipts Section Includes expected receipts from the principal sources of revenue. 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.

Preparing Financial Budgets Cash Budget Must prepare in sequence. Ending cash balance of one period is the beginning cash balance for the next. Data obtained from other budgets and from management. Often prepared for the year on a monthly basis.

Preparing Financial Budgets Illustration – Hayes Company Assumptions The January 1, 2011, cash balance is expected to be $38,000. Hayes wishes to maintain a balance of at least $15,000. Sales: 60% are collected in the quarter sold and 40% are collected in the following quarter. Accounts receivable of $60,000 at December 31, 2010, are expected to be collected in full in the first quarter of 2011. Short-term investments are expected to be sold for $2,000 cash in the first quarter. Continued

Preparing Financial Budgets Illustration – Hayes Company Assumptions Direct materials: 50% are paid in the quarter purchased and 50% are paid in the following quarter. Accounts payable of $10,600 at December 31, 2010, are expected to be paid in full in the first quarter of 2011. Direct labor: 100% is paid in the quarter incurred. Manufacturing overhead and selling and administrative expenses: All items except depreciation are paid in the quarter incurred. Management plans to purchase a truck in the second quarter for $10,000 cash.

Preparing Financial Budgets Illustration – Hayes Company Assumptions Hayes makes equal quarterly payments of its estimated annual income taxes. Loans are repaid in the earliest quarter in which there is sufficient cash (that is, when the cash on hand exceeds the $15,000 minimum required balance). Prepare a schedule of collections from customers.

Preparing Financial Budgets Illustration – Prepare a schedule of collections from customers.

Preparing Financial Budgets Illustration – Prepare a schedule of cash payments for direct materials.

Preparing the Financial Budgets Illustration – Cash Budget based on the assumptions and preceding schedules.

Standard Costs and Variance Analysis CHAPTER 11 Standard Costs and Variance Analysis

The Need for Standards Distinguishing between Standards and Budgets Both standards and budgets are predetermined costs, and both contribute to management planning and control. There is a difference: A standard is a unit amount. A budget is a total amount

Setting Standard Costs—a Difficult Task Ideal versus Normal Standards Companies set standards at one of two levels: Ideal standards represent optimum levels of performance under perfect operating conditions. Normal standards represent efficient levels of performance that are attainable under expected operating conditions. Properly set, normal standards should be rigorous but attainable.

Setting Standard Costs—a Difficult Task A Case Study To establish the standard cost of producing a product, it is necessary to establish standards for each manufacturing cost element— direct materials, direct labor, and manufacturing overhead. The standard for each element is derived from the standard price to be paid and the standard quantity to be used.

Setting Standard Costs—a Difficult Task Direct Materials The direct materials price standard is the cost per unit of direct materials that should be incurred.

Setting Standard Costs—a Difficult Task Direct Materials The direct materials quantity standard is the quantity of direct materials that should be used per unit of finished goods. The standard direct materials cost is $12.00 ($3.00 x 4.0 pounds).

Analyzing and Reporting Variances From Standards One of the major management uses of standard costs is to identify variances from standards. Variances are the differences between total actual costs and total standard costs.

Analyzing and Reporting Variances Illustration: Assume that in producing 1,000 gallons of Weed-O in the month of June, Xonic, Inc. incurred the following costs. The total standard cost of Weed- O is $42,000 (1,000 gallons x $42). Thus, total variance is $2,500.

Analyzing and Reporting Variances When actual costs exceed standard costs, the variance is unfavorable. When actual costs are less than standard costs, the variance is favorable. To interpret properly the significance of a variance, you must analyze it to determine the underlying factors. Analyzing variances begins by determining the cost elements that comprise the variance.

