1. Financial and Managerial Accounting
Chapter 20
Budgeting
Financial and Managerial Accounting
8th Edition
Warren Reeve Fess

2. Objectives
1. Describe budgeting, its objectives, and its impact on human behavior.
2. Describe the basic elements of the budget process, the two major types of budgeting, and the use of computers in budgeting.
3. Describe the master budget for a manufacturing business.
4. Prepare the basic income statement budgets for a manufacturing business.
5. Prepare balance sheet budgets for a manufacturing business.

3. Nature and Objectives of Budgeting
Establishing specific goals
Executing plans to achieve the goals
Periodically comparing actual results to the goals
Feedback
PLANNING
DIRECTING
CONTROLLING

4. Nature and Objectives of Budgeting Human Behavior and Budgeting
Setting budget goals too tightly
Setting budget goals too loosely
Setting conflicting budget goals

5. Nature and Objectives of Budgeting
Goal conflict occurs when individual self-interest differs from business objectives.
A student’s question, “Will this be on the test?” is evidence of goal conflict.

6. Static Budgets
Description: A budget that does not reflect potential changes in volume or activity level
Strength: It is simple—all expenses are budgeted as fixed costs
Weakness: It does not reflect changes in revenues and expenses that occur as volumes change
Typical usage: Service organizations or administrative departments of retailers and manufacturers

7. Static Budgets Electric Power 5,000 Supervisor salaries 15,000
Colter Manufacturing Company
Assembly Department Budget
For the Month Ending July 31, 2006
Direct labor $40,000
Electric Power 5,000
Supervisor salaries 15,000
Total department costs $60,000

8. Flexible Budgets
Description: A budget that shows revenues and expenses for a variety of volumes or activity levels
Strength: Provides information needed to analyze the impact of volume changes on actual operating results
Weakness: Requires greater research into costs—must differentiate fixed and variable costs
Typical usage: Operational departments of retailers and manufacturers whose costs change with sales and production

9. Flexible Budgets Colter Manufacturing Company
Assembly Department Budget
For the Month Ending July 31, 2006
Units of production 8,000 9,000 10,000
Variable cost:
Direct labor $40,000 $45,000 $50,000
Electric power 4,000 4,500 5,000
Total variable cost $44,000 $49,500 $55,000
Fixed cost:
Electric power $ 1,000 $ 1,000 $ 1,000
Supervisor salaries 15,000 15,000 15,000
Total fixed cost $16,000 $16,000 $16,000
Total department costs $60,000 $65, $71,000
Cost per unit is $5.50 at all levels of activity

10. Static and Flexible Budgets
Manufacturing Costs
Over budget by $12,000
Static Budget
Actual Results
Work on this
$60,000
$72,000
Based on 8,000 units
Based on 10,000 units

11. Static and Flexible Budgets
Manufacturing Costs
Over budget by only $1,000
10,000 units
9,000 units
8,000 units
Actual Results
Flexible Budget
10,000 units
Work on this
$60,000
$65,500
$71,000
$72,000

12. Budgeted Income Statement requires Budgeted Balance Sheet requires
Master Budget
Budgeted Income Statement requires
Budgeted Balance Sheet requires
Sales budget
Cost of goods sold budget:
Production budget
Direct materials purchases budget
Direct labor cost budget
Selling and administrative expense budget
Cash budget
Capital expenditure budget

13. Income Statement Budgets

14. Data for Elite Accessories
Direct Materials sq yd usage
per unit
Direct Materials cost per sq yd
Wallet
Handbag
Leather
0.30
1.25
$4.50
Lining
0.10
0.50
$1.20
Direct labour hours required
Direct labour cost per hour
Cutting Dept
0.15
$12.00
Sewing Dept
0.25
0.40
$15.00

15. + Desired units in ending Finished goods inventory
Sales
Budget
Production Budget
Expected units of sales
+ Desired units in ending Finished goods inventory
– Estimated units in beginning Finished goods inventory
= Total units to be produced

16. – Est. beginning materials inventory
Sales
Budget
Production Budget
Direct Materials
Purchases Budget
Materials needed for production
+ Desired ending materials inventory
– Est. beginning materials inventory
= Direct materials to be purchased

