Profit

Planning

McGraw-Hill/Irwin
9-2

Learning Objective 1

Understand why
organizations budget
and the processes they
use to create budgets.
9-3

The Basic Framework of Budgeting

A budget is a detailed quantitative plan for acquiring

and using financial and other resources over a specified
forthcoming time period.

1. The act of preparing a budget is called

budgeting.
2. The use of budgets to control an organization’s
activity is known as budgetary control.
9-4

Planning and Control

Planning – Control –
involves involves the steps
developing taken by
objectives and management that
preparing various attempt to ensure the
budgets to achieve objectives are
these objectives. attained.
9-5

Advantages of
Budgeting

Define goal
and objectives
Communicat Think about and
e plans plan for the future

Advantage
Coordinat s Means of
e allocating
activities resources
Uncover potential
bottlenecks
9-6

Responsibility Accounting

Managers should be held responsible for those

items — and only those items — that
the manager can actually control
to a significant extent.
 9-7

Choosing the Budget

Period

Operating
Budget

2005 2006 2007 2008

The
The annual
annual operating
operating budget
budget A continuous budget is a
may be divided into quarterly 12-month budget that rolls
or monthly budgets. forward oneone
forward month (or (or
month quarter)
as the current
quarter) as themonth (ormonth
current quarter)
is completed.
(or quarter) is completed.
9-8

Self-Imposed Budget

A budget is prepared with the full cooperation and

participation of managers at all levels. A
participative
budget is also known as a self-imposed budget.
 9-9

Advantages of Self-Imposed Budgets

1. Individuals at all levels of the organization are viewed

as members of the team whose judgments are valued
by top management.
2. Budget estimates prepared by front-line managers are
often more accurate than estimates prepared by top
managers.
3. Motivation is generally higher when individuals
participate in setting their own goals than when the
goals are imposed from above.
4. A manager who is not able to meet a budget imposed
from above can claim that it was unrealistic. Self-
imposed budgets eliminate this excuse.
9-10

Self-Imposed Budgets

Most companies do not rely exclusively upon self-

imposed budgets in the sense that top managers
usually initiate the budget process by issuing broad
guidelines in terms of overall profits or sales.
 9-11

Human Factors in Budgeting

The success of budgeting depends upon three important

factors:
1. Top management must be enthusiastic and committed
to the budget process.
2. Top management must not use the budget to pressure
employees or blame them when something goes wrong.
3. Highly achievable budget targets are usually preferred
when managers are rewarded based on meeting budget
targets.
9-12

The Budget
Committee

A standing committee responsible for

 overall policy matters relating to the budget
 coordinating the preparation of the budget
9-13

Learning Objective 2

Prepare a sales budget,

including a schedule of
expected cash
collections.
9-14

Budgeting Example

 Royal Company is preparing budgets for the quarter

ending June 30.
 Budgeted
April sales for20,000
the nextunits
five months are:
May 50,000 units
June 30,000 units
July 25,000 units
Augus 15,000 units.
t
 The selling price is $10 per unit.
9-15

The Sales
Budget

The individual months of April, May, and June are summed

to obtain the total projected sales in units and dollars for
the quarter ended June 30th
9-16

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% uncollectible.
The March 31 accounts receivable balance
of
$30,000 will be collected in full.
9-17

Expected Cash
Collections
9-18

Expected Cash
Collections

FFromrothe
From mtthe he SSBudget
Sales aalleess for April.
BBudgeudgett fforor AApprriill..
9-19

Expected Cash
Collections

From the Sales Budget for

May.
9-22

Expected Cash
Collections
9-23

Learning Objective 3

Prepare a production
budget.
9-24

The Production
Budget

Sales Production
Budget Budget
and d
Expected ete
pl
Cash
m
Co
Collection
s

Production must be adequate to meet budgeted

sales and provide for sufficient ending inventory.
 9-25

The Production
Budget

• The management at 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.

