CHAPTER 9 Budgetary Planning Budgeting Basics Budget A

CHAPTER 9 Budgetary Planning

Budgeting Basics Budget 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.

Concepts from the Book Unlike some chapters, most students are familiar with theme of this chapter. Also, most of the material is self explanatory. Consequently, this presentation will only highlight the concepts of the book, focusing on problems.

What I learned from my first budget experience Involve the department managers. Train. Have the budget forms build on one another. Get the sequence of activities right. Document all calculations. Provide important assumptions on inflation, volume growth and so on.

What I learned from my first budget experience Make reports provided during user friendly. Use graphics where possible. Make sure the account names are the same. Hold department heads accountable.

Games People Play Golden watch. Cut essential services—Mayor Koch. Claim someone above the reviewer wants a line item. Pad each line just a little. Wait until the last minute to turn it in so there can be no review.

Budgeting and Human Behavior Participative Budgeting May inspire higher levels of performance or discourage additional effort. Depends on how budget developed and administered. Invite each level of management to participate. This “bottom-to-top” approach is called Participative Budgeting LO 2: State the essentials of effective budgeting.

The Master Budget A set of interrelated budgets that constitutes a plan of action for a specified time period Contains two classes of budgets: Operating budgets: Individual budgets that result in the preparation of the budgeted income statement – establish goals for sales and production personnel Financial budgets: The capital expenditures budget, the cash budget, and the budgeted balance sheet – focus primarily on cash needs to fund operations and capital expenditures LO 3: Identify the budgets that comprise the master budget.

The Master Budget - Components LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Sales Budget 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 LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: 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: Essential to have a realistic estimate of ending inventory LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Direct Materials Budget Shows both the quantity and cost of direct materials to be purchased Derived from the direct materials units required for production (from the production budget) plus the desired change in ending direct materials units Budgeted cost of direct materials to be purchased = required units of direct materials X anticipated cost per unit LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Direct Labor Budget Shows both the quantity of hours and cost of direct labor necessary to meet production requirements Critical in maintaining a labor force that can meet expected production Total direct labor cost formula: LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Manufacturing Overhead Shows the expected manufacturing overhead costs for the budget period Distinguishes between fixed and variable overhead costs Example – Hayes Company Fixed cost amounts are assumed Expected variable costs per direct labor hour: indirect materials: $1. 00 indirect labor: $1. 40 utilities: $0. 40 maintenance: $0. 20 LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Manufacturing Overhead LO 3: Identify the budgets that comprise the master budget.

Operating Budgets: Budgeted Income Statement Important end-product of the operating budgets Indicates expected profitability of operations Provides a basis for evaluating company performance Prepared from the operating budgets Sales Budget Production Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget Selling and Administrative Expense Budget LO 4: Describe the sources for preparing the budgeted income statement.

Operating Budgets: Budgeted Income Statement Example – Hayes Company To find cost of goods sold: First, determine the unit cost of one Kitchen-mate Second, determine Cost of Goods Sold by multiplying units sold times unit cost: 15, 000 units X $44 = $660, 000 LO 4: Describe the sources for preparing the budgeted income statement.

Operating Budgets: Budgeted Income Statement LO 4: Describe the sources for preparing the budgeted income statement.

Financial Budgets: 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 LO 5: Explain the principal sections of a cash budget.

Operating Budgets: Budgeted Income Statement LO 5: Explain the principal sections of a cash budget.

Financial Budgets: Cash Budget Cash Receipts Section Includes expected receipts from the principal sources of revenue – usually cash sales and collections on credit sales Shows expected interest and dividends receipts as well as proceeds from planned sales of investments, plant assets, and capital stock Cash Disbursements Section Includes expected cash payments for direct materials and labor, taxes, dividends, plant assets, etc. Financing Section Shows expected borrowings and repayments of borrowed funds plus interest LO 5: Explain the principal sections of a cash budget.