Analyzing and Reporting Variances Direct Materials Variances In completing the order for 1,000 gallons of Weed-O, Xonic used 4,200 pounds of direct materials. These were purchased at a cost of $3.10 per unit. Standard price is $3. Actual Quantity x Actual Price (AQ) x (AP) Standard Quantity x Standard Price (SQ) x (SP) Total Materials Variance (TMV) - = $13,020 (4,200 x $3.10) $12,000 (4,000 x $3.00) - = $1,020 U

Analyzing and Reporting Variances Direct Materials Variances Next, the company analyzes the total variance to determine the amount attributable to price (costs) and to quantity (use). The materials price variance is computed from the following formula. Actual Quantity x Actual Price (AQ) x (AP) Actual Quantity x Standard Price (AQ) x (SP) Materials Price Variance (MPV) - = $13,020 (4,200 x $3.10) $12,600 (4,200 X $3.00) - $420 U =

Analyzing and Reporting Variances Direct Materials Variances The materials quantity variance is determined from the following formula. Materials Quantity Variance (MQV) Standard Quantity x Standard Price (SQ) x (SP) Actual Quantity x Standard Price (AQ) x (SP) = - $12,600 (4,200 X $3.00) $12,000 (4,000 x $3.00) - = $600 U

Matrix for Direct Materials Variances 1 2 3 Actual Quantity × Actual Price (AQ) × (AP) 4,200 x $3.10 = $13,020 Actual Quantity × Standard Price (AQ) × (SP) 4,200 x $3.00 = $12,600 Standard Quantity × Standard Price (SQ) × (SP) 4,000 x $3.00 = $12,000 Price Variance $13,020 – $12,600 = $420 U Quantity Variance $12,600 – $12,000 = $600 U 1 - 2 2 - 3 Total Variance $13,020 – $12,000 = $1,020 U 1 - 3

Analyzing and Reporting Variances The standard cost of Product XX includes two units of direct materials at $8.00 per unit. During July, the company buys 22,000 units of direct materials at $7.50 and uses those materials to produce 10,000 units. Compute the total, price, and quantity variances for materials.

Analyzing and Reporting Variances Direct Labor Variances In completing the Weed-O order, Xonic, Inc. incurred 2,100 direct labor hours at an average hourly rate of $9.80. The standard hours allowed for the units produced were 2,000 hours (1,000 gallons x 2 hours). The standard labor rate was $10 per hour. The total labor variance is computed as follows. (2,100 x $9.80) - (2,000 x $10.00) = $580 U

Analyzing and Reporting Variances Direct Labor Variances Next, the company analyzes the total variance to determine the amount attributable to price (costs) and to quantity (use). The labor price variance is computed from the following formula. (2,100 x $9.80) - (2,100 x $10.00) = $420 F

Analyzing and Reporting Variances Direct Labor Variances The labor quantity variance is determined from the following formula. (2,100 x $10.00) - (2,000 x $10.00) = $1,000 U

Analyzing and Reporting Variances Manufacturing Overhead Variances Manufacturing overhead variances involves total overhead variance, overhead controllable variance, and overhead volume variance. Manufacturing overhead costs are applied to work in process on the basis of the standard hours allowed for the work done.

Analyzing and Reporting Variances Total Overhead Variance The total overhead variance is the difference between actual overhead costs and overhead costs applied to work done. The computation of the actual overhead is comprised of a variable and a fixed component. The predetermined rate for Weed-O is $5, comprised of a variable overhead rate of $3 and a fixed rate of $2.

Analyzing and Reporting Variances Total Overhead Variance The formula for the total overhead variance and the calculation for Xonic, Inc. for the month of June.

Analyzing and Reporting Variances Total Overhead Variance The overhead variance is generally analyzed through a price variance and a quantity variance. Overhead controllable variance (price variance) shows whether overhead costs are effectively controlled. Overhead volume variance (quantity variance) relates to whether fixed costs were under- or over-applied during the year.

Analyzing and Reporting Variances The standard cost of Product YY includes 3 hours of direct labor at $12.00 per hour. The predetermined overhead rate is $20.00 per direct labor hour. During July, the company incurred 3,500 hours of direct labor at an average rate of $12.40 per hour and $71,300 of manufacturing overhead costs. It produced 1,200 units. (a) Compute the total, price, and quantity variances for labor. (b) Compute the total overhead variance.

Analyzing and Reporting Variances All variances should be reported to appropriate levels of management as soon as possible. The form, content, and frequency of variance reports vary considerably among companies. Facilitate the principle of “management by exception.” Top management normally looks for significant variances.

Analyzing and Reporting Variances Materials price variance report for Xonic, Inc., with the materials for the Weed-O order listed first.