1. Budgeting and Profit Planning
Chapter9
Budgeting and Profit Planning

2. BUDGETING BASICS
A formal written statement of management’s plans for a specified future time period, expressed in financial terms
Primary way to communicate agreed-upon objectives to all parts of the company
Promotes efficiency
Control device - important basis for performance evaluation once adopted

3. BUDGETING BASICS Benefits of Budgeting
Requires all levels of management to plan ahead and formalize goals on a recurring basis
Provides definite objectives for evaluating performance at each level of responsibility
Creates an early warning system for potential problems

4. BUDGETING BASICS Benefits of Budgeting
Facilitates coordination of activities within the business
Results in greater management awareness of the entity’s overall operations and the impact of external factors
Motivates personnel throughout organization to meet planned objectives

5. BUDGETING BASICS Role of Accounting
Historical accounting data on revenues, costs, and expenses help in formulating future budgets
Accountants are normally responsible for presenting management’s budgeting goals in financial terms
The budget and its administration are, however, entirely management’s responsibility

6. The Basic Framework of Budgeting
Detail
Budget
Master
Summary of
a company’s
plans.
Sales
Production
Materials

7. Advantages of Budgeting
Define goal
and objectives
Communicating
plans
Think about and
plan for the future
Advantages
Coordinate
activities
Means of allocating
resources
Uncover potential
bottlenecks

8. Choosing the Budget Period
Operating Budget
2008
2009
2010
2011
The annual operating budget
may be divided into monthly
or quarterly budgets.

9. The Perpetual Budget This budget is usually a twelve-month
Continuous or
Perpetual Budget
2008
2009
2010
2011
This budget is usually a twelve-month
budget that rolls forward one month
as the current month is completed.

10. Participative Budget System
Flow of Budget Data

11. Responsibility Accounting
Managers should be held responsible for those items — and only those items — that the manager can actually control to a significant extent.

12. The Budget Committee A standing committee responsible for
overall policy matters relating to the budget
coordinating the preparation of the budget

13. Chapter 9 Quiz: Question 1
Which of the following is NOT true about the Master Budget?
It is composed of many interrelated budgets.
It consists of 2 classes of budgets: Operating Budgets and Financial Budgets.
Within the master budget the first budget to be prepared is the sales budget.
It constitutes a plan of action for a specified period of time.
All of the above are true.

14. The Master Budget Sales Budget Selling and Administrative Budget
Production
Ending
Inventory
Budget
Direct
Materials
Budget
Labor
Manufacturing
Overhead

15. Budgeted Financial Statements
The Master Budget
Sales
Budget
Ending
Inventory
Budget
Selling and
Administrative
Budget
Production
Budget
Direct
Materials
Budget
Direct
Labor
Budget
Manufacturing
Overhead
Budget
Cash
Budget
Budgeted Financial Statements

16. The Sales Budget
A detailed schedule showing expected sales for the budgeted periods expressed in units and dollars.

17. The Sales Budget anticipated unit selling price First budget prepared
Derived from the sales forecast
Management’s best estimate of sales revenue for the budget period
Every other budget depends on the sales budget
Prepared by multiplying
expected unit sales volume for each product times
anticipated unit selling price

18. The Sales Budget Factors considered in Sales Forecasting:
General economic conditions
Industry trends
Market research studies
Anticipated advertising and promotion
Previous market share
Price changes
Technological developments

19. The Sales Budget - Example
Royal Company is preparing budgets for the quarter ending June 30.
Budgeted 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.
The selling price is $10 per unit.

20. The Sales Budget

21. The Sales Budget

22. The Production Budget Sales Production Budget
Completed
Production must be adequate to meet budgeted
sales and provide for sufficient ending inventory.

23. The Production Budget
Shows the units that must be produced to meet anticipated sales
Derived from sales budget plus the desired change in ending finished goods (ending finished goods less the beginning finished goods units)
Required production in units formula:

24. Let’s prepare the production budget.
Royal Company 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.

25. The Production Budget Budgeted sales 50,000 Desired percent 20%
Desired inventory ,000

26. The Production Budget
March 31
ending inventory

27. The Production Budget

28. The Production Budget

29. The Production Budget

30. The Direct Materials Budget
At Royal Company, 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 $0.40 per pound. Let’s prepare the direct materials budget.

31. The Direct Materials Budget
From production
budget

32. The Direct Materials Budget

33. The Direct Materials Budget
10% of the following
month’s production

34. The Direct Materials Budget
March 31
inventory

35. The Direct Materials Budget

36. The Direct Materials Budget

37. Chapter 9 Quiz: Question 2
The Willsey Merchandise Company has budgeted $40,000 in sales for the month of December. The company's cost of goods sold is 30% of sales. If the company has budgeted to purchase $18,000 in merchandise during December, then the budgeted change in inventory levels over the month of December is:
$ 6,000 increase.
$10,000 decrease.
$22,000 decrease.
$15,000 increase.

38. The Master Budget - Components

39. Expected Cash Collections
All sales are on account.
Royal’s collection pattern is:
70% collected in the month of sale,
25% collected in the month following sale,
5% is uncollectible.
The March 31 accounts receivable balance of $30,000 will be collected in full.