Financial Budgets: Cash Budget Must prepare in sequence. Ending cash balance of one period is the beginning cash balance for the next. Data obtained from other budgets and from management. Often prepared for the year on a monthly basis. LO 5: Explain the principal sections of a cash budget.

Financial Budgets: Budgeted Balance Sheet A projection of financial position at the end of the budgeted period. Developed from the budgeted balance sheet for the preceding year and the budgets for the current year. LO 5: Explain the principal sections of a cash budget.

LO 5: Explain the principal sections of a cash budget.

Budgeting: Merchandisers Sales Budget: Starting point and key factor in developing the master budget Use a purchases budget instead of a production budget Does not use the manufacturing budgets (direct materials, direct labor, manufacturing overhead) To determine budgeted merchandise purchases: LO 6: Indicate the applicability of budgeting in nonmanufacturing companies.

Budgeting: Service Companies Critical factor in budgeting is coordinating professional staff needs with anticipated services Problems if overstaffed: Disproportionately high labor costs Lower profits due to additional salaries Increased staff turnover due to lack of challenging work Problems if understaffed: Lost revenues because existing and future client needs for services cannot be met Loss of professional staff due to excessive work loads LO 6: Indicate the applicability of budgeting in manufacturing companies.

Budgeting: Not-for-Profit Companies Just as important as for profit-oriented company However, budget process differs significantly from that of a profit-oriented company Budget on the basis of cash flows (expenditures and receipts), not on a revenue and expense basis The starting point is usually expenditures, not receipts Management’s task is to find receipts needed to support planned expenditures Budget must be strictly followed, overspending often illegal LO 6: Indicate the applicability of budgeting in nonmanufacturing companies.

Exercise 9 -3 XYZ, CPAs are preparing their service revenue (sales) budget for the coming year. The practice is divided into three departments auditing, tax, and consulting. Billable hours for each department, by quarter, are provided on the following slide. . Of a

Exercise 9 -3 Department Quarter One Quarter Two Quarter Three Quarter Four Auditing 2200 1600 2000 2400 Tax 3000 2400 2000 2500 Consulting 1500 Average hourly billing rates are: auditing $80, tax $90, and consulting $100. Prepare a sales budget for 2008 by listing the departments and showing for each quarter and the year in total, billable hours, billable rate, and total revenue.

Budget--Auditing Department Billable hours Rate Revenue Quarter One Quarter Two Quarter Three Quarter Four Total 2200 1600 2000 2400 8200 $80 $80 $80 $176, 000 $128, 000 $160, 000 $192, 000 $656, 000 Simple formula: hours x billing rate equals revenue.

Budget--Tax Department Billable hours Rate Revenue Quarter One Quarter Two Quarter Three Quarter Four Total 3000 2400 2000 2500 9900 $90 $90 $90 $270, 000 $216, 000 $180, 000 $225, 000 $891, 000

Budget--Consulting Department Quarter One Quarter Two Quarter Three Quarter Four Total Billable hours 1500 6000 Rate $100 $100 $150, 000 $600, 000 Revenue

Budget—Total Dollars Department Quarter One Quarter Two Quarter Three Quarter Four Total Auditing $176, 000 $128, 000 $160, 000 $192, 000 $656, 000 Tax $270, 000 $216, 000 $180, 000 $225, 000 $891, 000 Consulting $150, 000 $600, 000 Total $596, 000 $494, 000 $490, 000 $567, 000 $2, 147, 000

Exercise 9 -5 XYZ company has adopted the following production budget for the first four months of 2009. Month Units January 10, 000 March 5, 000 February 8, 000 April 4, 000

Exercise 9 -5 Each unit requires 3 pounds of raw materials costing $2. 00 per pound. On December 31, 2008, the ending raw material inventory was 9000 pounds. Management wants to have a raw materials inventory at the end of the month equal to 30% of the next months production requirement. Prepare a direct materials purchase budget by month for the first quarter.