9-26

The Production
Budget
9-27

The Production
Budget

Budgeted May sales 50,000

Desired ending inventory % 20%
March 31
Desired ending inventory 10,000
ending inventory
9-30

The Production
Budget
9-31

The Production
Budget

AAsss uumm
Assumed eedd inventory.
ending
eennddiinngg
9-32

Learning Objective 4

Prepare a direct
materials budget,
including a schedule of
expected cash
disbursements for
purchases of materials.
9-33

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 is $0.40 per pound.
Let’s prepare the direct materials budget.
9-34

The Direct Materials

Budget

FFrrooproduction
From mm budget
pprroodduuctctiioonn
bbuuddggeett
9-35

The Direct Materials

Budget
9-36

The Direct Materials

Budget

March 31 inventory

10% of following Calculate the materials to

month’s production be purchased in May.
needs.
9-39

The Direct Materials

Budget
9-40

The Direct Materials

Budget

Assumed ending inventory

 9-41

Expected Cash Disbursement for

Materials

• Royal pays $0.40 per pound for its materials.

• One-half of a month’s purchases is 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.

9-42

Expected Cash Disbursement for

Materials
9-43

Expected Cash Disbursement for

Materials

Compute the expected cash

disbursements for
materials for the quarter.

140,000 lbs. × $.40/lb. = $56,000

9-46

Expected Cash Disbursement for

Materials
9-47

Learning Objective 5

Prepare a direct labor

budget.
 9-48

The Direct Labor

Budget

• At Royal, each unit of product requires 0.05 hours (3

minutes) 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 agree to a
wage rate of $10 per hour regardless of the hours worked
(no overtime pay).
• 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.
9-49

The Direct Labor

Budget

From production budget.

9-50

The Direct Labor

Budget
9-51

The Direct Labor

Budget

Greater
Greater of
of labor
labor hours
hours required
required
or labor
or labor hours
hours guaranteed.
guaranteed.
9-52

The Direct Labor

Budget
9-55

Learning Objective 6

Prepare a
manufacturing
overhead budget.
9-56

Manufacturing Overhead
Budget

• At Royal, manufacturing overhead is applied to units of

product on the basis of direct labor hours.
• The variable manufacturing overhead rate is $20 per
direct labor hour.
• 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.

9-57

Manufacturing Overhead
Budget

Direct Labor Budget.

9-58

Manufacturing Overhead
Budget

Total mfg. OH for quarter $251,000

= $49.70 per hour *
Total labor hours required 5,050

* rounded
9-59

Manufacturing Overhead
Budget

Depreciation is a noncash charge.

9-60

Ending Finished Goods Inventory Budget

Production costs per unit Quantity Total

Direct materials $ 2.00
Direct labor Cost 5.00 lbs.
Manufacturing overhead $
0.40
Budgeted finished goods inventory
Ending inventory in units
Unit product cost
Ending finished goods inventory

Direct materials
budget and information.
9-61

Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. $ $ 2.00
Direct labor 0.05 hrs. 0.40
$10.00 0.50
Manufacturing
overhead
Budgeted finished goods inventory
Ending inventory in units
Unit product cost
Ending finished goods inventory

Direct labor budget.

9-62

Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $ 10.00 0.50
Manufacturing overhead 0.05 hrs. $ 49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units
Unit product cost $
4.99
Ending finished goods inventory ?

Total mfg. OH for quarter $251,000

= $49.70 per hour *
Total labor hours required 5,050
9-63

Ending Finished Goods Inventory Budget

Production costs per unit Quantity Cost Total

Direct materials 5.00 lbs. $ 0.40 $ 2.00
Direct labor 0.05 hrs. $10.00 0.50
Manufacturing overhead 0.05 hrs. $49.70 2.49
$ 4.99
Budgeted finished goods inventory
Ending inventory in units 5,000
Unit product cost $ 4.99
Ending finished goods $24,950
inventory

Production Budget.
9-64

Learning Objective 7

Prepare a selling and

administrative
expense budget.
 9-65

Selling and Administrative Expense

Budget

• At Royal, the selling and administrative expenses budget is

divided into variable and fixed components.
• The 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.
9-66

Selling and Administrative Expense

Budget

Calculate the selling and administrative

cash expenses for the quarter.
9-69

Selling and Administrative Expense

Budget
9-70

Learning Objective 8

Prepare a cash budget.

