lecture 11 budgeting(1).pdf

7/27/2019 Lecture 11 Budgeting(1).pdf

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BU8101 Accounting: A User Perspective

Lecture 11

Budgeting

Compulsory Reading

WHB Chapter 23

11-1Lecture Date: 1 April 2013


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Lecture Outline

Definition and Concepts

Behavioral Aspects

Preparation of a Master Budget

Static Budget vs. Flexible Budget

Flexible Budgets

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Budgets

The Basis for Planning and Control

Control

Steps taken bymanagement to

ensure thatobjectives are

attained.

Planning

Developingobjectives for

acquisitionand use ofresources.

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A budget is a comprehensive financial planthat specifies how resources will be acquiredand used during a specified period of time.


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Purposes of Budgeting

Purposes

Provide informationthat can be usedto improve decisionmaking

Provide standardsused forperformanceevaluation andcontrol

Force managers toplan for resourcerequirements.

Improvecommunicationand coordination

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The Budgetary ProcessBudget expresses the companys strategic goals in quantitative terms

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Vision (Strategic Goal)

Formulate strategies to achieve vision

Prepare long-term budgets

Prepare short-term budgets (Operating Budgets)

Assign decision rights

Compare actual results to budgets

variance

Rewards /

Punishments


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Budget Periods

Operating Budget

2008 2009 2010 2011

Operating budgets ordinarilyOperating budgets ordinarilycover a onecover a one--year periodyear period

corresponding to a companys fiscal year. Manycorresponding to a companys fiscal year. Manycompanies divide their annual budgetcompanies divide their annual budgetinto quarterly & monthly budgets.into quarterly & monthly budgets.

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Operating budgets are more operational than strategic in

nature, done by lower-level managers.


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Budgeting

Behavioral Aspects

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Budget Problems

Perceived unfair or

unrealistic goals.Poor management-employee communications.

Solutions

Reasonable and

achievable budgets.

Employee participationin budgeting process.


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Flow of Budget Data

Supervisor Supervisor

MiddleManagement

Supervisor Supervisor

MiddleManagement

Top Management

ParticipativeBudgeting

A participative budget is a budget that is prepared with the fullcooperation and participation of managers at all levels.

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DetailDetail

BudgetBudget

DetailDetail

BudgetBudget

MasterMaster

BudgetBudget

Covering allphases of

a companysoperations.

DetailDetail

BudgetBudgetProduction

Types of Budgets

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The Master Budget

Production budget

Selling and

administrative

budget

Direct materials

budget

Manufacturing

overhead budget

Direct laborbudget

Cash budget

Sales budget

Budgetedbalance sheet

Budgetedincome

statement

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Operating

Budgets

FinancialBudgets


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SalesBudget

EstimatedUnit Sales

EstimatedUnit Price

Analysis of economic and market conditions

+Forecasts of customer needs from marketing personnel

The Sales Budget

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The Sales Budget

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:

April 20,000 magnets @ $10 = $200,000May 50,000 magnets @ $10 = $500,000

June 30,000 magnets @ $10 = $300,000

July 25,000 magnets @ $10 = $250,000

July is needed for Junes ending inventory computations11-12


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SalesBudget

ProductionBudget

The Production Budget

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The management of Basket wants endinginventory to be 20 percent of the next months

budgeted sales in units.

On March 31, inventory of 4,000 units were onhand.

Lets prepare the production budget.


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Units to Produce

Budgeted product sales in units

+ Desired product units in ending inventory

= Total product units needed Product units in beginning inventory

= Product units to produce

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Production must be adequate to meet budgeted salesand to provide sufficient ending inventory.


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April May June

Budgeted unit sales 20,000 50,000 30,000

Desired ending inventory 10,000 6,000 5,000

Total units needed 30,000 56,000 35,000

Less beginning inventory 4,000 10,000 6,000

Units to produce 26,000 46,000 29,000

Ending inventory = 20% of next month's sales needs.

June ending inventory = 0.2 25,000 July units = 5,000 units.

Beginning inventory is last month's ending inventory.


Units to Produce

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ProductionBudget

MaterialPurchases

ProductionBudget

Units


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The material purchases budget is based onproduction 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


Material Purchases

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Material Purchases

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Five pounds of material are needed for each unitproduced.

The management at Basket wants to have materials onhand at the end of each month equal to 10 percent of thefollowing months production needs.

The materials inventory on March 31 is 13,000 pounds.

July production is budgeted for 23,000 units.


