ACG 2071
Module 9: Budgeting
Budgets – charts a course for a business by outlining the plans of the business in financial terms
Objectives:
· Establishing specific goals
· Executing plans to achieve goals
· Periodically comparing actual results with goals
Management objectives:
· Planning
o A set of goals is often necessary to guide and focus individual and group actions.
o Budgeting supports the planning process by requiring all organizational units to establish their goals for the upcoming period.
o Planning not only motivates employees to attain goals but also improves overall decision making.
· Directing
o Once the budget plans are in place, they can be use to direct and coordinate operations in order to achieve the stated goals.
o Responsibility centers are led by a manager who has the authority over and the responsibility for the unit’s performance.
· Controlling
o Actual performance of an operation can be compared against the planned goals
§ Provides prompt feedback to employees about their performance.
§ Comparing actual results to the plan also helps prevent unplanned expenditures.
Budgeting Systems
v vary among businesses because of such factors as organizational structure, complexity of operations, and management philosophy.
v Differences in budget systems are even more significant among different types of business such as manufacturers and service businesses.
v Types of Budgets
o Continuous budgeting – maintains a 12-month projection into the future. The 12-month budge is continually revised by removing the data for the period just ended and adding estimated budget data for the same period next year.
o Zero based budgeting – requires manager to estimate sales, production, and other operating data as though operations are being started for the first time.
o Static Budget – shows expected results of a responsibility center for only one activity level. Once the budget has been determined, it is not changed, even if the activity changes.
o Flexible budget – shows expected results of a responsibility center for several activity levels.
Master Budget
o Manufacturing operations require a series of budgets that are linked together in the master budget.
o Major parts of the master budget are:
o Budgeted income statement
§ Sales budget
§ Cost of goods sold budget
· Production budget
· Direct materials purchases budget
· Direct labor cost budget
· Factory overhead cost budget
§ Selling and administrative expense budget
o Budgeted balance sheet
§ Cash budget
§ Capital expenditure budget
These budgets must be prepared in a specific order since the information from a prior budget is needed to prepare the next budget.
Budgeted Income Statement –
v Sales Budget
o Indicates for each product
§ the quantity of estimated sales and
§ expected selling price.
o In estimating the quantity of sales for each product, past sales volumes are often used as the starting point. They are revised for factors that are expected to affect future sales. Once sales volume is obtained, sales revenues can be computed.
o Example: Brite Lite sells two products in United States and Canada. Product A is estimated to sell 5,000 units in the United States and 10,000 units in Canada at $100 per unit. Product B sells 20,000 units in United States and 6,000 units in Canada at $50 per unit.
Brite Lite
Sales Budget
For year 2006
Product A / Product BUnits sold:
United States / 5,000 / 20,000
Canada / 10,000 / 6,000
Total units sold / 15,000 / 26,000
Sales price per unit / X $100 / X $50
Total sales / $1,500,000 / 1,300,000 / $2,800,000
Once the sales budget is completed, the Production budget is prepared.
Production Budget:
o Coordinates with sales budget to ensure that production and sales are kept in balance during the period
o Number of units manufactured to meet budgeted sales and inventory needs for each product is set forth in the production budget.
o Formula:
Expected units to be sold
+ Desired ending inventory
-Estimated beginning inventory
Total units to be produced
Example: Brite Lite expects to have beginning inventory of 3,000 units of Product A and 5,000 units of Product B. The company would like its ending inventory to be 10% of estimated sales.
Product A / Product BExpected sales (in units) / 15,000 / 26,000
Plus desired ending inventory / + 1,500 / + 2,600
Minus estimated beginning inventory / - 3,000 / - 5,000
Total production / 13,500 / 23,600
Expected sales came in from the Sales Budget.
Desired ending inventory
Product A: Estimated sales 15,000 x 10% = 1,500 units
Product B: Estimated sales 26,000 x 10% = 2,600 units
Beginning inventory given in problem.
Direct Materials Purchase Budget:
· The production budget is the starting point for determining the estimated quantities of direct materials to be purchased.
· Estimates purchase levels for the next year and costs.
· Formula:
Materials required for production
+ Desired ending materials inventory
-Estimated beginning materials inventory
Direct materials to be purchased
X cost per unit
Total direct materials cost
Example: Product A uses 2 lbs. of plastic and 3 lbs. of aluminum. Product B uses ½ lb. of plastic, 1 lb. of aluminum, and 2 lbs. of paper. Aluminum sells for $5 per lb. Plastic sells for $10 per lbs, and paper sells for $2 per lbs. Beginning inventory is 7,300, 3,600, and 5,200 lbs. Ending inventory is 4,000 lbs, 6,000 lbs, and 8,000 lbs.