40. Expected Cash Collections

41. Expected Cash Collections

42. Expected Cash Collections

43. Expected Cash Collections

44. Expected Cash Collections

45. Chapter 9 Quiz: Question 3
Avril Company collects it’s A/R as follows:
30% in the month of sale
60% in the month following sale
8% in the 2nd month following sale
The following sales are expected:
Jan....$100,000 Feb....$120,000 Mar....$110,000
Cash collections in March should be budgeted at: 
A. $110, C. $105,000.
B. $110, D. $113,000.

46. Expected Cash Disbursement for Materials
Royal 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.
The March 31 accounts payable balance is $12,000.
Let’s calculate expected cash disbursements.

47. Expected Cash Disbursement for Materials

48. Expected Cash Disbursement for Materials
140,000 lbs. × $.40/lb. = $56,000

49. Expected Cash Disbursement for Materials

50. Expected Cash Disbursement for Materials

51. The Direct Labor Budget
At Royal, each unit of product requires 0.05 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 $10 per hour regardless of the hours worked (Overtime paid as straight time).
For the next three months, the direct labor workforce will be paid for a minimum of 1,500 hours per month.
Let’s prepare the direct labor budget.

52. The Direct Labor Budget
From production
budget

53. The Direct Labor Budget

54. The Direct Labor Budget
Higher of labor hours required
or labor hours guaranteed.

55. The Direct Labor Budget

56. Manufacturing Overhead Budget
Royal Company uses a variable manufacturing overhead rate of $1 per unit produced.
Fixed manufacturing overhead is $50,000 per month and includes $20,000 of noncash costs (primarily depreciation of plant assets).
Let’s prepare the manufacturing overhead budget.

57. Manufacturing Overhead Budget
From production
budget

58. Manufacturing Overhead Budget

59. Manufacturing Overhead Budget
Depreciation is a noncash charge.

60. Ending Finished Goods Inventory Budget
Now, Royal can complete the ending finished goods inventory budget.
At Royal, manufacturing overhead is applied to units of product on the basis of direct labor hours.
Let’s calculate ending finished goods inventory.

61. Ending Finished Goods Inventory Budget
Direct materials
budget and information

62. Ending Finished Goods Inventory Budget
Direct labor
budget

63. Ending Finished Goods Inventory Budget
Predetermined Overhead Rate:
Total mfg. OH for quarter $251,000
Total labor hours required 5,050 hrs.
= $49.70 per hr.
(rounded)

64. Ending Finished Goods Inventory Budget
Production
Budget

65. Selling and Administrative Expense Budget
At Royal, variable selling and administrative expenses are $0.50 per unit sold.
Fixed selling and administrative expenses are $70,000 per month.
The fixed selling and administrative expenses include $10,000 in costs – primarily depreciation – that are not cash outflows of the current month.
Let’s prepare the company’s selling and administrative expense budget.

66. Selling and Administrative Expense Budget

67. Selling and Administrative Expense Budget

68. The 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

69. The Cash Budget
Royal:
Maintains a 16% open line of credit for $75,000.
Maintains a minimum cash balance of $30,000.
Borrows on the first day of the month and repays loans on the last day of the month.
Pays a cash dividend of $49,000 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.

70. The Cash Budget
Schedule of Expected
Cash Collections

71. The Cash Budget Schedule of Expected Cash Disbursements
Cash Collections
Schedule of Expected
Cash Disbursements

72. Selling and Administrative
The Cash Budget
Direct Labor
Budget
Manufacturing
Overhead Budget
Selling and Administrative
Expense Budget

73. Because Royal maintains
The Cash Budget
Because Royal maintains
a cash balance of $30,000,
the company must
borrow on its
line-of-credit

74. Financing and Repayment
Ending cash balance for April
is the beginning May balance.

75. CASH BUDGET Contributes to more effective cash management
Shows managers need for additional financing before actual need arises
Indicates when excess cash will be available

76. The Cash Budget

77. Financing and Repayment
Because the ending cash balance is
exactly $30,000, Royal will not repay
the loan this month.

78. The Cash Budget

79. The Cash Budget At the end of June, Royal has enough cash
to repay the $50,000 loan plus interest at 16%.

80. Financing and Repayment
$50,000 × 16% × 3/12 = $2,000 Borrowings on April 1 and repayment of June 30.

81. The Budgeted Income Statement
Cash
Budget
Budgeted
Income
Statement
Completed
After we complete the cash budget, we can prepare the budgeted income statement for Royal.

82. The Budgeted Income Statement

83. Chapter 9 Quiz: Question 4
The Stacy Company makes and sells a single product, Product R. Budgeted sales for April are $300,000. Gross Margin is budgeted at 30% of sales dollars. If the net income for April is budgeted at $40,000, the budgeted selling and administrative expenses are: 
$133,333.
$50,000.
$102,000.
$78,000.

84. The Budgeted Income Statement

85. The Budgeted Balance Sheet
Royal reported the following account balances on March 31 prior to preparing its budgeted financial statements:
Land - $50,000
Building (net) - $175,000
Common stock - $200,000
Retained earnings - $146,150

86. 25%of June
sales of
$300,000
11,500 lbs.
at $0.40/lb.
5,000 units
at $4.99 each
50% of June
purchases
of $56,800

88. Zero-Base Budgeting
Managers are required to justify all budgeted expenditures, not just changes in the budget from the previous year. The baseline is zero rather than last year’s budget.

89. International Aspects of Budgeting
Multinational companies face special problems when preparing a budget.
Fluctuations in foreign currency exchange rates.
High inflation rates in some foreign countries.
Differences in local economic conditions.
Local governmental policies.

90. End of Chapter 9