2. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Planning and Budgeting Chapter 13 Edited by Dr. Charles Bailey for ACCT3310

3. 13-2 Learning Objectives LO 13-1Understand the role of budgets in overall organization plans. LO 13-2Understand the importance of people in the budgeting process. LO 13-3Estimate sales. LO 13-4Develop production and cost budgets. LO 13-5Estimate cash flows. LO 13-6Develop budgeted financial statements. LO 13-7Explain budgeting in merchandising and service organizations. LO 13-8Explain why ethical issues arise in budgeting. LO 13-9Explain how to use sensitivity analysis to budget under uncertainty.

4. 13-3 Budgets LO 13-1 Understand the role of budgets in overall organization plans. We focus on the planning purpose of the budgeting process. For our purposes here, a budget is simply the plan, stated in financial terms, of how the organization expects to carry out its activities and meet the financial goals established in the planning process. We show how a master budget is developed and how it fits into the overall plan for achieving organization goals. Before we investigate the details of developing a master budget, we discuss the way that strategic planning can increase competitiveness and affect global operations. LO 13-1

5. 13-4 Overall Plan A master budget is part of an overall organization plan for the next year made up of three components: (1) the organization goals, (2) the strategic long-range profit plan, and (3) the tactical short-range profit plan. A master budget is part of an overall organization plan for the next year made up of three components: (1) the organization goals, (2) the strategic long-range profit plan, and (3) the tactical short-range profit plan. Top managers establish broad objectives, which serve as organization goals that company employees work to achieve. It is important to detail the specific steps required to achieve the goals. These steps are expressed in a strategic long-range plan. The plan for the coming year, which is more specific than long-range plans, is called the master budget, also known as the static budget, the budget plan, or the planning budget. LO 13-1

6. 13-5 Organizational and Individual Interaction: Developing the Master Budget LO 13-1

7. 13-6 Human Element in Budgeting LO 13-2 Understand the importance of people in the budgeting process. Organization goals Individual goals Goal congruence Participative Budgeting Use of input from lower- and middle-management employees; also called grass roots budgeting LO 13-2

8. 13-7 Sales Forecasting LO 13-3 Estimate sales. Forecasting sales is the most difficult aspect of budgeting. Sales staff Market researchers Delphi technique Trend analysis Econometric models LO 13-3

9. 13-8 Forecasting by Sales Staff After evaluating the sales forecasts derived from various sources, the budgeting task force at Santiago Pants arrived at the following sales budget for the next budget year: LO 13-3

10. 13-9 Forecasting Production LO 13-4 Develop production and cost budgets. Beginning balance BB Beginning balance BB Transfers in TI Transfers in TI Transfers out TO Transfers out TO + + – – = = Ending balance Units in beginning inventory Units in beginning inventory Required production Required production Budgeted sales Budgeted sales + + – – = = Units in ending inventory Units in ending inventory A production budget is a plan of resources needed to meet current sales demand and ensure that inventory levels are sufficient for future sales. LO 13-4

11. 13-10 Production Budget Management estimates that there will be 5,000 units in beginning inventory and 15,000 in ending inventory. Santiago Pants' sales budget is 160,000 units Budgeted sales Budgeted sales Units in ending inventory Units in ending inventory Units in beginning inventory Units in beginning inventory + + – – = = Required production Required production Rearranging for required production: 160,000 units 160,000 units 15,000 units 15,000 units 5,000 units 5,000 units + + – – = = 170,000 units 170,000 units LO 13-4

12. 13-11 Production Budget LO 13-4

13. 13-12 Production Costs Manufacturing overhead Manufacturing overhead Direct materials Direct materials Direct labor Direct labor Indirect labor Indirect materials Other LO 13-4

14. 13-13 Direct Materials Example LO 13-4

15. 13-14 Direct Materials Example Santiago Pants Estimated Production Materials Data Yards needed: LO 13-4