9-71

Format of the Cash

Budget

The cash budget is divided into four sections:

1. Cash receipts listing all cash inflows excluding
borrowing;
2. Cash disbursements listing all payments excluding
repayments of principal and interest;
3. Cash excess or deficiency; and
4. The financing section listing all borrowings,
repayments and interest.
 9-72

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 (both purchases paid in cash)
Has an April 1 cash balance of $40,000
9-73

The Cash
Budget

Schedule
Schedule of
of Expected
Cash Collections.
Expected Cash
Collections.
9-74

The Cash
Budget

Schedule
Schedule of
of Expected
Cash
Expected Cash
Disbursements.
Disbursements.
Direct Labor
Budget.

Manufacturing
Overhead Budget.

Selling and Administrative

Expense Budget.
9-75

The Cash
Budget

Because Royal maintains

a cash balance of $30,000,
the company must borrow
$50,000 on its line-of-
credit.
9-76

The Cash
Budget

Ending cash balance for April

is the beginning May balance.
9-77

The Cash
Budget
9-80

The Cash
Budget

$50,000 × 16% × 3/12 = $2,000

Borrowings on April 1 and
repayment on June 30.
9-81

The Budgeted Income Statement

Cash Budgeted
Budge Income
t Statemen
ed t
l et
p
m
Co

After we complete the cash budget, we can

prepare the budgeted income statement for
Royal.
9-82

Learning Objective 9

Prepare a budgeted
income
statement.
9-83

The Budgeted Income Statement

Sales
Sales Budget.
Budget.
Royal Company
Budgeted Income Statement
For the Three Months Ended June 30
Ending
Ending Finished
Finished
Sales (100,000 units @ $10) $ 1,000,000 Goods
Goods Inventory.
Inventory.
Cost of goods sold (100,000 @ $4.99) 499,000
Gross margin 501,000
Selling and administrative expenses 260,000 Selling
Selling and
and
Operating income 241,000 Administrative
Administrative
Interest expense 2,000 Expense
Expense Budget.
Budget.
Net income $ 239,000

Cash
Cash Budget.
Budget.
9-84

Learning Objective 10

Prepare a budgeted
balance sheet.
9-85

The Budgeted Balance

Sheet

Royal reported the following account balances prior to

preparing its budgeted financial statements:

• Land - $50,000
• Common stock - $200,000
• Retained earnings - $146,150
• Equipment - $175,000
9-86
Royal Company
Budgeted Balance Sheet 25%
25% of
of June
June
June 30 sales
sales of
of
Current assets $300,000.
$300,000.
Cash $ 43,000
Accounts receivable 75,000 11,500
11,500 lbs.
lbs.
Raw materials inventory 4,600 atat$0.40/lb.
Finished goods inventory 24,950 $0.40/lb.
Total current assets 147,550 5,000
5,000 units
units
Property and equipment at
at $4.99
$4.99 each.
each.
Land 50,000
Equipment 367,000
Total property and equipment 417,000
Total assets $ 564,550
50%
50% ofof June
June
Accounts payable $ 28,400 purchases
purchases
Common stock 200,000 of
of $56,800.
$56,800.
Retained earnings 336,150
Total liabilities and equities $ 564,550
9-87
Royal Company
Budgeted Balance Sheet
June 30
Current assets
Cash $ 43,00
Accounts receivable Raw 0Beginning balance $
Add: net income
75,00 146,150
materials inventory
239,000
Finished goods 0Deduct: dividends
Ending balance $ (49,000)
inventory Total current 4,60 336,150
assets 0
Property and equipment 24,95
50,00
Land 0
0
Equipment 147,55
367,00
417,00
0
Total property and equipment $ 0
Total assets 564,550
Accounts payable $ 28,400
Common stock 200,000
Retained earnings 336,150
Total liabilities $
and equities 564,550
9-88

End of Chapter
9