Exercise 9 -5 Units to be produced Direct materials per unit Total pounds needed for production January February  10, 000 X  3  30, 000   8, 000 X  3  24, 000 March 5, 000 X  3 15, 000 First remember the formula: Direct material units required for production + Desired ending direct material units + Beginning direct material units = Required direct material units to be purchased

Exercise 9 -5 Units to be produced Direct materials per unit Total pounds needed for production January February  10, 000 X  3  30, 000   8, 000 X  3  24, 000 March 5, 000 X  3 15, 000 Thus, in this step we calculate the direct materials needed for production by multiplying the units to be produced by the direct materials per unit.

Exercise 9 -5 Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials Total materials required January February March  10, 000 X  3  30, 000   8, 000 X  3  24, 000 5, 000 X  3 15, 000 7, 200   (pounds)*4, 500  37, 200  28, 500 3, 600 18, 600 To total pounds needed for production, we now add the desired ending inventory in pounds.

Exercise 9 -5 Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials Total materials required January February March  10, 000 X  3  30, 000   8, 000 X  3  24, 000 5, 000 X  3 15, 000 7, 200   (pounds)*4, 500  37, 200  28, 500 3, 600 18, 600 This gives us the total materials required for the period.

Exercise 9 -5 Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials Total materials required January February March  10, 000 X  3  30, 000   8, 000 X  3  24, 000 5, 000 X  3 15, 000 7, 200   (pounds)*4, 500  37, 200  28, 500 3, 600 18, 600 However, some of the material required for production can come from beginning inventory. Subtracting inventorying will, therefore, be our next step.

Exercise 9 -5 Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials Total materials required Less: Beginning direct materials Direct materials purchases January February March  10, 000 X  3  30, 000   8, 000 X  3  24, 000 5, 000 X  3 15, 000 7, 200   (pounds)*4, 500 37, 200  28, 500 3, 600 18, 600 9, 000   (pounds)7, 200  28, 200  21, 300 4, 500 14, 100 Now we know how many pounds are needed, what we do not know is the cost.

Exercise 9 -5 Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials Total materials required Less: Beginning direct materials Direct materials purchases Cost per pound Total cost of direct materials   purchases January February  10, 000 X  3  30, 000   8, 000 X  3  24, 000 5, 000 X  3 15, 000   (pounds)* 7, 200 4, 500  37, 200  28, 500 3, 600 18, 600   (pounds) 9, 000 7, 200  28, 200  21, 300 X  $2 4, 500 14, 100 X  $2 $56, 400 $28, 200 $42, 600 March Multiply pounds by costs per pound to get total cost.

Exercise 9 -8 XYZ Company is preparing its manufacturing overhead budget for 2008. Relevant cost data consists of the following: Units to be produced (by quarters): 10, 000, 12, 000, 14, 000, 16, 000.

Exercise 9 -8 Direct labor: time is 1. 5 hours per unit. Variable overhead costs per direct labor hour; indirect materials $0. 70; indirect labor $1. 20: and maintenance $0. 50. Fixed overhead costs per quarter: supervisor salaries $35, 000, ; depreciation $16, 000; and maintenance $12, 000. Prepare the manufacturing overhead budget for the year, showing quarterly data.

Exercise 9 -8 Things to remember when preparing an overhead budget: Overhead budgets are flexible budgets. This means that variable costs vary with some unit of input (like direct hours) or some unit of output (like product produced). The overhead rate is calculated by dividing the total overhead budget by the total base (direct labor hours, direct labor dollars, and so on).

Since the base is direct labor hours, let us calculate that first. Direct hours = 1. 5 x direct labor hours. Quarter One Units to be Produced Direct Labor Hours Two Three Four Total 10, 0 12, 0 14, 0 16, 0 52, 0 00 00 00 15, 0 18, 0 21, 0 24, 0 78, 0 00 00 00 We will multiply direct labor hours by variable cost/hour on the next slide.