Ending Inventory (lbs) / Beginning inventory (lbs.)Plastic / 4,000 / 7,300
Aluminum / 6,000 / 3,600
Paper / 8,000 / 5,200
Required: Prepare a direct material purchase budget.
Direct Materials Purchase Budget
AL / Plastic / Paper / TotalProduct A (13,500 units)
13,500 x 3 lbs. / 40,500
13,500 x 2 lbs. / 27,000
13,500 x 0 lbs. / 0
Product B (23,600 units)
23, 600 x 1lbs. / 23.600
23,600 x ½ lbs. / 11,800
23,600 x 2 lbs. / 47,200
Total needed for production / 64,100 / 38,800 / 47,200
+ Desired Ending inventory / 4,000 / 6,000 / 8,000
Total units needed / 68,100 / 44,800 / 55,200
- Beginning Inventory / -7,300 / -3,600 / -5,200
Total direct materials purchased / 60,800 / 41,200 / 50,000
Unit cost for material / X $5 / X $10 / X $2
Total costs / $304,000 / $412,000 / $100,000 / $816,000
Direct Labor Budget:
o Production budget also provides the starting point for preparing the direct labor cost budget.
Example: Department 1 has a labor cost of $10 per hour. Product A uses 6 hours in Department 1 and Product B uses 4 hours. Department 2 has a labor cost of $7 per hours. Production A uses 2 hours of Department 2’s labor and Product B uses ½ hour. Prepare a direct labor budget.
Department 1 / Department 2 / TotalProduct A (13,500 units)
6 hours per unit x 13,500 / 81,000
2 hours per unit x 13,500 / 27,000
Product B (23,600 units)
4 hours x 23,600 units / 94,400
½ hour x 23,600 units / 11,800
Total hours per department / 175,400 / 38,800
Labor cost per hour / X $10 / X $7
Total / $1,754,000 / $271,600 / $2,025,600
Factory Overhead Budget
Example: Indirect labor $25,000, Utilities $45,000, Maintenance $40,000, and insurances and taxes $60,000.
Factory Overhead Budget
Indirect labor / $ 25,000Utilities / 45,000
Maintenance / 40,000
Insurance & Taxes / 60,000
Total / $170,000
Cost of goods sold budget:
o Is composed of the budgets for production, direct materials, direct labor and factory overhead.
Cost of Goods Sold BudgetFinished goods inventory, January / $ 1,095,600.00
Work in process inventory, January / $ 214,400.00
Direct materials
Direct materials inventory, January / $ 99,000.00
Direct materials purchases / $ 2,587,500.00
Cost of direct materials available / $ 2,686,500.00
Less direct materials inventory, December / $ 104,400.00
Cost of direct materials placed in production / $ 2,582,100.00
Direct labor / $ 4,851,600.00
Factory overhead / $ 2,089,080.00
Total manufacturing costs / $ 9,522,780.00
Total work in process during period / $ 9,737,180.00
Less work in process inventory, December / $ 220,000.00
Cost of goods manufactured / $ 9,517,180.00
Cost of finished goods available for sale / $ 10,612,780.00
Less finished goods inventory, December / $ 1,565,000.00
Cost of Goods Sold / $ 9,047,780.00
Note: the above example does not match the examples before it. The numbers in red came from the appropriate budgets.
Selling and Administrative Budget:
o Sales budget is often used as the starting point for estimating the selling and administrative expenses.
Selling and Administrative Expenses BudgetSelling expenses
Sales salaries expense / $ 715,000.00
Advertising expense / $ 360,000.00
Travel expense / $ 115,000.00
Total selling expenses / $ 1,190,000.00
Administrative expenses
Officer's salaries expense / $ 360,000.00
Office salaries expense / $ 258,000.00
Office rent expense / $ 34,500.00
Office supplies expense / $ 17,500.00
Total administrative expense / $ 25,000.00 / $ 695,000.00
Total selling and administrative expense / $ 1,885,000.00
Budgeted Income Statement:
o Prepared from the completed budgets.
Budgeted Income StatementRevenue from sales / $ 13,336,000.00
Cost of goods sold / $ 9,047,780.00
Gross profit / $ 4,288,220.00
Selling and administrative expenses / $ 1,885,000.00
Income from operations / $ 2,403,220.00
Other income
Interest revenue / $ 98,000.00
Other expenses
Interest expenses / $ 90,000.00 / $ 8,000.00
Income before income tax / $ 2,411,220.00
Income tax / $ 600,000.00
Net income / $ 1,811,220.00
Note: numbers in red are from prior budgets.