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Material PurchasesApril May June

Units to produce 26,000 46,000 29,000

Pounds per unit 5 5 5

Material needs (lbs.) 130,000 230,000 145,000

Desired ending inventory 23,000 14,500 11,500Total material needs (lbs.) 153,000 244,500 156,500

Less beginning inventory 13,000 23,000 14,500

Material purchases (lbs.) 140,000 221,500 142,000

Ending inventory = 10% of next month's material needs.

June ending inventory = .10 (23,000 units 5 lbs. per unit).

June ending inventory = 11,500 lbs.

Beginning inventory is last month's ending inventory.

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Cash Payments for

Material Purchases

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Materials used in production cost $0.40per pound. One-half of a months purchases are paid forin 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.


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April May June

Material purchases (lbs.) 140,000 221,500 142,000

Cost per pound 0.40$ 0.40$ 0.40$

Total cost 56,000$ 88,600$ 56,800$

Payables from March 12,000$April purchases 28,000$ 28,000$

May purchases 44,300$ 44,300$

June purchases $28,400

Total payments in month 40,000$ 72,300$ 72,700$

$56,000 = $28,000

$88,600 = $44,300

$56,800 = $28,400

Cash Payments for

Material Purchases

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ProductionBudget

Direct Labor

ProductionBudget

Materials


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Direct Labor

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Each unit produced requires 3 minutes (.05 hours) of directlabor. Basket employs 30 persons for 40 hours each weekat a rate of $10 per hour. Any extra hours needed areobtained by hiring temporary workers at $10 per hour.

April May June

Units to produce 26,000 46,000 29,000

Hours per unit 0.05 0.05 0.05

Total hours required 1,300 2,300 1,450Wage rate per hour 10$ 10$ 10$

Direct labor cost 13,000$ 23,000$ 14,500$


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ProductionBudget

Materials /Direct Labor

ProductionBudget

Manufacturing

Overhead


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Manufacturing Overhead

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Variable manufacturing overhead is $1 per unit producedand fixed manufacturing overhead is $50,000 per month.

Fixed manufacturing overhead includes $20,000 indepreciation which does not require a cash outflow.

April May June

Units to produce 26,000 46,000 29,000

Variable overhead rate 1.00$ 1.00$ 1.00$

Variable overhead cost 26,000$ 46,000$ 29,000$

Fixed overhead 50,000 50,000 50,000Total mfg. overhead cost 76,000$ 96,000$ 79,000$

Deduct depreciation 20,000 20,000 20,000

Manufacturing overhead - cash 56,000$ 76,000$ 59,000$


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ProductionBudget Selling

andAdministrative

ExpenseBudget

Selling and Administrative

(S&A) Expense Budget

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Selling and Administrative

(S&A) Expense Budget

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Sellingexpense budget contain both variable and fixeditems.

Variable items: shipping costs and sales commissions.

Fixed items: advertising and sales salaries.

Administrative expense budget contain mostly fixed items.

Executive salaries and depreciation on office equipment.


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Sellingand

AdministrativeExpense

Budget

CashBudget

Cash Budget

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Format of the Cash Budget

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The cash budget is divided into four sections:

1. Cash receipts section lists all cash inflows excludingcash received from financing;

2. Cash disbursements section consists of all cashpayments excluding repayments of principal andinterest;

3. Cash excess or deficiency section determines if thecompany will need to borrow money or if it will be ableto repay funds previously borrowed; and

4. Financing section details the borrowings andrepayments projected to take place during the budgetperiod.


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Cash Receipts Budget

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All sales are on account.

Baskets collection pattern is:

70 percent collected in month of sale

25 percent collected in month after sale5 percent will be uncollectible

Accounts receivable on March 31 is $30,000, all of whichis collectible.


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April May JuneBudgeted unit sales 20,000 50,000 30,000

Price per unit 10$ 10$ 10$

Budgeted sales revenue 200,000$ 500,000$ 300,000$

Receipts from March sales 30,000$Receipts from April sales 140,000 50,000$

Receipts from May sales 350,000 125,000$

Receipts from June sales 210,000

Total cash receipts 170,000$ 400,000$ 335,000$

April: .70 $200,000 = $140,000 and .25 $200,000 = $50,000

May: .70 $500,000 = $350,000 and .25 $500,000 = $125,000

June: .70 $300,000 = $210,000

Cash Receipts Budget

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Cash Budget

Additional Information

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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 theend of a month.

Pays interest at 16 percent when a principal paymentis 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.