Now let’s calculate variable overhead costs Variable Costs: Costs/Hour Indirect Materials $ 0. 70 Indirect Labor $ 1. 20 Maintenance $ 0. 50 Total Variable Costs $ 2. 40 One Two Three Four Costs per hour are given in the problem Fixed Costs: Supervisory Salaries Depreciation Maintenance Total Fixed Costs In the next slide we will multiply them by hours shown on previous slide to get variable costs. Total Manufacturing Overhead Direct Labor Hours Overhead Rate per Hour Let’s do it! Total

Now let’s calculate variable overhead costs Variable Costs: Costs/Hour One Two Indirect Materials $ 0. 70 $ 10, 500 $ 12, 600 $ Indirect Labor $ 1. 20 $ 18, 000 $ Maintenance $ 0. 50 $ 7, 500 $ Total Variable Costs $ 2. 40 Three Four Total 14, 700 $ 16, 800 $ 54, 600 21, 600 $ 25, 200 $ 28, 800 $ 93, 600 9, 000 $ 10, 500 $ 12, 000 $ 39, 000 Fixed Costs: Supervisory Salaries Depreciation Maintenance Total Fixed Costs Total Manufacturing Overhead Direct Labor Hours Overhead Rate per Hour Let’s sum each quarter next!

Now let’s calculate variable overhead costs Variable Costs: Costs/Hour One Two Indirect Materials $ 0. 70 $ 10, 500 $ 12, 600 $ Indirect Labor $ 1. 20 $ 18, 000 $ Maintenance $ 0. 50 $ Total Variable Costs $ 2. 40 $ Three Four Total 14, 700 $ 16, 800 $ 54, 600 21, 600 $ 25, 200 $ 28, 800 $ 93, 600 7, 500 $ 9, 000 $ 10, 500 $ 12, 000 $ 39, 000 36, 000 $ 43, 200 $ 50, 400 $ 57, 600 $ 187, 200 Fixed Costs: Supervisory Salaries Depreciation Maintenance Total Fixed Costs Total Manufacturing Overhead Direct Labor Hours Overhead Rate per Hour Fixed costs are easy, they are the same each month regardless of production volume or direct labor hours.

Now let’s calculate variable overhead costs Variable Costs: Costs/Hour Indirect Materials $ 0. 70 $ 10, 500 $ 12, 600 $ 14, 700 $ 16, 800 $ 54, 600 Indirect Labor $ 1. 20 $ 18, 000 $ 21, 600 $ 25, 200 $ 28, 800 $ 93, 600 Maintenance $ 0. 50 $ 7, 500 $ 9, 000 $ 10, 500 $ 12, 000 $ 39, 000 2. 40 $ 36, 000 $ 43, 200 $ 50, 400 $ 57, 600 $ 187, 200 $ 35, 000 $ 140, 000 $ 16, 000 $ 64, 000 $ 12, 000 $ 48, 000 $ 63, 000 $ 252, 000 Total Variable Costs $ One Two Three Four Total Fixed Costs: Supervisory Salaries Now we total Depreciation fixed and Maintenance variable Total Fixed Costsoverhead to get total Total Manufacturing Overhead overhead Direct Labor Hours Overhead Rate per Hour

Now let’s calculate variable overhead costs Variable Costs: Costs/Hour Indirect Materials $ 0. 70 $ 10, 500 $ 12, 600 $ 14, 700 $ 16, 800 $ 54, 600 Indirect Labor $ 1. 20 $ 18, 000 $ 21, 600 $ 25, 200 $ 28, 800 $ 93, 600 Maintenance $ 0. 50 $ 7, 500 $ 9, 000 $ 10, 500 $ 12, 000 $ 39, 000 2. 40 $ 36, 000 $ 43, 200 $ 50, 400 $ 57, 600 $ 187, 200 Supervisory Salaries $ 35, 000 $ 140, 000 Depreciation $ 16, 000 $ 64, 000 Maintenance $ 12, 000 $ 48, 000 $ 63, 000 $ 252, 000 $ 99, 000 $ 106, 200 $ 113, 400 $ 120, 600 $ 439, 200 Total Variable Costs $ One Two Three Four Total Fixed Costs: Add hours for each Total Manufacturing Overhead quarter. Total Fixed Costs Direct Labor Hours Overhead Rate per Hour The suspense is killing me!