17. Selling & Administrative
Sales
Budget
Production Budget
Direct Materials
Purchases Budget
Cost of Goods
Sold Budget
Direct Labor
Cost Budget
Selling & Administrative
Expenses
Budget
Factory Overhead
Cost Budget

18. For the Year Ending December 31, 2006
Elite Accessories Inc.
Sales Budget
For the Year Ending December 31, 2006
Unit Sales Unit Selling Total
Product and Region Volume Price Sales
Wallet:
East……………….. 287,000 $12.00 $ 3,444,000
West………………. 241, ,892,000
Total……………. 528,000 $ 6,336,000
Handbag:
East……………….. 156,400 $25.00 $ 3,910,000
West………………. 123, ,090,000
Total……………. 280,000 $ 7,000,000
Total revenue from
Sales……………….. $13,336,000

19. For the Year Ending December 31, 2006
Elite Accessories Inc.
Production Budget
For the Year Ending December 31, 2006
From Sales Budget
Units
Wallet Handbag
Expected units to be sold…………. 528, ,000
Plus desired ending inventory, December 31, 2006…………… , ,000
Total………………………………. 608, ,000
Less estimated beginning inventory, January 1, 2006…………………. 88, ,000
Total units to be produced………… 520, ,000

20. Direct Materials Purchases Budget
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production:
Wallet (Note A)………………….. 156,000 52,000
Note A: Leather: 520,000 units x 0.30 sq. yd. per unit = 156,000 sq. yds.
Lining: ,000 units x 0.10 sq. yd. Per unit = 52,000 sq. yds.

21. Direct Materials Purchases Budget
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production:
Wallet (Note A)……..……..…….. 156,000 52,000
Handbag (Note B)……………….. 365, ,000
Note B: Leather: 292,000 units x 1.25 sq. yd. per unit = 365,000 sq. yds.
Lining: ,000 units x 0.50 sq. yd. Per unit = 146,000 sq. yds.

22. Direct Materials Purchases Budget
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production:
Wallet (Note A)……....………….. 156,000 52,000
Handbag (Note B).………………. 365, ,000
Plus desired inventory, Dec. 31, , ,000
Total……………………………… 541, ,000

23. Direct Materials Purchases Budget
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production:
Wallet (Note A) …………………. 156,000 52,000
Handbag (Note B) ………………. 365, ,000
Plus desired inventory, Dec. 31, , ,000
Total……………………………… 541, ,000
Less estimated inventory, Jan. 1, , ,000
Total square yards to be purchased.. 523, ,000

24. Direct Materials Purchases Budget
Elite Accessories Inc.
Direct Materials Purchases Budget
For the Year Ending December 31, 2006
Direct Materials
Leather Lining Total
Square yards required for production:
Wallet (Note A)………………….. 156,000 52,000
Handbag (Note B).………………. 365, ,000
Plus desired inventory, Dec. 31, , ,000
Total……………………………… 541, ,000
Less estimated inventory, Jan. 1, , ,000
Total square yards to be purchased 523, ,000
Unit price (per square yard)…………. x $4.50 x $1.20
Total value of materials to be purchased. $2,353,500 $234,000 $2,587,500

25. Direct Labor Cost Budget For the Year Ending December 31, 2006
Elite Accessories Inc.
Direct Labor Cost Budget
For the Year Ending December 31, 2006
Cutting Sewing Total
Hours required for production:
Wallet (Note A)…………. 52, ,000
Note A: Cutting Department: 520,000 units x 0.10 hr. per unit = 52,000 hrs.
Sewing Department: 520,000 units x 0.25 hr. per unit = 130,000 hrs.

26. Direct Labor Cost Budget For the Year Ending December 31, 2006
Elite Accessories Inc.
Direct Labor Cost Budget
For the Year Ending December 31, 2006
Cutting Sewing Total
Hours required for production:
Wallet (Note A)…………. 52, ,000
Handbag (Note B)……… , ,800
Note A: Cutting Department: 520,000 units x 0.10 hr. per unit = 52,000 hrs.
Sewing Department: 520,000 units x 0.25 hr. per unit = 130,000 hrs. .
Note B: Cutting Department: 292,000 units x 0.15 hr. per unit = 43,800 hrs.
Sewing Department: 292,000 units x 0.40 hr. per unit = 116,800 hrs

