Planning for Profit and Cost Control Chapter 7

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-2 Introduction Detail Budget Detail Budget Detail Budget Master Budget Combination of numerous specific budgets Sales Production Inventory

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-3 The Budget Committee A standing committee responsible for  overall policy matters relating to the budget.  coordinating the preparation of the budget.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-4 The Planning Process Planning -- involves developing objectives and preparing various budgets to achieve these objectives. Control Control -- involves the steps taken by management that attempt to ensure the objectives are attained.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-5 Three Levels of Planning for Business Activity Strategic Planning Top management long-range decisions. Capital Budgeting Intermediate-range planning Operations Budgeting Direct firm’s activity in the short-range

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-6 Three Levels of Planning for Business Activity Operating Budget The annual operating budget may be divided into quarterly or monthly budgets.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-7 Three Levels of Planning for Business Activity Continuous or Perpetual Budget This budget is usually a twelve-month budget that rolls forward one month as the current month is completed

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-8 Advantages of Budgeting Corrective Action Performance Measurement Coordination Planning

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-9 Consideration for the Human Factor Flow of Budget Data Participative Budget System

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-10 The Master Budget The master budget consists of a series of detailed schedules and budgets that describe the company’s overall financial plans for the coming accounting period. The three major budget categories are  Operating budget  Capital budgets  Financial statement budgets

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-11 Information Flow in the Master Budget Cash Payments for S & A Cash Payments for Inventory Inventory Purchases Budget Income Statement S & A Expense Budget Balance Sheet Cash Receipts Sales Budget Cash Budget Cash Flow Statement Cash Receipts and Payments Schedules Operating Budgets Pro forma Financial Statements Start

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-12 Sales Budget Detailed schedule showing expected sales for the coming periods.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-13 Sales Budget  Web Company is preparing budgets for the quarter ending June 30.  Budgeted sales for the next five months are: April $200,000 May $500,000 June $300,000 July $250,000 August $150,000.  Cash sales are 20% of the total and credit sales are 80%.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-14 Sales Budget $200,000 × 20% = $40,000 Accounts receivable at June 30 Accounts receivable at June 30

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-15 Schedule of Cash Receipts Sales Budget Schedule of Cash Receipts Completed Cash receipts flow from expected sales.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-16 Schedule of Cash Receipts Web expects to collect its accounts receivable in the month following the month of sale. On March 31, accounts receivable totaled $100,000. Let’s prepare the cash receipts budget.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-17 Schedule of Cash Receipts From the Sales Budget

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-18 Purchases Budget The total amount of inventory needed for each month is equal to the amount of budgeted sales plus the desired ending inventory.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-19 Purchases Budget At Web, cost of sales is equal to 70% of total budgeted sales. Management wants to maintain an ending inventory that is equal to 20% of the current month’s cost of budgeted sales. The ending inventory at March 31 is $15,000. Let’s prepare the purchases budget.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-20 Purchases Budget Budgeted Cost of Sales $140,000 Desired Ending Inventory % 20% Desired Ending Inventory $ 28,000

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-21 Purchases Budget The ending inventory for April is the beginning inventory for May. The ending inventory for April is the beginning inventory for May.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-22 Purchases Budget Now we can move on to the Schedule of Cash payments for Inventory Purchases. Now we can move on to the Schedule of Cash payments for Inventory Purchases.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-23 Cash Payments for Inventory Purchases Web pays 80% of inventory purchases in the month of acquisition and the remaining 20% in the month following acquisition. On March 31, Web owed $14,000 for purchases of inventory. Let’s prepare the Cash Payments for Inventory Purchases schedule.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-24 Cash Payments for Inventory Purchases March 31 accounts payable for inventory purchases March 31 accounts payable for inventory purchases

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-25 Cash Payments for Inventory Purchases April Inventory Purchases $153,000 Percent Paid in Following Month 20% May Payment for April Purchases $ 30,600 April Inventory Purchases $153,000 Percent Paid in Following Month 20% May Payment for April Purchases $ 30,600

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-26 Cash Payments for Inventory Purchases June Inventory Purchases $182,000 Percent Paid in July 20% Accounts Payable at June 30 $ 36,400 June Inventory Purchases $182,000 Percent Paid in July 20% Accounts Payable at June 30 $ 36,400

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-27 Selling and Administrative Expense Budget Sales commissions are 2% of sales and are paid in the month after they are earned. Supplies expense is 1% of sales. Utilities are paid the month after they are used. On March 31, Web owed $3,000 in sales commissions and $1,200 in utilities.. Web has developed the selling and administrative expense budget shown on the next screen.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-28 Selling and Administrative Expense Budget $200,000 Sales × 2% = $4,000

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-29 Selling and Administrative Expense Budget Let’s see how these expenses translate into cash payments for selling and administrative expenses. $200,000 Sales × 1% = $2,000

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-30 Selling and Administrative Expense Budget Let’s see how these expenses translate into cash payments for selling and administrative expenses.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-31 Schedule of Cash Payments for S&A Expenses Amortization Expense is a non-cash expense. March 31 Sales Commissions and Utilities. March 31 Sales Commissions and Utilities.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-32 Schedule of Cash Payments for S&A Expenses April Sales Commissions and Utilities. April Sales Commissions and Utilities.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-33 Schedule of Cash Payments for S&A Expenses The total quarterly expenses of $141,700, Web will pay $133,700 in cash and record liabilities of $6,000 for June sales commissions and $1,700 for June utilities.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-34 Cash Budget Web want to maintain a $10,000 balance in its cash account before any interest payments. The company has a $100,000 line-of-credit that requires 12% interest on any outstanding balance payable monthly. Web plans to purchase $50,000 of equipment on April 1. On March 31, Web’s cash balance is $18,000. Let’s put together the information developed so far and prepare Web’s cash budget.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-35 Cash Budget Cash Receipts Budget Payment for Inventory Purchases Schedule Cash Payments for S&A Schedule

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-36 Cash Budget

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-37 Cash Budget ($78,600 + $128,900) × 1% = $2,075

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-38 Pro Forma Income Statement CashBudgetCashBudget Pro Forma IncomeStatement IncomeStatement Completed After we complete the cash budget, we can prepare the pro forma income statement for Web.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-39 Pro Forma Income Statement S&A Expense Budget

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-40 Pro Forma Balance Sheet On March 31, Web had the following account balances:  Equipment $100,000,  Capital stock $200,000, and  Retained earnings $19,300. With this data and the information developed in our budgets, we can prepare Web’s Pro Forma Balance Sheet.

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-41 Cash Receipts Budget

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-42 Sales Budget Purchases Budget Cash Payments for S&A Cash Payments for Inventory

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-43 Beginning retained earnings $ 19,300 Net income for quarter 155,439 Ending retained earnings $174,739 Beginning retained earnings $ 19,300 Net income for quarter 155,439 Ending retained earnings $174,739

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-44 Cash Receipts Budget Cash Receipts Budget Cash Payments for S&A Cash Payments for S&A Cash Payment for Inventory Cash Payment for Inventory

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-45 Cash Budget

Copyright © 2003 McGraw-Hill Ryerson Limited, Canada 7-46 End of Chapter 7