Now let’s calculate variable overhead costs Variable Costs: Costs/Hour Indirect Materials $ 0. 70 $ 10, 500 $ 12, 600 $ 14, 700 $ 16, 800 $ 54, 600 Indirect Labor $ 1. 20 $ 18, 000 $ 21, 600 $ 25, 200 $ 28, 800 $ 93, 600 Maintenance $ 0. 50 $ 7, 500 $ 9, 000 $ 10, 500 $ 12, 000 $ 39, 000 2. 40 $ 36, 000 $ 43, 200 $ 50, 400 $ 57, 600 $ 187, 200 Supervisory Salaries $ 35, 000 $ 140, 000 Depreciation $ 16, 000 $ 64, 000 Maintenance $ 12, 000 $ 48, 000 Total Fixed Costs $ 63, 000 $ 252, 000 Total Manufacturing Overhead $ 99, 000 $ 106, 200 $ 113, 400 $ 120, 600 $ 439, 200 Total Variable Costs $ One Two Three Four Total Fixed Costs: Direct Labor Hours Overhead Rate per Hour 15, 000 18, 000 Last of all calculate rate (OH$/DLH) 21, 000 24, 000 78, 000

Now let’s calculate variable overhead costs Variable Costs: Costs/Hour Indirect Materials $ 0. 70 $ 10, 500 $ 12, 600 $ 14, 700 $ 16, 800 $ 54, 600 Indirect Labor $ 1. 20 $ 18, 000 $ 21, 600 $ 25, 200 $ 28, 800 $ 93, 600 Maintenance $ 0. 50 $ 7, 500 $ 9, 000 $ 10, 500 $ 12, 000 $ 39, 000 2. 40 $ 36, 000 $ 43, 200 $ 50, 400 $ 57, 600 $ 187, 200 Supervisory Salaries $ 35, 000 $ 140, 000 Depreciation $ 16, 000 $ 64, 000 Maintenance $ 12, 000 $ 48, 000 Total Fixed Costs $ 63, 000 $ 252, 000 Total Manufacturing Overhead $ 99, 000 $ 106, 200 $ 113, 400 $ 120, 600 $ 439, 200 Total Variable Costs $ One Two Three Four Total Fixed Costs: Direct Labor Hours Overhead Rate per Hour 15, 000 18, 000 21, 000 24, 000 78, 000 $ 5. 63

Problem 9 -2 A XYZ is preparing its annual budgets for the year ending 31/12/2009. Accounting assistants furnish the data show on the next slide. An accounting assistant has prepared the detailed manufacturing overhead budgets and the selling and administrative expense budget.

Problem 9 -2 A The latter shows selling expenses of $660, 000 for product JB 50 and $360, 000 for product JB 60, and administrative expenses of $540, 000 for product JB 50 and $340, 000 for JB 60. Income taxes are expected to be 30%. Prepare the budgets asked for in the textbook.