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Cash Budget

April May June

Beginning cash balance 40,000$ 30,000$ 30,000$Cash receipts 170,000 400,000 335,000

Total cash receipts 210,000$ 430,000$ 365,000$

Cash payments:Materials budget 40,000$ 72,300$ 72,700$Labor budget 13,000 23,000 14,500Manufacturing OH budget 56,000 76,000 59,000

S&A expense budget 70,000 85,000 75,000Equipment purchases 0 143,700 48,800Dividends 51,000 0 0

Total cash payments 230,000$ 400,000$ 270,000$

Balance before financing (20,000)$ 30,000$ 95,000$

Borrowing 50,000 0 0Principal repayment 0 0 (50,000)Interest 0 0 (2,000)

Ending cash balance 30,000$ 30,000$ 43,000$

$50,000 .16 3/12 = $2,000 11-35


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BudgetedIncome

Statement

CashBudget

The Budgeted

Income Statement

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Basket Company

Budgeted Income Statement

For the Three Months Ended June 30

Sales (100,000 units @ $10) 1,000,000$Cost of goods sold (100,000 @ $4.99) 499,000

Gross margin 501,000$

Computation of unit cost follows

The Budgeted

Income Statement

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Production costs per unit Quantity Cost TotalDirect 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

Total unit cost 4.99$

Total mfg. OH for quarter $251,000Total labor hours required 5,050 hrs.

= $49.70 per hr.

From labor and OH budgets

Labor Hours Overhead

April 1,300 76,000$

May 2,300 96,000

June 1,450 79,000

Total 5,050 251,000$

Manufacturingoverhead is applied

based ondirect labor hours.

The Budgeted

Income Statement

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Basket Company

Budgeted Income Statement

For the Three Months Ended June 30

Sales (100,000 units @ $10) 1,000,000$Cost of goods sold (100,000 @ $4.99) 499,000

Gross margin 501,000$

Selling and administrative expenses 260,000

Operating income 241,000$Interest expense 2,000

Net income 239,000$

The Budgeted

Income Statement

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Cash Budget

From S&A Expense Budget

April 80,000$

May 95,000

June 85,000

Total 260,000$


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BudgetedBalance

Sheet

BudgetedIncome

Statement

The Budgeted

Balance Sheet

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The Budgeted

Balance Sheet

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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 Company 25% of June


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Budgeted Balance Sheet

June 30, 2009Current assets

Cash 43,000$

Accounts receivable 75,000Raw materials inventory 4,600Finished goods inventory 24,950

Total current assets 147,550$

Property and equipmentLand 50,000$Building 174,500Equipment 192,500

Total property and equipment 417,000$

Total assets 564,550$

Liabilities and EquitiesAccounts payable 28,400$Common stock 200,000Retained earnings 336,150

Total liabilities and equities 564,550$

sales of$300,000

June End Inv.

11,500 lbs.@ $.40 per lb.

50% of Junepurchasesof $56,800

June End Inv.5,000 units

@ $4.99 each

Beginning balance 148,150$

Add: net income 239,000

Deduct: dividends (51,000)

Ending balance 336,150$

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Static vs. Flexible Budgets

Static Budgets

Traditional Budgets are prepared for a fixed activitylevel (e.g. Sales budget prepared for 500,000 units).

Flexible Budgets

Flexible Budgets are prepared for multiple activity levels(e.g. Sales budget prepared for 500,000 units, 800,000units, 1,000,000 units etc).

What if actualsales volume is800,000 units?

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Drawbacks of Static Budgets

Performance evaluation is

difficult when actual

activity differs from theactivity originally budgeted.

Hmm! Comparingcosts at differentlevels of activityis like comparing

apples with oranges.

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Flexible Budgeting


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Original Actual

Budget Results Variances

Units of Activity 10,000 8,000 2,000 U

Variable costsIndirect labor 40,000$ 34,000$ $6,000 F

Indirect materials 30,000 25,500 4,500 F

Power 5,000 3,800 1,200 F

Fixed costsDepreciation 12,000 12,000 0

Insurance 2,000 2,000 0

Total overhead costs 89,000$ 77,300$ $11,700 F

U = Unfavorable variance Barton,Inc. was unable to achieve the

budgeted level of activity.

Flexible Budgeting

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Original Actual

Budget Results Variances

Units of Activity 10,000 8,000 2,000 U

Variable costs

Indirect labor 40,000$ 34,000$ $6,000 F

Indirect materials 30,000 25,500 4,500 F

Power 5,000 3,800 1,200 F

Fixed costs

Depreciation 12,000 12,000 0Insurance 2,000 2,000 0

Total overhead costs 89,000$ 77,300$ $11,700 F

Flexible Budgeting

Q: Since cost variances are favorable, has

Barton done a good job controlling costs?

F = Favorable variance: actual costs

are less than budgeted costs.