16. 13-15 Direct Materials Example $ $ LO 13-4

17. 13-16 Direct Labor Example LO 13-4

18. 13-17 Overhead Example Santiago Pants Schedule of Budgeted Manufacturing Overhead For the Budget Year Ended December 31 Variable overhead needed to product 170,000 units: Indirect materials and supplies @ $0.30 per unit Materials handling @ $0.40 per unit Other indirect labor @ $0.10 per unit Total variable overhead Fixed manufacturing overhead (supervisory labor $102M, maintenance and repairs $50M, plant administration $85M, utilities $55M, depreciation $140M, insurance $30M, property taxes $60M,and other $22M) Total manufacturing overhead Variable overhead needed to product 170,000 units: Indirect materials and supplies @ $0.30 per unit Materials handling @ $0.40 per unit Other indirect labor @ $0.10 per unit Total variable overhead Fixed manufacturing overhead (supervisory labor $102M, maintenance and repairs $50M, plant administration $85M, utilities $55M, depreciation $140M, insurance $30M, property taxes $60M,and other $22M) Total manufacturing overhead $ 51,000 68,000 $ 17,000 $136,000 $544,000 $680,000 $ 51,000 68,000 $ 17,000 $136,000 $544,000 $680,000 LO 13-4

19. 13-18 Cost of Goods Sold Example Santiago Pants Budgeted Statement of Cost of Goods Sold For the Budget Year Ended December 31 Beginning work-in-process inventory Manufacturing costs: Direct materials: Beginning inventory Purchases Materials available for manufacturing Less: Ending inventory Total direct materials costs Direct labor Manufacturing overhead Total manufacturing costs Less: Ending work-in-process Cost of goods manufactured Add: Beginning finished goods inventory Less: Ending finished goods inventory Cost of goods sold Beginning work-in-process inventory Manufacturing costs: Direct materials: Beginning inventory Purchases Materials available for manufacturing Less: Ending inventory Total direct materials costs Direct labor Manufacturing overhead Total manufacturing costs Less: Ending work-in-process Cost of goods manufactured Add: Beginning finished goods inventory Less: Ending finished goods inventory Cost of goods sold $ 35,000 1,715,000 $1,750,000 (50,000) $ 35,000 1,715,000 $1,750,000 (50,000) $1,700,000 1,870,000 680,000 $1,700,000 1,870,000 680,000 $ -0- $4,250,000 -0- $4,250,000 120,000 a (375,000) b $3,995,000 $ -0- $4,250,000 -0- $4,250,000 120,000 a (375,000) b $3,995,000 a Management estimate b Estimate: (15,000 units × $25 value of finished goods) LO 13-4

20. 13-19 Marketing and Administrative Budget Example LO 13-4

21. 13-20 Income Statement Example LO 13-4

22. 13-21 Cash Budget LO 13-5 Estimate cash flows. The cash budget is a statement of cash on hand at the start of the budget period, expected cash receipts, expected cash disbursements, and the resulting cash balance at the end of the budget period. Cash receipts: – Collection of accounts receivable – Cash sales – Sales of assets – Borrowing – Issuing stock – Other LO 13-5

23. 13-22 Cash Budget Some cash disbursements: – Materials purchases – Manufacturing costs – Operating activities – Debt repayment – Acquisition of new assets – Income taxes – Dividends – Other activities Some cash disbursements: – Materials purchases – Manufacturing costs – Operating activities – Debt repayment – Acquisition of new assets – Income taxes – Dividends – Other activities LO 13-5