Data Given Product JB 50 Product JB 60 400, 000 200, 000 $25 Desired ending finished goods units 25, 000 15, 000 Beginning finished good units 30, 000 10, 000 2 3 Desired ending direct material pounds 30, 000 15, 000 Beginning direct material pounds 40, 000 10, 000 $3 $4 Sales Budget: Anticipated volume in units Unit selling price Production Budget: Direct materials budget: Direct materials per unit (pounds) Cost per pound

Data Given Product JB 50 Product JB 60 Direct labor time per unit 0. 4 0. 6 Direct labor rate per hour $12 $12 $21 Direct labor budget: Budgeted income statement: Total unit cost

Sales Budget Expected unit sales Unit selling price Total sales JB 50 JB 60 Total    400, 000    X $20 $8, 000    200, 000    X $25 $5, 000 $13, 000 Simple calculation: units x sales price = total sales dollars.

Budget Formula There is a generic formula we use in many of the budgets, it is: Transferred out + ending inventory – beginning inventory = transferred in. Converting this generic formula to terms consistent with the production budget: Units sold + ending inventory – beginning inventory = units to be produced. Knowing the generic formula will help you if you get a “brain cramp” on the test and forget a specific formula.

Production Budget We use the formula: Sales + ending inventory – beginning inventory = production in units Expected unit sales Add: Desired ending finished   goods units Total required units Less: Beginning finished goods   units Required production units JB 50 JB 60 400, 000 200, 000 Total   25, 000 425, 000  15, 000 215, 000   30, 000 395, 000   10, 000 205, 000 600, 000

Direct Materials Budget For the Year Ending December 31, 2009 __ Units to be produced Direct materials per unit Total pounds needed for   production JB 50 JB 60    395, 000       X 2    205, 000       X 3    790, 000 Total    615, 000      Our first step is to calculate total pounds needed for production by multiplying units to be produced (calculated in the sales budget) by the direct materials per unit given in the problem.

Direct Materials Budget For the Year Ending December 31, 2009 __ Units to be produced Direct materials per unit Total pounds needed for   production Add: Desired ending direct   materials (pounds) Total materials required Less: Beginning direct   materials (pounds) Direct materials purchases JB 50 JB 60    395, 000       X 2    205, 000       X 3 Total Now we use the       formula we 790, 000 615, 000 learned earlier: 30, 000 15, 000 units    820, 000    630, 000 transferred      out + 40, 000 10, 000 ending    780, 000    620, 000 inventory –      beginning inventory = Once we have the direct material in pounds, we need to units calculate the dollar amount. transferred in.

Direct Materials Budget For the Year Ending December 31, 2009 __ JB 50 Units to be produced Direct materials per unit Total pounds needed for   production Add: Desired ending direct   materials (pounds) Total materials required Less: Beginning direct   materials (pounds) Direct materials purchases Cost per pound Total cost of direct materials   purchases    395, 000       X 2    790, 000 JB 60 Total    205, 000       X 3    615, 000      30, 000    820, 000 15, 000    630, 000      40, 000 10, 000    780, 000    620, 000      X $3      X $4 $2, 340, 000 $2, 480, 000 $4, 820, 000

Direct Labor Budget For the Year Ending December 31, 2009 Units to be produced Direct labor time (hours) per   unit Total required direct labor   hours Direct labor cost per hour Total direct labor cost JB 50 JB 60 Total 395, 000    205, 000    650, 000              X. 4 X. 6    158, 000     X $12 $1, 896, 000 123, 000     X $12 $1, 476, 000    301, 000 X $10 $3, 372, 000 Two steps: Calculate hours first and then calculate dollar amount.

Now all we have to do is put this all together in the form of an income statement! Sales Cost of goods sold Gross profit Operating expenses   Selling expenses   Administrative     expenses       Total operating     expenses Income before income   taxes Income tax expense   (30%) Net income JB 50 JB 60 Total $8, 000  4, 800, 000  3, 200, 000 $5, 000 4, 200, 000   800, 000 $13, 000   9, 000   4, 000 ( 1 2   ) )    660, 000 ( 360, 000       1, 020, 000    340, 000     880, 000    540, 000    700, 000 1, 900, 000 $  100, 000 2, 100, 000   1, 200, 000    $2, 000   630, 000 $ 1, 470, 000

The End!!!