27. Direct Labor Cost Budget For the Year Ending December 31, 2006
Elite Accessories Inc.
Direct Labor Cost Budget
For the Year Ending December 31, 2006
Cutting Sewing Total
Hours required for production:
Wallet (Note A)…………. 52, ,000
Handbag (Note B)……… , ,800
Total…………………… , ,800
Note A: Cutting Department: 520,000 units x 0.10 hr. per unit = 52,000 hrs.
Sewing Department: 520,000 units x 0.25 hr. per unit = 130,000 hrs. .
Note B: Cutting Department: 520,000 units x 0.15 hr. per unit = 43,800 hrs.
Sewing Department: 520,000 units x 0.40 hr. per unit = 116,800 hrs

28. Direct Labor Cost Budget For the Year Ending December 31, 2006
Elite Accessories Inc.
Direct Labor Cost Budget
For the Year Ending December 31, 2006
Cutting Sewing Total
Hours required for production:
Wallet (Note A)…………. 52, ,000
Handbag (Note B)……… , ,800
Total…………………… , ,800
Hourly rate…………………… x $12.00 x $15.00
Total direct labor cost………… $1,149,600 $3,702,000 $4,851,600
Note A: Cutting Department: 520,000 units x 0.10 hr. per unit = 52,000 hrs.
Sewing Department: 520,000 units x 0.25 hr. per unit = 130,000 hrs.
Note B: Cutting Department: 520,000 units x 0.15 hr. per unit = 43,800 hrs.
Sewing Department: 520,000 units x 0.40 hr. per unit = 116,800 hrs

29. Factory Overhead Cost Budget For the Year Ending December 31, 2006
Elite Accessories Inc.
Factory Overhead Cost Budget
For the Year Ending December 31, 2006
Indirect factory wages……………………... $ ,800
Supervisory salaries……………………… ,000
Power and light…………………………… ,000
Depreciation of plant and equipment……… ,000
Indirect materials…………………………… ,800
Maintenance……………………………… ,280
Insurance and property taxes……………… ,200
Total factory overhead cost……………… .. $2,089,080

30. Data for Elite Accessories – cont’d
Estimated Inventories:
January 1, 2006
December 31, 2006
Finished Goods
$1,095,600
$1,565,000
Work in Process
$214,400
$220,000

31. Cost of Goods Sold Budget For the Year Ending December 31, 2006
Elite Accessories Inc.
Cost of Goods Sold Budget
For the Year Ending December 31, 2006
Finished goods inventory, January 1 ,2006….. $ 1,095,600
Work in process inventory, January 1, 2006… $ 214,400
Direct materials:
Direct materials inventory, January 1, 2006
(Note A)…………………………………. $ ,000
Note A: Leather: 18,000 sq. yds. x $4.50 per sq. yd $81,000
Lining: 15,000 sq. yds. x $1.20 per sq. yd ,000
Direct materials
inventory,
January 1, $99,000

32. Cost of Goods Sold Budget For the Year Ending December 31, 2006
Elite Accessories Inc.
Cost of Goods Sold Budget
For the Year Ending December 31, 2006
Finished goods inventory, January 1 ,2006….. $ 1,095,600
Work in process inventory, January 1, 2006… $ 214,400
Direct materials:
Direct materials inventory, January 1, 2006
(Note A)…………………………………. $ ,000
Note B: Leather: 20,000 sq. yds. x $4.50 per sq. yd $ 90,000
Lining: 12,000 sq. yds. x $1.20 per sq. yd ,400
Direct materials inventory, December 31, 2006 $104,400

33. Cost of Goods Sold Budget
Elite Accessories Inc.
Cost of Goods Sold Budget
Finished goods inventory, January 1 ,2006…. $ 1,095,600
Work in process inventory, January 1, $ 214,400
Direct materials:
Direct materials inventory, January 1, 2006
(Note A)…………………………………. $ ,000
Direct materials purchases (Slide 24)…… ,587,500
Cost of direct materials available for use…. $2,686,500
Less direct materials inventory,
December 31, 2006 (Note B)…………… ,400
Cost of direct materials placed in production $2,582,100
Direct labor (Slide 28)………………………. 4,851,600
Factory overhead (Slide 29)………………….. 2,089,080
Total manufacturing costs……………………. 9,522,780
Total work in process during period…………. $9,737,180
Less work in process inventory, December 31, ,000
Cost of goods manufactured……………………… ,517,180
Cost of finished goods available for sale…………... $10,612,780
Less finished goods inventory, December 31, ,565,000
Cost of goods sold………………………………….. $ 9,047,780