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I dont think I cananswer the question

using the originalbudget.

How much ofthe favorable costvariance is due to lower

activity, and how much is dueto good cost control?

Shouldnt variable costsbe lower if actual activity

is below budgeted activity?

Flexible Budgeting

To answer the question, we must flexthe budget to the actual level of activity.

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Fl ibl B d i


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Improve performance evaluation.

May be prepared for any activitylevel in the relevant range.

Show expenses that should haveoccurred at the actual level ofactivity.

Reveal variances due to good cost

control or lack of cost control.

Flexible Budgeting

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Flexible Budgeting

To flex a budget for different activity levels,we must know how costs behave withchanges in activity levels.

Total variable costs changein direct proportion tochanges in activity.

Total fixed costs remain

unchanged within therelevant range.

Fixed

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Fl ibl B d i


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Flexible Budgeting

Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000

Per Hour Cost Hours Hours Hours

Units of Activity 8,000 10,000 12,000

Variable costsIndirect labor 4.00 32,000$

Indirect material 3.00 24,000

Power 0.50 4,000

Total variable cost 7.50$ 60,000$

Fixed costsDepreciation 12,000$

Insurance 2,000

Total fixed cost

Total overhead costs

Variable costs are expressed as a

constant amount per hour.In the original budget, labor was

$40,000 for 10,000 hours resultingin a rate of $4.00 per hour.

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Flexible Budgeting


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Cost Total Flexible Budgets

Formula Fixed 8,000 10,000 12,000



Variable costs

Indirect labor 4.00 32,000$ 40,000$ 48,000$

Indirect material 3.00 24,000 30,000 36,000Power 0.50 4,000 5,000 6,000

Total variable cost 7.50$ 60,000$ 75,000$ 90,000$

Fixed costs

Depreciation 12,000$ 12,000$ 12,000$ 12,000$

Insurance 2,000 2,000 2,000 2,000Total fixed cost 14,000$ 14,000$ 14,000$

Total overhead costs 74,000$ 89,000$ 104,000$

Flexible Budgeting

Total variable cost = $7.50 per unit budget level in units

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Fl ibl B d ti


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Cost Total Flexible BudgetsFormula Fixed 8,000 10,000 12,000



Variable costs

Indirect labor 4.00 32,000$ 40,000$ 48,000$Indirect material 3.00 24,000 30,000 36,000

Power 0.50 4,000 5,000 6,000

Total variable cost 7.50$ 60,000$ 75,000$ 90,000$

Fixed costs

Depreciation 12,000$ 12,000$ 12,000$ 12,000$

Insurance 2,000 2,000 2,000 2,000

Total fixed cost 14,000$ 14,000$ 14,000$

Total overhead costs 74,000$ 89,000$ 104,000$

Flexible Budgeting

Fixed costs are expressed as a totalamount that does not change within

the relevant range of activity.

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Cost Total

Formula Fixed Flexible Actual

Per Hour Costs Budget Results Variances

Units of Activity 8,000 8,000 0

Variable costs

Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U

Indirect material 3.00 24,000 25,500 1,500 U

Power 0.50 4,000 3,800 200 F

Total variable costs 7.50$ 60,000$ 63,300$ $ 3,300 U

Fixed Costs

Depreciation 12,000$ 12,000$ 12,000$ 0

Insurance 2,000 2,000 2,000 0

Total fixed costs 14,000$ 14,000$ 0

Total overhead costs 74,000$ 77,300$ $ 3,300 U

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Indirect labor and indirect material haveunfavorable variances because actual costs are

more than the flexible budget costs.

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Review Questions

1. A store has budgeted sales of $36,000 in July. The store manager

wants to have $7,000 in inventory at the end of July. Its beginninginventory is expected to be $6,000. What is the budgeted amount ofmerchandise purchases?a. $36,000.b. $37,000.

c. $42,000.d. $43,000.

2. A company predicts its production and sales will be 24,000 units. Atthat level of activity, its fixed costs are budgeted at $12.50 per unit, andits variable costs are budgeted at $10.25. If its activity level declines to

20,000 units, what will be its fixed costs and its variable costs?a. Total fixed costs $300,000; Total variable costs $246,000.b. Total fixed costs $250,000; Total variable costs $205,000.c. Total fixed costs $300,000; Total variable costs $205,000.d. Total fixed costs $250,000; Total variable costs $246,000.

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Ch k Li t


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Check List

Do you have a good understanding of:

Preparation of various budgets (focus: operatingbudgets)

Limitations of static budgets Flexible budgets: preparation & analysis

lecture 11 budgeting(1).pdf

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