24. 13-23 Cash Budget Santiago Pants Cash Budget For the Budget Year Ended December 31 Cash balance beginning of period Receipts: Collections on accounts Collections employee loans Total receipts Less: Disbursements: Payments for accounts payable Direct labor Manufacturing overhead less noncash depreciation charges Marketing and administrative costs less noncash charges Payments for federal income taxes Dividends Reduction in long-term debt Acquisition of new assets Total disbursements Budgeted ending cash balance Cash balance beginning of period Receipts: Collections on accounts Collections employee loans Total receipts Less: Disbursements: Payments for accounts payable Direct labor Manufacturing overhead less noncash depreciation charges Marketing and administrative costs less noncash charges Payments for federal income taxes Dividends Reduction in long-term debt Acquisition of new assets Total disbursements Budgeted ending cash balance $6,840,000 100,000 1,694,000 1,870,000 540,000 1,422,000 350,000 30,000 23,000 1,470,000 $6,840,000 100,000 1,694,000 1,870,000 540,000 1,422,000 350,000 30,000 23,000 1,470,000 $ 830,000 6,940,000 7,399,000 $ 371,000 $ 830,000 6,940,000 7,399,000 $ 371,000 LO 13-5

25. 13-24 Cash Collections Example Santiago Pants Monthly Collection Experience Sales on Credit Expected Sales for Three Months LO 13-5

26. 13-25 Cash Collections Example Santiago Pants Multiperiod Schedule of Cash Collections For the Quarter Ended March 31 Beginning accounts receivable, January 1, $540,000 January sales, $500,000 a February sales, $450,000 b March sales, $600,000 c Total cash collections Beginning accounts receivable, January 1, $540,000 January sales, $500,000 a February sales, $450,000 b March sales, $600,000 c Total cash collections $540,000 100,000 $640,000 $540,000 100,000 $640,000 $375,000 90,000 $465,000 $375,000 90,000 $465,000 $337,500 120,000 $457,500 $337,500 120,000 $457,500 January $ 540,000 475,000 427,500 120,000 $1,562,500 $ 540,000 475,000 427,500 120,000 $1,562,500 Month FebruaryMarch Total for Quarter a 20% collected in January, 75% collected in February, and 5% not collected b 20% collected in February, 75% collected in March, and 5% not collected c 20% collected in March, 75% collected in April, and 5% not collected LO 13-5 Cash disc’t??

27. 13-26 Cash Disbursements Example Santiago Pants Monthly Disbursements for Purchases Experience Cash disbursement for current month's purchases 50% Cash disbursement for prior month's purchases 48 Cash discounts taken 2 Total cash disbursement for purchases100% Cash disbursement for current month's purchases 50% Cash disbursement for prior month's purchases 48 Cash discounts taken 2 Total cash disbursement for purchases100% Expected Purchases for Three Months January sales$120,000 February sales$200,000 March sales$250,000 January sales$120,000 February sales$200,000 March sales$250,000 LO 13-5

28. 13-27 Cash Disbursements Example Santiago Pants Multiperiod Schedule of Cash Disbursements For the Quarter Ended March 31 Beginning accounts payable, January 1, $256,000 January purchases, $120,000 a February purchases, $200,000 b March purchases, $250,000 c Additional cash payments Total cash disbursements Beginning accounts payable, January 1, $256,000 January purchases, $120,000 a February purchases, $200,000 b March purchases, $250,000 c Additional cash payments Total cash disbursements $256,000 60,000 250,000 $566,000 $256,000 60,000 250,000 $566,000 $ 57,600 100,000 250,000 $407,600 $ 57,600 100,000 250,000 $407,600 $ 96,000 125,000 250,000 $471,000 $ 96,000 125,000 250,000 $471,000 January $ 256,000 117,600 196,000 125,000 750,000 $1,444,600 $ 256,000 117,600 196,000 125,000 750,000 $1,444,600 Month FebruaryMarch Total for Quarter a 50% paid in January, 48% paid in February, and 2% discounts taken b 50% paid in February, 48% paid in March, and 2% discounts taken c 50% paid in March, 48% paid in April, and 2% discounts taken LO 13-5