Balance Sheet Budgets
v Cash Budget:
· Is one of the most important elements of budgeted balance sheet.
· Presents the expected receipts and payments of cash for a period of time.
· Three parts of the cash budget are
o Cash receipts
o Cash payments
o Other items
· We prepare a schedule for each of the three parts and then unite in the final cash budget presentation.
Cash Receipts Schedule:
Example: Magna Corporation has estimated sales of January $1,080,000, February $1,240,000, and March $970,000. Accounts receivable has a balance on January 1 of $370,000. The company expects that 10% of its sales will be in cash and the remainder in credit. Of the credit sales, 60% will be collected in the next month and the remainder the following month.
Required: Prepare a schedule of cash receipts.
Calculations:
January SalesSales / $ 1,080,000.00
Less cash portion ( 10% of sales) / $ 108,000.00
Credit sales / $ 972,000.00
Credit sales / $ 972,000.00
Collections in February / $ 583,200.00 / 60% of credit sales
Remainder collected in March / $ 388,800.00
February Sales
Sales / $ 1,240,000.00
Less cash portion ( 10% of sales) / $ 124,000.00
Credit sales / $ 1,116,000.00
Credit sales / $ 1,116,000.00
Collections in February / $ 669,600.00 / 60% of credit sales
Remainder collected in March / $ 446,400.00
March Sales
Sales / $ 970,000.00
Less cash portion ( 10% of sales) / $ 97,000.00
Credit sales / $ 873,000.00
Credit sales / $ 873,000.00
Collections in February / $ 523,800.00 / 60% of credit sales
Remainder collected in March / $ 349,200.00
Schedule of Cash Receipts
January / February / MarchReceipts of Cash Sales / $108,000 / $124,000 / $97,000
Receipt from collections:
Collection from last month’s sales / $370,000 / $388,800 / $446,400
Collection from current month’s / 583,200 / 669,600 / 523,800
Total receipts / 953,200 / 1,058,400 / 970,200
Schedule of Cash Payments
o Reduction in cash from manufacturing, selling and administrative, capital expenditures, and other sources.
Example: Magna Company has manufacturing costs of $840,000 in January, $780,000 in February, and $812,000 for March. The beginning balance in accounts payable is $190,000. Depreciation expense is $24,000 per month which is included in manufacturing costs. Manufacturing costs payments are allocated at 75% in month incurred and remainder the next month.
Calculations:
January Manufacturing CostsTotal manufacturing costs for month / $ 840,000.00
Less depreciation expense / $ 24,000.00 / does not require a payment of cash
Total manufacturing costs owed / $ 816,000.00
Payment in January
Total manufacturing costs owed / $ 816,000.00
'75% paid in month incurred / 75%
Payment in January / $ 612,000.00
Total manufacturing costs owed / $ 816,000.00
Less payment in January / $ 612,000.00
Payment in February / $ 204,000.00
February Manufacturing Costs
Total manufacturing costs for month / $ 780,000.00
Less depreciation expense / $ 24,000.00 / does not require a payment of cash
Total manufacturing costs owed / $ 756,000.00
Payment in February
Total manufacturing costs owed / $ 756,000.00
'75% paid in month incurred / 75%
Payment in February / $ 567,000.00
Total manufacturing costs owed / $ 756,000.00
Less payment in February / $ 567,000.00
Payment in March / $ 189,000.00
March Manufacturing Costs
Total manufacturing costs for month / $ 812,000.00
Less depreciation expense / $ 24,000.00 / does not require a payment of cash
Total manufacturing costs owed / $ 788,000.00
Payment in March
Total manufacturing costs owed / $ 788,000.00
'75% paid in month incurred / 75%
Payment in March / $ 591,000.00
Total manufacturing costs owed / $ 788,000.00
Less payment in March / $ 591,000.00
Payment in April / $ 197,000.00
January / February / March
Payments of prior month’s manufacturing costs / $190,000 / $204,000 / $189,000
Payments of current month’s manufacturing costs / 612,000 / 567,000 / 591,000
Total payments / $802,000 / $771,000 / $780,000
Completing the Cash Budget
o After preparing the schedule of cash receipts and the schedule of cash payments, we review additional items and prepare the formal cash budget.
Example:
· Cash balance on January 1 - $280,000
· Quarterly tax due on March 31 - $150,000
· Quarterly interest paid to creditors on January 10 - $22,500
· Selling and administrative expenses:
o January $160,000
o February $165,000
o March $145,000
· Interest revenue to be received on March 21 - $24,500
· Capital expenditures on equipment payable on February 28 - $274,000