1. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Financial & Managerial Accounting The Basis for Business Decisions FOURTEENTH EDITION Williams Haka Bettner Carcello

2. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin OPERATIONAL BUDGETING Chapter 23

3. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO1 To explain how a company can be “profit rich, yet cash poor.”

4. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Profit Rich, Yet Cash Poor Conditions leading to cash shortages when profits are high. Consider the following cash-to-cash cycle Large investments in assets to support rapid revenue growth. Long operating cycles (cash-to-cash cycles).

5. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Inventories DM  WIP  FG 166 days Accounts Receivable 81 days Cash 247 Days Even if sales are growing rapidly, cash is tied up in inventory and receivables for so long that a cash shortage will be the likely result. Profit Rich, Yet Cash Poor

6. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO2 To discuss the benefits that a company may derive from a formal budgeting process

7. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Control Steps taken by management to ensure that objectives are attained. Planning Developing objectives for acquisition and use of resources. A budget is a comprehensive financial plan for achieving the financial and operational goals of an organization. Budgeting: The Basis for Planning and Control

8. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Benefits Coordination of activities Performance evaluation Enhanced management responsibility Assignment of decision- making responsibilities Benefits Derived from Budgeting

9. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO3 To explain two philosophies that may be used in setting budgeted amounts.

10. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Budget Problems  Perceived unfair or unrealistic goals.  Poor management- employee communications. Budget Problems  Perceived unfair or unrealistic goals.  Poor management- employee communications. Solution  Reasonable and achievable budgets.  Employee participation in budgeting process. Solution  Reasonable and achievable budgets.  Employee participation in budgeting process. Establishing Budgeted Amounts: Behavioral Approach

11. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Establishing Budgeted Amounts: Total Quality Management Approach A commitment to the goal of completely eliminating inefficiency. Budgeted amounts set at levels representing absolute efficiency. Small failures to achieve budgeted amounts direct management to areas where improvement is possible.

12. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Flow of Budget Data Participation in Budget Process

13. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 2005200620072008 C a p i t a l B u d g e t s A continuous budget is usually a twelve-month budget that adds one month as the current month is completed. The annual operating budget may be divided into quarterly or monthly budgets. The Budget Period

14. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Ethics, Fraud, and Corporate Governance Budgets are often included in documents given to investors when governmental and not-for- profit entities seek to obtain debt financing. Material misstatements in these budgets act as a fraud upon the purchasers of bonds issued by the governmental or not-for-profit entities and expose both individuals and organizations to civil and criminal penalties.

15. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO4 To describe the elements of a master budget.

16. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Sales budget Production budgets Financial budgets: cash flow income balance sheet Cash budget Selling and administrative budget Cost of goods manufactured and sold budget The Master Budget

17. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO5 To prepare the budgets and supporting schedules included in a master budget.

18. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Sales Budget Estimated Unit Sales Estimated Unit Price Analysis of economic and market conditions + Forecasts of customer needs from marketing personnel Preparing the Master Budget

19. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Basket, Inc. is preparing budgets for the quarter ending June 30. The sales price is $10 per magnet. Budgeted sales for the next four months are: April20,000 magnets @ $10 =$200,000 May50,000 magnets @ $10 =$500,000 June30,000 magnets @ $10 =$300,000 July25,000 magnets @ $10 =$250,000 The Sales Budget July is needed for June ending inventory computations. Preparing the Master Budget

20. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Sales Budget Completed Production Budgets The Production Budget

21. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The management of Basket wants ending inventory to be 20 percent of the next month’s budgeted sales in units. 4,000 units were on hand March 31.  Let’s prepare the production budget. The management of Basket wants ending inventory to be 20 percent of the next month’s budgeted sales in units. 4,000 units were on hand March 31.  Let’s prepare the production budget. The Production Budget

22. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Production must be adequate to meet budgeted sales and to provide sufficient ending inventory. Budgeted product sales in units +Desired product units in ending inventory =Total product units needed – Product units in beginning inventory =Product units to produce The Production Budget

23. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The Production Budget

24. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The Production Budget

25. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The Production Budget

26. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Production Budgets Material Purchases Production Budget Units Completed The Production Budget

27. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The material purchases budget is based on production quantity and desired material inventory levels. Units to produce × Material needed per unit =Material needed for units to produce +Desired units of material in ending inventory =Total units of material needed – Units of material in beginning inventory =Units of material to purchase The Production Budget Material Purchases

28. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Five pounds of material are needed for each unit produced. The management at Basket wants to have materials on hand at the end of each month equal to 10 percent of the following month’s production needs. The materials inventory on March 31 is 13,000 pounds. July production is budgeted for 23,000 units. Five pounds of material are needed for each unit produced. The management at Basket wants to have materials on hand at the end of each month equal to 10 percent of the following month’s production needs. The materials inventory on March 31 is 13,000 pounds. July production is budgeted for 23,000 units. The Production Budget Material Purchases

29. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The Production Budget Material Purchases

30. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The Production Budget Material Purchases

31. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The Production Budget Material Purchases

32. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Payments for Material Purchases Materials used in production cost $0.40 per pound. One-half of a month’s purchases are paid for in the month of purchase; the other half is paid for in the following month. No discount terms are available. The accounts payable balance on March 31 is $12,000. Materials used in production cost $0.40 per pound. One-half of a month’s purchases are paid for in the month of purchase; the other half is paid for in the following month. No discount terms are available. The accounts payable balance on March 31 is $12,000.

33. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Payments for Material Purchases

34. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Payments for Material Purchases

35. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Payments for Material Purchases

36. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Payments for Material Purchases

37. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Production Budget Labor Production Budget Units Material Completed The Production Budget

38. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Each unit produced requires 3 minutes (.05 hours) of direct labor. Basket employs 30 persons for 40 hours each week at a rate of $10 per hour. Any extra hours needed are obtained by hiring temporary workers also at $10 per hour. The Production Budget Direct Labor

39. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Payments for Direct Labor

40. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Payments for Direct Labor

41. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Production Budget Units Material Labor Completed Production Budget Manufacturing Overhead The Production Budget

42. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Variable manufacturing overhead is $1 per unit produced and fixed manufacturing overhead is $50,000 per month. Fixed manufacturing overhead includes $20,000 in depreciation which does not require a cash outflow. Variable manufacturing overhead is $1 per unit produced and fixed manufacturing overhead is $50,000 per month. Fixed manufacturing overhead includes $20,000 in depreciation which does not require a cash outflow. The Production Budget Manufacturing Overhead

43. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Payments for Manufacturing Overhead

44. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Payments for Manufacturing Overhead

45. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Payments for Manufacturing Overhead

46. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Production Budget Completed Selling and Administrative Expense Budget Selling and Administrative (S&A) Expense Budget

47. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin  Selling expense budgets contain both variable and fixed items.  Variable items: shipping costs and sales commissions.  Fixed items: advertising and sales salaries.  Administrative expense budgets contain mostly fixed items.  Executive salaries and depreciation on company offices.  Selling expense budgets contain both variable and fixed items.  Variable items: shipping costs and sales commissions.  Fixed items: advertising and sales salaries.  Administrative expense budgets contain mostly fixed items.  Executive salaries and depreciation on company offices. Selling and Administrative (S&A) Expense Budget

48. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Variable selling and administrative expenses are $0.50 per unit sold and fixed selling and administrative expenses are $70,000 per month. Fixed selling and administrative expenses include $10,000 in depreciation which does not require a cash outflow. Variable selling and administrative expenses are $0.50 per unit sold and fixed selling and administrative expenses are $70,000 per month. Fixed selling and administrative expenses include $10,000 in depreciation which does not require a cash outflow. Cash Payments for (S&A) Expenses

49. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Payments for (S&A) Expenses

50. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Payments for (S&A) Expenses

51. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin All sales are on account. Basket’s collection pattern is: 70 percent collected in month of sale 25 percent collected in month after sale 5 percent will be uncollectible Accounts receivable on March 31 is $30,000, all of which is collectible. All sales are on account. Basket’s collection pattern is: 70 percent collected in month of sale 25 percent collected in month after sale 5 percent will be uncollectible Accounts receivable on March 31 is $30,000, all of which is collectible. Cash Receipts Budget

52. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Receipts Budget

53. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Receipts Budget

54. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Receipts Budget

55. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Receipts Budget

56. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Basket Company: Has a $100,000 line of credit at its bank, with a zero balance on April 1. Maintains a $30,000 minimum cash balance. Borrows at the beginning of a month and repays at the end of a month. Pays interest at 16 percent when a principal payment is made. Pays a $51,000 cash dividend in April. Purchases equipment costing $143,700 in May and $48,800 in June. Has a $40,000 cash balance on April 1. Basket Company: Has a $100,000 line of credit at its bank, with a zero balance on April 1. Maintains a $30,000 minimum cash balance. Borrows at the beginning of a month and repays at the end of a month. Pays interest at 16 percent when a principal payment is made. Pays a $51,000 cash dividend in April. Purchases equipment costing $143,700 in May and $48,800 in June. Has a $40,000 cash balance on April 1. Comprehensive Cash Budget Additional Information

57. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin

58. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin

59. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin

60. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin

61. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin

62. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin $50,000 ×.16 × 3/12 = $2,000

63. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Budgeted Income Statement Cash Budget Completed The Budgeted Income Statement

64. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The Budgeted Income Statement

65. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Computation of unit cost follows The Budgeted Income Statement

66. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Total mfg. OH for quarter $251,000 Total labor hours required 5,050 hrs. = $49.70 per hr. Manufacturing overhead is applied based on direct labor hours. The Budgeted Income Statement

67. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The Budgeted Income Statement

68. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The Budgeted Income Statement

69. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Budgeted Balance Sheet Completed Budgeted Income Statement The Budgeted Balance Sheet

70. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Basket reports the following account balances on June 30, prior to preparing its budgeted financial statements: Land - $50,000 Building (net) - $174,500 Common stock - $200,000 Equipment (net) - $192,500 Retained earnings - $148,150 Paid dividends of $51,000 Basket reports the following account balances on June 30, prior to preparing its budgeted financial statements: Land - $50,000 Building (net) - $174,500 Common stock - $200,000 Equipment (net) - $192,500 Retained earnings - $148,150 Paid dividends of $51,000 The Budgeted Balance Sheet

71. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin 25% of June sales of $300,000 25% of June sales of $300,000 11,500 lbs. @ $.40 per lb. 50% of June purchases of $56,800 50% of June purchases of $56,800 5,000 units @ $4.99 each 5,000 units @ $4.99 each

72. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin

73. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO6 To prepare a flexible budget and explain its uses.

74. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Performance evaluation is difficult when actual activity differs from the activity originally budgeted. Flexible Budgeting Hmm! Comparing costs at different levels of activity is like comparing apples with oranges. Consider the following condensed example from Barton, Inc....

75. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Flexible Budgeting

76. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin U = Unfavorable variance – Barton, Inc. was unable to achieve the budgeted level of activity. Flexible Budgeting

77. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin F = Favorable variance: actual costs are less than budgeted costs. Flexible Budgeting

78. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Since cost variances are favorable, have we done a good job controlling costs? Flexible Budgeting

79. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin I don’t think I can answer the question using the original budget. How much of the favorable cost variance is due to lower activity, and how much is due to good cost control? Flexible Budgeting

80. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Flexible Budgeting I don’t think I can answer the question using the original budget. How much of the favorable cost variance is due to lower activity, and how much is due to good cost control? To answer the question, we must the budget to the actual level of activity.

81. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Central Concept If you can tell me what your activity was for the period, I will tell you what your costs and revenue should have been. Flexible Budgeting

82. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Improve performance evaluation. May be prepared for any activity level in the relevant range. Show expenses that should have occurred at the actual level of activity. Reveal variances due to good cost control or lack of cost control. Flexible Budgeting

83. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin To a budget for different activity levels, we must know how costs behave with changes in activity levels.  Total variable costs change in direct proportion to changes in activity.  Total fixed costs remain unchanged within the relevant range. Fixed Variable Flexible Budgeting

84. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Let’s prepare budgets for Barton, Inc. Flexible Budgeting

85. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Flexible Budgeting Variable costs are expressed as a constant amount per hour. In the original budget, indirect labor was $40,000 for 10,000 hours resulting in a rate of $4.00 per hour. Variable costs are expressed as a constant amount per hour. In the original budget, indirect labor was $40,000 for 10,000 hours resulting in a rate of $4.00 per hour.

86. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Flexible Budgeting

87. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Flexible Budgeting Total variable cost = $7.50 per unit × budget level in units

88. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Flexible Budgeting Fixed costs are expressed as a total amount that does not change within the relevant range of activity.

89. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Now let’s prepare a budget performance report at 8,000 actual units for Barton, Inc. Flexible Budgeting Performance Report

90. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Flexible Budgeting Performance Report

91. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect labor and indirect material have unfavorable variances because actual costs are more than the flexible budget costs. Flexible Budgeting Performance Report

92. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Power has a favorable variance because the actual cost is less than the flexible budget cost. Flexible Budgeting Performance Report

93. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin End of Chapter 23