29. 13-28 Budgeted Balance Sheet Example LO 13-6 Develop budgeted financial statements. Assets Current assets: Cash Accounts receivable Inventories Other current assets Total current assets Long-term assets: Property, plant, equipment Less: Accumulated depreciation Total assets Assets Current assets: Cash Accounts receivable Inventories Other current assets Total current assets Long-term assets: Property, plant, equipment Less: Accumulated depreciation Total assets Budget Year $ 830 540 155 161 $1,686 1,866 (1,246) $2,306 $ 830 540 155 161 $1,686 1,866 (1,246) $2,306 $ 6,940 7,200 4,265 -0- $18,405 1,470 (220) $19,651 $ 6,940 7,200 4,265 -0- $18,405 1,470 (220) $19,651 $ 7,399 6,840 3,995 100 $18,334 -0- $18,334 $ 7,399 6,840 3,995 100 $18,334 -0- $18,334 $ 371 900 425 61 $1,757 3,336 (1,470) $3,623 $ 371 900 425 61 $1,757 3,336 (1,470) $3,623 Balance Jan 1AdditionsSubtractions Balance Dec 31 Santiago Pants Budget Balance Sheet For the Budget Year Ended December 31 ($000) LO 13-6

30. 13-29 Budgeted Balance Sheet Example Liabilities and Shareholders Equity Current liabilities: Accounts payable Taxes payable Current portion of long-term debt Total current liabilities Long-term liabilities Total liabilities Shareholders' equity Common stock Retained earnings Total shareholders Total liabilities and shareholders equity Liabilities and Shareholders Equity Current liabilities: Accounts payable Taxes payable Current portion of long-term debt Total current liabilities Long-term liabilities Total liabilities Shareholders' equity Common stock Retained earnings Total shareholders Total liabilities and shareholders equity Budget Year $ 256 187 23 $ 466 258 $ 724 $ 437 1,145 $1,582 $2,306 $ 256 187 23 $ 466 258 $ 724 $ 437 1,145 $1,582 $2,306 $1,715 550 23 $2,288 -0- $2,288 $ -0- 1,149 $1,149 $3,437 $1,715 550 23 $2,288 -0- $2,288 $ -0- 1,149 $1,149 $3,437 $1,694 350 23 $2,067 23 $2,090 $ -0- 30 $2,120 $1,694 350 23 $2,067 23 $2,090 $ -0- 30 $2,120 $ 277 387 23 $ 687 235 $ 922 $ 437 2,264 $2,701 $3,623 $ 277 387 23 $ 687 235 $ 922 $ 437 2,264 $2,701 $3,623 Balance Jan 1AdditionsSubtractions Balance Dec 31 Santiago Pants Budget Balance Sheet For the Budget Year Ended December 31 ($000) LO 13-6

31. 13-30 Assembling the Master Budget for a Manufacturing Firm LO 13-6

32. 13-31 Budgeting in Service Organizations Marketing and administrative cost budget Marketing and administrative cost budget Sales forecast Budgeted cost of services Budgeted cost of services Budgeted income statement Budgeted income statement Cash budget Budgeted balance sheets LO 13-7 Explain budgeting in merchandising and service organizations. LO 13-7

33. 13-32 Budgeting Retail and Wholesale Organizations Purchases Marketing and administrative cost budget Marketing and administrative cost budget Sales forecast Budgeted income statement Budgeted income statement Cash budget Budgeted balance sheets LO 13-7

34. 13-33 Budgeting Retail and Wholesale Organizations Castro Audio & Video, Inc. Estimated Information for Retail Operations LO 13-7

35. 13-34 Budgeting Retail and Wholesale Organizations LO 13-7

36. 13-35 Ethical Problems in Budgeting LO 13-8 Explain why ethical issues arise in budgeting. Budgets can create serious ethical issues for many people. The company must recognize the trade-off between encouraging unbiased reporting by managers and the use of budget information in performance evaluation and rewards. LO 13-8

37. 13-36 Budgeting Under Uncertainty LO 13-9 Explain how to use sensitivity analysis to budget under uncertainty. Budgets allow management to explore many alternatives. Spreadsheets are helpful in preparing budgets and quantifying “what-if” conditions. Questions like what if labor costs are 10 percent higher (or lower) than projected? LO 13-9

38. 13-37 Alternative Budgeting Scenarios Santiago Pants Alternative Budget Scenarios LO 13-9

39. 13-38 End of Chapter 13