34. Selling and Administrative Expenses Budget
Elite Accessories Inc.
Selling and Administrative Expenses Budget
For the Year Ending December 31, 2006
Selling expenses:
Sales salaries expense…………………………. $715,000
Advertising expense………………………… ,000
Travel expense………………………………… ,000
Total selling expenses………………………... $1,190,000
Administrative expenses:
Officers’ salaries expense………………………. $360,000
Office salaries expense…………………………. 258,000
Office rent expense……………………………... 34,500
Office supplies expense…………………………. 17,500
Miscellaneous administrative expense………… ,000
Total administrative expenses………………… ,000
Total selling and administrative expenses………… $1,885,000

35. Budgeted Income Statement For the Year Ending December 31, 2006
Elite Accessories Inc.
Budgeted Income Statement
For the Year Ending December 31, 2006
Revenue from sales (slide 18) $13,336,000
Cost of goods sold (slide 33) ,047,780
Gross profit $ 4,288,220
Selling & administrative expenses:
Selling expenses (slide 34) $1,190,000
Administrative expenses (slide 34) ,000
Total sell. & Admin. Expenses ,885,000
Income from operations $ 2,403,220
Other income:
Interest revenue $ 98,000
Other expense:
Interest expense , ,000
Income before income tax $ 2,411,220
Income tax ,000
Net income $ 1,811,220

36. Budgeted Balance Sheet
The cash budget is one of the most important elements of the budgeted balance sheet. We’ll begin with a schedule of collection from sales.

37. Data for Elite Accessories – cont’d
Account Receivable, January 1, 2006 = $370,000
January
February
March
Budgeted Sales
$1,080,000
$1,240,000
$970,000
10% of each month’s sales are cash sales, while 90% are credit sales. Of the credit sales, 60% are collected during the current month while the other 40% are collected during the following month
Accounts Payable, January 1, 2006 = $190,000
Manufacturing Costs
$840,000
$780,000
$812,000
Depreciation of $24,000 is a non-cash manufacturing cost. Of the cash manufacturing costs, 75% are paid in the current month while 25% are paid in the following month

38. Data for Elite Accessories – cont’d
Cash balance on January 1, 2006
$280,000
Quarterly Taxes paid on March 31
$150,000
Quarterly interest expense paid on Jan 10
$22,500
Quarterly interest revenue received on Mar 21
$24,500
Sewing equipment purchased in Feb
$274,000

39. Schedule of Collections from Sales
Elite Accessories Inc.
Schedule of Collections from Sales
For the Three Months Ending March 31, 2006
January February March
Receipts from cash sales:
Cash sales (10%)(see
Note A)……………………... $108,000 $ 124,000 $ 97,000
Note A: $108,000 = $1,080,000 x 10%
$124,000 = $1,240,000 x 10%
$ 97,000 = $ 970,000 x 10%

40. Schedule of Collections from Sales
Elite Accessories Inc.
Schedule of Collections from Sales
For the Three Months Ending March 31, 2006
January February March
Receipts from cash sales:
Cash sales (10%)(see
Note A)……………………... $108,000 $ 124,000 $ 97,000
Receipts from sales on account:
Collections from prior month’s
sales (40%)(see Note B)……. $370,000 $ 388,800 $446,400
Note B: $370,000, given as January 1, Accounts
Receivable balance
$388,800 = $1,080,000 x 90% x 40%
$446,400 = $1,240,000 x 90% x 40%

41. Schedule of Collections from Sales
Elite Accessories Inc.
Schedule of Collections from Sales
For the Three Months Ending March 31, 2006
January February March
Receipts from cash sales:
Cash sales (10%)(see
Note A)……………………... $108,000 $ 124,000 $ 97,000
Receipts from sales on account:
Collections from prior month’s
sales (40%)(see Note B)……. $370,000 $ 388,800 $446,400
Collections from current month’s sales (60%)(see Note
C)…………………………… 583, , ,800
Note C: $583,200 = $1,080,000 x 90% x 60%
$669,600 = $1,240,000 x 90% x 60%
$523,800 = $ 970,000 x 90% x 60%

42. Schedule of Collections from Sales
Elite Accessories Inc.
Schedule of Collections from Sales
For the Three Months Ending March 31, 2006
January February March
Receipts from cash sales:
Cash sales (10%)(see
Note A)……………………... $108,000 $ 124,000 $ 97,000
Receipts from sales on account:
Collections from prior month’s
sales (40%)(see Note B)……. $370,000 $ 388,800 $446,400
Collections from current month’s sales (60%)(see Note
C)…………………………… 583, , ,800
Total receipts from sales on account……………………... $953,200 $1,058,400 $970,200

43. Schedule of Payments for Manufacturing Costs
Elite Accessories Inc.
Schedule of Payments for Manufacturing Costs
For the Three Months Ending March 31, 2006
January February March
Payment of prior month’s
manufacturing costs (25%) (see Note A)………………… $190,000 $204,000 $189,000
Note A: $190,000, given as January 1, 2006 Accounts
Payable balance
$204,000 = ($840,000 –$24,000) x 25%
$189,000 = ($780,000 – $24,000) x 25%

44. Schedule of Payments for Manufacturing Costs
Elite Accessories Inc.
Schedule of Payments for Manufacturing Costs
For the Three Months Ending March 31, 2006
January February March
Payment of prior month’s
manufacturing costs (25%) (see Note A)………………… $190,000 $204,000 $189,000
Payment of current month’s
manufacturing costs (75%)
(see Note B)………………… , , ,000
Note B: $612,000 = ($840,000 – $24,000) x 75%
$567,000 = ($780,000 – $24,000) x 75%
$591,000 = ($812,000 – $24,000) x 75%

45. Schedule of Payments for Manufacturing Costs
Elite Accessories Inc.
Schedule of Payments for Manufacturing Costs
For the Three Months Ending March 31, 2006
January February March
Payment of prior month’s
manufacturing costs (25%) (see Note A)………………… $190,000 $204,000 $189,000
Payment of current month’s
manufacturing costs (75%)
(see Note B)………………… , , ,000
Total payments………………. $802,000 $771,000 $780,000

46. For the Three Months Ending March 31, 2006
Elite Accessories Inc.
Cash Budget
For the Three Months Ending March 31, 2006
January February March
Estimated cash receipts:
Cash sales (Slide 42)………….. $ 108,000 $ 124,000 $ ,000
Collections of accounts
receivable (Slide 42)……… ,200 1,058, ,200
Interest revenue……………… — — ,500
Total cash receipts……………. $1,061,200 $1,182,400 $1,091,700
Estimated cash payments for:
Manufacturing costs (Slide 45).. $ 802,000 $ 771,000 $ 780,000
Selling and administrative expenses……………………… 160, , ,000
Capital additions 274,000
Interest expense 22,500
Income taxes ,000
Total cash payments…………. $ 984,500 $1,210,000 $1,075,000

47. For the Three Months Ending March 31, 2006
Elite Accessories Inc.
Cash Budget
For the Three Months Ending March 31, 2006
January February March
Total cash receipts……………. $1,061,200 $1,182,400 $1,091,700
Estimated cash payments for:
Manufacturing costs (Slide 45).. $ 802,000 $ 771,000 $ 780,000
Selling and administrative expenses……………………… 160, , ,000
Capital additions 274,000
Interest expense 22,500
Income taxes ,000
Total cash payments…………. $ 984,500 $1,210,000 $1,075,000
Cash increase (decrease)…………. $ ,700 $ (27,600) $ ,700
Cash balance at beginning of month , , ,100
Cash balance at end of month……. $ 356,700 $ ,100 $ 345,800
Minimum cash balance…………… , , ,000
Excess (deficiency)………………. $ ,700 $ (10,900) $ ,800

48. Software Spreadsheet software for personal computers
is a powerful and flexible tool for budgeting.
Sensitivity analysis is the systematic varying
of budget data input to determine the effects
of each change on the budget.
Class Example